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.
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.
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.
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.
- See Section XXI (2) of the tax treaty between Canada and the United States NOTE - This link will open in a new tab.