Its everyone’s favourite time of year – tax time! We’ve collected a few helpful tips for exchange traded fund (ETF) investors.
The good news is that FY23 has been good to investors. The Australian share market has seen positive returns with the S&P®/ ASX 200 up 9.3% or up 16.0% including dividends for the financial year up to 15 June 2023. Dividends over this last financial year have been steady in Australia but higher offshore compared to the previous year.
Most equity ETFs hold a broad portfolio of company shares that match an index. The SPDR® S&P®/ASX 200 Fund (ASX Code: STW) for example, holds around 200 Australian companies. The SPDR® S&P® World ex Australia Carbon Control Fund (ASX Code: WXOZ) on the other hand holds over 900 global companies. When companies in the portfolio pay higher dividends, that flows directly through to higher distributions by the ETF. In other words, ETFs simply “pass through” the dividends they receive.1 As economic resilience, a strong labour market and a robust consumer resulted in better earnings, we saw higher dividends start to flow through for share market investors. We expect full year dividends for global portfolios to be 7-8% higher over this financial year than last financial year.2 Dividends have been steady in the Australian share market with stronger dividends from the big banks offset by weaker dividends from the big miners.3
Many ETFs distribute their income more than once a year, and eagle eyed investors may have already noticed some significantly higher distribution payments from their equity ETFs.
ETFs don’t only distribute income; they sometimes distribute capital gains. 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.
Capital gains inside an ETF typically occur where there has been a strong rise in share market prices, and where the index being tracked by the ETF requires rebalancing.
Many market capitalisation ETFs, like STW, track indices that don’t require much rebalancing and so rarely distribute much by way of realised gains. However, where the index has higher turnover, it is more common for the year end distribution to include realised capital gains.
While income from dividends may be higher than last year, capital returns have also been higher for most ETFs. This means that some ETFs may have realised gains to distribute. It can be hard to forecast realised gains for ETFs – take the example of property ETFs. The rising interest rate environment has meant that valuations of property have come under pressure. But with turnover usually low for property ETEs, the price falls in property securities may not necessarily result in crystallisation of losses. Whether an ETF has realised gains or losses to distribute this year will depend on a few factors; how old the ETF is, which sectors or markets it holds, and whether the portfolio turnover is high or low.
In past years, we have had mixed reactions from investors when the distribution amount includes realised capital gains. Some investors appreciate the additional payments, while others would prefer it if the ETF wasn’t required to distribute these amounts. It is important to stress that distributions of realised capital gains don’t impact total returns. A distribution of realised gains increases the “Income” return of the ETF. However, the ETF price normally drops immediately after the distribution, and so the “Growth” return is reduced, leaving the total return unaffected.
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. Given some of the healthy dividends paid by miners and banks this year were fully franked, investors who have held Australian equity ETFs at each distribution point during the year ended 30 June 2023, will likely receive franking credits in their tax return.
Here are some of our favourite tips:
Most issuers provide a guide to your tax statement. The SPDR ETFs 2023 tax guide will be available at the same time as your SPDR ETF tax statement.