“In this world, nothing can be said to be certain, except death and taxes.” - While this acclaimed quote from Benjamin Franklin will no doubt resonate with readers, investors and traders may find it difficult to identify the rules that apply to them. It is difficult to understand the exact amount they may owe in taxes, especially if dividends from foreign companies are also involved.
Even though BrokerChooser cannot give personalized tax advice (see disclaimer here), we set out to cover the basics of taxation. We will look at some examples in the hope of painting a clear picture. Let's get started!
When you trade or invest in your brokerage account, the following are likely to trigger a tax liability:
- selling a security with a profit, which qualifies as a capital gain
- interest (coupon) payments on bonds
- dividends on stocks/ETFs/funds
Taxation of capital gains
Capital gains occur when you sell an asset at a higher price than the purchase price.
What is an asset? It can be anything from a painting to real estate. However, when it comes to profit from trading and investments, an asset is usually a security ie a bond, stock, ETF, or fund. Derivatives like CFDs are usually included as well.
An interest payment from a bond is not considered capital gain. Yet, selling a bond at a higher price than what you paid for it (and this can happen if interest rates have fallen), qualifies as capital gain.
How capital gains are taxed varies from country to country. By and large, capital gains carry a lower tax rate than regular income. For example, for US taxpayers, if the asset has been held for at least a year before disposal, it’s considered a long-term capital gain. Long-term gains carry a lower tax rate.
But let's suppose you live in the UK - chances are you are also a UK tax resident. This means you’ll need to follow UK tax rules for determining your capital gains tax rate. It does not matter where your earnings come from. For example, if you invest in American stocks sold on a US exchange or from FTSE CFDs, you will still have to pay British taxes.
Say you realized a nice profit on selling a US stock like Facebook. You actually don’t owe any taxes to Uncle Sam, unless of course, you're a US tax resident.
Your broker’s country of residence is also irrelevant when it comes to determining where your capital gains tax is due. It is only your tax residency status that determines taxation. That is the reason brokers ask for your tax ID upon registering your account. Most countries are part of the OECD’s Common Reporting Standards, which is an automated exchange of information that ensures your local tax authority will know about your foreign brokerage account.
In most countries, your broker will not withhold any capital gains tax because they don’t know which tax bracket you are in and whether you qualify for any deductions.
For example, taxpayers in the UK have a £12,300 tax-free capital gain allowance, but your broker doesn’t know whether you’ve already used up this allowance at other brokers. (Speaking of tax breaks, we highly recommend checking out your country’s tax-advantaged or retirement accounts like the ISA accounts in the UK and IRAs in the US.)
Investors and traders usually have to declare capital gains in their annual tax returns.
This is true if you made transactions during the year but otherwise owe no taxes for that year. You will want to declare any losses you have incurred because that loss can be carried forward to reduce next year’s tax burden in most countries.
The precise rules depend on the tax legislation of the country where you are a tax resident. Some places, like Hong Kong, don’t have a capital gains tax, while some levy a tax on wealth (and not actual gains), like the Netherlands. As a rule of thumb, in most countries, you’ll need to calculate realized gains minus realized losses for any given year and you can deduct any past losses carried forward and pay taxes on the net result. A realized gain means that you actually closed a position/sold a particular asset. If you bought Tesla shares at $20 apiece many years ago and never sold them, that’s not a taxable event in most countries as it means that you have not realized the profit.
Bear in mind, however, that the information provided here is a general guideline and there are many exceptions.
Taxation of dividends
The taxation of dividends on foreign stocks raises a number of questions for most investors. To avoid any misunderstanding, interest (coupon) payments from corporate and government bonds are not considered dividends.
If you have a dividend-paying stock and you didn’t sell it before the ex-dividend day it means your brokerage account will be credited with the dividend in a few days or weeks.
It doesn’t matter how long you have held the stock, even if you buy it one day before the ex-dividend day you’ll get the same dividend as an investor who held the stock for years.
If both the company and the investor are in the same country, it is relatively easy to determine how much tax should be paid after the dividend(s), who should pay it and when because all issues will be settled by the respective country’s regulation.
For example, for US taxpayers, the tax rate for dividends depends on whether the dividends are qualified or nonqualified and usually qualified dividends are more advantageous.
How much tax do you have to pay if you get a dividend from a foreign company?
If you are in a cross-border situation (e.g. if a company registered in country X pays dividends to an individual tax resident in country Y), much more attention needs to be paid to taxation.
Unlike the capital gains tax, tax to be paid to a foreign tax authority on dividends paid by foreign companies is usually withheld by your broker, hence the name withholding tax.
For example, the withholding tax in the Netherlands is currently set at 15%. This usually means that if you receive €100 in dividends from a Dutch company, €15 would go to the Dutch tax authorities and your brokerage account would only be credited €85.
However, this does not automatically mean that you’re done with your taxes as you may owe taxes to your own government as well (for example if you’re a German tax resident) or in some cases, you can be eligible for a refund. The latter largely depends whether the two countries have signed a double tax treaty (DTT) but more on that later.
Even if you have a dividend reinvestment plan (i.e. you instructed your broker to automatically buy shares of the company that paid the dividend to you from that money), you will still have to pay the withholding tax and only the net amount will be reinvested. In addition, you are bound to be hit with the dividend withholding tax even if you hold a long position in a stock via a CFD (contract for difference) with your broker and not the stock itself.
Below is a list of factors that could affect taxation:
- Taxation rules in the country where the company you get the dividend from is incorporated and has tax residence - for example some Russian companies are incorporated in Cyprus and they have their shares listed on the London Stock Exchange. If they pay a dividend, no dividend tax will be withheld because Cyprus (the country where they are incorporated) has no dividend tax. Click here for a list of withholding tax rates across the globe.
- Local taxation rules in the country where you’re a tax resident - your home country may have a higher tax rate for dividends which means that you may need to pay more than was withheld by your broker.
- Double tax treaty (DTT) between the country where the company is incorporated and the investor’s tax residence (this is a bilateral treaty for the avoidance of double taxation). This is perhaps the most important bit. Suppose you’re in country A and you receive dividends from a company from country B. Country B withholds its share of taxes, say 15%, and then your home country levies its own rate, which in a high tax bracket could be as much as 30%. This means you’d have to pay a whooping 45% in taxes. Fortunately, most countries have signed a double tax treaty agreement with each other, meaning country B will only withhold a reduced rate (in most cases around 15%) and if that rate is lower than what you’d normally pay in your home country in dividend tax, then only the difference is due to your home country’s taxman.
- The tax profile of the private individual (e.g. stocks that are in tax-advantaged or retirement accounts - although the withholding tax levied by foreign authorities will still be debited to these accounts as well)
This might sound complicated, so let’s see an example.
A German tax resident has shares in a US company that just paid dividends.
If the person in question does not have any tax connections to the US (other than the dividend being sourced from the US), the individual qualifies as a non-resident alien from a US tax perspective and as such is subject to the standard 30% withholding tax.
In Germany, private individuals have to pay 25% personal income tax after all dividends they receive, to which an extra solidarity surcharge (a specific German tax that needs to be paid by all taxpayers in Germany) of 5.5% of the due tax applies.
However the US and Germany have signed a double tax treaty, under which the withholding tax for stocks is 15% (unless the person holds 10% or more of the voting shares of the company - which is very unlikely, especially if we’re speaking about a large cap company like Apple or General Motors).
In practice, this means that if a company paid $100 in dividends, $15 will be deducted by the broker and $85 will be credited to the brokerage account.
To simplify it (and not considering the detailed German foreign tax credit rules): only the difference between the 25% German tax and the 15% US withholding tax, i.e. 10% is payable to the German tax authorities as dividend tax.
Note that this is for standard brokerage accounts, specific exemptions may apply in Germany (for example retirement accounts).
Furthermore, some countries might allow their taxpayers to lower their tax bills using foreign tax credits or other relief methods even if there is no double tax treaty in place.
Planning ahead: stocks that pay a high dividend can mean a high tax bill too
Holding high-dividend stocks issued in a country with a high dividend tax rate may not be a good idea for some investors. Imagine a stock paying a 15% dividend each year coupled with a 30% withholding tax. This would mean each year you have to pay almost 5% of your investment in taxes if you can’t claim a refund or get a foreign tax credit.
ETFs paying dividend
When you are faced with choosing between distributing or accumulating ETF (the latter meaning the fund will reinvest dividends automatically whereas the former pays distributions), we recommend looking at the tax implications as well. For some countries it might be better to choose the accumulating type.
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Dividends from US companies
It is very important to remember that for US stocks, you need to fill out a form called W-8BEN for the discounted double tax treaty rate to apply. The form needs to be filled electronically when you register your account at a broker that offers US stocks. It can also be done later, but make sure to complete it before the ex-dividend day, otherwise you’ll be hit with the 30%.
As you can see, the US has signed double tax treaties with most countries and applies a 15%-25% withholding tax instead of the standard rate of 30%. For a full list of countries, please visit this link.
|Dividends from stocks and ETFs|
The W-8BEN form is used to verify your country of residence for tax purposes and certifies that you qualify for a lower withholding tax rate.
It is a hassle-free way to get the reduced rate for all your dividend-paying companies that are incorporated in the USA. The form only needs to be filled out once every three years.
... and elsewhere
Most countries (except the US) don’t have a form like this. Therefore in most cases, your broker will deduct the standard dividend withholding tax rate levied by the particular country instead of the reduced rate. Even if your country has a double tax treaty with the country in question, the rebate won't be applied.
For example, the standard dividend tax rate for Belgian stocks is 30% and this high rate may automatically be applied to your account even though it should be a lower one as per the DTT (e.g. 15% for US and 10% for UK tax residents). In most cases, there are no systems in place to assure the discounted percentage is deducted at source even though your broker knows your tax residency; instead, they simply use the standard rate. This is especially true for discount brokers, which usually argue that account holders should contact relevant foreign tax authorities and request a refund. But that can be a long and bureaucratic process. We heard from investors that some tax authorities (e.g. the Belgian and the Austrian) are eager to co-operate and issue refunds, while others usually don’t respond at all (e.g. Italy).
The bottom line
Capital gains occur if you sell with a profit. The method and extent of capital gains taxation vary from country to country. By and large, taxes levied on capital gains have lower rates than regular income taxes. Make sure you check tax-free allowances available in your country and whether you can defer, reduce or completely avoid paying these taxes by opening special accounts like the ISA and IRA accounts in the UK and US, respectively.
The country in which your broker is registered or where it operates is irrelevant when it comes to determining the capital gains tax due. It is your tax residency (and local tax code) that counts.
Unlike with dividends, brokers do not withhold any capital gains tax and usually, you'll have to file a tax return.
In most cases, if you receive a dividend from a foreign company, your broker will withhold a foreign tax. The rate depends on where the company that is paying the dividend (and not the broker) is incorporated and whether your home country and the other country in question have signed a double tax treaty (DTT).
More often than not, you'll find that there is a DTT in place and it makes financial sense to check as a DTT will guarantee lower withholding tax rates and you can deduct this tax when you calculate how much extra (if any) you owe to your home country in taxes.
Experience shows that even though investors should be charged a reduced withholding tax rate because of a DTT, brokers usually don’t go the extra mile to check the applicable rate and instead calculate with the higher, standard withholding rate. In such cases, investors can try to claim back the difference from their tax authority, which often is an arduous and time-consuming process.
To end on a positive note: if a US company paid you a dividend and you filled out the correct form (W-8 BEN), which is easy to do, you’ll be taxed at the reduced rate.
If you find the above investment situations similar to yours, make sure you do not miscalculate your tax burden and end up paying less or more than what is due. We recommend contacting a personal income tax expert in your home country (where you are a tax resident) who has access to an international tax expert network.
Special consideration might be required if your citizenship(s) and tax residency differ.
What happens if you short a stock that pays dividends?
If you short the stock (meaning you are betting on the stock price falling), you’ll be the one paying the dividend. This process is called “Payment in Lieu” (Pil). Paying the fee normally doesn’t attract any tax obligations for you.
Conversely, if you have a long position but your broker has your stock loaned out to a short seller you’ll get a Pil credit instead of the dividend.
US taxpayers who are recipients of Pil credits should discuss the tax implications with their tax adviser.
Does it matter which country your broker is from when it comes to how much you owe in taxes?
In theory no, but make sure your broker is following US rules and requires you to fill out a W-8BEN form if you hold dividend-paying American stocks. The form ensures you only pay the dividend tax that the double tax treaty with your country specifies (usually 15%), otherwise you’ll be hit with a 30% withholding tax.
I have shares in a US company and my broker debited 30% of my dividend. What am I missing?
Check if your country has a Double Tax Treaty (DTT) with the US. If it does and the rate is lower you should fill out a W-8BEN form at your broker as per the above question.
I have shares in a US company and my broker debited 38% of my dividend. What am I missing?
Note that discounts stipulated by Double Tax Treaties (DTTs) do not apply to unitholders of US Limited Partnerships or LPs (which differ from regular corporations). If you receive distributions (technically LPs don’t pay dividends) because of holding LP units, you will be subject to as much as 38% in withholding taxes. Some noteworthy examples are: Enterprise Products Partners (NYSE:EPD), Energy Transfer (NYSE:ET) and Brookfield Property Partners (NASDAQ:BPY)