Passive income, personal finance and fintech.
My portfolio is subject to two tax models with quite a different effective tax rate. My stock screening is therefore heavily influenced by which tax model is in effect, and in this article I will explain the difference between them.
The default tax rate
We'll start off with the most common tax rate, which states that capital gains and dividends received are taxed at 25%. But any source tax from foreign states can be deducted before taxation in Norway. The effective tax rate will therefore always be 25% within this model.
The tax exemption model
Now to the good stuff. With some exceptions, the dividends I receive from companies headquartered in the European Economic Area (EEA) are close to tax free. The model states that you only need to pay 3% of the calculated tax on received dividends, and 0% of capital gains. The effective tax rate on dividends received therefore becomes:
Effective tax rate = 25% * 3% = 0.75%
The following example illustrates the different after-tax values I receive from stocks inside and outside the EEA, and why the effective tax rate needs to be considered when screening for new investments.
Dividend received outside EEA: $100 * (1 - 25%) = $75
Dividend received inside EEA: $100 * (1 - 0.075%) = $99.25
To be indifferent between the two alternatives, the dividends received from outside the EEA needs to be 32.33% ($132.33 * 75% = $99.25) higher than within the EEA.
Due to this, a stock from outside the EEA will only fit in my portfolio due to diversification needs, or if the expected yield is 32.33% greater than the peers inside the EEA.
Return of paid in capital
A quick note on classification of dividends: Some companies classifies the dividends as return of paid in capital. This drops the tax rate on the dividends received to 0%, but increased the taxable capital gains in the future. For simplicity I therefore state the effective tax rate for these companies equals the tax rate on capital gains (0% and 25%).