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Investing is not just about choosing the right assets, but also about maximizing returns after taxes. You may find yourself asking:
- Which account is best for each asset class?
- Should I hold foreign assets in my TFSA or a taxable account?
- Can I recover the foreign withholding tax on my investment income?
In this blog post, we look at how to maximize returns in a taxable account by understanding the tax implications of different types of investments: Canadian fixed income, foreign fixed income, Canadian equity, US equity and international equity.
Canadian tax rules and regulations
In Canada, different types of investment income are taxed differently. Interest income, such as that from bonds or GICs, is fully taxable at your marginal tax rate. Canadian dividends qualify for a dividend tax credit, which can significantly reduce the tax payable. Capital gains are 50% taxable, meaning only half of your capital gains are included in your income for tax purposes.
Canadian fixed income
Canadian fixed income, such as bonds or GICs, generates interest income, which is fully taxable at your marginal tax rate. Therefore, these are best held in registered accounts like RRSPs or TFSAs where they can grow tax-free. In a taxable account, the interest income would be subject to tax each year. The only exception here are discount bonds, which can be uniquely tax-efficient in a non-registered account versus conventional bonds. Discount bonds tend to have a combination of capital gains and lower interest income.
Foreign fixed income
Foreign fixed income is subject to a withholding tax by the country where the income is generated. This tax can often be recovered when the income is earned in a taxable account by claiming a foreign tax credit. However, in registered accounts, this withholding tax is often not recoverable. Therefore, foreign fixed income is generally more tax-efficient in a taxable account.
Canadian equity
Dividends from Canadian equities are eligible for the Canadian Dividend Tax Credit. This can greatly reduce the tax payable on this income, making Canadian equities tax-efficient in both registered and non-registered accounts.
US equity
US equities held in a taxable account are subject to a 15% US withholding tax on dividends. However, this tax can often be recovered by claiming a foreign tax credit. In an RRSP, there is no US withholding tax due to a tax treaty between Canada and the US. Therefore, US equities are generally more tax-efficient in an RRSP. TFSAs are also not ideal for US dividends as withholding taxes apply and are never recoverable.
International equity
Dividends from international equities are subject to withholding taxes by the country where the income is generated. These taxes can often be recovered when the income is earned in a taxable account by claiming a foreign tax credit. However, in registered accounts, these withholding taxes are often not recoverable. Therefore, international equities are generally more tax-efficient in a taxable account.
In conclusion, understanding the tax implications of different types of investments can help you maximize your after-tax returns. Always consider the tax efficiency of an investment before deciding where to hold it. Remember, the goal is not just to make money, but to keep as much of it as possible after taxes.
What investments to hold in a taxable account
- Canadian discount bonds
- Foreign fixed income
- Canadian equity
- International equity
What investments to hold in an RRSP
- Conventional Canadian bonds (premium bonds)
- Canadian equity
- US equity
For more information on navigating taxes with ETFs, explore our ETF Education resources.
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