ETFs and tax-efficiency

ETFs are treated the same as conventional open-end mutual funds for tax purposes.

Investors generally pay taxes on income and capital gains distributions during the life of the investment, as well as on any capital gains generated on the sale of their ETF units.

Indexed investments, such as index ETFs, can provide a tax advantage relative to actively managed open-end mutual funds because their management tends to require less portfolio turnover. Lower turnover can minimize capital gains distributions, which can in turn, improve long-term after-tax performance and tax efficiency.

Index ETFs may also be more tax-efficient than their index mutual fund counterparts. That's because ETFs generally don't experience cash redemptions from investors. Although ETF units are redeemable like mutual fund units, most investors who want to sell their ETF units will do so on the stock exchange. This means that an ETF, unlike a mutual fund, does not need to sell its portfolio securities in potentially capital-gain generating transactions in order to raise cash to meet investor redemption requests.

Only certain authorized dealers typically redeem ETF units directly, and in a majority of circumstances, the ETF redeems to the authorized dealers by providing them with a basket of the ETF’s portfolio securities. With these "in-kind" redemption transactions, ETFs are able to minimize transaction costs and portfolio-level capital gains.

 

Important note:

The information presented here addresses certain Canadian federal income tax considerations for Canada-resident individual investors. It is presented for general investor education, and does not constitute tax, legal, or financial advice. Please consult your tax and/or financial advisor for the tax results applicable to your specific situation.