What Canadian investors need to know about the Trump tax bill

If the first six months are any indication, the reign of U.S. President Donald Trump is going to be a rough one for Canadian investors.

First, the stock market plunged earlier this spring as Mr. Trump’s tariffs started a global trade war. Stocks have mostly recovered, but a new threat has emerged in the form of legislation that would allow Washington to ramp up the taxation of Canadians holding U.S. stocks.

The One Big Beautiful Bill Act is not yet law – it passed in the U.S. House of Representatives by a single vote but must still pass in the Senate – and may change in scope. For now, it has the potential to more than double the tax applied to dividends from U.S. companies received by Canadian investors and corporations.

The ultimate effect of the tax changes could be costly in total but perhaps not so bad on an individual basis. Regardless, it’s too early to make changes in your investment portfolio.

“Currently, we’re not making any moves, and I’m recommending everyone do the same thing and just wait to see what the information actually is,” said Justin Bender, a portfolio manager at PWL Capital. “Then we can assess and see if there’s any changes necessary.”

Ultimately, Section 899 of the legislation could introduce a withholding tax of 20 to 50 per cent of dividends received by Canadians. There are estimates that this extra tax could cost individual investors, pension funds and others billions of dollars.

The point of Section 899 is to give the U.S. a weapon to punish what it considers to be unfair taxes in other countries. Thought to be a target is our digital services tax, which mainly applies to U.S. tech giants generating revenue in Canada.

Estimates from Mr. Bender show a worst-case additional drag on returns of 0.46 percentage points from U.S. stocks and U.S. equity exchange-traded funds when the higher withholding tax is fully phased in over four years. Think of this cost as being in addition to the management expense ratio of an ETF or mutual fund.

If your return from a U.S. equity fund was a net 10 per cent with the management expense ratio (MER) included, then a higher withholding tax could ultimately leave you with as little as 9.54 per cent. Note that fund returns are always published on a net basis, with the MER included and, where applicable, foreign withholding taxes already deducted.

Under existing U.S. tax law, there is a base withholding tax rate of 30 per cent for foreign investors holding U.S. stocks. A Canada-U.S. tax treaty generally reduces this rate to 15 per cent.

No withholding tax applies to U.S. dividends paid into registered retirement savings plans and registered retirement income funds by U.S.-listed stocks and ETFs. There’s no clear sense of whether this exemption would continue to apply under Section 899.

In a non-registered account, you can offset the 15-per-cent withholding tax by claiming an offsetting foreign tax credit. In a TFSA, registered education savings plan, first home savings account or registered disability savings plan, the withholding tax cannot be recovered; it is also non-recoverable in RRSPs and RRIFs if you hold a Canadian-listed U.S. equity ETF.

Canadian investors have a massive level of exposure to U.S. stocks directly and through funds. About $60-billion is invested in just four TSX-listed ETFs that track the S&P 500 index.

But investing in the S&P 500, and the even more tech-focused Nasdaq, is much more about growth than dividend income. The dividend yield on the S&P 500 right now is about 1.3 per cent, half the level of the yield on Canada’s S&P/TSX composite index.

“It’s very low, which is why this tax maybe isn’t as much of an issue as people are making it out to be,” Mr. Bender said. “Some extra withholding taxes are probably not going to blow up your financial plan.”

Mr. Bender added that the impact is further diminished by the fact that most investors have diversified their U.S. exposure with bonds and Canadian stocks, plus international markets in many cases.

Investors who use ETFs for exposure to U.S. stocks can buy funds listed on U.S. exchanges as well as those located in Canada. Among Canadian-listed funds, there are those that hold U.S. stocks directly and those that are effectively a wrapper for a U.S.-listed fund in the same corporate family. Mr. Bender said either of these ETF types would be affected similarly by higher U.S. withholding taxes.