News Analysis date published New: 
Wednesday, April 6, 2011 - 11:00

The Legal "Tax Loophole" for Income Investors

Wednesday, April 6, 2011 - 11:00am

Did you know the United States withholds a portion of dividends paid to many foreign investors?

This amount comes right off the top, before the payment even hits an investor's account. Even after this cut, the foreign investor will still have to pay taxes on what's left.

But the United States isn't just being greedy. Just about every nation does something similar.

Switzerland withholds up to 35% of dividends paid to foreign investors... Israel withholds up to 25%... Canada takes 15% off the top.

Typically the higher yields found abroad can make up the difference. For instance, the high yields on foreign utilities can still make them worthwhile to most investors, even with the withholding.

And truth be told, you can get this withheld money back. Investors filing for a foreign tax credit via IRS Form 1116 can reclaim foreign dividends withheld. But you won't receive this cash until you file your tax return, sometimes up to a year after the actual dividend has been paid.

But there's also a legal tax loophole you can use to your advantage. And it can mean more income in your pocket immediately, without the hassle of filing additional tax forms and waiting to get your money back.

A select cadre of ZERO-tax nations

For decades, the United States has wanted to attract foreign investment. Likewise, many countries crave American capital.

To promote mutual investment, the United States has signed tax treaties with about 50 countries that reduce the taxes withheld on your dividend payments.

While the treaty terms vary from nation to nation -- Switzerland, for example, withholds only 15% of dividends paid to U.S. investors -- there is a select cadre of nations where the dividend withholding tax is zero. Every cent paid by the foreign company makes it into your account.

In total, fewer than two dozen countries either have tax treaties with the United States that result in 0% withholding or simply don't withhold dividends paid to foreign investors. Of those, many are smaller nations that aren't exactly hotspots for income investing.

But there are a few gems that offer attractive dividends and zero withholding...

Brazil doesn't withhold a dime of dividend income. It's also one of the best growth stories in the world. And Brazilian stocks pay some of the world's highest dividend yields. In my High-Yield International portfolios, for instance, I hold a Brazilian power company yielding almost 7%. Meanwhile, Hong Kong, the gateway to investing in China, doesn't withhold any dividends either.

Action to Take --> Now I'm not saying to ignore any country that withholds dividends -- that would be like going to a restaurant and limiting yourself to only one side of the menu. There are simply too many attractive high yields out there, even if a little is taken off the top.

But if maximizing short-term income is your primary goal, then this "tax loophole" should be one of your favorite tools.

[Note: Right now 210 profitable companies yielding 12% or more are found abroad... versus 17 here in the United States. That's good news if you invest abroad. To help, I've put together a brief memo outlining some of the benefits of international high-yield investing. Be sure you don't miss it.]

Paul Tracy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.