Taxes on investments

Most countries have separate tax rates for investment income. Some (esp. low-tax countries like Romania) have a flat rate, others distinguish short-term and long-term gains (ex: US, Georgia). In some countries, only a portion of the investment income is taxed (ex: 50% of capital gains in Canada) and certain deductions and/or tax credits apply. Yet in others, investment income is taxed as ordinary income (ex: Estonia) and may even be subject to socials (ex: Hungary, Romania).

The tax treatment will usually depend on:

1. Type of investment income
2. Type of account you hold your investment in

Types of investment income

• Capital gains: gain/loss from the disposal (sale) of assets (stocks, ETFs, real estate, etc.)
• Dividends: cash distributions from corporations you owe shares in
• Interest: cash distributions from interest-bearing assets (savings and money market accounts, bonds, CDs, etc.)

NOTE: there are taxable benefits like health/life insurance, private pension, and annuity where funds are also invested.

In general, capital gains are taxed the least:

• you are not liable for the tax until you realize the gain (i.e. sell)
  • exception: wealth tax on your net worth (ex: Italy, Spain, Colombia)
  • risk: proposal to tax unrealized gains (ex: in the US)
• you may defer the tax if you reinvest the gains (ex: 1031 exchange in the US)
• you may not pay the tax if you pass away
  • your beneficiary(ies) will pay estate/inheritance/gift tax
  • rarely, no tax at all (ex: stepped-up basis in US)
• you can time the sale to minimize the tax (ex: when retired)
  • also to offset gains with losses (tax-loss harvesting)
• certain asset classes may be taxed more favorably than others
  • real estate
    • you can claim depreciation, deduct legal fees, commissions, etc.
    • gains may be exempt from tax up to a certain amount (ex: primary residence deduction)
    • tax rates may be lower if you own the property for multiple years
      • may apply to local but not foreign real estate
  • stocks/ETFs
    • you may deduct transaction, accounting, and advisor fees
    • you may qualify for a one-time exemption (ex: QSBS in US)

Dividends are usually taxed higher than capital gains:

• some countries distinguish qualified/eligible and non-qualified/non-eligible divs
  • depending on where corp is based, private vs. public corp, % of shares and # of years you hold, etc.
• dividends from certain sources may be taxed at a higher rate
  • ex: distributions from REITs, MLPs, etc.
• foreign dividends can be taxed differently
  • you may be subject to WTH tax at the source
  • you may claim a foreign tax credit to offset double taxation
  • you may be unable to claim dividend tax credits (ex: Canada)
  • dividends from ADRs are subject to regular WTH tax despite the DTT (unless proper paperwork is filed)

Interest income is usually the least tax-efficient:

• interest is often taxed as earned income
  • exception: certain bonds (ex: municipal in the US) may be exempt from federal and/or state tax

Types of investment accounts

• Margin/cash account
• Registered account
  • retirement account (ex: IRA, RRSP, etc.)
  • education account (ex: 529 Plan, RESP, etc.)
  • health account (ex: HSA)
• Trust

Margin account is a standard taxable account. It's best suited for:

• foreign dividends
  • you can usually opt for a reduced WTH tax based on DTT (ex: 30% -> 15% from US stocks)
  • you can also claim foreign tax credit(s) to offset WTH tax already paid
  • otherwise, under a territorial tax regime, you pay no tax domestically
    • however, if there's no DTT, you'll pay regular WTH tax (ex: 30% in US)
    • you can also buy from another stock exchange (in UK, Germany, etc.) to pay lower WTH tax
• risky or speculative investments
  • ex: penny stocks, SPACs, IPOs, stock options
  • you can offset capital gains with losses
  • rarely, you can offset ordinary income (ex: up to USD 3k in US)
• angel investing
  • capital gains may be tax-exempt if you sell shares of a small business (start-up)
  • ex: up to USD $10M in QSBS (US), up to CAD 500k in LCGE (Canada)

Registered accounts are specialized tax-advantaged accounts. They work best for:

• dividends and interest
  • income may be exempt from tax (ex: Roth IRA, TFSA)
    • optimal for non-qualified domestic dividends (ex: REITs)
  • otherwise, tax may be deferred until you make withdrawals (ex: 401k, RRSP)
  • however, WTH tax on foreign dividends is not recoverable
    • with some exceptions provided in DTTs (ex: US dividends exempt from WTH tax in Canadian RRSP)
• growth stocks
  • capital gains are also tax free (or deferred until you withdraw)
• low-risk investments
  • contribution room is limited and non-recoverable if you sell for a loss
  • safe investments lower the risk of losing your principal (for a degree, retirement, etc.)
    • i.e. core portfolio with low volatility, limited downside risk, and steady growth
    • ex: broad-market index funds (ETFs), blue-chip stocks, value stocks

Disclaimer

IANAFA. This is not financial or tax advice. Do your own research and/or consult a licensed professional.