With ETFs (and mutual funds), return of capital and reinvested distributions are two key pieces of information you need to know in order to determine capital gains or losses.Getty Images/iStockphoto
In February, 2001, I bought 91 shares of the iUnits S&P/TSX 60 exchange-traded fund for a total cost of $4,520.70. In October, 2016, I sold 364 units of the iShares S&P/TSX 60 Index ETF (ticker: XIU) for total proceeds of $7,816.01. It appears there was a stock split at some point because I have no record of further purchases. Any clue how I should report this investment when filing my 2016 tax return?
I chose this reader's question because it touches on a number of issues that affect the calculation of capital gains – a process that can be particularly tricky with ETFs.
First, let's deal with the stock split. As the reader indicated, the iShares (formerly iUnits) S&P/TSX 60 Index ETF did indeed split its units four-for-one in 2008. The key thing to know about stock splits is that, while they affect the adjusted cost base (ACB) per unit, they do not change the investor's total cost base. In this case, the reader has four times as many units but his total initial cost is still $4,520.70.
So, can he just subtract his cost of $4,520.70 from his sale proceeds of $7,816.01 to calculate his capital gain? Nope. It's not that simple.
With ETFs (and mutual funds), there are two other key pieces of information you need to know in order to determine capital gains or losses. They are return of capital and reinvested distributions. Let's look at each of these in turn.
Return of capital (ROC) is the portion of a distribution that does not consist of dividends, interest or realized capital gains. ROC is not immediately taxable; rather, it is subtracted from the ACB of the investment, which has the effect of increasing the capital gain (or reducing the capital loss) when the units are ultimately sold. ROC (also known as a "cost base adjustment") is identified on your T3 tax slip and also on your year-end brokerage statements.
What if you haven't kept all your records? No worries. Every year around February, iShares (and other ETF providers) publish the "distribution characteristics" – including the amount of ROC – of each of its ETFs for the previous calendar year. This information is available on the BlackRock Canada website under "Resources" and "Tax Information Centre."
Unfortunately, the annual data only go back a few years. To find longer-term ROC information, you'll have to go to the specific web page for XIU. (Once there, look for the heading "distributions" and click on "view full chart." Next, click on "calendar year" and "table." Finally, scroll down until you see a bar that you can slide to the right to reveal more columns, including "return of capital.")
I added up all of XIU's ROC distributions from 2001 through 2015 and got 31.63 cents a unit. Multiplied by 364 units, that's total ROC of $115.13 that must be subtracted from the ACB (in addition to any ROC that appears on the investor's 2016 T3).
Now, let's turn to XIU's reinvested distributions. These amounts – also known as phantom distributions – usually consist largely of capital gains distributed at year end. But instead of paying the money to you in cash, the ETF plows it back into the fund.
When a fund reinvests a distribution, it's treated the same way for tax purposes as if you were adding new money – that is, the amount is added to your ACB. This has the effect of reducing your capital gain (or increasing your capital loss) when you ultimately sell.
To recap: ROC reduces your ACB, and reinvested distributions raise your ACB.
Unlike ROC, reinvested distributions aren't recorded on your T3 so you'll have to go directly to your ETF provider's website. (With iShares ETFs, you can find the most recent reinvested distributions by looking under "resources," and "resource library," and then scrolling down to "press releases." For the previous few years, you can consult the "distribution characteristics" document mentioned previously. To go even further back, look on the specific page for XIU under "distributions," click on "view full chart," then choose "recent" and "table.")
I added up XIU's reinvested distributions per unit since 2001 and got $1.46 (note: all of the per unit data appear to have been adjusted for the 2008 unit split). Multiplying this by 364 units produces total reinvested distributions of $531.44.
The investor's new ACB (subject to any further ROC on the 2016 T3) is therefore the initial cost of $4,520.70, minus ROC of $115.13, plus reinvested distributions of $531.44, which equals $4,937.01. As you can see, the new ACB is higher than the original cost, which reduces the capital gain that the investor would otherwise have to report.
Tracking ROC and reinvested distributions can be a pain in the behind, and there are services – such as acbtracking.ca and adjustedcostbase.ca – that will do the work for you. But with tax time approaching, it's a skill worth learning. As this example illustrates, it might even save you money.