Nonresident alien investors and Ireland domiciled ETFs

This page shows why it may be better for a non-US investor (US nonresident alien (NRA)) with no US tax treaty to invest in Ireland domiciled exchange-traded funds (ETFs) as opposed to the popular US domiciled mutual funds discussed often by US-based investors.

Please note that for Europeans it has become difficult to buy US domiciled funds due to 2018 European MiFID and PRIIPs regulations.

This page uses the rate of 30% for any dividend withholding calculations. This is the US dividend tax rate in the absence of a dividend tax treaty.

Domicile
In law, domicile is the status or attribution of being a lawful permanent resident in a particular jurisdiction. A person's domicile is often the determining factor for many legal aspects, including investing and taxation. Investment funds also have a domicile, and here this too determines the applicable legislation, including taxation.

US tax treaties
Depending on your country of residence, you may be able to benefit from a US tax treaty for lower rates and higher exemptions. If you do, some parts of this article may not apply directly as you may be able to benefit from lowered treaty rates.

A list of treaties can be found at United States Income Tax Treaties - A to Z.

Why invest in Ireland domiciled ETFs as an NRA?
A few reasons for preferring Ireland domiciled ETFs over US domiciled ETFs:
 * Ireland domiciled ETFs can benefit from the US/Ireland tax treaty rate of 15% on dividends and 0% on interest paid to Irish corporations, instead of 30% for US nonresident aliens in countries without a US tax treaty.
 * Ireland domiciled ETFs insulate investors from US estate taxes of up to 40% of the balance of US situated assets above $60,000.
 * US domiciled ETFs holding non-US securities can suffer double tax withholding. The US domiciled ETF pays withholding to international governments, then the US levies 30% of the remaining distributed dividends. Ireland domiciled ETFs avoid this.
 * Complex and constantly changing US tax laws affecting US nonresident aliens. Leave it to iShares and Vanguard Dublin to deal with those.
 * Non-residents of Ireland are not liable to Irish gift tax or inheritance tax.
 * Availability of accumulating funds that reinvest dividends and which may help some investors reduce or avoid Level 3 tax.
 * For Europeans it has become difficult to buy US domiciled funds due to 2018 European MiFID and PRIIPs regulations.

For more information about Irish funds, see: Why Ireland for funds?, by Irish Funds.

Caveats of investing in Ireland domiciled ETFs?
Some of the downsides:
 * US domiciled ETFs often have lower expense ratios.
 * US domiciled ETFs usually have narrower bid/ask spreads.
 * For Europeans it has become difficult to buy US domiciled funds due to 2018 European MiFID and PRIIPs regulations.
 * Most Ireland domiciled USD denominated ETFs have rather low daily trading volumes. See: Understanding ETF liquidity at ETF.com.
 * ETF options are limited but sufficient to build Bogleheads-style lazy portfolios.
 * Depending on your broker, buying Ireland domiciled ETFs usually costs more in transaction fees. Beware that next to transaction costs, brokers can have annual custody fees.
 * Some EU domiciled ETFs are synthetic. See EU investing for more information.
 * The taxation mentioned here is only applicable for non-Irish residents. For people residing in Ireland another set of rules applies.

No Irish (capital gains or dividend) tax withholding for Ireland domiciled ETFs
Ireland does not withhold any taxes on capital gain or dividends paid by Ireland domiciled UCITS ETFs for non-residents of Ireland.

Additionally, Ireland does not levy any inheritance, estate, or capital transfer taxes on Ireland domiciled funds held by non-residents of Ireland. Ireland domiciled ETFs are therefore completely 'tax transparent' to investors.

Multiple levels of dividend tax withholding
Investors that hold funds that hold securities can be taxed on dividends by multiple countries at multiple levels.

There are 3 levels of dividend taxation to apply.


 * L1TW: Percentage of tax withholding by the home country of the security on the dividends distributed by the underlying international securities (Level 1).
 * L2TW: Percentage of tax withholding by the country where the fund is domiciled on the dividends distributed by the fund (Level 2).
 * L3T: Percentage of taxation that the individual investor needs to pay in their home country (Level 3).

Estimating Level 1 dividend tax withholding paid by US domiciled funds
According to the PWL Capital white paper, the following are the percentages of tax withholding paid by different types of US domiciled ETFs

&dagger; Note that iShares MSCI EAFE ETF (EFA) excludes the US. You can use that number to approximate Level 1 taxes for the ex-US developed markets portion of the fund in question. If the US domiciled fund you are analyzing has 60% US stocks vs 40% ex-US developed markets, the Level 1 tax withholding will be 0.40 * 7.5% = 3.0% approximately.

Estimating Level 1 dividend tax withholding paid by Ireland domiciled funds
Using annual reports of the most traded funds from iShares and Vanguard, the following is the resulting Level 1 percentages leaked by funds per percent dividend yield. Those figures were calculated for this wiki post. If you find other sources online confirming, please update and reference accordingly.

Keep in mind that each index provider (MSCI/FTSE) has a different definition of "Developed Markets" and "Emerging Markets". Different indices have different allocations of those markets, too.

Calculating dividend tax withholding as a ratio
To better compare different ETFs we can convert the tax withholding percentages into a total annual approximation, let's call it the Tax Withholding Ratio (TWR). This makes it easily comparable to the expense ratios found on funds' fact sheets.

To calculate the dividend Tax Withholding Ratio (TWR), we need four pieces of information:
 * L1TW: Percentage of tax withholding paid by the fund on the dividends distributed by the underlying international securities held (Level 1). This can be estimated using each fund's annual report, by dividing "Non-reclaimable withholding tax" by "Dividend Income".
 * L2TW: Percentage of tax withholding on dividends the individual pays (Level 2). If you are a non-treaty US nonresident alien investing in US domiciled ETFs, that number is 30%. If you are investing in Ireland domiciled ETFs and you do not reside in Ireland, you do not have to pay any Irish tax withholding.
 * YIELD: Annual yield of the fund. As you cannot know the amount of future dividends in advance, an approximation based on historical values (gross before withholding was paid) should be sufficient. Dividend yield is used in the formula as the Level 1 taxes are paid on dividends received by fund.
 * TER: The fund's Total Expense Ratio. Can be obtained from a fund's KIID document.

The calculation after that is rather simple: TWR = (YIELD &times; L1TW) + ((YIELD &times; (1 - L1TW) - TER) &times; L2TW) The first term in parentheses calculates the Level 1 leakage. The second term uses the remaining dividend, deducts the fund's TER and then applies the individual's Level 2 tax to the remaining sum.

You can now add the TWR to the fund's published expense ratio to get a comparable total ratio paid annually. Note that this does not include the dividend tax that the investor pays to their resident-country on the dividends actually received.

Example calculation for S&P 500 ETFs
Let us compare the US domiciled Vanguard S&P 500 ETF (VOO) vs Ireland domiciled Vanguard S&P 500 UCITS ETF (VUSA).

Vanguard S&P 500 ETF (VOO): TWR for VOO = 0 (no L1 withholding) + ((2.0% * (1 - 0) - 0.05%) * 0.30) = 0.59%
 * L1TW = 0%, as it is US domiciled, holding US securities
 * L2TW = 30%, US nonresident alien rate for countries without a US tax treaty
 * YIELD = 2.0%, estimated as we need it for comparison purposes, not exact dollar calculations
 * TER = 0.05%

Vanguard S&P 500 UCITS ETF (VUSA): TWR for VUSA = (2.0% * 0.15) + 0 (no L2 withholding) = 0.30%
 * L1TW = 15%, as it is Ireland domiciled, holding US securities
 * L2TW = 0%, no Irish tax withholding on UCITS funds
 * YIELD = 2.0%, estimation
 * TER = 0.07%

L1TW for VUSA can be also calculated using its annual report. For 2014, Foreign Withholding Tax (7,721,652) divided by Dividend Income (52,371,805) = 14.74%. TedSwippet explains that it's not 15.0% on the dot due to a 2.5% REIT allocation, which may distribute dividends or capital gains at different rates than the US treaty rate of 15% for dividends. A tax drag differing from the treaty rate may for instance be caused by foreign companies in an index, capital gains being taxed differently than dividends and REITs can recharacterize distributed dividends as return of capital, which is not to be taxed.

Including the funds' expense ratios: VOO's total cost is 0.64% for a nonresident alien with no US tax treaty, while VUSA's total cost is 0.37%. For this investor then, VUSA is the better holding.

Example calculation for FTSE World ETFs
Let us compare the US domiciled Vanguard Total World Stock ETF (VT) vs Ireland domiciled Vanguard FTSE All-World UCITS ETF (VWRL).

Vanguard Total World Stock ETF (VT): &dagger; Ratios of US/EM/DM obtained from VT's Vanguard.com portfolio page. TWR for VT = (2.0% * 0.039) + ((2.0% * (1 - 0.039) - 0.17%) * 0.30) = 0.07794 + 0.52562 = 0.60%
 * L1TW &dagger; = 0% * 52% (US) + 9% * 10.8% (Emerging Markets) + 39% * 7.5% (ex-US developed) = 3.9%
 * L2TW = 30%, US nonresident alien rate for countries without a US tax treaty
 * YIELD = 2.0%, estimation as we need it for comparison purposes, not exact dollar calculations
 * TER = 0.17%

Vanguard FTSE All-World UCITS ETF (VWRL): TWR for VWRL = (2.0% * 0.103) + 0 (no L2 withholding) = 0.21%
 * L1TW = 10.3%
 * L2TW = 0%, no Irish tax withholding on UCITS funds
 * YIELD = 2.0%, estimation
 * TER = 0.25%

Including the fund expense ratios: VT's total cost is 0.77% for a nonresident alien with no US tax treaty, while VWRL's total cost is 0.46%. For this investor, VWRL is the better holding. Note that as allocation to countries changes over time, the tax drag will change over time as well. Also note that as yield changes over time, the tax drag will change over time as well.