[EU] About the cost of taxes on dividends in European funds

[RME]

Hello again!
I'm raising this issue here because we were unable to answer this question on local investor forums, I hope someone here knows the answer.

We have noticed that funds domiciled in europe underperform US domiciled ones.



Also, when we take a look to the fund documentation we see the following:



It underperforms the index by 1,00% each year.

Some user pointed out that these could be the effect on taxing dividends that are reinvested on the European fund.
This tax could be 30% on dividends.

Did anyone noticed this issue?

We would like to defer tax and reinvest dividends on S&P500 until the fund is sold.

Possible paper explaining this issue:
https://www.robeco.com/media/e/f/d/efd8 ... 7-1855.pdf

[selters]

You are right. When a US company pays dividends to a European listed S&P 500 fund, US tax authorities withhold between 15% and 30% of the dividends before they are paid out to the S&P 500 fund or ETF. This is often called a dividend tax leakage. I don't know what determines the withholding rate, but 15-30% is the range. If the dividend yield is 2% before taxes, only between 1.40% and 1.70% of the dividends are actually received by the S&P 500 fund. The 0.30%-0.60% of return is essentially flushed down the toilet every year.

If you live in a country that has a tax treaty with the US and you buy US listed ETFS, such as VOO or VTI, you can usually receive the dividends every year and claim a foreign tax credit against your home country's tax authorities to reduce your annual taxes by the equivalent amount of the withholding taxes that have already been withheld by the US. This way there is no dividend tax leakage. But you have to pay taxes on the dividends every year. It is still the most tax efficient way to invest in US stocks for non-US citizens outside the US.

If you do not live a in a country that has a tax treaty with the US, then European listed ETFs are still your best bet, despite the dividend tax leakage.

You can also read this for more information: https://www.bogleheads.org/wiki/Nonresi ... Irish_ETFs

[BeBH65]

And what this graph does not show is the dividend withholding by the country of the investor.
Your country will normally tax te dividends that the fund pays you before you receive them
In many European countries you can avoid this by using accumulating funds, where the fund dividends are reinvested without withholding tax.

Have a look at the pages listed here Non-US_domiciles#Tax_issues, especially the tax trap and decision table one.

[RME]

Thanks for your anwsers!

I have researched and I have reached this conclusion:


S&P500 funds domiciled in Europe loss between 30 and 35% of their dividends in tax even if they are accumulation ones.

S&P500 funds domiciled in USA (like VOO) follow the S&P 500 GROSS INDEX.
S&P500 funds domiciled in Europe (Ireland) follow the S&P 500 NET INDEX.

They are returning 68 basis points LESS than VOO due to this.

[alpine_boglehead]

S&P500 funds domiciled in Europe loss between 30 and 35% of their dividends in tax even if they are accumulation ones.

Are you sure? I was under the impression that the Ireland-domiciled funds only loose 15% to US withholding tax.

E.g. here is is stated that

Irish ETFs can benefit from the US/Ireland double tax treaty which reduces standard withholding tax rates from 30% to zero on US-source interest and 15% on US-source dividends.

If you check Vanguard's S&P 500 index fund's annual statement (downloadable here) on page 228 (page 230 of the PDF file), the fund received dividends of 271,884,091 and paid foreign withholding tax of 41,287,532, which is about 15%.

A problem with this withholding tax is that it isn't passed through the funds, so in your home country you likely pay taxes on the dividends as if they hadn't been taxed yet (but this may depend on your jurisdiction). E.g. for me in Austria this means that I pay 15% US withholding tax and then 27.5% on what remains in Austria, as opposed to direct stock holdings for which the 15% are taken into account, so only 12,5% are taxed in Austria.

By my calculation, VWRL (Vanguard FTSE All-World) is reduced from a gross yield of roughly 2.7% to 1.4% after taxes and expense ratio.

[RME]

Check out this table, some funds seem to pay less withholding tax than others.



The AVG row is the tracking error from the GROSS index, the AVG (exTER) row is the tracking error from the GROSS index excluding fees.


For example, the fund called "BNP Paribas Easy S&P 500 UCITS ETF C EUR (EUR) | ESEE" seem to track the GROSS index without paying witholding tax.
This could be related with the fund domicile, in this case is FRANCE. FR0011550185.

[RME]

They seem to be three different types of european S&P500 funds:
- The ones who pay 30% witholding tax on dividends (-0.60%)
- The ones who pay 15% witholding tax on dividends (-0.30%)
- The ones who are Synthetic (Use SWAPS) and don't pay tax (0)

[Lauretta]

They seem to be three different types of european S&P500 funds:
- The ones who pay 30% witholding tax on dividends (-0.60%)
- The ones who pay 15% witholding tax on dividends (-0.30%)
- The ones who are Synthetic (Use SWAPS) and don't pay tax (0)

That's a very interesting point - synthetic ETFs are not usually recommended but from your analysis they seem the best ones for tax reasons, so I am surprised that Amundi, Lyxor and BNP are not more popular.
Did you get to this conclusion by finding documents related to this (if so do you have a link) or based on your comparison of performances?
What's the difference between the ones who pay 30% and those who pay 15%?

[TedSwippet]

That's a very interesting point - synthetic ETFs are not usually recommended but from your analysis they seem the best ones for tax reasons ...

There are headaches on the near horizon though, in the shape of IRC section 871(m):

Through the introduction of Section 871(m) of the Internal Revenue Code (IRC), the US Congress aims to prevent non-US persons from using derivative instruments to avoid US withholding tax on US equities. These new rules apply withholding tax to dividend equivalent amounts (DEAs) received by non-US persons from derivatives or securities that reference dividends paid by US equities. Section 871(m) already applies to delta-one transactions issued since 1 January 2017 and will be subsequently applied to non-delta-one transactions issued as from 1 January 2019.

[airelleofmusic]

I personally know the manager of the fund BNP Paribas S&P 500, he recently won the 2018 AGEFI prize for the best tracking difference, because he uses several index swaps and succeeded in managing the tax effect (I will to ask him how he does).

[RME]

I'm very impressed about the high quality of answers in this forum, you guys rock!

They seem to be three different types of european S&P500 funds:
- The ones who pay 30% witholding tax on dividends (-0.60%)
- The ones who pay 15% witholding tax on dividends (-0.30%)
- The ones who are Synthetic (Use SWAPS) and don't pay tax (0)

That's a very interesting point - synthetic ETFs are not usually recommended but from your analysis they seem the best ones for tax reasons, so I am surprised that Amundi, Lyxor and BNP are not more popular.
Did you get to this conclusion by finding documents related to this (if so do you have a link) or based on your comparison of performances?
What's the difference between the ones who pay 30% and those who pay 15%?

I've concluded that just by empirical evidence in tracking errors by seeing the table above, but there it seems to be more information about it here:
http://monevator.com/lyxor-core-etfs-ve ... -wrinkles/

USA taxes 30% on dividends and some funds manage to reduce it to 15% by double taxation treaties between countries.
The question is why iShares seem to get this straight and Vanguard don't.

I personally know the manager of the fund BNP Paribas S&P 500, he recently won the 2018 AGEFI prize for the best tracking difference, because he uses several index swaps and succeeded in managing the tax effect (I will to ask him how he does).

Thanks!

That's a very interesting point - synthetic ETFs are not usually recommended but from your analysis they seem the best ones for tax reasons ...

There are headaches on the near horizon though, in the shape of IRC section 871(m):

Through the introduction of Section 871(m) of the Internal Revenue Code (IRC), the US Congress aims to prevent non-US persons from using derivative instruments to avoid US withholding tax on US equities. These new rules apply withholding tax to dividend equivalent amounts (DEAs) received by non-US persons from derivatives or securities that reference dividends paid by US equities. Section 871(m) already applies to delta-one transactions issued since 1 January 2017 and will be subsequently applied to non-delta-one transactions issued as from 1 January 2019.

Interesting.

[RME]

What would happen with witholding tax on dividends if an European buys an American fund/ETF (domiciled in USA) that doesn't distribute dividends (accumulation)?
Is this a loophole?

[Lauretta]

What would happen with witholding tax on dividends if an European buys an American fund/ETF (domiciled in USA) that doesn't distribute dividends (accumulation)?
Is this a loophole?

I believe acc ETF don't exist in the US, see viewtopic.php?t=118381

[airelleofmusic]

Yes, using index swaps for european funds allow to avoid taxation on dividends (0% instead of 15% if you use physical replication). Also the BNP S&P 500 fund is better than competitors because the manager made many more tender offers to get the "best" price for the index swap (hence better performance for the fund).

[BeBH65]

This is what our wiki mentions on synthetic etf

Synthetic ETFs are an advanced investing concept and not recommended for new investors. The underlying securities of synthetic ETFs, which are comprised of derivatives and other products, impose extra levels of risk to investors. These ETFs are not regulated as well as those comprised of equities and bonds. It is imperative that investors understand these risks. Please ask in the forum for guidance.

While they attempt/promise to follow the index they do not actually hold the stocks of the index.

[airelleofmusic]

Ahah exactly the fund only holds different swaps.

[Lauretta]

This is what our wiki mentions on synthetic etf

Synthetic ETFs are an advanced investing concept and not recommended for new investors. The underlying securities of synthetic ETFs, which are comprised of derivatives and other products, impose extra levels of risk to investors. These ETFs are not regulated as well as those comprised of equities and bonds. It is imperative that investors understand these risks. Please ask in the forum for guidance.

While they attempt/promise to follow the index they do not actually hold the stocks of the index.

Thank you for sharing. For information, I asked people at Amundi (which does both physical and synthetic ETF) about the risks of synthetic ETFs, and they said that in 2012 the ESMA - European Securities and Markets Authority, decreed that synthetic ETFs are not more risky than physical ones and that they each have their specific risks. I didn't look at the details of ESMA analysis though.

[Lauretta]

Yes, using index swaps for european funds allow to avoid taxation on dividends (0% instead of 15% if you use physical replication). Also the BNP S&P 500 fund is better than competitors because the manager made many more tender offers to get the "best" price for the index swap (hence better performance for the fund).

interesting. I saw a video where the BNP manager received a prize you mentioned. They stressed the importance of tracking error besides fees, which makes sense.
However, considering the question of taxation on dividends for US stocks, I think Ted Swippet in his message above noted that the rules will soon change and European synthetic ETFs will no longer be able to avoid taxation on US dividends.
Interesting you mention european funds: does this mean that synthetic ETFs for Europe avoid taxation on dividends and this rule is set to continue in future?

[airelleofmusic]

Yes, using index swaps for european funds allow to avoid taxation on dividends (0% instead of 15% if you use physical replication). Also the BNP S&P 500 fund is better than competitors because the manager made many more tender offers to get the "best" price for the index swap (hence better performance for the fund).

interesting. I saw a video where the BNP manager received a prize you mentioned. They stressed the importance of tracking error besides fees, which makes sense.
However, considering the question of taxation on dividends for US stocks, I think Ted Swippet in his message above noted that the rules will soon change and European synthetic ETFs will no longer be able to avoid taxation on US dividends.
Interesting you mention european funds: does this mean that synthetic ETFs for Europe avoid taxation on dividends and this rule is set to continue in future?

It is said in the previous article http://securities.bnpparibas.com/insigh ... is-it.html : "Section 871(m) already applies to delta-one transactions issued since 1 January 2017 and will be subsequently applied to non-delta-one transactions issued as from 1 January 2019. The derivatives have a delta calculated by the issuers equal to 1 (however, derivatives issued as from 1 January 2019 with a delta greater or equal to 0.8 will be also covered) or meet a substantial equivalence test"

However, some synthetic ETFs does not fall into that scope, for example the S&P500 is out of scope https://www.exchange-data.com/docs/fact ... erview.pdf meaning that with synthetic S&P 500 ETFs you will be able to avoid taxes on dividends in the future (until the law changes)

[international001]

A problem with this withholding tax is that it isn't passed through the funds, so in your home country you likely pay taxes on the dividends as if they hadn't been taxed yet (but this may depend on your jurisdiction). E.g. for me in Austria this means that I pay 15% US withholding tax and then 27.5% on what remains in Austria, as opposed to direct stock holdings for which the 15% are taken into account, so only 12,5% are taxed in Austria.

By my calculation, VWRL (Vanguard FTSE All-World) is reduced from a gross yield of roughly 2.7% to 1.4% after taxes and expense ratio.

(sorry if it's not appropriate to bring back and old thread)

I thought that if the fund was accumulation domiciled in Ireland, you would not have to pay taxes on dividends in your home country. And if it was not distribution, you can typically take a credit in your home country for the amount of taxes paid

[alpine_boglehead]

A problem with this withholding tax is that it isn't passed through the funds, so in your home country you likely pay taxes on the dividends as if they hadn't been taxed yet (but this may depend on your jurisdiction). E.g. for me in Austria this means that I pay 15% US withholding tax and then 27.5% on what remains in Austria, as opposed to direct stock holdings for which the 15% are taken into account, so only 12,5% are taxed in Austria.

By my calculation, VWRL (Vanguard FTSE All-World) is reduced from a gross yield of roughly 2.7% to 1.4% after taxes and expense ratio.

(sorry if it's not appropriate to bring back and old thread)

I thought that if the fund was accumulation domiciled in Ireland, you would not have to pay taxes on dividends in your home country. And if it was not distribution, you can typically take a credit in your home country for the amount of taxes paid

There's two parts to the topic

a) Regarding the tax handling of accumulation - this probably depends on your country, there seem to be countries where accumulating funds have the advantage that the reinvested dividends are not taxed immediately. But not where I live, here there's "dividend equivalents" (German "ausschüttungsgleiche Erträge") which are taxed immediately, and the cost basis for the holdings is raised to prevent double taxation.

b) The problem that the withholding taxes already paid (e.g. 15% for the US) are not taken into account when you're taxed in your home country is called dividend tax leakage. It's very real for me. VWRL distributions (on which withholding taxes have been paid) are taxed at 27.5% local tax.
I've considered replicating the S&P 500 via individual holdings. It would be doable, but too much effort for my small portfolio, be anything but simple, and there don't seem to be ex-US ETFs (aka "International" in the US ) in Europe, only more specialized like Europe, Japan, Emerging ..., contributing to complicating things. Yet, the wheels are in motion, maybe someday a broker/robo advisor will pop up that will do just that for you, i.e. replicate the market via individual holdings (with the double benefit of preventing double taxation and tax loss harvesting on individual positions). I'd wager that there's already such a service for wealthy individuals. Or maybe not, as they obviously put their portfolios offshore.

[BeBH65]

A problem with this withholding tax is that it isn't passed through the funds, so in your home country you likely pay taxes on the dividends as if they hadn't been taxed yet (but this may depend on your jurisdiction). E.g. for me in Austria this means that I pay 15% US withholding tax and then 27.5% on what remains in Austria, as opposed to direct stock holdings for which the 15% are taken into account, so only 12,5% are taxed in Austria.

By my calculation, VWRL (Vanguard FTSE All-World) is reduced from a gross yield of roughly 2.7% to 1.4% after taxes and expense ratio.

(sorry if it's not appropriate to bring back and old thread)

I thought that if the fund was accumulation domiciled in Ireland, you would not have to pay taxes on dividends in your home country. And if it was not distribution, you can typically take a credit in your home country for the amount of taxes paid

Please do not generalize. Please do not think there is something like "typically".
The tax laws and tax treaties of each "home country" needs to be analysed in detail individually.

As i write in the other thread: I am not aware of any (european) country that is supposed to give you tax credit for L1 dividend witholding taxes if you invest through funds (independend if they are accumulating or distributing). Actually i only heard about tax credit in the context of US investors, investing through US domiciled funds.
Which are the countries that you supose have such Tex credit for l1 dividend witholding tax?

[international001]

Thanks a lot for following up.

Let's keep discussing then in the other thread so others are not confused (viewtopic.php?f=1&t=253457)

[Snuupy]

I see that this thread has more activity about dividend tax withholding than the other one, so I've continued the conversation here.

https://www.pwc.com/ca/en/services/tax/ ... -87-m.html

871(m) has been delayed until 2021.

Can I get any insight as to which indexes this applies to, and which ones it doesn't? Ideally, it would be awesome if a world ETF could get US dividends without tax.

[DJN]

Very interesting post, thanks for starting and resurrecting it. I had a quick look to see what funds I could find that are synthetic, they are usually prefixed with an X. I ignored distribution funds. I also didn't pursue small cap as there are only either S&P or Russell versions which are fine and there is an European one too.

ACCUMULATING
Fixed Income
Title: Xtrackers Barclays Global Aggregate Bond ETF - ISIN: LU09429970798
Tag: XBAE
TER: 0.20%
Size: E270M
Description: Global, govt, corp


Equity
Title: Invesco MSCI World UCITS ETF - ISIN: IE00B60SX3494
Tag: SCOJ
TER: 0.19%
Size: E627M
Description: Global, dev

Title: Amundi MSCI Emerging Markets UCITS ETF - ISIN: LU1681045453
TAG: AUEM
TER: 0.20%
Size: E2579M
Description: Emerging markets

[daze]

Yes, using index swaps for european funds allow to avoid taxation on dividends (0% instead of 15% if you use physical replication). Also the BNP S&P 500 fund is better than competitors because the manager made many more tender offers to get the "best" price for the index swap (hence better performance for the fund).

By the KIID (docfinder.is.bnpparibas-ip.com/api/files/115336d7-8ff1-442b-8149-81191a26ac02/6656),
it seems that BNP S&P 500 is tracking "NET Total Return Index" instead of "Gross Total Return Index".

It tracks the index very well, since the tracking is done by swaps. Therefore, it actually will be 30% tax on dividends.

[international001]

Sorry.. I don't understand or I read conflicting info

So if the fund use swaps, they have to pay 0% or 30% on dividends to the IRS?

What about the Vanguard SP500 available in Europe? Uses physical replication?

[BeBH65]

A gross return index shows the result as if 100% of the dividends are reinvested.
A net return index shows the result as if the standard dividend witholding tax is paid before reinvesting the remainder of the dividends. The standard dividend witholding tax for the US 30%.

In a synthetic fund, the counterparty promises the result of the index that they are tracking. The investor gets the result of the index that is being tracked. As the fund does not actually hold the stocks, it does not actually get dividends, and hence does not actually pay dividend tax.

A synthetic fund that tracks a net index will have a return as-if the standard 30% dividend tax is paid.
A synthetic fund that tracks the gross index will have a return as-if no dividend tax is paid internally in the fund.

A physically replicating accumulating US-equity fund domiciled in ireland pays 15% dividend witholding tax, and given the investor that return. If the fund "tracks the index well" this will be between the gross and the net return index.
A physically replicating accumulating US-equity fund domiciled in Luxemburg pays 30% dividend witholding tax, and given the investor that return. If the fund "tracks the index well" this will be the same as the net return index.