The dividend tax credit makes owning some Canadian stocks worthwhile, despite the poor returns of the TSX.

XIC vs VFV
S&P 500 vs TSX 300

If you look at the graph above that compares the return of the US S&P 500 Index ETF SPY to the TSX 300 Index ETF XIC, excluding dividends, you might ask yourself, as I did, why own any Canadian stocks?

Tax advantaged Canadian dividends

Frankly, the only reason for retirees to own Canadian stocks is the tax advantaged nature of the dividend tax credit. As the following table shows, a retiree can pay very low tax rates of 9% or less (in Ontario where I am writing this) for Canadian qualified dividends in a taxable account. (In a registered account, the US index ETF has been by far the better choice).

Blog 2 Tax brackets

The problem is that, if you have an income over $46,000 and if you want consistent income without having to pay 33-52% tax, you need to invest in Canadian dividend payers. If you invest in US dividend stocks, outside of a RSP or RIF, the tax rate is the same as interest income. Even within a TFSA, US dividends are subject to a US with holding tax of 15%, which you cannot recover.

No tech, Business unfriendly environment

Why is the Canadian stock market performing so poorly ? Primarily because we don’t have the big tech names which are powering the US stock market over the past number of years, and because we have a business unfriendly environment which is discouraging business investment (pipelines, minimum pay, excessive regulation, Trump). According to Goldman Sachs, fully 62% of the increase in the S&P 500 over the past year came from 10  stocks – the FAANGs  (Facebook, Apple, Amazon, Netflix, Google) and a few others such as Microsoft. Instead, the TSX is primarily slow growing financials (Banks, Insurance) and risky resources (Oil, Minerals).

On the plus side, the Canadian dividend payers do grow their dividends at a reasonable rate of 4-10% per year. So one can invest in Canadian banks that yield around 3.5%, Canadian infrastructure companies (pipelines, Brookfield) that yield around 4.5%, or a dividend ETF that yields  4%, and be reasonably certain that even after taxes the dividends will keep up with or exceed inflation.

3 thoughts on “The dividend tax credit makes owning some Canadian stocks worthwhile, despite the poor returns of the TSX.

Add yours

  1. US Dividends may be taxable in a non-RRSP/RRIF account, but the withholding tax is recoverable as a foreign tax credit. Only in a TFSA can you not offset the IRS withholding. And within RRSP/RRIF, there is no withholding tax paid.

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    1. Agreed, but 1) you don’t get the benefit of the Dividend Tax Credit which can mean very low tax rates for Canadian dividends for those with a taxable income under $75,000 per year (9% or less in Ontario), 2) US dividends are taxed at the highest tax rate equal to interest income and 3) US dividend rates are substantially lower than Canadian, due in part to the much higher valuations in the US. For example, the S&P 500 index ETFs pay a dividend of about 1.7% versus 2.7% for the TSX 300 ETF.

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