Do You Need to Pay Taxes When Investing in ETFs?

When you invest in U.S. stocks or ETFs, cash dividends are subject to withholding tax. This applies whether you trade through overseas brokers or domestic brokers; as long as you receive cash dividends, you will be affected by taxes. Non-U.S. tax resident investors are exempt from U.S. capital gains tax. Additionally, if you directly hold U.S. government bonds (like U.S. Treasury bonds, municipal bonds, or corporate bonds), you do not have to pay interest tax. However, interest from government bonds held through bond funds or bond ETFs (like TLT) is considered a dividend and taxed at the dividend tax rate.

Who is Considered a U.S. Tax Resident?

The Internal Revenue Service (IRS) typically considers the following as U.S. tax residents:

1. All U.S. citizens and green card holders.

2. Companies and entities registered or operating in the U.S.

3. Foreign nationals who are legally residing in the U.S.:

        a. Permanent residents holding a green card;

        b. Individuals holding valid non-immigrant visas and meeting the residency duration requirements.

Dividend Tax and Refund Situations

Regarding dividend tax, the U.S. generally imposes a tax rate of about 30% on cash dividends from U.S. companies. However, if the investor's country has a tax treaty with the U.S., they can apply for a reduced dividend tax rate. For example, the tax rate for China is 10%, while for Canada, it is 15%. When investors receive dividends from an ETF, the broker typically withholds this tax in advance. For certain ETFs, dividends may be exempt from taxation. In such cases, the broker will confirm the withheld tax at a later date (usually at the beginning of the following year) and refund either the full amount or a portion of it. TLT has specific circumstances regarding this.

Refund Timing and Limits

Regarding the tax refund amount, brokers recalculate and return the corresponding tax amount based on documentation from the tax authorities.

Refunds typically occur in the first quarter of the following year. Please note that the refund date may vary depending on the actual processing progress of the U.S. cooperating brokerage firms.

Special Refund Situations

Certain ETF products, such as the iShares 20+ Year Treasury Bond ETF (TLT), have specific rules regarding tax refunds. TLT primarily invests in U.S. government bonds with maturities of over 20 years, and its tax treatment involves both dividends and capital gains. The tax treatment is as follows:

Dividends: The dividends distributed by TLT are considered qualified interest from U.S. government bonds. For non-U.S. tax resident investors, this income is generally tax-exempt and should not be regarded as ordinary income or qualified dividends, hence no dividend tax is owed.

Capital Gains: When investors sell shares of TLT at a price higher than the purchase price, capital gains will be realized. The capital gains tax rate depends on the holding period, but for non-U.S. tax resident investors, capital gains earned in the U.S. securities market are not subject to U.S. tax.

If non-U.S. tax resident investors hold TLT through uSMART, uSMART may handle withholding tax matters based on the above policies.

*The tax-related statements above are for informational purposes only and are not intended to constitute any tax advice. For specific enquiries, please consult a professional tax advisor. The content provided is for reference only and does not constitute an offer, solicitation, recommendation, opinion, or guarantee regarding any securities, financial products, or instruments. While uSmart Securities Limited has made every effort to ensure the accuracy of this article, it does not guarantee the accuracy, timeliness, or completeness of the information and is not responsible for any opinions expressed in the content.