"In this world nothing can be said to be certain, except death and taxes."
Benjamin Franklin
If you are like us, cost-conscious and a non-US person, US-listed ETFs are probably a bad idea. A caveat to this is that we are by no means tax experts, but we do understand the enormous effect of cost on investment returns. For this reason, tax cannot be ignored.
Yes, they are liquid, "cheap", heavily marketed, used by robo-advisors all over the world, and in general great products... but not for non-US persons. This may strike you as a surprise, but there are taxes that simply cannot be ignored, changing the "cost" quite drastically, especially when the ETF invests in non-US assets.
1. First hidden cost on US-listed ETFs: Dividend withholding tax
Let's say you want to have exposure to emerging markets. The lowest cost, or "cheapest" exposure you can get is Vanguard's US-listed Vanguard FTSE Emerging Markets ETF (VWO), which has an expense ratio of 0.08%. Because of its popularity, VWO has gathered more than US$109.0 billion in assets, as of the end of 2024.
VWO also has a dividend yield of 2.55%, and therein lies the problem. As a Hong Kong-based investor with no US tax treaty, there is a dividend withholding tax of 30% levied at the fund level because it is a US-listed ETF, even though its underlying assets are not in the US.
Furthermore, if your country of residence does not have tax treaties with the underlying countries where these dividends are sourced, the effective dividend withholding tax on US-listed ETFs could be even higher – with underlying country tax plus the 30% US-imposed tax.
For reference, here is the list of countries that have tax treaties with Hong Kong, which may only get your tax down to 30% in the best case.
The “cheap” 0.08% expense ratio of the US-listed ETF has now grown to a cost of approximately 0.845%.
2. Second hidden cost on US-listed ETFs: Estate tax
That is not even the end of it. Let's say you are a Hong Kong investor who held a basket of US-listed ETFs before you passed on. No matter where those ETFs were invested, your US-listed assets (ETFs included), exempting the first US$60,000, would be legally subject to up to 40% draconian US estate tax.
As an example, if you lived in Hong Kong and had US$1,000,000 in a US-listed ETF that only invested in China, the estate tax will be applied to US$940,000, which can amount to US$376,000 of payable tax. That does not seem right at all.
How to reduce taxes when you invest in US securities through UCITS funds/ETFs
UCITS, or the Undertakings for Collective Investments in Transferable Securities, began in 1985 as a regulatory framework to make cross boarding distribution of investment funds in the EU and beyond compliant, transparent, and with stronger protections for investors.
Today, there are thousands of UCITS funds listed by global fund managers such as Vanguard, Dimensional Fund Advisors, Blackrock, PIMCO, and more, making their strategies available to global investors in a more tax efficient manner.
Sticking with the emerging markets example, Vanguard’s emerging markets UCITS ETF (VFEM/VFEG) has a cost of 0.22%. As compared to its US-listed ETF counterpart, they are far cheaper, taxes considered.
When investing in funds, there are three levels of taxes to consider:
- Fund domicile-level: Jurisdictions such as the US, UK, Germany, and Singapore charge business tax on capital gains at the fund manager level. In contrast, tax-neutral jurisdictions like the Cayman Islands, Jersey, Hong Kong, Switzerland, Luxembourg, and Ireland do not impose corporate income tax on capital gains for investment funds.
- Fund-level:US ETFs typically incur a 30% withholding tax on dividends (reduced by treaties, e.g., Singapore/Hong Kong), while Ireland-domiciled UCITS funds avoid local taxes but retain underlying country taxes (e.g., 15% on US stocks via the US-Ireland treaty).
- Investor-level: This is dependent on each investor's individual tax status, typically based on your country of residence. For individual investors in Singapore, this is zero.
Underlying US exposure in portfolios
At the end of the day, it may be hard to avoid owning any US-listed securities in your portfolio.
The US makes up over 60% of the MSCI All Countries World Index as of the end of 2024, which is one of the most widely used benchmarks for global equity portfolios.
The liquidity and depth of the US market may trump the potentially onerous tax obligations, but there are alternative structures such as UCITS funds and ETFs that you can consider to get the same US exposure in a more tax-efficient manner.
You may be forgiven for not knowing about the implications of US withholding tax like so many others. But, if some of your hard-earned savings are taken by the US tax authorities without you knowing it, then ignorance is definitely not bliss.
Read more:
- Beginners mistakes to avoid
- The power of diversification in investing
- Why unit trusts are great for passive index investing
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