What on Earth’s withholding tax? Why has no one told me about it before? WTF? These and other questions beginning with W bounced around my mind when I first discovered this mysterious cost of investing abroad.

The number of parties tapping your investments for a percentage is unending, up to and including shadowy foreign agencies (aka tax authorities).

Withholding tax is paid on income you’ve earned overseas. For investors in shares, equity funds, and ETFs, it can have an outsized impact on your dividend income, because it’s highly likely that you’re paying more tax than you should.

The amount taken varies:

• The United States takes 30%
• Switzerland relieves you of 35%
• France deducts anywhere from 12.8% to 25%

It gets worse. Once you’ve got that dividend income back to the UK, Her Majesty’s Revenue & Customs (HMRC) wants another piece of it to the tune of your UK dividend tax rate.

Even the taxman can see this double-tax whammy is unfair. But it’s up to you to do something about it, and that means understanding the system…

Claim back withholding tax

The US should only take 15% off your gross dividends, not 30%. That’s according to the Double Taxation Agreement (DTA) in force between the UK and Uncle Sam.

The UK has similar agreements with many other countries around the world, which theoretically reduce the amount of withholding tax UK investors pay to foreign powers.

I say theoretically, because you have to actively claim your 15% back from the US Internal Revenue Service (IRS). They don’t just hand it back with their compliments. Quelle surprise. The same goes for any other country that deducts withholding tax at a higher rate than agreed in the DTA. In most cases you shouldn’t be paying over 15%.

To reclaim or stop the deduction at source, you must fill in a tax form. Which form, how torturous it is, whom you send it to, and how often depends on the country you invest in. 

For the US, it’s a W-8BEN form. 

It’s basically a Kafka-esque labyrinth and the best advice is to find a broker who will handle the paperwork for you.

Get foreign tax credit relief

You can reduce the impact of withholding tax further by offsetting it against UK tax due on your foreign dividends.1

HMRC state in their foreign tax guidance:

You’ll get relief on the lower of:

• the foreign tax payable under the terms of the [double tax] agreement
• the amount of UK tax due

So in the case of US dividends, you can offset the 15% withholding tax you’ve already paid over there against the UK tax due:

• Basic-rate taxpayers – 8.25%, which won’t cover all your withholding tax liability.2

• Higher-rate taxpayers – liable for 33.75%/39.35% can offset the entire 15%.

You offset foreign withholding tax against UK tax by filling in a self-assessment tax return.

Two routes are open to you at this stage, one of which is far better than the other:

1. Deduction
2. Foreign tax credit relief

Whatever you do, choose foreign tax credit relief. Relief offsets your entire withholding tax payment against your UK tax liability.

Deduction only reduces the amount of taxable income. It’s far less cost-effective, although it may be the only option available in a few cases.

If your investments are shielded from UK tax by an ISA/SIPP then there’s no need to claim the foreign tax credit relief.

Beware that ISAs don’t protect you from withholding tax. The IRS and their ilk don’t give two hoots for subtleties like that.

Avoid the whole palaver

SIPPs qualify for a zero rate of withholding tax from certain countries including the US.

However, not all brokers structure their SIPPs to enjoy this freebie so check with your broker first if the extra 15% off is a deal-breaker.

ETF and fund investors can also duck withholding tax on their dividends by investing in the right funds.

Funds/ETFs domiciled in Ireland and Luxembourg do not levy withholding tax on dividends paid to UK investors. You only pay regular UK rates of tax, or nothing at all if your investment is tucked away in an ISA or SIPP.

Most of the market-leading trackers available to UK passive investors are based in Ireland, Luxembourg or the UK. Watch out for the occasional ETF based in France or another more taxing territory. 

Any index tracker worth its salt will tell you where it’s domiciled on its webpage or factsheet. 

Say no to withholding tax

Interrogate your dividend statements to find out if you’ve paid too much withholding tax. You can find out the rate you should have paid by checking an individual country’s DTA with the UK.

• If you’ve overpaid, then get your broker onto the refund case.
• If you’re thinking of diversifying into foreign shares or funds, then check the withholding tax rate that applies.
• Choose a broker who will handle the recovery paperwork for you or offers a SIPP that pays US dividends gross of tax.
• Plump for UCITS funds domiciled in countries that don’t charge withholding tax.
• ISAs and fund reporting status are no defense against withholding tax.

That ends another broadcast against the evils of hidden costs.

Take it steady,

The Accumulator

1. This only applies to countries that have a Double Tax Agreement with the UK. Even then, there are a few exceptions. [↩]
2. Doesn’t apply to all countries, or to funds 60% invested in interest-bearing assets. Claim foreign tax credit relief to cover the few exceptions. [↩]

The US fund manager Peter Lynch may have been the best growth investor that ever lived. He was certainly their best writer.

Lynch wrote1 the classic One Up on Wall Street. It’s an insanely easy-to-read introduction to a style of investing that netted Lynch an average annual return of 29% over 13 years.

That’s enough to turn £1,000 into £27,000, incidentally. If only all fund managers delivered that kind of return, they’d be worth the fees!

Of course most don’t, which is why passive index funds are the best place for most investors’ money.

13 signs of a good share to buy

For those of us who actively speculate with some of our ill-gotten gains, however, following in Lynch’s footsteps is irresistible. Not just because of his track record, but because unlike Ben Graham or Walter Schloss, he makes investing sound so much darn fun!

Like all great growth investors (as opposed to those value curmudgeons) Lynch was an incurable optimist, prepared to suspend his disbelief to see how a company’s earnings could grow.

Key to this was developing a ‘story’ about a share – the elevator pitch for why Lynch had invested in it.

But companies always promise jam tomorrow, and Lynch’s method was hardly to go for the most exciting story in town. Rather, he looked for 13 attractive characteristics in a share, which he spelled out in a lovely chapter in One Up On Wall Street.

Re-reading it on a train trip to visit fellow Monevator writer The Accumulator recently, I decided it would be fun to rip off recall these 13 pointers, and to look for examples from the UK market today.

“When somebody says ‘Any idiot could run this joint,’ that’s a plus as far as I’m concerned, because sooner or later any idiot probably is going to be running it!” – Peter Lynch

1. It sound dull – or even better ridiculous

Lynch’s perfect company has a dopey name that stockbrokers are embarrassed to mention on CNBC: Bob Evans Farms, say, or the long forgotten Pep Boys – Manny, Joe, and Jack. Who would want to invest in that?

Good British equivalents include: UK Coal; M.P. Evans Group; and Shanks Group. Dullards all. Bad names belong to mining firm Xstrata, and ‘Essenta’ – the latest moniker for Goodfellas pizza maker Northern Foods.

2. It does something dull

One of my favourite UK listed companies is James Halstead. If the boring name doesn’t send you to sleep, its business will. James Halstead a world leader in vinyl flooring.

Zzzzz! But just look at the share price and dividend record…

Exciting companies blow up or get overhyped, or both. SuperGroup makes sexy men’s fashion AND has a sexy name, which is a dangerous combination.

3. It does something disagreeable

Lynch wouldn’t want to invest in Apple at $300 a share. Not because Apple isn’t a great company, but because who wouldn’t want to own a wonderful life-enhancing company like Apple? Who wouldn’t tell their friends? Who wouldn’t puff the price up even further?

Instead, Lynch says look for companies that do something disagreeable or possibly obscene. The aforementioned Shanks is in waste management. Condom maker SSL used to be a great one – and it had a dishwater dull name – but sadly Unilever recently snapped it up.

4. It’s a spin-off

Many great companies started life as spin-offs. So did loads of doomed companies, but any one tick on this checklist isn’t a reason to invest. You need a whole lot of ticks – plus good financials – to be confident.

Spin-offs are good for two main reasons: Firstly, they’re often well funded otherwise they can’t be spun away, and secondly they may do better outside of the dead hand of a bureaucracy.

Two that spring to mind in the UK are Autonomy spin-off Blinx and the stamp specialist Stanley Gibbons. Oh, and Carphone Warehouse is doing better since it was spun-off by Talk Talk, too. It’s got serious about retail, linking up with the mighty Best Buy here and in the US.

5. The institutions don’t own it, and the analysts don’t follow it

Pretty self-explanatory – if the City is already in love with your share, who is left to buy it?

Lots of tiny oil and mining companies used to fit into this category, but the past ten years has seen them outed. The neglected tech sector might be a better place to forage for forgotten companies today.

6. The rumours abound: It’s involved with toxic waste and/or the mafia

If your company really is messing with radioactive compost or the Mob, your investment is doomed. What Lynch is getting at here is that a slightly messy company with a bad reputation can sometimes trade far too cheaply out of fear. You’d buy it ahead of the restoration of its reputation.

B.P. is an obvious candidate – after the media firestorm that followed the oil leak, many fund managers dumped it to avoid tricky questions. Tobacco and even drug companies sometimes sit in this bracket.

My investment at the height of the credit crisis in Prodesse, a US mortgage investment trust, definitely involved an element of this.

7. There’s something depressing about it

Perhaps the best share in this category in the UK is Dignity. While its name is a bit too snappy, its business – selling coffins and burial costs up-front – isn’t anything a young Cityboy wants to think about.

I almost picked up these shares earlier in the year. On the numbers it looked great, but thoughts of the grave loomed large and I went for a walk in the sun with an ice cream instead. Worth thinking about.

8. It’s in a no-growth industry

Careful. The idea is not to invest in a doomed industry (there aren’t many whalebone processors left on the London Stock Exchange) but rather in a sector that isn’t going anywhere fast.

The reason? Smart kids from Harvard and Cambridge and Imperial and MIT all want to create the next Google or Twitter. They don’t want to launch the next Carrs Milling (grinds seed) or British American Tobacco (looks bad on your Guardian Soulmates profile).

With luck, your boring company will be left alone to quietly absorb competitors and grow in its stagnant pool for years to come.

9. It’s got a niche

Lynch’s niches aren’t the same thing as a ‘market position’. ARM designs chips, but so does Intel and Imagination Technologies and many more.

A better niche for Lynch is a gravel pit.

Sutton Harbour Group would pass his test. This company owns and operates Plymouth City Airport and Sutton Harbour, amongst other things. Nobody is going to be building rival airports or boatyards in Plymouth anytime soon.

10. People have to keep buying it

Think Diageo, Glaxo, Greggs, and British American Tobacco. They all make consumable products.

So does the aforementioned SuperGroup, but you don’t have to buy and wear t-shirts with made-up Japanese writing splashed on the front (at least not outside of certain Mancunian nightspots) so that’s not such a good ‘un on this measure, either.

The reason for preferring consumables companies is obvious – the customers have to come back for more, again and again. In contrast, I might only buy a new games console every five years – plenty of time for me to decide to buy a rival’s shiny one next time

11. It’s a user of technology

Lynch prefers companies that employ technology to make more money, as opposed to companies that merely make money from technology.

The smart application of technology has transformed supermarkets and banks and oil exploration and many more sectors. An awful lot of computer companies have gone bust along the way.

12. The insiders are buying

You can track directors’ share deals in newspapers like the Financial Times at the weekend, or via services like Digital Look.

If the company execs admire the company they run so much they’ll pony up to own more of it, that can be a good sign. They at least know whether they’re fibbing in the annual reports.

It’s not always a positive signal. Rok went bust, and key directors were buying just weeks before its demise! Poor judgment can extend from the boardroom to the broking account, it seems.

13. The company is buying back its own shares

Buybacks were rarer in Lynch’s day. Many company directors now routinely use company profits to buy and cancel the company’s own shares, as opposed to paying dividends. Buy backs are an easy way to boost earnings per share, and thus for directors to hit their targets and generate those lovely bonuses.

Share buy backs do suggest the company is throwing off cash, though, and may indicate the company is cheaply valued.

And there are certainly worse things a director can do with your money. BHP Billiton resumed a $13 billion buyback programme after abandoning an exceptionally expensive bid. Shareholders probably had a lucky escape!

Inspired by Peter Lynch’s thoughts on what to look for in a share? You really should buy One Up on Wall Street (US readers here).

1. Okay, and his ghost, John Rothchild [↩]

My weekly ramble, followed by some great links.

First up, the peerless Mike Piper of Oblivious Investor has a new book out! In Can I Retire?, Mike attempts to answer one of the big questions in one of the smallest books you can buy.

Actually, he breaks it down into two smaller questions:

1. How much money will you need to retire?
2. How should you manage your retirement portfolio to minimize the risk of outliving your money?

And in his usual inimitable style, Mike candidly pitches:

How does this book hope to be better than, for example, The Bogleheads’ Guide to Retirement Planning or Jim Otar’s Unveiling the Retirement Myth?

It doesn’t. It’s not better. It’s shorter.

Can I Retire? is written for the person who might not be able to find the time to read Otar’s entire 525-page book or the 370-page Bogleheads’ Guide.

If you’re one of my U.S. readers, you’ll be thrilled to hear that buying the book will cost you a mere $5!

Actually, it’ll only cost you $5 if you’re a UK reader, too, but the sections on Roth accounts and minimizing taxes won’t be much use when it comes to planning geriatric bliss on the Costa Blanca.

Not for the first time I’m wondering whether I should work with Mike to adapt the US-centric sections of his book for the UK, which is starved of easy-to-read money guides.

Now for something completely different

I suspect you’re one of the two million who’ve already seen this (and I don’t at all agree with our furry friend’s assessment) but this QE2 video is funny:

Quantitative easing has seldom been such a hoot (unless perhaps you’re the chap getting to spend the printed money…)

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