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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, and are held in a Canadian brokerage or financial institution.

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.

For tax reporting, you'll receive a T5 slip from your Canadian brokerage for distributions from a foreign ETF held in your brokerage.  You'll receive a T3 slip for distributions from a Canadian ETF.  T5s must be issued by a brokerage by the end of February, but T3s have a deadline of March 31st.

Distributions made by foreign ETFs to Canadian taxpayers (those filing a Canadian tax return) are usually considered foreign dividends, 100% taxable.  This will be evident when reported on the T5 you receive from your Canadian brokerage.  While distributions from US ETFs are categorized as capital gains or return of capital for US taxpayers (those filing a US tax return), they will still be considered fully taxable to Canadian taxpayers.  See the 2012 Tax Court Case Schmidt v. The Queen. However, in this case the decision was based on the taxpayer not providing documentation for his position.  S. 90(1) of the Income Tax Act (ITA) provides that the amount of a dividend received from a non-resident corporation is to be included in income. In order for a distribution from a non-resident corporation to be considered a return of capital for Canadian tax purposes, and thus reduce ACB under s. 53(2)(b)(ii) of the ITA, the distribution would have to be considered a return of capital under corporate tax law and not US tax law. See Tax Interpretation 9711965 from 1997.

Distributions made by Canadian ETFs to shareholders can consist of

bullet Canadian dividends eligible for dividend tax credit
bullet capital gains, only 50% taxable
bullet return of capital - this amount is not taxable, but reduces the adjusted cost base of shares
bulletreinvested distributions - taxable, but not received in cash, increases the adjusted cost base
bullet other income, 100% taxable
bullet foreign income, 100% taxable
bullet reduction re foreign income tax withheld

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.

Ownership of some US ETFs may require a US tax return to be filed

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!

How do I calculate the adjusted cost base (ACB) and capital gain when I sell my Canadian ETFs?

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:

  1. the total that you paid to purchase your shares, including any commission,
  2. plus the amount of all reinvested distributions or dividends,
  3. less the "return of capital" (ROC) component of any distributions,
  4. less the ACB of any previously sold shares.

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:

bullet the net proceeds received, after commissions or fees,
bullet less the ACB of the shares sold  (=ACB of total shares x # of shares sold divided by total # of shares prior to sale)

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.

ETFs Purchased With Borrowed Funds - Return of Capital

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.

Reinvested Distributions from Canadian ETFs

You might not know that a Canadian 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 a Canadian 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 totalling 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 2020 may be included in the T3 income for 2019, 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.  BlackRock (iShares) issued Estimated Annual Reinvested Capital Gains Distributions for the iShares ETFs for 2020 (pdf), on December 22, 2020.  These reinvested capital gains distributions are included in the amount of capital gains in box 21 on the T3 slip.  They are not normally included in any other of the T3 boxes.

To find the press release on iShares reinvested distributions on the BlackRock website, go to their 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, and hopefully all, brokerages are now updating book values properly on monthly investment statements.

You may notice that on either your March 31st or April 30th 2020 statement, the book value of your Canadian ETFs increased by the amount of the 2019 reinvested capital gains distribution, and decreased by the amount of the return of capital (ROC).

It's been reported to us that Qtrade has shown the capital gains distributions as a positive amount in box 21 (this is correct) and also as a negative amount in box 42, return of capital.  Technically, this is also correct, although not done by other brokerages, as far as we know.  Positive amounts in box 42 are used to reduce your cost basis, so the negative amount would be used to increase your cost basis.  Most brokerages only include the box 21 amount, and leave it up to you to increase the cost basis in any records you keep.  As noted above, they should be increasing the cost basis on your brokerage statements for the box 21 amounts.  If you use tax preparation software, you will likely not be able to enter a negative amount for box 42.  In this case, just enter the total of the positive amounts.  This doesn't flow through to your taxable income.

John Heinzl has 3 good articles on "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.  At the time of the latest article not all brokerages were doing this, but hopefully by now (2019) they all are.

Example of ACB calculation for 1,000 shares of iShares S&P TSX Capped Composite Index Ticker XIC.TO

Date/Detail Cost per Share Total Cost (ACB)
Feb 2/15 purchase including commission $23.50999 $23,509.99
Mar 20/15 ROC -0.00073 -0.73
Jun 19/15 ROC -0.00075 -0.75
Sep 18/15 ROC -0.00074 -0.74
Dec 31/15 ROC -0.00076 -0.76
Dec 31/15 non-cash capital gains dist. 0.45073 450.73
Ending ACB 2015 $23.95774 $23,957.74

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 $0.45073 per share, or $450.73 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:

NASDAQ

NYSE

Ontario Securities Commission Investor Education Fund

Canadian ETF Association - the knowledge source for everything ETF in Canada

TaxTips.ca Resources

Tax treatment of income from mutual funds

Reporting foreign income and expenses

Trade date vs settlement date

Revised: August 02, 2021

 

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