One of the reasons exchange-traded funds (ETFs) have gained popularity with Australian investors is because they are highly tax efficient. Compared to managed funds and Listed Investment Companies (LICs), ETFs tend to have lower turnover and pay out fewer capital gains.
This is great news for investors in ETFs who typically inherit a lower tax bill during their holding period compared to other fund structures which need to distribute regular capital gains from redemptions or frequent rebalancing.
If you’ve invested in ETFs on your own, through a broker, or with the help of an automated investment service like Stockspot, here are some tax issues to consider. Keep in mind that this article is general information only and doesn’t consider your personal circumstances.
- Best to own ETFs in your own name
- Australian share ETFs can pass on franking credits
- Capital gains on ETFs
- Tax on ETF distributions
- Tax on foreign ETF income
- Lower capital gains tax compared to most active managed funds
- ETFs are tax efficient compared to unlisted managed funds
- What you need to lodge your tax return via eTax or an accountant
- Ask your accountant or seek personal tax advice if your situation is complex
It is best to own ETFs in your own name
Whether you’re managing a portfolio of ETFs on your own, or using an automated investment service like Stockspot, you should check how the ETFs are owned.
If you own ETFs through an Australian online broker or Stockspot, the ETFs should be owned legally and beneficially in your name on a Holder Identification Number (HIN) at the CHESS subregister.
From a tax perspective it is the safest and most simple way to own ETFs as it is clear what income and capital gains you have made through the year. Owning ETFs in your own name means you get full access to franking credits and don’t need to pay other people’s tax.
If you own ETFs through an online broker, you’ll need calculate your tax liability each year using the Annual Tax Statements from each of the ETFs you own.
How Stockspot calculates tax
Stockspot makes life easier by combining the statements from all ETFs you own. It means that you or your accountant only need to use a single document to do your tax.
Income from the individual ETFs as well as any capital gains will be summarised in your annual investor statement from us.
We send all clients their annual investor statement in August after we receive and process the Annual Tax Statements are received from all of the ETFs that our clients hold.
We get this information directly from the ETF registries like Computershare and Link Market Services. Stockspot clients also receive the full benefits of franking credits on Australian ETF income.
In addition to franking credits, Stockspot calculates the 15% withholding tax benefit on your overseas income and the 50% capital gains discount on investments held for 12 months.
What to check with other brokers and investment services
If you invest in ETFs via another investment service, overseas based stock broker, Separately Managed Account (SMA), or a managed investment scheme which uses a custody or trustee structure, tax can get more complex. You may or may not get the full benefit of franking credits.
Before investing it’s important to find out what tax information they’ll provide to you at tax time each year. It will differ service to service and some won’t provide a comprehensive summary to help you prepare your tax.
You or your accountant will have a fair amount of tax work to complete each year, especially if you own a few ETFs. It’s also crucial to ask if you’re receiving the full benefits of:
- franking credits on your Australian ETF income
- the 15% withholding tax benefit on your overseas income
- the 50% capital gains discount on investments held for 12 months
Platforms and investment services which use an overseas custodian or a managed investment scheme structure may not be able to pass on all of these important tax benefits to you. These tax benefits can add up to over 1% per year in extra returns so you don’t want to miss out on this tax value.
The dividend system in Australia can offer important advantage for investors in ETFs. If Australian company taxes are already paid by the companies within an ETF, then investors do not need to pay those taxes again at the personal level. The corporate taxes paid are passed down to the Australian investor through tax credits (often known as as franking credits).
With ETFs you receive the benefit of franking credits but are generally less reliant on them because your portfolio will be diversified across different sectors and asset classes. For example, the Stockspot portfolios returned 0.270% to 0.685% in franking credit value in 2018.
The benefits of franking credits
Franking credits can be used to reduce an investor’s total tax liability to account for the taxes on dividends already paid by companies. For individuals or complying superannuation entities, any excess franking credits can be refunded at the end of the year if the investor’s tax liability is less than the amount of the franking credits.
The dividends investors receive will only be taxed at their marginal tax rates. This is a big benefit for those on lower tax brackets including self managed superannuation funds (SMSFs).
Within the Stockspot core portfolios Vanguard Australian Shares Index (VAS) distributes franking credits which we summarise for clients in their annual investors statement. This makes it easy for you or your accountant to claim the full value of franking credits on your tax return.
Capital gains on ETFs
If you sold any ETFs during the year, you will be required to calculate your Capital Gains Tax (CGT) liability (if any) with respect to those ETFs. ETF issuers won’t send a Capital Gains Tax Statement by default so it’s up to you to calculate any capital gains and put in in the correct place on your tax return.
Where you’ve owned an ETF for 12 months, the law allows the taxable capital gain to be reduced by 50% for individuals. This means that tax is only paid on half of the capital gain.
For Stockspot clients, we calculate your tax liability for you including any ETFs that were sold or rebalanced during the year. This will be summarised in your annual investor statement from us.
Tax on ETF distributions
A distribution from an ETF represents your share of the income earned by a fund. Each ETF may earn different types of income, for example dividends, realised capital gains or interest. Also, the income may be Australian or foreign.
ETFs can be a bit complex because they are structured as unit trusts, not ordinary shares. This means the types of income earned by an ETF can be split across different categories when they are distributed to you.
If you manage your own ETF portfolio, the income components required to complete your tax return will be shown in the Annual Tax Statement posted to you or available to download from the registry website associated with each particular ETF.
In 2016 the ATO changed the rules around trusts by creating the Attribution Managed Investment Trust regime or AMIT. This has added further complexity to ETF tax. For Stockspot clients, we calculate the total distributions received from all the ETFs you owned during the year. It will be summarised in your annual investor statement.
Tax on foreign ETF income
Where an ETF invests in overseas companies, some of the income distribution may be withheld from investors. This is known as withholding tax. The level of withholding tax varies depending on where the company resides and the tax rules in place between Australia and the residing country.
For example, Australian investors who buy ETFs domiciled in the United States will incur a 30% withholding tax on any distributions. Australian investors are generally eligible to reclaim some of this back as a foreign tax credit.
US-domiciled ETFs available on the ASX require that investors completes a W 8BEN form to reclaim a 15% foreign tax credits. In 2018 Blackrock converted 14 of their iShares US domiciled ETFs to Australian domiciled ETFs.
This removed the annoying W8BEN form for investors in the following ETFs: IAA, IEM, IEU, IJH, IJP, IJR, IKO, IOO, IRU, ITW, IVE, IVV, IXI, IXJ and IZZ.
Within the Stockspot core portfolios, iShares Global 100 ETF (IOO) and iShares Emerging Markets ETF (IEM) previously required that investors complete a W-8BEN form to claim back tax.
We made it easy for clients by completing the form for you so all you need to do is print, sign and send to a reply-paid address for the 15% saving. These ETFs have since been re-domiciled so no longer require a W8BEN form.
Lower capital gains tax compared to most active managed funds
Generally, ETFs have low portfolio turnover as they track an index rather than buying and selling stocks regularly. It makes them tax efficient as there is rarely a capital gains tax (CGT) liability being passed to individual investors.
ETFs are tax efficient compared to unlisted managed funds
ETFs are also more tax efficient than managed funds because they trade on stock exchanges, such as the Australian Securities Exchange (ASX). Unlike unlisted managed funds, ETF portfolio managers do not need to sell the shares they’ve invested in to raise cash to pay investors who redeem or sell the fund.
For unlisted managed funds, this redemption process can lead to a capital gains tax (CGT) liability for all investors, regardless of how long they have owned the fund. One ETF investor’s sell decision has no impact on other investors.
Lodging your tax return
What you need to lodge your tax return via eTax or an accountant
If you own ETFs through an online broker, you need calculate your tax liability each year using the Annual Tax Statements from each ETF you own.
To do this combine the totals provided by each ETF as well as calculate any capital gains (or losses) that you’ve made during the financial year.
Stockspot combines the statements from all ETFs you own. It means that you or your accountant will only need to use a single document to do your tax. Income from the individual ETFs and any capital gains will be summarised in your annual investor statement from us.
If you own ETFs via a platform, another robo-adviser, Separately Managed Account (SMA), or managed investment scheme you need to find out what tax information they’ll provide to you.
It’s also important to find out if you’re receiving the full benefits of franking credits on your Australian income, the 15% withholding tax benefit on your overseas income and the 50% capital gains discount on investments held for 12 months.
Ask your accountant or seek personal tax advice
Keep in mind that this article is general information only and doesn’t consider any individual’s personal circumstances. ETFs offer a range of tax advantages for Australian investors, however everyone’s individual circumstance are different. Each ETF can also have a different tax treatment.
You should consult with your accountant to learn more about the tax consequences of owning ETFs and how it may impact your overall tax. This is particularly important if you are a non tax resident of Australia or are investing via a Trust or Self Managed Super Fund.
The Australian Taxation Office (ATO) also has a helpline for personal tax enquiries, which is 13 28 61. In addition, the ATO has a number of publications which will help you understand what you need to do to complete your return.
Find out how Stockspot makes it easy to grow your wealth and invest in your future.
This article was originally published in July 2016 and has been republished with up to date information.