When you earn foreign-source income, a non-resident withholding tax will typically be deducted before the payment is received. For example, when you, as a foreign person, receive a dividend from a US corporation, a 30% tax will be automatically withheld at the source. This rate can be reduced if the country you are a tax resident of has a tax treaty with the US (ex: 15% for Canadian residents, see WTH taxes in US).
Unfortunately, the WTH tax is non-refundable. However, you may be able to claim a foreign tax credit to offset double taxation when you file your domestic tax return. Also, if the tax was withheld by mistake (ex: by a US client even though your service/product was not US-sourced) or at an incorrect rate (ex: a general rate was applied instead of a reduced rate based on a tax treaty), you could file a foreign tax return to claim a refund (ex: Form 1040-NR in US).
The WTH tax is deducted from foreign-source payments such as dividends, interest, and royalties. Rental income (along with REITs) is often subject to the standard WTH tax that can't be reduced by a tax treaty (ex: 30% in US). Capital gains and directors fees may also be subject to WTH tax.
The rate of withholding also depends on the type of investment account (margin, registered, etc.) (see taxes on investments). Unfortunately, there may be multiple levels of WTH taxes (ex: divs from a US-listed ETF that holds international stocks). Level 1 WTH tax is levied by the foreign country where the corporation is domiciled and is often non-recoverable, while Level 2 WTH tax is levied by the country where the security is listed. For a US/Canada perspective, see this white paper.
Workarounds for WTH taxes
1. Invest in contries with a zero or low non-resident WTH tax
- some countries don't levy a WTH tax on dividends, ex: UK (LON), HK (HKG)
- other countries have a low WTH tax, ex: 10% in China (SHG)
- NOTE foreign divs from interlisted stocks are still subject to WTH tax
- ex: US company is listed on both NYSE (USD) and TSX (CAD)
- Canadian residents will still pay 15% WTH tax even if they buy on TSX
- WTH tax is deducted based on the origin of the distributions (i.e. US)
- which stock exchange the shares are traded on and in which currency is irrelevant
- NOTE companies in EM countries (ex: Russia) have low P/Es and high div yield
2. Move to a country with a lower WTH rate based on a tax treaty
- some countries that signed DTTs have a lower WTH tax
- ex: US WTH tax is generally 30%, but is 10% for tax residents of Bulgaria, Romania, etc.
- ex: Japan has a 20% WTH tax that can be reduced to 10-15%
3. Invest in domestic companies
- divs from local companies are often subject to lower tax rates and/or tax credits
- ex: qualified divs in US, eligible divs in Canada, etc.
- in lower tax brackets, you may be exempt from tax and/or have a negative tax to offset other income
- NOTE div income above a certain threshold may affect your pension (ex: OAS clawback in Canada)
4. Earn capital gains
- WTH tax is usually not applied to capital gains
- instead of dividends or interest, earn from capital appreciation
- ex: invest in growth stocks (ex: US tech), sell shares when retiring
- ex: sell call options for a premium, trade futures, etc.