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You've written about reinvested or "phantom" distributions before and indicated that investors need to look up this information on the fund company's website. I've been doing this for my Canadian ETFs, but last year I bought two U.S. ETFs and no matter where I look, I cannot find any information for any reinvested distributions. Am I doing something wrong?
No, you're not. First, let me recap how "phantom" distributions arise and where to find the information for Canadian exchange-traded funds. Then I'll briefly discuss U.S. ETFs, which have some key differences with their Canadian counterparts.
In Canada, ETFs (and mutual funds) sometimes declare a year-end capital gains distribution to unitholders. Instead of actually paying the distribution in cash, however, funds often reinvest it internally. This is why it's called "phantom" distribution – you never actually see the money.
You still have to pay tax on the reinvested amount, however. It's the same principle as with a stock that's enrolled in a dividend reinvestment plan, or DRIP. Even though you don't receive the dividend in cash, it's still taxable as if you did.
Here's what many investors miss: Every time you reinvest a dividend or distribution, you have to add the amount to your adjusted cost base (ACB), because you're effectively putting new money to work. If you fail to adjust your ACB, you'll end up reporting a larger capital gain when you eventually sell your units, causing you to pay more tax than necessary. (Some brokers adjust the ACB for you, but many don't. The onus is on you to make sure your ACB is accurate.)
Determining whether you received a reinvested distribution can be a bit tricky. Capital gains distributed by your ETF are reported on your T3 slip, but the portion that consists of a reinvested distribution from a specific security is not broken out separately (although, according to TaxTips.ca, in some cases it might be mentioned in a footnote or identified as a "non-cash distribution" in the year-end T3 summary from your broker).
The safest way to determine whether your ETF had a reinvested distribution is to check with the ETF provider. On the iShares Canada website, for instance, click on "Resources" and then "Tax Information Centre." There you'll find a PDF titled "2015 Distribution Characteristics" that provides a full breakdown of every iShares ETF's distributions during the year, including reinvested distributions per unit, if any. You can also go to the page of the particular ETF you own and look under "Distributions."
Sometimes it takes a little more digging. After hunting around the BMO ETF website, I eventually found a press release with the headline "BMO Asset Management Inc. Announces Annual Reinvested Distributions for BMO Exchange Traded Funds." Alternatively, you can search for a specific ETF by symbol and then click on the "Tax & Distributions" tab. For Vanguard Canada ETFs, you'd think reinvested distributions would be mentioned in the "Distribution history" PDF on the page for each ETF. Nope. You have to click on "Prices and distributions," then scroll down the page to "view distribution history." Go figure.
Now for the good news: If you own U.S. ETFs, you probably won't have to subject yourself to such torture. Why? Because, unlike Canadian ETFs, U.S. ETFs typically pay their capital gains distributions in cash instead of reinvesting them. That explains why the reader couldn't find any reinvested distributions with his U.S. ETFs.
But U.S. ETFs also have a downside: For Canadian investors, U.S. ETF distributions are fully taxable as foreign income, regardless of their composition. According to TaxTips.ca: "When distributions from U.S. ETFs are categorized as capital gains or return of capital for U.S. taxpayers, they will still be considered fully taxable to Canadian taxpayers." This was the subject of a 2012 Tax Court of Canada case, Schmidt v. The Queen.
For more information on phantom distributions, you can read some of my previous columns via the following link, tgam.ca/ELdV.
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John Heinzl