Thursday, December 18, 2014

Considering Foreign-Domiciled Dividend Growth Stocks

I was recently asked by a reader to discuss foreign stocks, dividend taxation, and how that applies to some of the stocks I discuss and invest in.
The reader, who goes by wtd7576, commented in my recent article on Unilever PLC (UL):
Nice analysis and good luck.An interesting topic as well as explanation would be to discuss buying a foreign stock like this and its tax ramifications for the average U. S. Investor. Companies ike BP, Royal Dutch Shell, Unilever, etc., are all worth looking at but many investors have shied away from foreign investments due to tax considerations and are you really getting the yield here that they report. Thanks.
So this article will attempt to do just that.
Now, I’m going to limit the scope of this article for the sake of simplicity and brevity. There’s no possible way I could cover dividend taxation across every major country in the world for every investor out there. There’s way too much complexity there, as tax circumstances change rather dramatically depending on the situation. It’s difficult enough to navigate my own tax situation.
However, what I will attempt here is to discuss my thoughts on foreign stocks in more general terms, what I personally invest in and why, and how this information may help you.

Why Foreign Stocks At All?

I think it’s a valid question to ask: Why invest in any foreign companies? Can’t a dividend growth investor just stick to US-domiciled companies?
Well, one could certainly stick to US-listed stocks only and avoid any foreign taxation headaches altogether. And that might not be a bad way to go. After all, most of the major US-domiciled multinational companies that have lengthy track records of paying and growing dividends – think The Coca-Cola Company (KO)Johnson & Johnson (JNJ), and Exxon Mobil (XOM) – typically derive substantial portions of their revenue from sales abroad and do business all over the world. So by investing in a wide selection of high-quality dividend growth stocks with sizable operations abroad you’re already diversifying yourself geographically in regards to international exposure. You’re basically exposing yourself to both developed and emerging markets, and the global economy.
However, I’ve personally found that a number of really high-quality companies that pay substantial dividends and have strong track records of increasing those dividend payouts reside abroad. While the US is certainly fertile ground for excellent investments, especially in the dividend growth stock space, it isn’t the only game in town.
For instance, relating to my recent article on Unilever, this is a company with 14 brands with more than 1 billion euros in annual sales. They own brands like Axe, Ben & Jerry’s, Breyers, Country Crock, Dove, Hellman’s, Knorr, Lipton, and Vaseline. This is a fantastic company that pays out a generous dividend that’s growing, and sports great fundamentals. Why wouldn’t I want to own a piece of this company?

Stick To The Low-Hanging Fruit

So I do own equity in a few foreign companies. Specifically, these companies are: BHP Billiton PLC (BBL),The Bank of Nova Scotia (BNS)BP PLC (BP)Royal Dutch Shell PLC (RDS.B)Toronto-Dominion Bank (TD)Unilever PLC (UL)Vodafone Group PLC (VOD).
Why these companies specifically? 
Well, I consider them low-hanging fruit:
  • They’re all domiciled (or partly domiciled in the case of dual-listed stocks) in countries where corporate laws and oversight are similar to the US. We’re talking Canada and the United Kingdom here.
  • The businesses themselves are easy to understand – banking, oil & gas, consumer products, telecommunications, and basic materials are easy to wrap my brain around. For instance, I wouldn’t want to invest in some tech startup in the middle of India any more than I would want to invest in one in the middle of Silicon Valley. Your standards shouldn’t change simply because the country of origin has.
  • All these stocks are offered on a US exchange. This means I don’t need to worry about foreign stock markets and their laws/protections, currency conversion rates, or whether or not the dividends are qualified. I invest via ADR shares, which stands for American Depository Receipts. ADRs represent ownership in foreign companies, but trade on a US exchange. They basically make it incredibly easy to invest in foreign companies. However, the drawback is that they usually come with fees of some sort for the additional costs of the program – I notice a penny per share is lopped off of the dividend in a lot of cases.

Foreign Dividend Taxes

There’s one other feature of most of the above stocks that qualifies as “low-hanging fruit”, in my view, and that’s favorable dividend taxation.
UK-domiciled stocks, for instance, do not tax dividend payments to US investors at the local state level, due to a tax treaty between the US and UK. So that means that UK-listed ADR shares, like BP, RDS.B, and UL, do not have any foreign dividend tax withholding. That essentially puts them on par with US-listed stocks from a dividend tax standpoint.
It’s important to note that a number of UK-domiciled stocks have a dual-listing structure. Unilever, BHP Billiton, and Royal Dutch Shell are all examples of this. I have personally chosen to invest in the UK-listed ADRs in these companies so as to avoid any foreign dividend taxation. The details of and reasons behind these dual-listings can be found on any of the respective company’s investor relations sites.
You’ll notice that I also have investments in two Canadian banks. Canada taxes dividends at just 15% at the state level due to a tax treaty, which means my dividend from BNS or TD is a little lighter by the time it gets to me. However, the US allows a dividend tax credit to be filed at tax time so as to avoid double taxation. Up to $300 in foreign dividend taxes can be reclaimed directly on the 1040. Anything over $300 will require Form 1116. You can read more about this directly from the IRS.
It’s important to note that while the tax credit is great in that it’s a dollar-for-dollar reduction of your tax liability, there are some limitations there. The credit you can claim is the lesser of the foreign dividend tax paid or the amount of the US tax liability on that income. Basically, the US isn’t going to reimburse over and above what they would tax on the same dividend income.
An interesting aspect about Canadian dividends specifically is that if you, as a US investor, hold shares in Canadian corporations in a qualified retirement account, the dividends generally do not have any foreign tax withholding. However, this doesn’t apply to shares in Canadian REITs. The US and Canada amended their tax treaty back in 2009 so as to allow US investors to avoid the loss of a piece of their dividend payouts in tax-advantaged accounts. So holding TD, for instance, in an IRA means you collect the full dividend without the usual 15% dividend withholding tax. This benefit is uncommon, as most foreign dividend taxes are lost forever if you’re holding foreign-domiciled shares in a retirement account and you incur foreign dividend tax withholding.
Now, I’m only covering two countries here. Obviously, there are a lot of other options out there. But when factoring in the low-hanging fruit I was discussing above and favorable taxation laws, I consider stocks domiciled in the UK and Canada to be the best options for US-based dividend growth investors looking for foreign exposure. A lot of other countries just tend to fall in the “too hard” pile for me, but I would recommend serious due diligence if you’re interested in buying stocks in other countries.
I will say that there are two other countries out there that might want to be considered.
Switzerland is one country that offers some interesting opportunities. For instance, I’m personally interested in initiating a stake in Nestlé SA (NSRGY) at some point. It’s a high-quality company with a solid yield, and the 15% foreign withholding tax can be fully reclaimed. In addition, Novartis AG (NOV) shows some promise.
Bermuda is another option. They do not tax dividends at the state level, so stocks like Seadrill Ltd (SDRL)pay out the full dividend with no foreign dividend tax withholding.


So I put this post together real quick to answer the question asked, but it is by no means comprehensive in regards to foreign dividend taxation. That would probably require a 30-page essay to cover in-depth, and even then it wouldn’t really apply to everyone due to individual tax circumstances that can be quite unique.
But I wanted to cover what I do and why, and how that may apply to others out there interested in owning international stocks. I find it quite easy to invest in high-quality dividend growth stocks abroad. UK-domiciled stocks operate a lot like US stocks, except that some pay semi-annual dividends and there is sometimes a small fee attached. In addition, sometimes the dividend raises can be lumpy or uneven due to exchange rates. But these ADRs trade on our exchanges, pay dividends in dollars, and offer an opportunity to own equity in some truly world-class companies. In addition, I find that a lot of UK-listed stocks offer significantly higher yields than some of their US counterparts. Canadian stocks are also a great option as well, as discussed.
There are probably 20-30 high-quality stocks that pay and raise dividends across just Canada and the UK, so I find no reason to really go any further than that, other than maybe Switzerland for a couple of specific stocks. I’d rather pluck the low-hanging fruit than strain myself to reach for higher branches, especially when there’s plenty of fruit to be had at eye-level. Between those stocks and what’s already offered here at home, you’ll certainly not lack ideas or opportunities.
Just make sure that if you are interested in owning any foreign stocks that you perform the same due diligence that you otherwise would with any domestic companies. The research and valuation process should be the same, no matter where the company is domiciled.
Full Disclosure: Long UL, KO, JNJ, XOM, BBL, BP, BNS, RDS.B, TD, and VOD.
What do you think? Are you a fan of foreign stocks? Are the countries discussed fertile ground, or are there better options out there? 
Thanks for reading.

This article was written by Dividend Mantra. If you enjoyed this article, please subscribe to my feed [RSS]


Post a Comment

Recent Posts From DIV-Net Members