A Canadian resident investor holds a US equity ETF in a non-registered account. The ETF holds underlying US stocks which pay dividends. The US government levies a 15% withholding tax on these dividends before they reach the ETF, and then the ETF distributes the net dividends to the Canadian investor. The Canadian investor is in a 40% marginal tax bracket. What is the effective tax treatment of these US dividends for the Canadian investor?

Question: A Canadian resident investor holds a US equity ETF in a non-registered account. The ETF holds underlying US stocks which pay dividends. The US government levies a 15% withholding tax on these dividends before they reach the ETF, and then the ETF distributes the net dividends to the Canadian investor. The Canadian investor is in a 40% marginal tax bracket. What is the effective tax treatment of these US dividends for the Canadian investor?

Answer options:

• The 15% US withholding tax is completely irrecoverable, and Canadian tax is applied to the gross dividend.
• The 15% US withholding tax is recoverable via a foreign tax credit in Canada, and Canadian tax is applied to the net dividend. ✅ The 15% US withholding tax is irrecoverable, and Canadian tax is applied to the net dividend received after US withholding.
• The 15% US withholding tax is applied, and then Canadian tax is only applied to the portion of the dividend exceeding the 15% already withheld by the US.

Correct answer: The 15% US withholding tax is irrecoverable, and Canadian tax is applied to the net dividend received after US withholding.

Explanation: When holding US equity ETFs in non-registered accounts, there is a two-layer tax. The 15% US withholding tax on the underlying dividends is generally irrecoverable because the ETF is treated as an intermediary. The Canadian investor then pays Canadian tax on the net dividend received after the US withholding.