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Its everyone’s favourite time of year – tax time! We’ve collected a few helpful tips for exchange traded fund (ETF) investors.
What should Australian ETF investors expect this tax year compared with last?
You should expect generally lower distributions from ETFs that hold Australian or international shares.
Most equity ETFs hold a broad portfolio of company shares that match an index. The SPDR S&P/ASX 200 Fund (STW) for example, holds around 200 Australian companies. The SPDR S&P World ex Australia Fund (WXOZ) on the other hand holds over 1,500 overseas companies. When companies in the portfolio pay lower dividends, that flows directly through to lower distributions by the ETF. In other words, ETFs simply “pass through” the dividends they receive. We have seen significant cuts in dividends for many companies in both Australia and overseas in light of the COVID-19 crisis. For Australian companies you need look no further than the big banks, retailers and some resource companies to find high profile dividend cuts and cancellations in the first half of 2020. Depending on the index it is tracking, we would expect ETF distributions to drop by 10% to 30% this year compared to last year due to lower dividends.
Mind you, that is not all a bad thing. Many companies who have cancelled or deferred dividends have done so to protect their balance sheet and their long-term viability. It is unwise to pay a dividend when you don’t have the earnings to support it. Furthermore, while income is important, investors should never lose sight of total returns. A higher dividend today means a lower price tomorrow; a lower dividend today means a higher price tomorrow. ETF prices normally drop immediately following a distribution. The silver lining to lower ETF distributions is that the immediate drop in ETF prices due to the distribution will be smaller than if a large distribution was made.
What about franking?
Most Australian listed ETFs don’t pay tax – they just pass their income on to investors, and it is the investors who pay tax. The same is true for franking credits. Most Australian listed equity ETFs receive franking credits from the companies they hold, and they pass those credits on to investors at distribution time. Just like company shares, the franking credit doesn’t form part of the cash distribution – it is a tax credit that you may be able to use when you complete your tax return.
Are dividends the only part of ETF distributions?
If you were managing a large portfolio containing hundreds of Australian or international shares, you would need to perform hundreds of tax calculations each year beyond just adding up the dividends. ETF issuers do these tax calculations “behind the scenes”, and then reflect the results in the year end distribution to investors. The most common additional item is capital gains. If an ETF has traded its shares during the year, to rebalance for example, it may have generated capital gains. The ETF doesn’t pay tax on those gains – it simply passes them on to the investor in the year end distribution. Much like other investments, these gains can be discounted or undiscounted. For investors, the tax calculations involved from owning a single ETF are much more simple than the calculations required for a widely diversified share portfolio.
ETFs that hold investments other than shares may also have additional distributions to pay. Fixed income ETFs, for example, need to distribute any coupon payments or interest payments they have received from the portfolio. They may also have to distribute any profits they have made from trading bonds.
What are your top tips for a smooth EOFY?
Here are some of our favourite tips:
How can I find out more information?
Most issuers provide a guide to your tax statement. The SPDR ETFs 2020 tax guide will be available at the same time as your SPDR ETF tax statement.
SSGA Australia is not licensed to give tax advice and the information represented in this material does not constitute legal, tax, or investment advice. Investors should consult their legal, tax, and financial advisors before making any financial decisions.
Adtrax code: 3139846.1.1.ANZ.RTL
Expiration: 30/06/2021