We love our dividends – well, most do. The Singapore stock market is one of the highest yielding stock markets in APAC and among other developed countries.
However, there is one crucial factor to take note when it comes to dividends from international stocks – foreign withholding tax.
For example, a non-US tax resident investing in the US market pays a 30% foreign withholding tax on all dividends received from US stocks and ETFs.
One common workaround to reduce foreign withholding taxes is to invest in Irish Domiciled UCITS ETFs which reduces the foreign withholding taxes on US dividends to 15%
So, if you want to invest in an S&P 500 ETF, you should consider investing in an Irish Domiciled S&P 500 UCITS ETF because it is the more tax-efficient option.
But is it the more cost-efficient option?
I have broken this article into two parts:
- Part 1: How Irish domiciled ETFs are more tax efficient (this article)
- Part 2: Comparison of the overall costs of using Irish domiciled ETFs vs US domiciled ETFs
Foreign Withholding Taxes
The concept of foreign withholding tax is simple (even though the implementation is very complicated).
It is a tax levied by the country on payments due to foreign entities. As long as the money leaves the country, it gets taxed. The main incentive for governments to impose this tax is to keep the money flowing within their country.
Example: US stocks
Let us stick to the US example.
US tax residents are required to pay income taxes and taxes on their capital gains and dividends. Any money they gain from the selling of their stocks or receiving dividends is taxed as part of their income tax.
Non-US tax residents are exempted from capital gain taxes. However, they are required to pay a flat 30% withholding taxes on their dividends from US stocks or ETFs.
So, before you could buy a US stock from an online broker, you typically have to fill a W-8Ben form to declare your tax residency status first.
In this example, I have decided to purchase Apple (AAPL) from my online broker in Singapore. When Apple pays out a dividend of $100, the brokerage will automatically deduct $30 to pay to the US government. I will receive a net dividend of $70. So in my statement, it will show:
- +$100 dividends from AAPL
- -$30 foreign withholding
Apple is more straightforward because it is a US incorporated company listed in the US market.
When a foreign incorporated company listed in the US market pays out dividends, there may be an initial amount withheld by the company’s local government.
So, what happens when I buy Alibaba (BABA), an ADR (American Depository Receipt) listed in NYSE (not the same stock listed in HKEX)?
- When Alibaba pays out a dividend of $100, there will be 10% withheld by the Chinese government. So, it will be $100 – $10 = $90
- After that, an additional 30% is withheld by the US government. So, in the end, I will receive $63, which is $90- $37.
I am not entirely sure because Alibaba had never paid dividends. It might be more complicated than that.
Read more about withholding taxes for ADR here.
To avoid double taxation, some countries offer tax credit to refund the initial withholding amount.
Example: A Fictional US ETF
What happens to foreign withholding taxes in the case of an ETF?
For ETFs, the critical thing to note is where the fund is domiciled to determine whether it is subjected to foreign withholding tax.
For example, the SPDR S&P 500 ETF (S27.SI) is listed in Singapore. Still, it is domiciled in the US and subjected to the same 30% dividend withholding taxes.
Let us imagine a fictional ETF called the iPhone ETF. It is created and managed by a fund company domiciled in the US. It has a single holding AAPL.
- When AAPL pays out a $100 dividend, the fund manager receives it. Because it is a US-domiciled fund, there are no withholding taxes and the fund manager gets the full $100.
- The fund manager then deducts $10 out of the $100 as part of fees and expenses and decides to distribute the remaining $90.
- As the investor who bought the iPhone ETF, I will receive $90. However, because I am a non-US tax resident, the US government will withhold 30%, and I will get a net amount of $63.
Example: A Fictional Irish Domiciled ETF
Now, the fictional fund company in the earlier example had a subsidiary in Ireland and created an exact ETF but domiciled in Ireland instead of the US. I will name it the iPhone UCITS ETF.
It also has a single holding – AAPL.
- When AAPL pays out a $100 dividend, it is subjected to a foreign withholding tax, because the fund is in Ireland. So money flows from the US to Ireland. Due to the tax treaty between the two countries, the withholding rate is only 15%. Thus, the fund manager in Ireland will receive a net amount of $85. The US government withholds $15.
- The fund manager then deducts $10 out of the $85 as part of fees and expenses and decides to distribute the remaining $75 to the ETF holders.
- I receive the full $75 distributed because of there is no withholding tax imposed by Ireland on Singapore residents.
UCITS stands for the Undertakings for Collective Investments in Transferable Securities. It is an EU regulation for funds which allow them to be traded more easily among EU countries.
It does not mean anything with the name UCITS is an Irish domiciled fund. Any EU country can create a UCITS fund.
Example: a global ETF
So now, the iPhone ETF is doing well, and the fund manager in the US decides to add another company into the fund – Hon Hai Precision Industry (2317.TW)
Taiwan withholds 20% of dividends paid to foreign entities. The withholding rate for both the US and Ireland is the same at 20%
So, what happens when Apple and Hon Hai Precision both pay a dividend of $100 each?
US Domiciled Fund
- When Apple pays a $100 dividend, the fund manager receives the full amount. However, when Hon Hai Precision pays a $100 dividend, the fund manager only receives $80. Thus, the fund manager would have received $180 in total.
- Deducting $10 for fees and expenses, the fund manager decides to distribute the remaining $170 to the ETF holders.
- As a Singapore investor, I will receive $119 because the US government withholds $51 (30% of $170).
So, when it comes to global portfolios, there will be cases of double taxation – where the same dividend is taxed twice (in the case of the iPhone ETF domiciled in the US).
Irish Domiciled Fund
The fund manager of the iPhone UCITS ETF (domiciled in Ireland) decides to follow suit and add Hon Hai Precision into the portfolio. So when both Apple and Hon Hai Precision both pay a dividend of $100:
- When Apple pays a dividend of $100, the fund manager receives $85. When Hon Hai Precision pays $100, the fund manager receives $80, which in total would be $165
- Deducting $10 for fees and expenses, the fund manager decides to distribute the remaining $155 to the ETF holders.
- As a Singapore investor, I will receive $155 in full because of no Irish withholding tax.
So, in this fictitious example, even though the funds are identical, the investor received $155 dividends from the Irish domiciled fund compared to $119 from the US domiciled fund. The higher amount for the Irish domiciled fund is due to a higher tax efficiency.
The tax advantage of Irish domiciled ETFs are twofold:
- US foreign withholding taxes are at a lower rate due to the tax treaty between US and Ireland – 15% instead of 30%
- Avoid double taxation because there is no withholding taxes between Ireland and Singapore (This happens quite often in global portfolios)
It is a very simplified illustration of dividend withholding taxes. The actual situation will be much more complicated.
Dividend Withholding Taxes Summary
Typically, as illustrated in my examples above, there are three levels of taxes.
- Portfolio Level
- Fund Level
- Investor Level
At the portfolio level, the dividends paid by the stocks in the portfolio are withheld by the respective local governments where the company is incorporated.
At the fund level, the dividends paid by the fund are withheld by the respective local government where the fund is domiciled.
At the investor level, whatever dividends I received are taxed based on my tax residency. Singapore does not levy taxes on dividends; hence I receive the full amount.
If you need a more in-depth explanation, please refer to the guide by investment moats.
Irish domiciled funds or ETFs are more tax efficient because of the tax treaty between US and Ireland and between Ireland and Singapore.
Irish domiciled funds or ETFs also help investors avoid double taxation (as long as your country has a tax treaty with Ireland). So investors thinking of investing in a global fund or ETF should also consider an Irish domiciled fund (if you are not a tax resident of US)
We will explore the other costs involved in ETF investing and make a more thorough comparison on which ETFs are more cost efficient.