Light at the end of the ACB Tracking Tunnel for ETFs?

One of the few thorns in the side of investors holding ETFs in taxable accounts has been the necessity to track their Adjusted Cost Base (ACB) in order to correctly calculate capital gains for income tax reporting. The T3 and T5 slips received from brokers enable the reporting of yearly income without any problem but figuring out capital gains after a sale of ETF units can be a complicated headache, as our posts explaining how to do it here and here would suggest.

Note that such issues do not arise at all in any kind of registered account so anyone with ETFs only in such accounts can relax. There's no tax reporting or ACB tracking to do.

Return of Capital (ROC) and Re-Invested (Non-cash) Distributions (RID)  - Complexity that matters
The challenge of figuring out the correct ACB in a taxable account arises from the requirement to subtract the amount of any ROC and to add any RID from the starting ACB.

ROC - The ROC has always been fairly easy to find as it shows up on T3 slips in box 42 for Canadian-listed ETFs. (US-listed ETFs don't have the problem of ROC and RID as Canadian Couch Potato explains in Adjusted Cost Base with US-Listed ETFs). Box 42 shows the actual dollar amount to subtract from ACB. Fairly simple.

RID on the other hand has required several extra steps. First was finding a source for data. The various ETF providers such as iShares, BMO, Powershares, RBC etc almost all do so in one manner or another somewhere on their website (usually the Distributions tab on an individual ETF's profile page).

The better comprehensive source is CDS Innovations (kudos to Canadian Couch Potato for noting this site, which is not well enough publicized) where the ETF providers are legally required to upload the data for all their ETFs within 60 days of year end. You need to have Excel to open the files (free software such as OpenOffice unfortunately does not work). Each ETF has a file for each year. A screenshot of part of the 2013 list with some BMO ETFs is below.

(click image to enlarge)

The second step is to actually do the calculations. That involves taking the per unit/share amount and multiplying by the number of ETF units/shares held at the RID distribution date, which is usually, but not always, bundled with the regular cash distribution in the last distribution of the year in late December. If you do not sell the units before the indicated Ex-dividend date (see explanation in the Globe and Mail of the various types of dates relating to dividends) then you can add the RID amount to your ACB. That's important for the investor since a higher ACB means less of a capital gain (Sale price minus ACB = Capital Gain) to report upon sale of the units. As we noted in our previous posts on ACB, the RID amount is taxed in the year that it is allocated, so to avoid double taxation when the units are sold, it is necessary to add the RID to ACB.

Example: How important RID is can be seen in an example. Take a popular ETF, the iShares S&P/TSX Capped Composite ETF (TSX symbol XIC) which conveniently does show a complete distributions history on one page. Suppose an investor had bought 1000 units on March 1, 2001 at the closing price that day of  $9.84 and sold on December 30th, 2013 at the closing price of $21.33 (historical prices here on Yahoo Finance). The sum of Re-invested distributions in that period is $1.96422 and represents 17.1% of that gain. At a 40% marginal tax rate, forgetting to add in the RID would mean paying an extra $393 in income tax (1000 units x $1.96422 x 50% capital gains inclusion x 40% marginal tax rate = $393). Of course, the summed ROC of $0.31571 would need to be subtracted to properly peg the ACB. But the net of RID and ROC would still mean a saving of about $330 on a capital gain tax bill of $2300 had no adjustment for RID and ROC been done.

This example illustrates another reality. Over time the amount of Re-Invested Dividends given off by ETFs vastly outweighs ROC, so it is even more important not to forget it. The government certainly doesn't want you to forget subtracting ROC from the ACB, since that increases the capital gain and therefore tax, but it certainly won't mind or care if you forget adding the double-tax eliminating RID!

Online brokers to the rescue with automatic ACB updating
A solution that seems to work in most circumstances at most brokers is simply to use the Book Value tracked and updated automatically by the online broker. Brokers update the ETF Book Values for both ROC and RID data. Below is a sample entry in a broker account for RID distributed to a shareholding of 2200 shares of the BMO Low Volatility Canadian Equity ETF (ZLB) owned at the end of December 2013.

(click to enlarge)

The offsetting positive and negative dividend transactions of $692.96 serve to increase the Book Value but leave no extra cash in the account, since RID is a non-cash item. This type of book-keeping helps explain why RID is sometimes called a phantom or special distribution. We can check that the amount is correct by going to BMO's webpage for the ETF where the Distributions tab shows a RID amount of $0.312144, which when multiplied by 2220 shares equals $692.96.

A similar annual entry would update Book Value with the same amount that appears in the T3 box 42 total year ROC and would reduce Book Value.

That's the good news, now the caveats. The accuracy of automatically updated Book Value aka ACB will not be reliable in certain circumstances:

• Distributions made in years before the date such automatic updating started; at one broker it was 2005, but check with your own.
• ETFs transferred, especially partial transfers, between online brokers - the Book Value may not follow; it is possible at some brokers to manually adjust the Book Value yourself online or phone the broker to request it be done to the correct figure you have calculated. After that, it should update correctly.
• The same ETF held in multiple brokerages - each broker keeps its own Book Value correctly but you must, according to the Canada Revenue Agency, sum and average all your shares for ACB. If you sell from one of the accounts, the proper ACB per unit is the average of all units, not the Book Value per unit of the units in that particular account.
• Delay between the time the RID or ROC was distributed and when the adjusting transaction shows up in the account - as we see with the ZLB example above, it took two months from January to March for the RID to show up and the ROC has still not done so; yet this is not a big impediment since any sale in January this year would not need to be reported for income tax until next year's return.
• Mistakes can happen and some brokers may be more diligent or careful than others updating RID and ROC, as some comments in this Couch Potato post suggest. Spot checking transactions for ETF on statements for March and April when RID and ROC adjustments should show up is a good idea. The brokers disclaim any legal responsibility for the accuracy of Book Value, so the onus is always on us the investors to verify what happens in our accounts. 

Disclaimer: This post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.