The nature of assets held in an RRSP or a TFSA is very important if you decide to invest in foreign securities that generate dividends or interest.
Investments Allowed
Since 2005, the Income Tax Act no longer imposes a limit on foreign content within RRSPs or TFSAs. Therefore, one can diversify an investment portfolio by investing in foreign securities as they wish. In the case of new investments denominated in a foreign currency within an RRSP or a TFSA, however, one must make sure that the total amount of contributions made does not exceed the annual limit in Canadian Dollars set by law.
Exemptions
In general, RRSP and TFSA accounts are exempt from any Canadian income taxes on income received. Therefore, an investment that is subject to income tax abroad is less appealing, since this tax reduces the final yield. In addition, the holder of an RRSP or a TFSA will not recover this tax through a foreign tax credit or deduction when calculating their taxable income.
Tax Treaty with the United States
In the case of eligible investments listed on an American stock exchange, there is a big difference between RRSPs and TFSAs, since the tax treaty between Canada and the United States grants a US tax exemption for investments held within RRSPs and RRIFsFootnote1 but not TFSAs.
This agreement provides that income earned by Canadian pension plans (including RRSPs or RRIFs) on investments in US entities are free from tax in the United States. By contrast, this exemption does not apply in the case of a TFSA since such an account is not treated as the equivalent of a pension plan. A 15% tax will be deducted at source in the United States on US-based dividends paid to a TFSA.
It should be noted that, under the tax treaty, interest income and capital gains earned on US securities by any person residing in Canada shall be taxable only in Canada.
Conclusion
The tax exemption provided for in the Convention between Canada and the United States for RRSPs and RRIFs is rather exceptional and not found in any other tax treaty signed by Canada. Therefore, for tax purposes, it will generally always be better to hold US investments in RRSPs rather than TFSAs. For other countries, it might be wise to hold foreign securities personally in order to claim the deduction for foreign taxes if such taxes are imposed on income received. Overall, if a stock does not pay a dividend and its appeal is its potential to increase in value, the investment may be held in an RRSP, RRIF or TFSA because the capital gain realized upon its disposition shall not be taxable in Canada nor in a foreign country if a tax treaty exists with the latter.
Since the levels and bases of taxation can change, any reference in this publication to the impact of taxation should not be construed as offering tax advice; as with any transaction having potential tax implications, clients should consult with their own tax advisors.
Notes
- See Section XXI (2) of the tax treaty between Canada and the United States NOTE - This link will open in a new tab.
As an expert in the field of Canadian tax laws and investment strategies within registered accounts, I bring a wealth of knowledge and experience to shed light on the nature of assets held in RRSPs (Registered Retirement Savings Plans) and TFSAs (Tax-Free Savings Accounts). My expertise is grounded in a comprehensive understanding of the Income Tax Act and its implications for individuals investing in foreign securities through these tax-advantaged accounts.
The article you've provided touches upon crucial aspects of investing in foreign securities within RRSPs and TFSAs, highlighting the significance of the nature of assets and the associated tax considerations. Let's break down the key concepts discussed in the article:
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Foreign Content Limit Elimination (2005):
- The Income Tax Act removed the limit on foreign content within RRSPs and TFSAs in 2005.
- Investors can now diversify their portfolios by freely investing in foreign securities.
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Annual Contribution Limit:
- While there's no restriction on foreign content, investors must ensure that contributions in foreign currency within RRSPs or TFSAs do not exceed the annual limit set in Canadian Dollars.
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Tax Exemptions:
- RRSP and TFSA accounts are generally exempt from Canadian income taxes on received income.
- Investments subject to income tax abroad may be less attractive, as the tax reduces the final yield.
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Tax Treaty with the United States:
- A significant distinction exists between RRSPs and TFSAs regarding US investments due to the tax treaty between Canada and the United States.
- RRSPs and RRIFs (Registered Retirement Income Funds) benefit from a US tax exemption on income earned from US entities, which doesn't apply to TFSAs.
- TFSAs may incur a 15% tax on US-based dividends.
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Exceptional Tax Exemption for RRSPs and RRIFs:
- The tax exemption in the Canada-US tax treaty for RRSPs and RRIFs is unique and not found in other tax treaties.
- Holding US investments in RRSPs is generally more advantageous for tax purposes compared to TFSAs.
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Tax Implications for Other Countries:
- For investments in other countries, holding foreign securities personally may be advisable to claim deductions for foreign taxes, if applicable.
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Capital Gains Considerations:
- Investments with the potential for capital gains can be held in RRSPs, RRIFs, or TFSAs, as the capital gains realized upon disposition are not taxable in Canada or a foreign country (with a tax treaty).
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Disclaimer on Tax Advice:
- The article concludes with a reminder that references to the impact of taxation should not be considered as tax advice, and individuals should consult their tax advisors for transactions with potential tax implications.
In summary, the article emphasizes the importance of understanding the tax implications and treaty agreements when investing in foreign securities within RRSPs and TFSAs, providing valuable insights for investors seeking to optimize their portfolios within the framework of Canadian tax laws.
