If you hold your foreign stocks in an Individual Savings Acount (ISA) or Self-Invested Personal Pension (SIPP), you’re sheltering them from UK tax as much as possible. But you may still be paying more tax on them than is absolutely necessary.
That’s because many foreign governments impose withholding tax (WHT) on dividends before they even reach you. And in many cases, they are charging WHT at a higher rate than they are supposed to under their double taxation agreements (DTAs) with the UK.
Many investors don’t read the rules on this and just accept what they get. But if you understand how it works, you may be able to reclaim a sizeable amount of tax from abroad.
You could even get an extra 15% tax break on American dividends in your SIPP that most investors don’t know about. To find out how, read on.
Foreign dividends in ISAs and SIPPs
ISAs do not have any special status for foreign tax. Just because they are a UK tax shelter doesn’t mean that foreign governments are going to cut them any extra tax breaks.
So when it comes to WHT, foreign stocks in an ISA get treated exactly the same as foreign stocks outside an ISA. Obviously, you may save on additional UK income tax and capital gains tax by using an ISA, but you don’t get an increased refund on the WHT over and above what you’d get anyway.
SIPPs are different. Under some tax treaties, there are special clauses for WHT on dividends paid into a pension scheme. One very important case is the UK-US DTA. Under this, dividend payments by US companies into a UK pension scheme should be taxed at a zero rate (see the HMRC manual and the treaty text [PDF]).
The standard WHT on US dividends is 30%. This is reduced to 15% under the UK-US DTA, which is the rate that will apply whether you hold US stocks outside or inside an ISA. But if you hold them in a SIPP and your SIPP adminstrator is thorough enough, you can get them paid gross of all tax.
So far so good. So do many investors lose out on foreign WHT in their ISAs and SIPPs? And what can you do about it?
The two reasons why you pay too much WHT
There are two reasons why dealing with WHT is complicated. The first is that many countries don’t allow you to get the reduction you’re due under the relevant DTA up front. Instead, you have to file for a refund.
That can be costly and time-consuming. Understandably, many stock brokers and wrap providers don’t think it’s worth all the paperwork.
The second is that when you hold foreign stocks through a domestic stock broker, they are usually held in a nominee account. This means that the account is in the name of the stock broker (or another intermediary) who is holding them on behalf of you, the beneficiary.
You have rights over the shares and your ultimate ownership is clear. But within the nominee account, they are often held alongside lots of other investors’ shares. These pooled nominee accounts are used instead of individual accounts for each investor because it makes trading and settlement easier and cheaper.
Some brokers have all their clients’ holdings of foreign stocks in the same pooled nominee account, whether the client is holding them in a regular account, an ISA or a SIPP. That means that you can’t apply any special tax treatment due to SIPPs to the whole group of shares, which makes handling WHT exemptions and reclaims even more complicated.
Overall, brokers tend to handle WHT on US stocks best. That’s because investors can file a W-8BEN form which entitles them to receive the dividends with WHT deducted at the lower treaty rate initially, rather than having to reclaim the additional WHT afterwards. In addition, US stocks are the most widely held by UK investors and so having the arrangements in place to handle US dividend WHT is cost effective.
Getting reduced WHT on US dividends usually works smoothly if your stock broker is a qualified intermediary. This means that they have an agreement with the IRS that allows them to receive dividends gross of tax, sort out what’s due and make the necessary payments. Most will ask you to complete the W-8BEN form when you initially open a general dealing account or ISA, and then pay US dividends to you net of only 15% WHT rather than 30%.
However, depending on the way their nominee accounts are set up, not all brokers are able to pay SIPP dividends with zero WHT. So if you intend to hold US stocks in your SIPP and your US dividend income is large enough that the extra 15% could be handy, it’s worth checking whether your broker does. Brokers that can get US dividends paid gross into their SIPPs include AJ Bell Youinvest and Hargreaves Lansdown.
You should also be aware that not all brokers will handle W-8BEN forms for dealing accounts and ISAs – some firms consider the cost and admininstration involved not worthwhile (examples include Halifax/iWeb/Motley Fool and iDealing). If you use one of these, your dividends will be paid net of 30% WHT, so you should take this tax cost into account when deciding which broker is most cost-effective for you.
How to reclaim excess withholding tax
For countries other than the US, things are unlikely to go so smoothly. A few firms will handle reclaims for one or more other countries, but generally most do not consider it cost-effective to try to get WHT reductions for anything other than US stocks.
In this situation, you may want to consider reclaiming the WHT yourself. Unfortunately, this is only possible for ISAs and standard dealing account – a SIPP is legally a different entity to you and the reclaim must be done by the SIPP administrator. Since administrators don’t generally consider this worthwhile for anything other than US shares, this tax break – which potentially applies to a dividends from a number of countries – is unfortunately lost.
The process of reclaiming WHT varies between countries – you can find details and forms for WHT reclaims here for several countries including the US, France, Germany, Spain, Switzerland and Ireland. Briefly, you will need to get paperwork from your tax office confirming that you are entitled to the payment at the reduced treaty rate. You also need to have evidence that you received the dividend after the higher rate of WHT had been deducted.
This is typically a dividend tax voucher – but if your foreign stocks are if held in a nominee account, you won’t always have this. In that case, you’ll need to get some evidence from your stock broker, the custodian or the paying agent to confirm that tax has been deducted.
If the prospect of tackling this puts you off, it may be worth consulting a decent accountant or tax adviser. They will be able to do the work for you, albeit for a fee.
There are also specialised companies that will do the work for you, at least where the dividends are being paid from companies in major countries such as the US, France or Germany. However, the feedback on many of these agencies seems to be quite negative, so investigate thoroughly before signing up to one.