How do I calculate the taxes for an ETF?

I live in Portugal and I am using DeGiro to buy the iShares Core S&P 500 (distributing), which is domiciled in Ireland. I am buying that ETF in XETRA, a German Exchange. Portugal has tax treaties with Germany, Ireland, the Netherlands and the US. Where do I pay taxes and how much I should pay?

Calculating taxes for ETFs in Europe can look a bit confusing since there are many countries involved in a single ETF transaction:

  • the domicile (i.e. “country”) of the underlying assets – For example, if you hold the iShares Core S&P 500 ETF. The ETF effectively buys shares from companies from the US.
  • the domicile of the ETF – the iShares Core S&P 500 ETF is domiciled in Ireland. Other popular domiciles in Europe include Luxembourg, France and Germany.
  • the domicile of the broker – Some investors have brokers which aren’t domiciled in their fiscal residency. For example, DeGiro is a Dutch broker.
  • the domicile of the exchange – UCITS ETFs are usually available through many stock exchanges so they can reach a wider audience. The iShares Core S&P 500 ETF (distributing) is listed in 5 different countries.
  • your fiscal residency – the country where you pay taxes.

Generally, in regards to securities taxation the only things that matter are the domicile of the security and the domicile of the owner of the security.

ETFs complicate this a bit because you are the owner of a security (i.e. an ETF) which in turn owns other securities (e.g. companies in the US) so, you end up having to consider the relationships of 3 countries instead of only 2. The following domiciles affect your taxes when holding ETFs:

  • The domicile of the underlying assets – The ETF will be paying these taxes directly and not you since the ETF is the entity effectively owning shares in the companies (e.g. Google). The existence of these taxes affects your returns though since you will receive the net amount. The existing tax treaties between the domicile of the ETF and the domicile of the underlying assets helps reduce the tax liabilities of the fund and increase your returns. This is often called Level 1 taxation.
  • The domicile of the ETF – When you invest in an Irish ETF you effectively own a share of an Irish entity. The tax treaties between your fiscal residency and the ETF will determine your tax liabilities. Some popular domiciles (e.g. Ireland, Luxembourg) don’t charge taxes to foreign investors on fund distributions and capital gains. This is often called Level 2 taxation.
  • Your fiscal residency – Most countries charge taxes on your worldwide income. For example, if you live in Portugal and hold an Irish ETF, you are liable for taxes in Portugal even though your income came through Ireland. This is often called Level 3 taxation.

Dividend taxes

Calculating dividend taxes tends to be the most complicated because dividend taxes are often withholding. That is, the countries of the security may charge dividend taxes directly when the interests are being paid meaning only the net amount is paid to the receiver.

Let’s go over a few examples to understand how dividend taxes may be calculated

Example 1

Fund: iShares Core S&P 500 ETF (distributing)
Domicile of the assets: US
Domicile of the ETF: Ireland
Fiscal Residency: Portugal

  • Level 1 Tax – The underlying assets are from the US. The ETF will pay dividend withholding tax of 15% due to a tax treaty between Ireland and the US (otherwise it would have been 30%). The investor receives only the net amount of the dividends after all taxes are paid.
  • Level 2 Tax – The ETF is domiciled in Ireland therefore the fund does not withhold dividend taxes for foreign investors.
  • Level 3 Tax – The investor would have to pay a dividend tax rate of 28% to Portugal.

Example 2

Fund: iShares Core S&P 500 ETF (accumulating)
Domicile of the assets: US
Domicile of the ETF: Ireland
Fiscal Residency: Portugal

  • Level 1 Tax – The underlying assets are from the US. The ETF will pay dividend withholding tax of 15% due to a tax treaty between Ireland and the US (otherwise it would have been 30%). The investor receives only the net amount of the dividends after all taxes are paid.
  • Level 2 Tax – The fund didn’t distribute any dividends so no dividend taxes are due to Ireland. Besides that, Ireland does not withhold taxes for foreign investors in Irish ETFs.
  • Level 3 Tax – The investor wouldn’t pay any taxes to Portugal since the fund didn’t distribute any dividends.

Example 3

Fund: SPDR S&P 500 ETF (SPY)
Domicile of the assets: US
Domicile of the ETF: US
Fiscal Residency: Portugal

  • Level 1 Tax – The fund and the assets are both from the US so, no dividend withholding taxes have to be paid by the fund.
  • Level 2 Tax – The investor would have to pay 15% in dividend withholding taxes (since the fund is domiciled in the US and the US and Portugal have a tax treaty)
  • Level 3 Tax – The investor would be able to deduct the 15% in taxes already withheld by the US in order to pay a total of 28% in dividend taxes (the investor would only pay the additional 13%). The main difference between this example and the others is that since the investor directly holds a fund domiciled in the US, they are the one paying the taxes to the US and can use that to reduce expenses in level 3 tax.

As the examples above show, there is some degree of dividend tax leakage in the Ireland domiciled fund when compared to the US fund. That is, in this example an investor ends up paying more taxes for holding an Ireland domiciled fund than an US domiciled fund due to the tax treaties between the investor’s country (i.e. Portugal) and the US. If the investor’s country didn’t have a tax treaty with the US it would have been more beneficial (from a dividend tax perspective) to hold an Ireland domiciled fund.

There are a large number of reasons to avoid US domiciled funds all together. But it is worth noting that the relative combinations of these countries of underlying assets, fund domicile and your fiscal residence affects your dividend returns.

Capital gains taxes

Capital gains are easier to calculate because they aren’t withheld in most jurisdictions.

An example:

Fund: iShares Core S&P 500 ETF (distributing)
Domicile of the assets: US
Domicile of the ETF: Ireland
Fiscal Residency: Portugal

  • Level 1 Tax – The underlying assets are from the US. No taxes would be withheld.
  • Level 2 Tax -Ireland does not charge foreign investors taxes on capital gains for Irish funds.
  • Level 3 Tax – The investor would have to pay a capital gains tax rate of 28%