Archive | Taxes

Tax Tips for BMO ETF Investors

Last week I offered some tips for investors who are tracking their adjusted cost base with Vanguard ETFs. In this post I’ll offer similar advice for those who use BMO exchange-traded funds. These tips expand on As Easy as ACB, a paper co-authored with Justin Bender, which thoroughly explains how to calculate the adjusted cost base of your ETF holdings.

The BMO Equal Weight REITs (ZRE), which is the real estate component the Complete Couch Potato portfolio, provides our first example. You can start by downloading the BMO ETF 2013 Tax Parameters, which gives a summary of all distributions for the year. Scan the list until you find ZRE.

Notice ZRE reported both return of capital (ROC) and capital gains in 2013. ROC is normally paid in cash, and although it appears in Box 42 of your T3 slip, it’s not taxable in the year it’s received. However, it lowers your adjusted cost base and therefore increases your future tax liability.

Capital gains are taxable in the current year (they’ll appear in Box 21).

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A Tax Tip for Vanguard ETF Investors

As the tax filing deadline approaches, many investors are busy calculating the adjusted cost base for their ETF holdings. Last year at this time, Justin Bender and I collaborated on a paper called As Easy as ACB, which explains the rather complicated procedure.

An often overlooked part of ACB calculation involves adjusting for reinvested distributions (also called non-cash distributions). As the name implies, these are typically capital gains that were reinvested in the fund rather than paid to investors in cash. At the end of the year these will appear on your T3 slips and you’ll pay tax on them, even though you didn’t actually receive any income. But here’s the step that can get missed: if an ETF has a reinvested distribution, you should increase your cost base by an equal amount, which will reduce your future capital gains liability. If you don’t, you’ll pay the tax again when you eventually sell shares in the ETF.

The curious case of the missing distributions

If you held shares of the Vanguard FTSE Canada Index ETF (VCE) this year, your job is a little trickier. You probably looked on the fund’s web page to see whether VCE had any reinvested distributions in 2013.

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iShares Advantaged ETFs: Where Are They Now?

Before being bought by BlackRock early in 2012, Claymore Investments pioneered many new services and unconventional products. One of these was its so-called Advantaged ETFs, which used a complicated structure to convert fully taxable bond interest and foreign income into tax-favoured return of capital and capital gains.

Barely a year after these funds joined the iShares family, the 2013 federal budget took aim at this sleight of hand. While the government is grandfathering contracts already in force, it won’t allow new ones, which means the eventual end of the tax break promised by the Advantaged ETFs. A couple of weeks after the budget, iShares stopped accepting new subscriptions for these funds until they decided how to handle the situation.

The ETFs are open for business again, but several have new names and all have new strategies. Here’s a summary:

The iShares Global Monthly Advantaged Dividend has become the Global Monthly Dividend Index ETF (CYH). The tax-favoured structure is gone, but the investment strategy is largely the same: the fund is about half US and half international dividend stocks. However, the older version used two US-listed Guggenheim ETFs as its underlying holdings.

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The True Cost of Foreign Withholding Taxes

Back in the fall of 2012, I wrote a pair of blog posts about the impact of foreign withholding taxes in US and international equity funds. The first explained the general idea of this tax on foreign dividends, while the second showed which funds are best held in which types of account (RRSP, TFSA, non-registered). This is a complicated and confusing topic, so I was surprised at the enormous interest these articles generated from readers, the media, advisors and even the ETF providers themselves.

What was missing from those articles, however, was hard numbers: it’s one thing to say this fund is more tax-efficient than that one, but by how much? To my knowledge no one has ever quantified the costs of foreign withholding tax in a comprehensive way—until now. Justin Bender and I have done this in our new white paper, Foreign Withholding Taxes: How to estimate the hidden tax drag on US and international equity index funds and ETFs.

The factors that matter

The amount of foreign withholding tax payable depends on two important factors. The first is the structure of the ETF or mutual fund.

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New Tax-Efficient ETFs from BMO

Bonds are one of the least tax-friendly asset classes: most of their return comes from interest payments, which are taxed at the highest rate. They’re even less tax-efficient when their market price is higher than their par value: these premium bonds are taxed so unfavorably they can actually deliver a negative after-tax return. Unfortunately, because interest rates have trended down for three decades, virtually every bond index fund and ETF is filled with premium bonds. Enter the BMO Discount Bond ETF (ZDB), which begins trading tomorrow. This unique new ETF promises to eliminate the problem that has long plagued bond funds in non-registered accounts.

Let’s take a step back and review the important idea underpinning this new ETF. Consider a premium bond with a coupon of 5% and a yield to maturity of 3%. The bond will pay you 5% interest annually and then suffer a capital loss of 2% at maturity, for a total pre-tax return of 3%. Now consider a discount bond that pays a coupon of 2% and has the same yield to maturity of 3%: now, in addition to the interest payments,

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A Touch of (Corporate) Class

ETFs are generally more tax-efficient than mutual funds, but there is one area where they’re at a disadvantage. Investors who use non-registered accounts can take advantage of corporate class mutual funds, which can reduce or defer taxes. Well, now the country’s newest ETF provider, Purpose Investments, has launched the first corporate class ETFs in Canada.

It’s little surprise the innovation comes from Purpose. The company’s CEO is Som Seif, who founded Claymore Investments back in 2005. Claymore was an ETF pioneer: they were the first to offer pre-authorized cash contributions (PACCs), dividend reinvestment plans (DRIPs) and systematic withdrawal plans (SWPs). Then they teamed up with Scotia iTRADE to offer the first commission-free ETF program. Seif exited Claymore after they were bought by BlackRock in 2012, and it was only a matter of time before he got behind a new project that shook up the ETF business.

Before looking at the new ETFs, let’s review how corporate class funds work. Most mutual funds are structured as trusts. Income flows through to investors and retains its character: in other words,

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Making Smarter Asset Location Decisions

Last week’s posts about tax loss selling prompted some interesting questions about asset location in the comments section. Holding your ETFs and index funds in the most tax-efficient accounts can have a big impact on your long-term returns. But although it’s often easy to set up a portfolio with proper asset location, it can be a challenge to maintain the right balance when you add new money.

Say you’re using the Global Couch Potato portfolio spread across three accounts. Your TFSA and RRSP are maxed out at $25,000 and $125,000, respectively, and you have another $75,000 in a non-registered account. Your optimal asset location might look like this:

So far, so good. But now you’ve won second prize in a beauty contest and received a $25,000 windfall. Since you can’t add it to your tax-sheltered savings, you put the money in your non-registered account. Then you enter the new values into your rebalancing spreadsheet and discover your portfolio is now off its target:

The naive way to rebalance your portfolio would be to make all the transactions in your non-registered account.

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Finding the Perfect Pair for Tax Loss Selling

If you’re using ETFs in a non-registered account, there’s plenty of opportunity to harvest capital losses and reduce your tax bill. Justin Bender and I tell you exactly how to do this in our new white paper, Tax Loss Selling: Using Canadian-listed ETFs to defer taxes on capital gains.

As I explained in my previous post, tax loss selling involves dumping an ETF that has declined in value to crystallize the loss, and then buying a similar (but not identical) ETF to maintain the exposure in your portfolio. The Canada Revenue Agency considers any two index funds tracking the same benchmark to be identical property. So you cannot, for example, claim a loss after selling the iShares S&P 500 (XUS) and replacing it with the Vanguard S&P 500 (VFV): if you do, it will be denied as a superficial loss.

Fortunately this year has seen a number of new ETF launches, including international equity ETFs from iShares and Canadian and US equity ETFs from Vanguard. These give Canadians much better options when tax loss selling,

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Tax Loss Selling with Canadian ETFs

Traditional equity index funds are often touted for the tax-efficiency of their structure, and rightly so. But there’s another potential tax advantage that few ETF investors employ. Justin Bender and I explain the details in our brand new white paper, Tax Loss Selling: Using Canadian-listed ETFs to defer taxes on capital gains.

Tax loss selling is a technique for harvesting capital losses in non-registered accounts so they can be used to offset capital gains incurred elsewhere. Suppose you hold $50,000 worth of a Canadian equity ETF and its value declines to $45,000. By selling your shares, you can crystallize a capital loss of $5,000. And by claiming that loss, you may be able to offset a $5,000 capital gain elsewhere in your portfolio, potentially deferring hundreds of dollars in taxes.

When you file your tax return, any capital losses must first be used to offset gains you’ve incurred in the current tax year. Any remaining losses can be carried back up to three years, or carried forward indefinitely to offset future capital gains. (To carry back current capital losses to prior years, you need to file form T1A – Request For Loss Carryback with your return.)

The problem with realizing a capital loss is that it can mean selling a security that plays an important role in your portfolio.

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