Besides fixed income, one asset allocation that is often overlooked is foreign dividend paying stocks. While some may think there is not much difference between foreign dividend payers and their US counterparts, the reality is there are several important aspects to consider.
The first is the impact of foreign exchange fluctuations between the payer’s currency and the US dollar. Even with ADRs, (American Deposit Receipts) that trade on US exchanges, dividends are paid in the currency of the country the company is domiciled in. For example, HSBC Holdings (HSBC), the parent company of giant international HSBC Bank and formerly known as Hong Kong Shanghai Bank is headquartered in London after moving from Hong Kong in 1999. While the stock has dual listings on both the Hong Kong and London exchanges, the company reports its results and pays its dividends in Great Britain Pounds (GBP).
One HSBC ADR traded on the NYSE represent five London traded shares and ADR investors in America acquire five times the dividend per London shares because of this ratio. Therefore, if the London shares announced a USD $0.10 per share dividend, ADR investors would receive $0.50 per ADR. However, dividends are declared and paid in GBP, not USD. For example, over the past nine years, the list below are the annual dividend paid by HSBC.
Year; Pound dividend declared; USD : Pound exchange rate; USD dividend paid per London Share; Total dividend paid per ADR
2013 - 0.3016 - 1 : 1.62 - $0.49 x 5 = $2.45
2012 - 0.2816 - 1 : 1.74 - $0.49 x 5 = $2.45
2011 - 0.2597 - 1 : 1.57 - $0.41 x 5 = $2.05
2010 - 0.2273 - 1 : 1.58 - $0.36 x 5 = $1.80
2009 - 0.2179 - 1 : 1.59 - $0.34 x 5 = $1.70
2008 - 0.3826 - 1 : 1.67 - $0.64 x 5 = $3.20
2007 - 0.4593 - 1 : 1.99 - $0.90 x 5 = $4.50
2006 - 0.4193 - 1 : 1.93 - $0.81 x 5 = $4.05
2005 - 0.4033 - 1 : 1.81 - $0.73 x 5 = $3.65
The impact of the exchange rate fluctuations becomes quite clear using the above long-term table. As the USD strengthens and the GBP declines, the USD dividend paid goes down, and the opposite is true. For example, the highest exchange rate is in 2007 at 1:1.99 and the lowest is in 2011 at 1:1.57. This represents a 21% differential. All else being equal, the same declared dividend by HSBC in GBP could fluctuate by as much as 21% for US investors, based on exchange rates.
American investors buying foreign stocks will receive a higher relative USD dividend when the USD is weaker than when it is stronger – regardless of the amount declared and paid in the foreign currency. If you believe the USD is in a cyclical or structural decline versus other currencies, then investing in foreign dividend paying stocks could provide a improved return than dividend growth alone.
Below is one of several online currency exchange rate graphing sites. This one is easy to use and allows for 5-year graphs. It is important for investors to appreciate the impact of currency exchange fluctuations on the income received.
http://www.oanda.com/currency/historical-rates/
Another aspect is the taxation of foreign dividends and the impact on total stock returns. The discussion below should not be construed as tax advice and a qualified tax advisor should answer all questions. In the US, most dividends are separated into “qualified” and “non-qualified”, with different income taxes for each category. Unless specified, for US residents, the IRS does not withhold taxes from each dividend payment and all taxes are due annually. However, this is not the case with foreign governments.
Each country either has or has not a tax treaty with the US. Usually, if the country has a tax treaty with the US, the issue of withholding taxes is addressed and amounts of withholding are set via the treaty. Some countries exempt all dividends from withholdings while others limit the exemption to IRA-type account only. Others have no exemption regardless of where the investment is held.
For most investors with less than $300 deducted in tax withholding from dividends from investments held in non-tax advantaged accounts, it is pretty simple to reclaim this withholding. There is a line on your personal Form 1040 for foreign dividend taxes paid, and it is a credit again total tax due.
However, the amount withheld may not be a one-for-one offset. From the IRS Publication 514: “The amount of foreign tax that qualifies as a credit is not necessarily the amount of tax withheld by the foreign country. If you are entitled to a reduced rate of foreign tax based on an income tax treaty between the U.S. and a foreign country, only that reduced tax qualifies for the credit.”
For example, Switzerland has a 35% withholding rate, even though the US Tax Treaty stipulates a 15% tax due. Since the Swiss government does not which country the investor is located, they withhold the same 35% for every investor. In this case, taxpayers can deduct only 20% of the 35% withheld by the Swiss government.
Investors should not shy away from investing in foreign dividend paying stock just because of these tax issues. The final impact should be figured into the anticipated return to determine the desirability of the specific investment.
For instance, Pargesa (PGRAF) is a Swiss-based investment holding company that owns 50% of Groupe Bruxelles Lambert (GBLBF). GBLBF is headquartered in Brussels. PGRAF is subject to 35% Swiss withholding while GBLBF is subject to 25% Belgium withholding – even though the dividend is originally paid by GBLBF. The investment thesis for holding the higher-taxed PGRAF is the possibility that the Frere Family may purchase all shares sometime in the future, which could be at a premium to the added taxes paid over time.
Canadian companies usually do not withhold tax for investments held in IRA-type accounts, but will for accounts with no tax advantages.
It is important for investors to determine their exposure to foreign withholding dividend tax, and the ability to recoup the tax, prior to investing in the shares.
More information can be found at the IRS website here:
http://www.irs.gov/pub/irs-pdf/p514.pdf
http://www.irs.gov/Individuals/International-Taxpayers/Foreign-Tax-Credit-Compliance-Tips
Below is a list of tax withholdings by country:
No withholding tax will be credited from the following countries:
Cuba, Iran, Libya, North Korea, Sudan, Syria
The table below lists the countries that have no withholding taxes on dividends paid to U.S. residents:
http://www.djindexes.com/mdsidx/downloads/withholding_tax.pdf
Countries with No Tax Withholding Rate for Dividends:
Argentina 0.00%, Bahrain 0.00%, China - Red Chips 0.00%, Colombia 0.00%, Croatia 0.00%, Cyprus 0.00%, Egypt 0.00%, Estonia 0.00%, Hong Kong - Local Shares 0.00%, India 0.00%, Jordan 0.00%, Mauritius 0.00%, Oman 0.00%, Qatar 0.00%, Singapore 0.00%, Slovakia 0.00%, South Africa 0.00%, Tunisia 0.00%, United Kingdom 0.00%, UAE 0.00%, Vietnam 0.00%
The following table below shows the withholding tax rates by country on dividends paid to U.S. residents:
Country Withholding Tax Rate for Dividends
Australia 30.0%, Austria 25.0%, Bangladesh 15.0%, Belgium 25.0%, Bosnia 5.0%, Brazil 15.0%, Bulgaria 15.0%, Canada 15.0%, Chile 35.0%, China - A Shares* 10.0%, China - B Shares**, 10.0%, China - C Shares*** 10.0%, Czech Republic 15.0%, Denmark 28.0%, Finland 28.0%, France 25.0%, Germany 26.4%, Greece 10.0%, Hungary 10.0%, Iceland 15.0%, Indonesia 20.0%, Ireland 20.0%, Israel 20.0%, Italy 27.0%, Japan 10.0%, Kazakhstan 15.0%, Kenya 10.0%, Kuwait 15.0%, Latvia 10.0%, Lebanon 10.0%, Lithuania 15.0%, Luxembourg 15.0%, Macedonia 10.0%, Malaysia 25.0%, Malta 35.0%, Mexico 10.0%, Morocco 10.0%, The Netherlands 15.0%, New Zealand 30.0%, Nigeria 10.0%, Norway 25.0%, Pakistan 10.0%, Peru 4.1%, Philippines 30.0%, Poland 19.0%, Portugal 20.0%, Romania 16.0%, Russia 15.0%, Saudi Arabia 5.0%, Serbia 20.0%, Slovenia 20.0%, South Korea 27.5%, Spain 19.0%, Sri Lanka 10.0%, Sweden 30.0%, Switzerland 35.0%, Taiwan 20.0%, Thailand 10.0%, Turkey 15.0%, UK - REITS only 20.0%, Ukraine 15.0%
Disclosure: I am long HSBC, PRGAF, GBLBF. HSBC is followed by Guiding Mast Investments newsletter
I appreciate your time and interest in Guiding Mast Investments, George Fisher