ETFs may earn dividends and interest income from the securities they own, and they may realize capital gains or losses when investments are sold. This income may be reduced by the ETF’s expenses. The ETF distributes any remaining income or capital gains to unitholders by way of distributions, which are taxed at the investor’s applicable tax rate. This is preferable to having the income retained by the ETF, where it would be taxed at the highest marginal tax rate. Income is distributed in the same form as it is earned by the ETF: as interest income, Canadian dividends, foreign income or net capital gains – or a combination of the four.

No. While monthly and quarterly distributions are paid in cash to the unitholder, capital gains distributed annually in December are paid as a reinvested distribution (no cash is distributed to the unitholder).

These capital gain distributions are reinvested in additional units of the ETF, and units are immediately consolidated such that the ETF’s total units outstanding does not change. The capital gain distribution will be immediately taxable and will appear on your T3 tax slip. Your adjusted cost base (ACB) is increased by the amount of the reinvested distribution, which will lower any realized capital gain or increase any realized capital loss when you eventually sell your ETF units.

For investments in a non-registered account, annual taxes apply to capital gain distributions, whether they are paid in cash or as reinvested distributions.

To explain, let’s consider an investor, who invests in 10 units of an ETF for $100. Over a given period, the unit price grows to $12, based on $1.60 of dividends and $0.40 in price appreciation.

So, their total investment value grows to $120.

The ETF distributes the $1.60 of dividends per unit to the investor , so they receive $16 in cash. After the distribution, the unit price falls to $10.40 and their investment value falls to $104 ($10.40 x 10 shares).

However, because the investor also received $16 in cash, their total wealth is unchanged at $120 ($104 + $16).

ROC is a tax term used to describe distributions in excess of an ETF's earnings (income, dividends and capital gains). For tax purposes, ROC represents a return to investors of a portion of their own invested capital.

However, the inclusion of ROC in a distribution does not indicate whether an ETF has gained or lost value, since it may have unrealized capital gains that have not yet been paid out.

ROC distributions typically occur when an ETF declares a regular monthly distribution. If interest, dividends and realized capital gains earned by the ETF are less than declared distributions, an ROC distribution is added to make up the remainder. ROC distributions help stabilize the amount of cash flow you receive on a regular basis from a particular investment.

Annual tax information is submitted to the Canadian Depository for Securities (CDS) by investment firms in February; each investment firm uses this information to prepare and mail tax forms to ETF unitholders towards the end of March.

The answer depends on whether or not your ETFs are held in a registered or a non-registered plan. Income earned on investments held in a registered plan is not immediately taxable and a T3 tax slip is not issued. However, a T3 tax slip will be issued if ETFs are held in a non-registered plan and there’s a taxable distribution. Annual tax applies to any distributions received other than return of capital.