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Most publicly traded Canadian companies pay dividends that are eligible for the dividend tax credit. U.S. dividends, on the other hand, do not qualify for the DTC and are therefore taxed at the same rate as interest or other income.

Ryan Remiorz/The Canadian Press

If I have two companies that have the same dividend yield, but one company is Canadian and one is American, what is the after-tax return of the one versus the other? I'm pretty sure the Canadian stock would provide a better return than the U.S. stock, because Canadian dividends are taxed favourably. So why would anyone ever buy a U.S. stock that pays the same dividend?

There are a number of angles to explore here. Let's start with why someone would buy a U.S. stock that has the same pre-tax dividend yield as a Canadian stock.

First of all, it's important to realize that the dividend is only one component of a stock's total return. An investor might expect the U.S. company to deliver a higher capital gain than a Canadian company with the same yield. The investor might also expect the U.S. stock's dividend to grow at a faster rate.

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Looking at the current yield in isolation doesn't give you a complete picture of an investment's merits; a company that pays a 2-per-cent yield and has a dominant market position and excellent growth prospects might well be a better long-term investment than a company that pays a 5-per-cent yield but is losing market share in a highly competitive industry.

Why invest in the U.S. market? Well, the United States offers a much broader selection of companies, particularly global consumer, technology, health-care and industrial stocks that are under-represented in Canada. Another plus is that some of these U.S. companies have been raising their dividends for decades and will likely continue to announce annual increases.

Now to the tax consequences of Canadian and U.S. dividends.

Most publicly traded Canadian companies pay dividends that are eligible for the dividend tax credit. Thanks to the DTC (which I explained in a recent column), Canadian dividends are taxed at a substantially lower rate than interest or other income.

For example, an Ontario resident with $100,000 of income in 2015 would have a 25.38-per-cent marginal tax rate on eligible dividends, compared with 43.41 per cent on other income. An Ontario resident with $70,000 of income would pay tax of just 8.46 per cent on dividends, compared with 31.15 per cent on other income. And, at an income level of $44,701 or less in Ontario, the effective tax rate on eligible dividends is actually negative.

U.S. dividends do not qualify for the DTC and are therefore taxed at the same rate as interest or other income. What's more, in a non-registered account, U.S. dividends are subject to a 15-per-cent withholding tax, which will be deducted before the dividend lands in your account. In most cases, however, you can recoup this amount by claiming it as a foreign tax credit on your return.

The good news is that you can avoid tax on U.S. dividends by holding U.S. stocks in a retirement account such as a registered retirement savings plan (RRSP), registered retirement income fund (RRIF) or locked-in retirement account (LIRA). Because these accounts are for pension or retirement purposes, the U.S. income is exempt from withholding tax under the Canada-U.S. tax treaty. Tax only comes into play when you make withdrawals from these registered plans.

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You have to be careful, however. The exemption does not extend to tax-free savings accounts (TFSAs) or registered education savings plans (RESPs). If you hold U.S. stocks in these accounts the 15-per-cent withholding tax will still apply. What's more, you won't be able to claim it as a credit on your tax return. So, in general, RRSPs and other retirement accounts are a better place to hold U.S. dividend stocks.

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