Hi, I am just not sure what they mean when they are discussing the tax advantage that is gained by an ETF by using the “in kind” process. Can anyone explain how this tax advantage works to me as i dont really understand it. The statement is on the last paragraph of Los 76b SS 18 in schwesser top of page 254. thanks!
In kind, meaning, securities are not bought and sold by the ETF like a mutual fund and assuming capital gains. In kind is a non taxable transfer of assets.
First: Most of the times, governments collect tax on capital gains (i.e. appreciation in value) at the time of sale. (i.e. when capital gains are realized). Second : In a traditional fund… when investors want their money back… the fund sells assets (stocks or bonds) for cash… and returns money to investors. Third : In this process… the fund has to pay tax to government as… capital gains are now realized. Fourth : However… in case of ETFs… when “investors in ETFs” want money back (i.e. redemption)… ETFs do not sell assets… Rather, they transfer a portion of assets to the “investors in ETFs” Fifth : Thus, ETFs are not required to pay tax as they have not sold anything.
kamran - first: not a bad explanation. second: i’m still confused on why you numbered your sentences.
Except not much of that is true… "Second : In a traditional fund… when investors want their money back… the fund sells assets (stocks or bonds) for cash… and returns money to investors. "
And all this is only applicable in the US tax system, as most other countries tax the investor’s gain on the fund as a whole, rather than the gains on the assets within the fund. Perhaps personal taxation in other countries ought to be part of the CFA curriculum. Or maybe they should just leave this sort of nonsense out.
I completely agree with the “leave this sort of nonsense out”. It’s amazing that CFAI contends this is a global exam and then tests things about the US tax code.