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How To Choose An Exchange Traded Fund

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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

(2)

ETFs and Tax

Yvonne Kunihira-Davidson,

Panelist

Director

(3)

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)

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

(5)

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,

(6)

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).

(7)

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

(8)

ETFs and Tax

Nathan Hall, Panelist

Partner

(9)

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

(10)

ETFs and Tax

Dan Draper, Panelist

Global Head of ETFs

(11)

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

(12)

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

(13)

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

(14)

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

(15)

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

(16)

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.

(17)

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.

(18)

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

References

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