Tuesday, 20 January 2009

ETFs and Mutual Funds - Calculating Capital Gains

The previous post on this blog explained that an investor must calculate the capital gain when he/she sells a mutual fund or ETF and must report that gain on his/her annual tax return. This post now explains how to figure out the capital gain.

Step 1: The first number to calculate the gain is the amount you receive, quite straightforwardly the net cash after deduction of fees and commissions incurred by the sale.

Step 2: The second number is the cost, or the Adjusted Cost Base (ACB) in tax parlance. The formula is:
ACB =
Total Paid to Purchase Shares/Units (plus fees and commissions)
+
Reinvested Distributions (all of Capital Gains, Income and Dividends)
-
Return of Capital (ROC)
-
ACB of Previous Sales of Shares/Units

The ACB changes with each purchase, distribution and ROC over the years the fund is owned. The ACB is a running total for the fund. There is no selling oldest or newest shares first, they are all mixed together.

Mutual fund companies generally keep track of the ACB and you can see this on statements or obtain this information from them but they also advise to do the calculation yourself since most disclaim liability for possible inaccuracy due to situations such as deemed dispositions and incomplete return of capital deductions.

The ETF companies cannot provide the ACB of your holdings (iShares explains why in this FAQ); you must do the calculation yourself for ETFs using the data on the T3 slips and brokerage detail statements for the T3 (box 21 = capital gains; box 42 = ROC).

It is important to track ACB because if you do not, you will be paying taxes twice on reinvested distributions - once when reporting the gain on the T3 and again when you sell part or all of the holding. Remember, the higher the ACB, the less the capital gain and the less tax there is to pay.

The chart below shows examples of ACB tracking calculations for a mutual fund and for an ETF. Note especially (see yellow cell) that when an ETF reinvests capital gains distributions, no additional shares are issued or created, as explained in the iShares FAQ linked above.

The easiest way to keep track of ACB is to do an annual update when the fund companies announce their tax distributions and issue T3 slips for the previous year, sometime around the end of February. The websites of ETF and Mutual Fund companies disclose the annual distributions on a per share/unit basis, which enables the re-construction of past years if statements or T3 slips have been mislaid.

Managing Taxes from iShares Canada
ETF Tax Information page at Claymore Canada

Disclaimer: this post is not to be construed as advice; it is for information purposes only. Consult a tax accountant or financial professional for proper advice.