Tax Treatment of Exchange Traded Funds

The following is provided for information and interest purposes only and is not held out to be any form of advice. Taxation Law and its interpretation is subject to change and therefore the tax treatment of investments and the strategies which may be employed to mitigate tax cannot be guaranteed.You should not rely on the information posted here and should instead seek and take timely specialist financial legal and or tax advice specific to your own individual situation prior to making any decisions about investment actions transactions or inaction. 

Exchange Traded Funds (ETFs) are a type of Collective Investment Scheme. Most investors will be familiar with Collective Investment Schemes such as Open Ended Investment Companies (OEICs) or Unit Trusts.

ETFs have become increasingly popular over recent years. An investor in an ETF will get an income and capital return that exactly matches the index (from an exchange) being chosen or tracked, whether that is the FTSE all share index, an index based on an overseas stock exchange or an index that reflects a particular investment grade of Corporate Bonds and so on.

There is an added attractiveness derived from the fact that charges are usually rather less than those charged by managers of tracker funds/unit trusts.

A number of ETFs are Luxembourg or Irish open-ended companies. With this legal tructure, distributions of income are normally treated as dividends. Tax will not normally be withheld from such dividends.

However, where ETFs which are invested in loan stocks, the distributions therefrom may be treated as interest in the hands of the investor (effective 22 April 2009).

The realisation of the value of an investment in an ETF (by way of a sale or other designated chargeable transfer) will ordinarily give rise to a capital gain or loss. Any gain can of course be dealt with like any other gain, by way of mitigation using the Capital Gains Tax Allowance or other tax treatments.

With regard to an ETF which is invested in qualifying corporate bonds, a capital gain may arise if the investment value is realised. This contrasts with a direct investment in the same corporate bonds where, upon a realisation of the value this, would not give rise to a capital gain!  

To summarise: it is not just a matter of what an investor chooses to invest in that is relevant but also the way in which an investment is actually structured. This above conversation is really just a snapshot example of the potential pitfalls which lie ahead for the un- or ill- advised investor who invests without regard to such matters.Neil A Sewell MBA Chartered Financial Planner

Neil A Sewell MBA, Chartered Financial Planner at SewellBrydenGunn

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