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U.S. Dividend Stock Investing for Canadian Investors

U.S. Dividend Stock Investing for

Canadian Investors

U.S. Dividend Stock Investing for Canadian Investors

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Introduction

By Dan Stringer, CGA, CPA

The Tax Implications for Canadian Investors of Dividend-Paying US

Securities Canadian investors have always had a strong home bias towards their investments. From a

Vanguard report issued in early January 2015, Canadians have over 59% of their equity assets

invested in Canada. However, Canada’s equity markets make up just 3.6% of the overall global

equity market (likely less now after the massive commodity/energy sell-off over the last year).

A lot of this may be a hangover from an old restriction on Canadian RRSP accounts (similar to

US- based IRA accounts) that limited foreign investments (equities, bonds, real estate, etc.) to

just 30% of the account. This limitation has long since been removed as the perils of investing

too heavily in your own jurisdiction have become better known. Some may be simply more

comfortable with investing at home. There also may be some concern about any tax

implications foreign investments may bring with them.

In Canada, there are three main types of self-directed investing accounts:

1. Standard investment accounts

2. Tax-Free Savings Accounts (TFSAs)

3. Registered Retirement Savings Plans (RRSP)

Each has a particular place for an investor depending on their time frames and investment needs.

They also provide differing treatments for the two key components of dividend investing: capital

gains and dividends.

Capital gains are generated whenever an equity is sold for more than it was bought for.

Likewise, if an equity is sold for less than your purchase price, a capital loss is generated. The

formula for this is the Proceeds of Disposition (sale price) less the Adjusted Cost Base (purchase

price). Currently, any gains or losses are included in your tax return at a 50% inclusion rate, i.e.

if you make a $200 capital gain, you only pay tax at your marginal rate on $100 (50% x$200).

In layman’s terms, the Adjusted Cost Base (ACB) is the cost to acquire your lot of shares at the

current exchange rate at the time of purchase plus any brokerage costs associated with

acquiring the equity. This is calculated for each individual share an investor owns.

If you purchase the same equity at different times for different prices, the total number of

shares is added up with your total expense to give an average cost per share. This serves as your

cost base. Specifically for foreign shares, the prevailing interest rate at the time of purchase

(usually this will be set by your brokerage firm) is used to set the ACB.

U.S. Dividend Stock Investing for Canadian Investors

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Likewise, the Proceeds of Disposition (Proceeds) takes the share price you receive multiplied by

the number of shares sold, less any brokerage costs associated with selling the shares. When

shares are denominated in a foreign currency, the prevailing exchange rate in effect at the time

is applied to the sale price by the brokerage house. This will be included in any confirmation of

your trade.

Your capital gain or loss is the difference between your Proceeds and your ACB. This is only

triggered on the actual sale of an equity; there are no deemed gains if you have a large gain but

have not realized it through the sale of shares. As part of your gains/losses, you will have a

foreign exchange component that is built in to the translation of your capital gains into

Canadian currency.

Most dividends from foreign companies (non-Canadian) will be received and translated by the

brokerage house into Canadian currency at the time of record. If you happen to have a foreign

currency denominated account (i.e. USD), it is permissible to apply an average foreign exchange

rate to the total dividends received over the course of a year; these can be found on the Bank of

Canada website. In this case, the home currency of the dividend received is not converted as it is

stored in that currency. There is a withholding tax rate of 15% that is applicable to dividends

received by Canadians on US securities. Although the withholding tax will be deducted at source,

Canadians are able to apply them as a tax credit when they file their annual tax returns.

The choice of which accounts you should use when purchasing US-based dividend stock depends

on your time frame, cash flow requirements and your aversion to taxes, even if they are

temporary.

Standard Investment Account. If you need the funds you are investing in to be liquid, this is the best option as there are no

restrictions to returning your capital to you should you need it. However, it is also the least tax

advantaged. Any net capital gains will be taxed at a 50% inclusion rate. Additionally, the

dividends received will also be subject to the 15% withholding tax I mentioned earlier. This

account will also create the most headaches for you come tax time.

Brokerages are required to send a form summarizing any income earned from these accounts

each year to the account holder; this is called a T5 form and is to be used when filing yourtaxes.

These are most often issued in the underlying currency of the trade, potentially requiring you to

convert it in to Canadian dollars. Brokerages will also send you an activity report of any share

sales or purchases during the year. However, it is incumbent upon the taxpayer to calculate his

or her capital gains/losses during the year and to report it on their tax return.

Tax-Free Savings Accounts. TFSA’s are almost as liquid as investment accounts. Per the Canada Revenue Agency (CRA),

starting from their creation in 2009, taxpayers were permitted to contribute $5,000 CAD

annually for the tax years 2009 to 2012, $5,500 in 2013 and 2014 and $10,000 in 2015. The new

U.S. Dividend Stock Investing for Canadian Investors

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Prime Minister Justin Trudeau has indicated it is likely this will be rolled back to $5,500 in 2016

and indexed to inflation after this, though this has not yet been passed in to law.

For the average investor, though, this means they can contribute up to $41,000 total into a

TFSA, which can then grow its capital gains and income tax free. However, most notably is

should you require these funds back, you can pull an amount up to what you have contributed

out without paying tax; any gains or income accrued remains sheltered from tax until they are

pulled out beyond the contribution limit. There are some restrictions if you pull out and re-

contribute in the same year though; please consult the CRA website if you have any further

concerns.

This means your capital gains on share transactions are sheltered from tax until you start to pull

money out of the account. However, withholding tax still applied on dividends received from US

based corporations. And, unlike the regular brokerage accounts, no tax credit is given for the

amounts deducted. This is a very large negative for holding dividend-paying securities in a TFSA

vehicle. If you choose to do so, you will need to factor in a realization of only 85% of the stated

dividends.

For those with young children, there is a similar type savings vehicle called the Registered

Education Savings Plan (RESP) . This has most of the same properties of a TFSA in that any gains

and dividends are held tax free; however, for US dividends, withholding tax is applied at a 15%

rate and is non-recoverable. There can be additional issues surrounding delayed withdrawal or if

the funds are never used for post-secondary education.

Registered Retirement Savings Accounts. RRSPs have been a very lucrative retirement vehicle for Canadians – any contributions are

deductible against income (subject to certain maximums), all capital gains and dividends growth

tax-free until retirement. Additionally, due to a tax treaty with the US, no withholding tax is held

back on dividends received from US companies when held within an RRSP. However, these are

also the most illiquid funds; if you need to withdraw the funds held in these accounts prior to

retirement, you are subject to a withholding tax (this time to the Canadian government) of up to

30%, depending on the amount withdrawn. This is clearly the most tax advantaged account type,

but it is also the most illiquid.

Please note that the above rules do NOT apply to the Master Limited Partnership (MLP)

corporate structure that has gained favor in the United States over the last several years. MLPs

are currently subject to a 35% withholding tax for Canadian investors, which is not recoverable

in any of the accounts I have noted above. As a result, this significantly impairs their utility as an

investment option for Canadians.

In summary, if you are considering investments in US dividend paying-stocks, you need to both

consider your time frame for the funds you are investing as well as the tax implications since the

three main accounts:

U.S. Dividend Stock Investing for Canadian Investors

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Standard Brokerage Account Pro: Most liquid of all investment accounts

Con: Most tax disadvantaged (all capital gains and dividends are taxable), Withholding Tax on

Foreign dividends is incurred but is recoverable as a tax credit

Overall assessment: If you could need quick access to your funds, this is the best vehicle for

accumulating US-based dividends.

TFSA Pro: Contributions can be accessed easily, with some contribution limits that are impacted in

the current year of withdrawal, capital gains and dividends are tax sheltered from income tax

Con: Withholding tax is applied to US-based dividends and is not recoverable, impairing your

potential return.

Overall assessment: Due to the permanent impairment of your potential return on dividends, if

possible, avoid purchasing US dividend-paying stocks in a TFSA.

RRSP

Pro: All capital gains and dividends are sheltered from tax, no withholding tax is applied to

dividends from US-based equities

Con: Funds are the most illiquid as RRSPs are designed to facilitate retirement savings.

Overall Assessment: If you have a long investing timeframe, RRSPs are the best type of account

to hold US-based dividend paying stocks.

Most brokerages offer these options when you are applying to open a brokerage account, either

self-directed or with a broker so please consider the types of investments you may wish to hold

as well as your overall investing goal when you set up your account.

About the Author:

Dan Stringer, CGA, CPA is a controller with an aerospace company, responsible for tax filings, tax

audits and tax planning. He is a regular contributor at Seeking Alpha, specializing in small and

micro-cap companies and helps manage the portfolio of his family office. If you have any

questions or comments, you can reach him at djstringer1974@gmail.com.

Note: in the next section we’ll go over three of my top recommendations for Canadian investors

to consider if just starting out with The Dividend Hunter.

-- Tim

U.S. Dividend Stock Investing for Canadian Investors

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Main Street Capitol

I added Main Street Capital Corp (NYSE:

MAIN) as a Dividend Hunter

recommendation for the July 2014 issue of

the newsletter. Since that time, the monthly

dividend paid by MAIN has been increased

three times, and three special dividends

have been declared. It is time to re-review

this best in class business development company (BDC).

Legally, a BDC is a closed-end investment company, similar to closed-end mutual funds (CEF).

The difference is that a CEF owns stock shares and bonds, while a BDC makes direct investments

into its client companies. A BDC will have hundreds of outstanding investments to spread the

risk across many small companies. The client companies/borrowers of a BDC will be corporations

that are too small or too new to be able to issue stock or bonds into the publicly traded markets.

As a risk control factor, BDCs are limited to leverage of no more than one times its equity. This

means that if a BDC has $500 million of equity raised from selling shares, it can borrow another

$500 million. The company can then make $1 billion of loans or equity investment.

Main Street Capital Stands Apart

Our BDC portfolio selection, Main Street Capital Corp. (NYSE: MAIN), really is quite different

from the rest of the BDC crowd. Since its 2007 IPO, MAIN has more than quadrupled the total

return of a BDC index. Here is a list of some of the reasons why this company is different than

most of its BDC peers:

Main Street Capital Corp. (NYSE: MAIN)

http://www.mainstcapital.com/

Last: $37.00

Dividend & Yield: $2.22 (5.98%) Market

Sector: Diversified Investments

U.S. Dividend Stock Investing for Canadian Investors

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• MAIN is internally managed with insiders owning about 2.9 million shares. Co-founder,

Chairman and CEO Vince Foster is the single largest individual shareholder. Main Street

is the most conservatively managed company in the BDC sector. Here are some of the

factors that set the company apart:

• An investment grade BBB credit rating. Investment grade is rare among the BDC crowd

and allows Main Street to borrow at a much lower cost of capital compared to its peers.

• Operating, admin and management costs are 1.4% of assets compared to 3.4% for the

average BDC and 2.7% for commercial banks.

• Net debt is just 0.68 times company NAV

• The share price is about 1.5 times the book or NAV value. The premium to NAV allows

MAIN to issue new shares and put the capital to work with earnings that are

immediately accretive to the per share value.

MAIN uses a unique two tier approach to its portfolio. This strategy allows Main Street to

generate a high level of interest income and also capital gains from equity investments.

In the middle market, MAIN provides debt financing to companies with stable finances and low

risk of default. Currently Main Street has 81 middle market clients with an average loan amount

of $8.1 million. The loans total over $630 million or about 33% of MAIN's total portfolio. Middle

market loans are floating rate, and matched with MAIN's floating rate debt facility. The average

8.4% yield on this group of loans is 5% higher than Main Street's debt used to fund the

U.S. Dividend Stock Investing for Canadian Investors

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loans to clients. The 5% interest margin is almost pure cash flow that can be used to help pay

dividends on MAIN's stock shares.

In the lower middle market, the company takes equity stakes along with providing debt

financing. The equity provides a significant boost to the total returns generated. Lower middle

market companies are smaller than the typical BDC client. These are companies with annual

revenues between $10 and $150 million and there are over 175,000 of these companies in the

U.S. Currently MAIN has 71 lower middle market clients with loans and equity investments

worth about $830 million. Seventy percent of the investments are loans with an average yield

of 12.5%. The 30% equity position gives an average 36% ownership of the client companies.

The equity stakes are what have allowed the MAIN NAV to increase by almost 60% since the

2007 IPO.

Core Income Holding Investment

The lower middle market client and middle market client mix provides a combination of net

interest income to support MAIN's very excellent history of dividend payments. The result has

been a BDC that has generated both regular dividend growth for investors and special dividends

to pay out capital gains. As an additional bonus, MAIN pays monthly dividends, smoothing out

the cash flow into your brokerage account. To illustrate, this chart shows the historical dividend

payments to MAIN shareholders:

U.S. Dividend Stock Investing for Canadian Investors

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In August 2015, the monthly dividend was increased a second time by 1/2 cent to $0.18, and

then again in September of 2016, the dividend was increased to $0.185 a month. This dividend

rate is 2.7% higher than a year ago. At $37 per share, MAIN currently yields 5.94%.

Also, the company has been paying a special dividend twice a year to pay out some of the profits

from the lower middle market equity investments. Over the last year, the two payments have

totaled $0.55 per share, bringing the total yield to over 8%.

MAIN generates a significant cash flow cushion to cover the dividends to be paid. This is a very

important factor for us when considering which stocks to add to the portfolio. As of December

31st, 2016, the distributable net investment income was $2.37 per share. This is interest income

only, no capital gains, and provides 1.10 times coverage for the monthly dividend. The high

share price to book value ratio (a little over 1.5 times) for Main Street allows the company to sell

shares and generate an immediate positive result for investors. This capital can then be put to

work to generate a growing cash flow stream to support future dividend increases.

Recommendation: MAIN should be a core holding for any income focused investor. Establish

an initial position and be ready to add shares during market corrections such as what occurred

in January to February of 2016.

U.S. Dividend Stock Investing for Canadian Investors

Ship Finance International

Ship Finance International Limited (NYSE: SFL) was

one of the original recommended investments when

we launched The Dividend Hunter in July 2014. It

remains as a core investment holding to provide both

a high current yield and a growing dividend stream.

For a stock that has increased its dividend rate in each

of the last four quarters, SFL still yields right

around 12%. That high yield shows that the market has plenty of fears about Ship Finance being

able to sustain the dividend, despite the regular dividend increases. I want to show you what I

look at to analyze the company and its ability to continue to pay and grow the dividend.

I have been following SFL since soon after it was spun off by Frontline Ltd. (NYSE: FRO) in

January 2004. The market has always priced the company like it was exposed to shipping rates,

instead of like the very conservative financing company that it is. That lack of understanding is

to our benefit, in the form of the high yield and growing dividends. Since I am familiar with the

company, I keep an eye on a few items from each quarterly earnings release. The most

important is this cash flow chart published in each earnings presentation.

Ship Finance International Limited

(NYSE: SFL)

http://www.shipfinance.bm/

Last: $14.85

Dividend & Yield: $1.80 (12.24%)

Market Sector: Shipping

U.S. Dividend Stock Investing for Canadian Investors

This chart shows what Ship Finance did with its cash flow for the trailing 12 months. The far-

right column, which the company calls Distributable Cash, is the free cash flow that is available

to pay dividends. Ship Finance generated $268 million in cash flow. Dividends of $1.80 per share

were paid and there were about 93.5 million shares outstanding. Total dividends paid were

about $168 million, which means the company generated cash flow that was over 1.5 times the

dividends.

I also like the fact that Ship Finance aggressively pays down its debt, as indicated by the $187

million of loan amortization. Many high-yield companies just continue to refinance and add debt

as they growth their businesses. The pay down of debt by Ship Finance gives the company more

flexibility and the ability to take advantage of disruptions in the shipping markets.

Here is a similar chart from a two years earlier:

The cash flow available for distribution has increased by 31% over the last year and a half. In

comparison, the dividend has been increased by less than 10% and the share count has not

U.S. Dividend Stock Investing for Canadian Investors

increased. The company's financials are steadily getting stronger, with cash flow to pay

dividends and excess cash flow to help pay for new assets that will continue to grow revenue

and cash flow.

If you are at all familiar SFL, you know the stock is volatile and all kinds of news can affect the

share price. What I have shown here is that the important news, actual financial results,

handily support the dividend with lots of potential for future dividend increases. Management

has indicated they would like to keep growing the dividend rate. It appears that those hopes

will eventually become facts and grow the income stream into our brokerage accounts.

Ship Finance is a buy/add recommendation as long as the share price is below $16. Watch for

dips in the price to add to your SFL position.

U.S. Dividend Stock Investing for Canadian Investors

Reaves Utility Income Fund

For a variety of reasons, the universe of higher

yielding stocks is primarily focused on the finance,

commercial property, and energy infrastructure

economic sectors. Most of The Dividend Hunter

recommendations are out of these sectors. Because

of this, I am always on the lookout for higher yield

investments that will diversify the portfolio holdings

across additional economic sectors.

U.S. based utility companies have long been viewed as safe-haven dividend stocks. These are the

highly regulated companies that provide electric power, natural gas, and water to homes and

commercial customers. The regulatory agencies approve the rates that utility charges. Rates are

set so that the utility can cover the infrastructure spending to maintain and upgrade its assets

and then earn a fixed rate of return above the necessary capital spending. The locked in

regulated profit margins gives a high level of cash flow predictability. As a result, utility stocks are

favored as steady and moderate growth dividend payers.

I have not previously included any utility focused investments in The Dividend Hunter

recommendations because yields have been low compared to stocks out of the other sectors.

For example, the Utilities Select Sector SPDR ETF (NYSE: XLU) yields about 3.37%, below my

Dividend Hunter usual minimum of 4%. So I was pleased to discover the Reaves Utility Income

Fund (NYSE: UTG), which gives utility sector exposure and a current 6% yield.

The S&P utility sector makes up just over 3% of the S&P 500 universe. There are about 80 listed

U.S. based utility companies. As I noted earlier, the utility sector is also highly regulated by both

Reaves Utility Income Fund (NYSE:

UTG)

http://www.utilityincomefund.com/

Last: $33.35

Dividend & Yield: $1.92 (6.18%)

Market Sector: Utilities

U.S. Dividend Stock Investing for Canadian Investors

the states and the federal government. As a result, the sector is not glamorous, with few

examples of out-performance, or crashing and burning. The sector has been much less volatile

than the overall market, with Yahoo! Finance showing 3 and 5-year beta statistics of 0.37 and

0.19, respectively. From Investopedia, the explanation of beta:

"Beta is calculated using regression analysis, and you can think of beta as the tendency

of a security's returns to respond to swings in the market. A beta of 1 indicates that the

security's price will move with the market. A beta of less than 1 means that the security

will be less volatile than the market. A beta of greater than 1 indicates that the

security's price will be more volatile than the market. For example, if a stock's beta is

1.2, it's theoretically 20% more volatile than the market."

Reaves Asset Management

Reaves has about $2.7 billion of assets under management. The company was formed in 1961

and has performance results going back to the 1970's. Services include separately managed

accounts, a utilities and energy infrastructure mutual fund, and utilities focused ETF and a

closed-end fund, the Reaves Utility Income Fund.

The company uses a bottom up investment approach built on long-term and ongoing

relationships with utility management teams and with the regulators. I recently interviewed one

of the portfolio managers at Reaves, Jay Rhame, and he noted that the Reaves Jersey City offices

are on the route from Wall Street to the Newark International Airport. Utility company

management teams make sure they include a stop at the Reaves location when they visit New

York City to pitch their companies to the big Wall Street firms. With its sole focus on the utility

sector, Reaves has a very deep understanding of the operations and financial results of all the

companies in the group.

The Fund

As of the end of April 2016, UTG held positions in 62 different stocks. About 45% of the

portfolio is traditional electricity, gas and water utilities. The fund also owns telecom stocks like

AT&T, media companies like Time Warner Cable, and energy and utility infrastructure companies

as smaller percentages of the portfolio. As is typical for a closed-end fund, UTG uses a moderate

amount of leverage to increase its dividend cash flow. As of October 31st, 2016 leverage is at

28.66%. In dollar terms, the fund has an asset capitalization of $807 million and the leverage

allows it to own $1.12 billion of assets.

Some closed-end funds trade at significant discounts or premiums to their net asset value (NAV)

which is the total fund assets divided by number of shares. Over the last 52 weeks, the average

discount for UGT was 3.76% and the current (as of 01/26/2016) (potentially 7.8 %as of

10/31/17) discount is 9.3%. These are quite small discount numbers compared to the closed-

end fund averages. The current higher than average discount makes UTG shares an even more

compelling purchase.

U.S. Dividend Stock Investing for Canadian Investors

Investment Results

UTG launched in February 2004 and the fund has paid a dividend every month since. Yes, this is a

monthly dividend investment. The dividend has never been reduced and has been increased

eight times in the last 11 years. The UTG dividends have always been 100% income without any

return-of-capital– a tactic some closed-end funds use to support dividends that really have not

been earned by the portfolio.

The bottom line with UTG is that you get a conservatively and expertly managed utility stock

focused fund. Currently the yield is 6.18% with low to moderate dividend growth potential and

monthly dividends.

Recommendation: Buy and accumulate UTG as long as the yield is above 6.5%.

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