Qualified dividends in international funds

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johnanglemen
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Qualified dividends in international funds

Post by johnanglemen »

Why do total international funds consistently have a dramatically lower percentage of qualified dividends than total US funds? Vanguard Total International, for instance, hovers around 70%, while Vanguard Total Stock hovers around 100%. I am aware that dividends from a few countries are not eligible for qualified treatment, but my understanding is that these comprise a miniscule portion of the Total International holdings, and are certainly not enough to account for a 30% difference. Is there some other structural/systemic reason for international dividends to be less qualified? If so, does that reason alone justify holding International at less than market weight if your investing space is entirely taxable (assuming you discount any other reason to underweight International)?
DSInvestor
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Re: Qualified dividends in international funds

Post by DSInvestor »

If you don't like the tax treatment of international funds, reduce or eliminate your allocation to them. You have to decide what's more important to you, the tax treatment or the diversification. Didn't John Bogle say that he'd be comfortable with just US stocks given that US companies do so much business internationally?
Last edited by DSInvestor on Sun Apr 19, 2015 9:07 pm, edited 1 time in total.
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johnanglemen
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Re: Qualified dividends in international funds

Post by johnanglemen »

DSInvestor wrote:If you don't like the tax treatment of international funds, reduce or eliminate your allocation to them. You have to decide what's more important to you, the tax treatment or the diversification.
This doesn't address my question. My question is whether there is some structural reason that international funds churn out lower qualified dividends than US funds, and if so, what is it?
DSInvestor
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Re: Qualified dividends in international funds

Post by DSInvestor »

Here's a link to page that talks about foreign qualified dividend income:
http://sherayzenlaw.com/foreign-qualifi ... nd-income/
Qualified Foreign Corporation

IRC Section 1(h)(11)(C)(i) defines the concept of qualified foreign corporation as (subject to certain exceptions) any foreign corporation that is either (i) incorporated in a possession of the United States, or (ii) eligible for benefits of a comprehensive income tax treaty with the United States that the Secretary determines is satisfactory for purposes of this provision and that includes an exchange of information program (the so-called “treaty test”).

A foreign corporation that does not satisfy either of these two tests is treated as a qualified foreign corporation with respect to any dividend paid by such corporation if the stock with respect to which such dividend is paid is readily tradable on an established securities market in the United States. Section 1(h)(11)(C)(ii) (see Notice 2003-71, 2003-2 C.B. 922, for the definition, for taxable years beginning on or after January 1, 2003, of “readily tradable on an established securities market in the United States”).

It is important to remember that a dividend from a qualified foreign corporation is also subject to the various limitations in section 1(h)(11). For example, a shareholder receiving a dividend from a qualified foreign corporation must satisfy the holding period requirements of section 1(h)(11)(B)(iii).
BTW, your international holdings will have paid foreign taxes which may allow you to claim the foreign tax credit. How does the size of that credit compare to the difference in tax for having a portion of the dividend be non-qualified?
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Taylor Larimore
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Re: Qualified dividends in international funds

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johnanglemen wrote:Why do total international funds consistently have a dramatically lower percentage of qualified dividends than total US funds? Vanguard Total International, for instance, hovers around 70%, while Vanguard Total Stock hovers around 100%. I am aware that dividends from a few countries are not eligible for qualified treatment, but my understanding is that these comprise a miniscule portion of the Total International holdings, and are certainly not enough to account for a 30% difference. Is there some other structural/systemic reason for international dividends to be less qualified? If so, does that reason alone justify holding International at less than market weight if your investing space is entirely taxable (assuming you discount any other reason to underweight International)?
johnanglemen:

Wikipedia helps answer your question:

http://en.wikipedia.org/wiki/Qualified_dividend

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
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johnanglemen
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Re: Qualified dividends in international funds

Post by johnanglemen »

Taylor Larimore wrote:
johnanglemen wrote:Why do total international funds consistently have a dramatically lower percentage of qualified dividends than total US funds? Vanguard Total International, for instance, hovers around 70%, while Vanguard Total Stock hovers around 100%. I am aware that dividends from a few countries are not eligible for qualified treatment, but my understanding is that these comprise a miniscule portion of the Total International holdings, and are certainly not enough to account for a 30% difference. Is there some other structural/systemic reason for international dividends to be less qualified? If so, does that reason alone justify holding International at less than market weight if your investing space is entirely taxable (assuming you discount any other reason to underweight International)?
johnanglemen:

Wikipedia helps answer your question:

http://en.wikipedia.org/wiki/Qualified_dividend

Best wishes.
Taylor
Nope. It doesn't. As I already noted in my original post, the vast majority of holdings in Total International are among countries that (under treaty law) are eligible to yield qualified dividends.

Nothing in that Wikipedia article explains a 30% delta between Total International and Total Stock in terms of the qualified dividend rate.
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johnanglemen
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Re: Qualified dividends in international funds

Post by johnanglemen »

DSInvestor wrote:Here's a link to page that talks about foreign qualified dividend income:
http://sherayzenlaw.com/foreign-qualifi ... nd-income/
Qualified Foreign Corporation

IRC Section 1(h)(11)(C)(i) defines the concept of qualified foreign corporation as (subject to certain exceptions) any foreign corporation that is either (i) incorporated in a possession of the United States, or (ii) eligible for benefits of a comprehensive income tax treaty with the United States that the Secretary determines is satisfactory for purposes of this provision and that includes an exchange of information program (the so-called “treaty test”).

A foreign corporation that does not satisfy either of these two tests is treated as a qualified foreign corporation with respect to any dividend paid by such corporation if the stock with respect to which such dividend is paid is readily tradable on an established securities market in the United States. Section 1(h)(11)(C)(ii) (see Notice 2003-71, 2003-2 C.B. 922, for the definition, for taxable years beginning on or after January 1, 2003, of “readily tradable on an established securities market in the United States”).

It is important to remember that a dividend from a qualified foreign corporation is also subject to the various limitations in section 1(h)(11). For example, a shareholder receiving a dividend from a qualified foreign corporation must satisfy the holding period requirements of section 1(h)(11)(B)(iii).
BTW, your international holdings will have paid foreign taxes which may allow you to claim the foreign tax credit. How does the size of that credit compare to the difference in tax for having a portion of the dividend be non-qualified?
Yes, and if you compare the "List of Eligible Treaties" from that page to the country holdings of Total International, you see that the vast, vast majority of the holdings in Total International are qualified countries. So unless there's a company in Brazil generating 30% of the fund's dividends, I don't see what that explains.

It's important to understand whether there's a major structural difference here (i.e. one that will persist for the long run) or whether it's just happenstance that things have played out this way so far. If it's the former, I'm more comfortable lowering my international portion, as that is an efficient reflection of a reality. If it's the latter, I would not want to do so, as that is much closer to market timing.

The size of the foreign tax credit is much smaller than the cost of the non-qualified dividends in my case.
DSInvestor
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Re: Qualified dividends in international funds

Post by DSInvestor »

According to this IRS page
http://www.irs.gov/instructions/i1099di ... tml#d0e150
IRS wrote:Qualified foreign corporation.

A foreign corporation is a qualified foreign corporation if it is:
  • Incorporated in a possession of the United States or
  • Eligible for benefits of a comprehensive income tax treaty with the United States that the Treasury Department determines is satisfactory for this purpose and that includes an exchange of information program.
If there is a comprehensive tax treat with the US, does it mean that all companies in that country are qualified, or does each company need to eligible for the benefits of that tax treaty?

Also I noticed that Emerging Markets Index dividend was 37% QDI. EM is about 19% of TISM but I'm not sure how much EM contributed to the total dividend for TISM.

Here's a link to an iShares document for 2014 QDI numbers. I was surprised to see that ACWX ETF ishares MSCI ex-US ETF was 93.27% QDI. I looked this up to see how their individual country ETFs did for QDI.
http://www.ishares.com/us/literature/ta ... ummary.pdf
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grabiner
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Re: Qualified dividends in international funds

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DSInvestor wrote:Here's a link to page that talks about foreign qualified dividend income:
http://sherayzenlaw.com/foreign-qualifi ... nd-income/
Qualified Foreign Corporation

IRC Section 1(h)(11)(C)(i) defines the concept of qualified foreign corporation as (subject to certain exceptions) any foreign corporation that is either (i) incorporated in a possession of the United States, or (ii) eligible for benefits of a comprehensive income tax treaty with the United States that the Secretary determines is satisfactory for purposes of this provision and that includes an exchange of information program (the so-called “treaty test”).

A foreign corporation that does not satisfy either of these two tests is treated as a qualified foreign corporation with respect to any dividend paid by such corporation if the stock with respect to which such dividend is paid is readily tradable on an established securities market in the United States. Section 1(h)(11)(C)(ii) (see Notice 2003-71, 2003-2 C.B. 922, for the definition, for taxable years beginning on or after January 1, 2003, of “readily tradable on an established securities market in the United States”).

It is important to remember that a dividend from a qualified foreign corporation is also subject to the various limitations in section 1(h)(11). For example, a shareholder receiving a dividend from a qualified foreign corporation must satisfy the holding period requirements of section 1(h)(11)(B)(iii).
From the same link:
There are also other requirements under the treaty test. As stated above, in order to be treated as a qualified foreign corporation under the treaty test, a foreign corporation must be eligible for benefits of one of the approved U.S. income tax treaties. Accordingly, the foreign corporation must be a resident within the meaning of such term under the relevant treaty and must satisfy any other requirements of that treaty, including the requirements under any applicable limitation on benefits provision. For purposes of determining whether it satisfies these requirements, a foreign corporation is treated as though it were claiming treaty benefits, even if it does not derive income from sources within the United States.
Thus, I suspect that some foreign corporations do not meet the other rules to make their dividends qualified, even if the country is otherwise eligible. In addition, there are US-specific rules as to what may legally be considered a dividend; it may happen that some foreign distributions taxed as dividends do not qualify. This would explain why Developed Markets Index has historically had about 80% qualified dividends, while Vanguard's large-cap indexes are usually 100%. (Tax-Managed International, when it was a separate fund, did have 100% qualified dividends; it may have deliberately deviated from the index by excluding non-qualified corporations.)
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johnanglemen
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Re: Qualified dividends in international funds

Post by johnanglemen »

grabiner wrote:
DSInvestor wrote:Here's a link to page that talks about foreign qualified dividend income:
http://sherayzenlaw.com/foreign-qualifi ... nd-income/
Qualified Foreign Corporation

IRC Section 1(h)(11)(C)(i) defines the concept of qualified foreign corporation as (subject to certain exceptions) any foreign corporation that is either (i) incorporated in a possession of the United States, or (ii) eligible for benefits of a comprehensive income tax treaty with the United States that the Secretary determines is satisfactory for purposes of this provision and that includes an exchange of information program (the so-called “treaty test”).

A foreign corporation that does not satisfy either of these two tests is treated as a qualified foreign corporation with respect to any dividend paid by such corporation if the stock with respect to which such dividend is paid is readily tradable on an established securities market in the United States. Section 1(h)(11)(C)(ii) (see Notice 2003-71, 2003-2 C.B. 922, for the definition, for taxable years beginning on or after January 1, 2003, of “readily tradable on an established securities market in the United States”).

It is important to remember that a dividend from a qualified foreign corporation is also subject to the various limitations in section 1(h)(11). For example, a shareholder receiving a dividend from a qualified foreign corporation must satisfy the holding period requirements of section 1(h)(11)(B)(iii).
From the same link:
There are also other requirements under the treaty test. As stated above, in order to be treated as a qualified foreign corporation under the treaty test, a foreign corporation must be eligible for benefits of one of the approved U.S. income tax treaties. Accordingly, the foreign corporation must be a resident within the meaning of such term under the relevant treaty and must satisfy any other requirements of that treaty, including the requirements under any applicable limitation on benefits provision. For purposes of determining whether it satisfies these requirements, a foreign corporation is treated as though it were claiming treaty benefits, even if it does not derive income from sources within the United States.
Thus, I suspect that some foreign corporations do not meet the other rules to make their dividends qualified, even if the country is otherwise eligible. In addition, there are US-specific rules as to what may legally be considered a dividend; it may happen that some foreign distributions taxed as dividends do not qualify. This would explain why Developed Markets Index has historically had about 80% qualified dividends, while Vanguard's large-cap indexes are usually 100%. (Tax-Managed International, when it was a separate fund, did have 100% qualified dividends; it may have deliberately deviated from the index by excluding non-qualified corporations.)
Doesn't DSInvestor's finding above dispute that? iShares MSCI ACWI ex U.S. ETF had 93.27% qualified dividends in 2014.

"The MSCI ACWI ex USA Investable Market Index (IMI) captures large, mid and small cap representation
across 22 of 23 Developed Markets (DM) countries (excluding the United States) and 23 Emerging Markets
(EM) countries*. With 6,070 constituents, the index covers approximately 99% of the global equity opportunity
set outside the US."

So why is Vanguard Total International doing so poorly on the qualified front?
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johnanglemen
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Re: Qualified dividends in international funds

Post by johnanglemen »

In fact, until recently, Vanguard Total International used the very same index as that iShares ETF...
DSInvestor
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Re: Qualified dividends in international funds

Post by DSInvestor »

The iShares ACWX ETF only seems to hold 1,141 stocks vs Total International's 5905.

The iShares ETF uses representative sampling which explains why there are far fewer holdings and may also help explain the higher QDI figures.
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