Your original question was: "Why then, doesn't the SEC require that mutual funds that own foreign dividend-paying stocks report two expense ratios"
In order to call for the reporting of two different ERs, it was necessary for you to establish two points: that foreign taxes paid should be included in the ER reported, and that (given that taxes paid are included in the ER) that the reported amount of foreign taxes paid by the fund should be different depending on whether the owner holds the fund in a taxable or tax-deferred account.
Stated that way, the second part sounds silly. A fund pays the same amount of dollars per share (of given share class) in expenses independent of who owns it.
Regardless, all I needed to do to address your original question was demonstrate a problem with either of the two points (include taxes in ER, and report them two different ways). I spoke primarily to the latter, though I touched tangentially on the former.
You cited Schwab (presumably with approval), that said the difference between a taxable account and a tax-deferred account was merely a timing issue - that in the tax deferred account "there's no deduction or credit
currently available", but that nevertheless a foreign tax paid " reduces the amount of tax the IRS is able to collect
when you start making withdrawals."
I simply explained what you had cited as a reference. Suggestion for the future - if you doesn't agree with everything on a page provided as a reference, don't cite it, or say explicitly what you are citing it for. "Resource" opens the whole page up to use.
The posts tossed in a lot of extraneous items, some of which generated more heat than light. For example,
12b-
1 fees as the exemplar expense. Those fees come with a lot of baggage. You might have used almost any other fund expense instead.
Ideally, one might try to find another fund expense that closely resembled a foreign tax. I've an idea - how about a
domestic government assessment (tax or fee) paid by a fund? There's the
SEC Section 31 fee that brokers tack onto your sale of securities on an exchange. (It's that little fee, typically a few cents that you see on your sell trade confirms.)
Funds pay this government charge when they trade securities, so that's a similar expense. Oh wait, that isn't included in the ER either. Oh well :-)
Regarding the thesis that the "only case where it would be a 'timing issue' is the one where you paid taxes at a rate of
100% on the money withdrawn from the retirement account", it's easy enough to show that isn't correct.
We'll stay on point here and filter out as much noise as possible. We'll focus strictly comparing the impact of foreign taxes paid in a taxable account with their impact in an IRA by eliminating other sources of tax liability.
Assume that the original contribution was nondeductible (so that there's no tax due on the principal when withdrawn). Assume that all income generated by the fund comes in the form of nonqualified dividends (so the tax rate for the taxable and IRA accounts are the same). Assume no growth of principal. We'll assume that taxes are paid from another pocket, so that this extra cash doesn't clutter calculations either.
Getting back to my original example - in year
1, your investment earns dividends (after expenses other than foreign taxes) of $
1.
10. The investment pays $0.
10 in foreign taxes, and distributes $
1 in cash, while declaring that you have $
1.
10 in income. In year 2, assume no growth, no dividends. For our final assumption, we'll say that in year 2 you close out the IRA (and are over age 59.5 - no penalties).
Remember that I'm showing only that the result in the IRA is the same as taking a deduction (not a credit) in the taxable account.
Year
1:
Taxable account, have an extra $
1 nonqualified cash dividend in your account. You declare income of $
1.
10 and a deduction of $0.
10, for net taxable ordinary income of $0.025 (assuming 25% tax bracket).
IRA: You have an extra $
1 in your account.
Year 2:
Taxable account - no change. You have the extra $
1 in your taxable account, no taxes due.
IRA: No growth. You have your original post-tax investment and $
1 of increased value. You close your account. You owe ordinary income of $0.025 on that $
1 (which again comes from another pocket).
Same taxes owed. Just deferred a year. Timing.
---------------------------
The conceit is that the fund is a pass through entity. It passes some of the tax liability through to you. Notably, foreign taxes, but only sometimes. When it does, it is you not the fund paying the taxes. That happens by the fund giving you the full distribution (here $
1.
10), and then taking back the tax amount so that it can pay it
for you.
That's not an expense of the fund (i.e. one included in the calculation of fund income passed through to you). It's your expense. As the IRS
writes, "You can claim a credit only for foreign taxes that are imposed on
you".
For the IRA investor, that foreign tax is a fee like any other - a brokerage commission, a load, a redemption fee, etc. The investor gets to treat that foreign tax collected from the IRA the same way as any other expense incurred
by the IRA.
For the investor with a taxable account, the foreign tax is again an expense borne by the account, not by the fund. It is precisely because the investor (not the fund) is paying the tax that the investor gets to take a deduction or credit.
