Stocks, Bonds etc. -> Investing Tax Issues -> Exchange-traded funds (ETFs)
Tax Treatment of Income From Investments in Exchange-Traded Funds (ETFs)
This information is regarding investments which are held outside of RRSPs or other registered accounts.
ETFs are funds whose goal is to achieve the same return as a stock index. The MER, or management expense ratio for ETFs is much lower than for mutual funds, and there are no front end or back end loads (fees) for ETFs. They are traded like a stock, with brokerage commissions paid on the purchase and sale. There are many types of exchange traded funds available, such as SPDRs (Standard & Poor Depository Receipts, also know as Spiders), iShares (Canadian and US), Diamonds, and others.
Distributions made by foreign ETFs to Canadian shareholders are usually considered foreign dividends, 100% taxable. When distributions from US ETFs are categorized as capital gains or return of capital for US taxpayers, they will still be considered fully taxable to Canadian taxpayers. See the 2012 Tax Court Case Schmidt v. The Queen.
Distributions made by Canadian ETFs to shareholders can consist of
The distributions that are declared may not necessarily be paid to shareholders. Part or all of the distribution may be reinvested, not paid in cash. The amount of the reinvested distribution is added by the shareholder to the adjusted cost base of the shares in the ETF.
Distribution and tax information for exchange-traded funds can usually be found on the websites of the companies providing the ETFs. However, the tax information is not usually available until after the end of the year.
When shares in ETFs are sold, the resulting gain or loss is a capital gain or loss.
If shares are sold at a loss, and then repurchased within 30 days by you, your spouse, or certain other persons affiliated with you, this is considered a superficial loss, and may not be deducted from income.
US estate tax may be payable by Canadian residents on US assets owned at the time of death, including shares in US corporations. We have been unable to confirm if investments in foreign ETFs traded on US stock exchanges would be subject to US estate tax.
If a US ETF is a partnership or an S-corporation which "flows through" income, losses and deductions to partners or shareholders, even a Canadian may be issued a Schedule K-1, which may require the Canadian investor to file a US 1040-NR (non-resident) federal tax return, and possibly a state tax return. The US Internal Revenue Service (IRS) 1040-NR instructions indicate there are exceptions to this requirement, at least for the federal return. If you have received a Schedule K-1, it is best to get professional tax advice. If you're considering investing in a US investment which is a "flow-through" type investment, get professional advice on the US and Canadian tax consequences first.
Tax Tip: Exercise caution when investing in foreign ETFs - best to stay with those holding common shares!
If you hold Canadian ETFs in a non-registered account, you must keep track of your adjusted cost base (ACB) for each ETF. The ACB of your investment in an ETF will be the total of:
For accounting purposes, when you increase the ACB of your investment for reinvested distributions, the entry is debit asset, credit income. For instance, if the total taxable distribution is $5, with $4 actually paid and $1 being reinvested, the entry to record the $5 would be to credit income (increase income) $5, debit cash (increase cash) $4, and debit investment ACB (increase ACB) $1.
If the ETF had a return of capital (ROC), this amount will be shown on your T3, and will not be included in income, but is part of that total cash distribution. If you use software to track your dividends and other investment income, you will have recorded the cash amounts received as income already. Once you get your T3 and know the ROC amount, you can make an adjustment to reduce the recorded income and reduce the ACB of the ETF.
If the total return of capital amounts eventually reduce the adjusted cost base of the investment to a negative amount, this negative amount is reported as a capital gain by the investor.
When you sell some or all of your shares, your capital gain or loss is:
There are online services available that can help you track the ACB of your investments. One such service is AdjustedCostBase.ca, another is ACBTracking.ca. We have not used these services, so cannot advise as to how well they work.
When mutual funds or exchange traded funds are purchased with borrowed funds, any return of capital should be used to pay down the debt or purchase other investments for which the interest would be tax deductible. If the funds from return of capital are used for personal purposes, the interest on this amount is no longer deductible. The return of capital is a reduction of adjusted cost base, which means that the investor no longer has as much money invested. When this happens, the Tax Court has ruled, in Van Steenis v. The Queen, 2018 TCC 78, that there is no longer a direct link between the borrowed funds and the investment in mutual funds. See our article on interest expense on funds used to purchase investments.
You might not know that an ETF has "paid" reinvested distributions unless you do some checking. Reinvested distributions are different with an ETF than with a mutual fund. When distributions of a mutual fund are reinvested, the number of units you own increases. Not so with an ETF.
The amount of reinvested distributions from an ETF are not identified separately in a box on your T3, but the reinvested distribution per share might be detailed in the footnotes box, or on your T3 summary as a non-cash distribution. Reinvested capital gains distributions will be included as capital gains on your T3, but a portion of the capital gains reported on the T3 may have been part of a cash payment.
In order to determine the amount to use to increase your ACB, and thus reduce future capital gains, you may have to check the website of the ETF provider. In the distributions detail for the ETF, it will show the reinvested amount per share. Multiply this by the number of shares owned at the end of the year to determine the amount by which to increase your ACB.
Another thing that can be done is to compare the total of distributions that you were actually paid to the total of distributions shown on your T3. When totaling the distributions from the T3, include the actual amount of dividends, not the taxable amount. Keep in mind that a distribution that you received in January of 2018 may be included in the T3 income for 2017, because it was recorded by the ETF in December. Any difference should match the total calculated using the reinvested amount per share from the ETF provider's website. You may have to do some digging on the website of the ETF to find the needed information. iShares issued a pdf document in December 2017 which provided the information on reinvested capital gains distributions for all iShares for 2017. These reinvested capital gains distributions are included in the amount capital gains in box 21 on the T3 slip. To find the press release on iShares reinvested distributions on the BlackRock website, go to their Resources page and choose Press Releases. Information on the breakdown of distributions for iShares ETFs into different tax categories, including reinvested distributions, is available on the BlackRock Tax Information Centre.
How Are Brokerages Reporting Reinvested Distributions from Canadian ETFs?
It appears at least some brokerages are providing more information so that investors can more easily determine the amount of the ACB adjustment from reinvested distributions.
In a TD Direct Investing account, "in and out" transactions were shown in activity for March 2016 for the amount of the 2015 reinvested capital gains distributions from a particular iShares ETF. The transactions showed a "trade date" (actually the date posted) of March 15, 2016 and a settlement date of January 8, 2016. There was an increase in the cash for "CG Div", and then a reduction in the cash for "DRIP" (dividend reinvestment). This is the amount that has to be used to increase your ACB for 2015, and it will be included in the capital gains shown on your 2015 T3. The TD Direct Investing T3 Trust Income Summary did not reference the non-cash distribution separately.
In another brokerage's account, a corporate account holding the same iShares ETF did not have these transactions shown (as of March 30, 2016). However, the T3 for this account showed the amount of per share non-cash distributions as a footnote on the Trust Income Summary.
We'd be interested in hearing from other holders of ETFs as to whether more information was provided this year for their reinvested capital gains - let us know the type of ETF, your brokerage, and whether they showed a transaction in your account, or provided information on your T3 or on your T3 summary. See our Contact Us page for our contact email.
John Heinzl has 3 good articles on these "phantom distributions" in the Globe and Mail, the latest of which indicates that the cost basis on your account may be increased by your brokerage as a result of your reinvested distributions. This didn't happen in the corporate account mentioned above, so not all brokerages are doing this.
Example of ACB calculation for 1,000 shares of iShares S&P TSX Capped Composite Index Ticker XIC.TO
Note: The December 31, 2015 Return of Capital (ROC) and non-cash distribution for reinvested capital gains are related to a distribution on January 6, 2016. The total capital gain reported for XIC in box 21 of the T3 for 2015 is $0.4840 per share, or $$484.40 for 1,000 shares.
Tax Tip: Keep good records, and calculate the ACB of your Canadian ETFs after receiving your T3 each year.
For more information on ETFs, see the following web sites:
Revised: June 20, 2018
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