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[OP]
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Nov 3, 2003
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ETFs and Taxes

I'm a little confused about the tax implications of ETFs. Since capital gains can be realized at any time, does it make personal tax planning a challenge? Also, apart from capital gains realized from selling and buying units, does one need to keep track of capital gains, or is everything detailed in the T3s? Finally, what is the difference between dividends declared in the distribution vs. return of capital? Thank you.
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Feb 1, 2012
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First, you probably know this, but taxes on dividends, interest and capital gains only apply to non-registered accounts. For Canadian domiciled ETFs you will get a T3; for US domiciled ETFs you will get a T5. You won't get tax slips for registered accounts.

Tax implications depend on the ETF and how actively it is managed. Most broad market index ETFs don't trade much so they won't realize much capital gains or losses in the fund. Actively managed funds that trade a lot could have larger capital gains, reinvested distributions or RoC. You will get a tax slip (T3 or T5) so you don't need to track capital gains internal to the fund, just enter the amounts from the slip on your taxes for interest, dividends, capital gains and foreign income (foreign dividends are taxed as foreign income and taxed at your marginal rate). You do need to track and report any additional capital gains when you sell.

Dividends paid by ETFs are taxable in the current year and will appear on your tax slip. Return of Capital is not taxed in the current year. Rather it lowers your adjusted cost base thus adding to your capital gain when you sell. You are responsible for tracking any RoC received and subtracting it from your cost base. RoC will appear in box 42 of your T3.

In addition to the link posted upthread, the following white paper from PWL Capital explains tracking your cost base in detail.
As Easy as ACB – Understanding and tracking your adjusted cost base with ETFs
I solemnly swear, to never assume I have an inkling at which direction the market will head, and to never make any investments based on a timing strategy.
[OP]
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Thank you, freilona and Deepwater. I'm only talking about non-registered accounts.

I'm still confused with Return of Capital. If it appears on the T3, then why is it necessary to look up CDS Innovations for the distributions? I'm just finding the whole concept of RoC unintuitive.
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TBH I would have a hard time really explaining RoC, just like I would have a hard time doing long division. I just know I need to subtract it from my ACB to enable correct capital gains reporting when I sell, and if I don't the govt might get mad and come after me. :) For example if you get $100 of RoC from iShares XIC then you subtract that amount from your cost base for XIC.

There are different sources for the same info: T3, ETF provider websites and CDS. Some have more detail. One potential issue using a T3, is sometimes a broker will put more than one ETF on a single T3, which makes it impossible to apportion the RoC properly to each ETF. I use TDDI and in addition to the T3 it also provides a document called Summary of Trust Income that breaks out the T3 data in more detail, for each ETF, each distribution and each T3 box. If your broker puts more than one ETF on a T3 and does not give such a breakdown you may need to use CDS or the providers' website.

There is another item you also should track, which is Reinvested Capital Gains Distributions, also called Phantom Distributions. Basically it is capital gains distributions that are reinvested rather than paid out to you in cash. These distributions are taxed in the year you receive them. You should track that and add it to your cost base, otherwise when you sell you will be taxed again on those distributions. https://www.adjustedcostbase.ca/blog/ph ... cost-base/

So basically you must subtract RoC received from your adjusted cost base, otherwise when you sell you will under-report capital gains, thus cheating on your taxes. You should add Reinvested Capital Gains to your cost base, otherwise you will pay tax on those distributions twice, once when they are received, and again when you sell.

I use TDDI and everything I need is either on my monthly statements or on the Summary of Trust Income, so I do not use CDS or the provider websites. I can't speak for other brokers.

The PWL white paper to which I linked upthread and the help guide at www.AdjustedCostBase.ca explain this well, but you may have to read a couple of times to really understand. Don't hesitate to ask if you still have questions and I will try to answer.
I solemnly swear, to never assume I have an inkling at which direction the market will head, and to never make any investments based on a timing strategy.
[OP]
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Nov 3, 2003
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Deepwater wrote:
...There is another item you also should track, which is Reinvested Capital Gains Distributions, also called Phantom Distributions. Basically it is capital gains distributions that are reinvested rather than paid out to you in cash. These distributions are taxed in the year you receive them. You should track that and add it to your cost base, otherwise when you sell you will be taxed again on those distributions. https://www.adjustedcostbase.ca/blog/ph ... cost-base/

So basically you must subtract RoC received from your adjusted cost base, otherwise when you sell you will under-report capital gains, thus cheating on your taxes. You should add Reinvested Capital Gains to your cost base, otherwise you will pay tax on those distributions twice, once when they are received, and again when you sell.

I use TDDI and everything I need is either on my monthly statements or on the Summary of Trust Income, so I do not use CDS or the provider websites. I can't speak for other brokers.

...
Thanks for taking the time to explain in more detail. You're definitely correct in that I have to re-read the information available to really understand!

Do the documents TDDI provide clearly indicate what is what? (i.e., Reinvested Capital Gains Distributions, RoC, etc.)

And are mutual funds similarly taxed?

Thanks.
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Gigi wrote: Do the documents TDDI provide clearly indicate what is what? (i.e., Reinvested Capital Gains Distributions, RoC, etc.)
Various types of taxable income (dividends, interest, capital gains, foreign income, RoC, foreign taxes paid) are clearly broken out on TDDI's Summary of Trust Income with the associated T3 box, and these roll up to the numbers on the T3. You can transcribe all of the numbers into your tax software. The exception is RoC (box 42), which does not go on your tax return. Rather you subtract RoC from your Adjusted Cost Base so you can properly claim capital gains when you sell.

The one exception to this is Reinvested Capital Gains Distributions, which are not broken out on the T3 or Summary of Trust Income. That's because that income is already included in Capital Gains (box 21). If your ETF had a reinvested distributions in the year, your statement for the following March will show something like:
-Dividend Reinvestment Plan BMO Capped Composite ETF -$1234.00
-Distribution BMO Capped Composite ETF $1234.00
That is a reinvested distribution and you add that amount (in this example $1234) to your cost base for the ETF. The reason it does not show up until the following March is the ETF totals all the capital gains and losses for the year to determine the total.

Having said all that I have found that TDDI's book value and average cost per share are accurate, so you could probably get by just using their numbers. I track my own ACB using www.adjustedcostbase.ca, since if I decide to switch brokers some time in the future, the cost from TDDI may not carry fwd to the new broker.

And are mutual funds similarly taxed?
Yes, mutual funds may have all the same types of taxable distributions (depending on the fund's holdings). There is a difference in how reinvested capital gains distributions for mutual funds are accounted for, because mutual funds can issue partial units and ETFs cannot. This article explains it:
https://www.theglobeandmail.com/investi ... om-menace/

Hope this helps.
I solemnly swear, to never assume I have an inkling at which direction the market will head, and to never make any investments based on a timing strategy.
[OP]
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Nov 3, 2003
2044 posts
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GTA
Deepwater wrote: Hope this helps.
Most definitely!!!! Thanks so so much for taking the time to write such detailed explanations. I've always been interested in ETFs but didn't want to jump into it without understanding its tax consequences. Now all I have to do is pick some good ones!

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