ETFs and Tax
Paul Amery, Moderator
Editor
www.indexuniverse.eu
Yvonne Kunihira-Davidson, Panelist
Director
Burt, Staples & Maner LLP
Nathan Hall, Panelist
Partner
KPMG
Dan Draper, Panelist
Global Head of ETFs
ETFs and Tax
Yvonne Kunihira-Davidson,
Panelist
Director
FATCA Overview
FATCA treatment of ETFs and other Collective Investment Vehicles
What does the future hold from a US withholding tax perspective?
US withholding tax regulatory regime
4
FATCA Overview
FATCA stands for the “Foreign Account Tax Compliance Act” which was
incorporated into the HIRE Act that became law on March 18, 2010.
The goal of FATCA is to require non-U.S. financial institutions and non-U.S.
entities owned by U.S. persons to provide information to the IRS
identifying U.S. persons invested in non-U.S. bank and securities accounts.
The FATCA regime goes into force on January 1, 2013.
FATCA’s lever to achieve this goal is a NEW 30% withholding tax levied on
“withholdable payments” made to non-participating “foreign financial
institutions” (“FFIs”).
“Withholdable payments” include all U.S. source income (“FDAP”) and
gross proceeds from the sale or disposition of any property of a type that
Broad definition of FFIs that includes any non-U.S. entity that:
Accepts deposits;
Holds financial assets for the account of others;
Engages primarily in the business of investing, reinvesting, or trading in
securities, partnership interests, commodities, or any interest in such
securities.
FFI Examples: banks, securities brokers and dealers, hedge funds,
collective and family investment vehicles, private equity funds, trusts
and trust companies, etc.
Rules apply to all FFIs in an “affiliated group” – that is, to all
more-than-50% owned FFI affiliates and entities of an FFI worldwide regardless of
whether they receive U.S. source amounts.
FFIs can be exempt from 30% withholding if they meet certain criteria,
The FATCA statute excludes from the definition of a financial account a
debt or equity interest in a fund which is regularly traded on an
established securities market, e.g. ETFs.
However, ETFs were not identified as belonging to a class of institutions
which are deemed per se “good” and therefore exempt from 30% FATCA
withholding.
Consequently, at this time, it is envisaged that such entities will have to
enter into an FFI Agreement and comply with certain obligations,
including the requirement to impose withholding on passthru payments
and to calculate their passthru payment percentage (to the extent they
receive a passthru payment).
Notice 2011-34 which was issued on April 8, 2011 expanded on the
limited views offered in the previous Notice 2010-60. It states that
Treasury/IRS are considering the circumstances under which CIVs
regularly traded on an established securities market could be treated as
“deemed compliant”, (thereby exempt from FATCA withholding).
Consider the impact of FATCA on ETFs from the following perspectives:
ETF Industry
ETF providers
ETF Investors
ETFs and Tax
Nathan Hall, Panelist
Partner
Tax Can Strike At Three Levels
Fund
Equity
Debt
Derivatives
Investors
Investor level
Tax reporting: Austria, Belgium, Germany,
Switzerland, UK, US, EU
Some important distinctions:
•
ETF versus ETC
•
SICAV versus FCP
•
Synthetic versus Full Replication
Fund level
Residence of fund
Net asset taxes and stamp duty
Investment level
Withholding taxes and treaty access
ETFs and Tax
Dan Draper, Panelist
Global Head of ETFs
ETFs and Tax: something to consider
When choosing an ETF, investors often give first consideration to the size of the fund, its TER, turnover, and
market spreads, while leaving tax as a secondary issue
Tax has a reputation for being complex, and is generally perceived as having limited impact on returns
This alternative perspective illustrates the attention that tax deserves
Example 1*
The MSCI EM Latin America rallied more than 75%
between July 2009 and March 2011**
A UK based private investor holding an ETF tracking this
benchmark for the period would see the following
results:
-
If the ETF holds Reporting Fund Status (RFS): a capital
gains tax of 28% - i.e.
net return of 54%
-
If the ETF does not have RFS: income tax as
appropriate (e.g ~40%) – e.g.
net return of ~45%
The
10% difference in return
created by tax is higher
than the combined differences caused by TER and
tracking error
UK domiciled private investor
ETF tracking MSCI EM Latin America, w RFS
Index level
Gross
return
Net return
Jul-09
398
Apr-11
698
75%
54%
ETF tracking MSCI EM Latin America, w/out RFS
Index level
Gross
return
Net return
Jul-09
398
Apr-11
698
75%
45%
Difference on 100,000 GBP invested
9,045
GBP
ETFs and Tax: something to consider
Example 2
For the same benchmark, a French domiciled private investor would similarly see a large difference by
selecting an ETF with P.E.A. (Plan d’Epargne en Actions) status – a tax exempt wrapper in France applicable to
investments into European stocks – as opposed to one without such status
Assuming the investor is a private client, this would be taxed at 31.3% on capital gains
The
23% tax differential
in the net return of 2 ETFs
tracking the same benchmark with the same quality
is again much higher than the combined
differences cause by TER and tracking error
The
tax regime
applying to an ETF therefore has a
major impact
on clients’net returns
Credit Suisse always takes tax into consideration when designing how to replicate a benchmark
What follows is an overview of some aspects an issuer takes into consideration on this theme
France domiciled private investor
ETF tracking MSCI EM Latin America, w PEA status
Index level
Gross
return
Net return
Jul-09
398
Apr-11
698
75%
75%
ETF tracking MSCI EM Latin America, w/out PEA status
Index level
Gross
return
Net return
Jul-09
398
Apr-11
698
75%
52%
Difference on 100,000 EUR invested
23,593
ETFs and Tax: the issuer perspective
1)
Fund domicile with respect to investor domicile
The investor’s country of tax residence is significant in relation to the fund’s country of incorporation
- E.g. A European domiciled investor holding an Irish domiciled fund investing in US equities receives after
taxation 85% of dividends. When holding a US domiciled fund investing in the same underlying, the investor
is subject to an initial taxation of 30% (70% of dividends received*)
An ETF issuer therefore needs to accurately define its target clients, in order to design products that suit their
specific needs
* 15c of this amount can be re-claimed, where applicable. This does however involve an operational burden and may imply a delay between submission and settlement of the claim.
Local Equities (USA)
European listed ETF
(Irish domiciled) European investor
Local Equities (USA)
US listed ETF
(US domiciled) European investor
85c Net dividend (15% withholding tax) 85c Gross dividend (no withholding tax)
Source: CS ETFs, assuming 100c Gross dividend
ETFs and Tax: the issuer perspective
2)
Fund domicile with respect to the country of incorporation of index benchmark constituents
The country of incorporation of a fund (C1) is significant when tracking a given benchmark, on the basis of the
domicile of the constituents (C2) and of the taxation treaties in place between C1 and C2
Domestic funds can sometimes receive 100% of dividends
-
E.g. When tracking the DAX index, a German domiciled fund is preferable to a Luxembourg equivalent
Double taxation treaties differ from one country to another
-
US equity trackers domiciled in Ireland receive 85% of dividends, while US equity trackers domiciled in
Luxembourg receive 70%
For an ETF issuer, it is important to be able to launch ETFs advantageously for a given jurisdiction, or run multiple
platforms in different countries, in order to be able to track different underlyings most efficiently
Local Equities (MSCI Canada)
European listed ETF
(Irish domiciled) Non US-based investor
Local Equities (MSCI Canada)
US listed ETF
(US domiciled) Non US-based investor
Local Equities (MSCI Canada)
US listed ETF
(US domiciled) US-based investor
ETFs and Tax: the issuer perspective
Therefore:
No“perfect structure” exists, but different products can be tax-optimised for different types of clients
Investors should understand their own tax situation and then screen the ETF market to select the issuer that
best matches their circumstances
Overview of
tax related themes
discussed with our clients in
different jurisdictions
UK, Reporting Fund Status: where the share class has successfully held RFS (or UK Distributor Status)
throughout the investor’s entire ownership period, the capital gains tax rate (e.g. 28%) should apply as
opposed to the income tax rate applying to non-RFS ETFs (e.g. 40%).
All CS ETFs hold RFS
France, P.E.A.:
All swap-backed CS ETFs are P.E.A. compliant, holding in their substitute basket European blue
chips
Questions and themes from clients
Germany, Black vs White funds(*): in Germany the taxation of foreign investment funds is based on a
transparency principle, under which vehicles fall into one of three categories:
-
White funds: funds registered for public distribution and fulfilling certain publication requirements for tax
purposes
-
Grey funds: non-registered funds with a tax representative and disclosure of all tax relevant data
-
Black funds: all other funds
For white funds, taxation is similar to that of German domiciled funds (apart from the fact that investors
cannot receive any German corporation and withholding tax credit). The difference between white and
grey funds is that capital gains realised by a grey fund always represent full taxable income for corporate
and non-corporate investors, irrespective of whether the fund is distributed or not. German corporate and
non-corporate investors in black funds are taxed on an unfavourable lump-sum basis.
Disclaimer
Credit Suisse Exchange Traded Funds (CS ETFs) may not be suitable for all investors. Credit Suisse AG does not guarantee the performance of the shares or funds. The value of the investment involving exposure to foreign currencies can be affected by exchange rate movements. We remind you that the levels and bases of, and reliefs from, taxation can change. Affiliated companies of Credit Suisse AG may make markets in the securities mentioned in this document. Further, Credit Suisse AG and/or its affiliated companies and/or their employees from time to time may hold shares or holdings in the underlying shares of, or options on, any security included in this document and may as principal or agent buy or sell securities.