Its everyone’s favourite time of year – tax time! We’ve collected a few helpful tips for exchange traded fund (ETF) investors.
While share markets have risen strongly since this time last year, we are expecting lower full year distributions than 2019/20 for many ETFs.
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 Fund (ASX Code: 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. Cuts in dividends began in the second quarter of 2020 in response to the COVID-19 crisis, however they continued through the second half of 2020 and into 2021. In fact, over the full year, we expect dividends from companies to be materially lower in 2020/21 than they were in 2019/20. That means that we expect full year distributions from most equity ETFs to be lower this year than last year.
While income from dividends may be lower than last year, we expect some ETFs may have realised gains to distribute this year which could boost total 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.
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 ETFs, like STW and WXOZ, 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. Given the strong rise in share market prices over the last year, we expect some equity ETFs may have realised gains to distribute this June.
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.
Here are some of our favourite tips:
Most issuers provide a guide to your tax statement. The SPDR ETFs 2021 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.
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