ETF investments: some useful information at tax time

Exchange-traded funds (ETFs) are a popular choice for investors due to their simplicity, diversification and cost-effectiveness. But just like any other investment, ETFs come with their own set of tax implications. Understanding these can help you make informed decisions. Here, we provide some general details on the tax treatment of ETFs, including distributions received on them and capital gains made from selling them.

What are ETFs?

An ETF is a type of investment fund, ordinarily in the form of a unit trust, that is traded on stock exchanges, much like individual stocks. They typically track an index, a commodity, bonds or a basket of assets, giving investors exposure to a diversified portfolio without having to buy each asset individually.

How ETFs make you money

ETFs generate income for investors in two main ways: distributions and capital gains.

What are distributions?

ETF distributions are payments made to ETF holders, usually from income from the ETF’s underlying assets, (like e.g., dividends received from the stocks or interest from the bonds within the ETF). Distributions may also include capital gains made by the ETF itself (e.g., the ETF has sold one of its underlying assets and made a capital gain). These distributions are usually paid to investors quarterly or semi-annually.

How are distributions from ETFs taxed? 

ETFs usually provide investors with a Standard Distribution Statement that breaks down what you need to declare in your tax return. Distributions are generally considered ordinary income, meaning they need to be included in your annual tax return. The type of income distributed (e.g., dividends, interest) should retain its character when it reaches you. This means if the ETF distribution includes dividends, you’ll pay tax on the dividends at your marginal tax rate.

What happens when your distribution has franking credits? 

These credits represent tax already paid by the companies in which the ETF has invested. You may be able to use these credits to offset your own tax liability, reducing the overall tax you owe.

Here’s what happens when you make a profit on selling your ETFs

Generally, when you hold your ETF units on a capital account and sell them for more than you paid for them (yay), the profit you make may be considered a capital gain.

In Australia, the tax treatment of capital gains for individuals depends on how long you’ve held the ETF units, among other factors:

• Short-term gains: if you sell the ETF units within 12 months of buying them, the entire gain is added to your assessable income and taxed at your marginal tax rate.
• Long-term gains: if you hold the ETF units for more than 12 months, you may qualify for a 50% discount on the capital gain. If you’re eligible for the discount, then only half of the gain is included in your assessable income and taxed at your marginal tax rate.

Here’s what happens when you lose money on selling your ETFs

Generally, if you hold your ETF units on a capital account and sell them for less than what you paid, that’s called a capital loss. Capital losses can be used to offset capital gains made in the same year or future years, reducing the amount you pay in tax. Such capital losses cannot be used to offset against other assessable income.

Three important things to remember:

To stay on top of your tax when it comes to ETF investments, you might want to…

1. Keep detailed records of your ETF transactions, including purchase and sale dates, purchase prices and sale prices, and any associated costs with your purchase or sale. Your future-self with thank you.
2. Take the time to understand distribution statements (Standard Distribution Statements) that break down the income components of your ETF earnings. These statements are crucial for your tax return so keep them handy.
3. If you choose to reinvest your ETF distributions rather than receiving them as cash, the distributions which are reinvested can still result in tax. If you’re not sure always check with your accountant or financial advisor.

^Disclaimer

^{Taxation considerations are general and based on present taxation laws and may be subject to change. You should seek independent, professional tax advice before making any decision based on this information.}

^{Commonwealth Securities Limited (CommSec) is also not a registered tax (financial) adviser under the Tax Agent Services Act 2009 (Cth) and you should seek tax advice from a registered tax agent or a registered tax (financial) adviser if you intend to rely on this information to satisfy the liabilities or obligations or claim entitlements that arise, or could arise, under a taxation law. Investing carries risk. Past performance is not an indicator of future performance and should not be relied upon.}

^{For the latest information, check the ATO website or speak to your accountant or financial advisor.}