AdjustedCostBase.ca now offers a streamlined method for importing phantom distribution and return of capital transactions for many exchange traded funds (ETF’s), publicly traded mutual funds, income trusts and real estate investment trusts (REITs). Learn more about this feature.
A phantom distribution (or reinvested capital gain distribution or notional distribution) occurs when an exchange-traded fund (ETF) or mutual fund makes a taxable distribution, but it’s reinvested back into the fund as opposed to being paid out in cash.
In the case of ETFs, an investor does not usually receive additional shares as a result of a reinvested distribution (hence the name, “phantom distribution”). This is because ETF providers (a) do not maintain client records, and (b) cannot issue fractional shares.
Phantom distributions usually occur when an ETF or fund incurs a capital gain, and the capital gain is reinvested instead of being paid out in cash. The capital gain will be immediately taxable and should appear on your T3 or T5 slip that you receive from your brokerage. So the capital gain will be accounted for when you compile your tax slips.
However, investors need to take additional steps to ensure that their adjusted cost base (ACB) is correctly calculated when phantom distributions occur. A phantom distributions, similar to a DRIP, results in an increase in ACB equal to the amount of the reinvested distribution. It’s in your best interest to account for phantom distributions. If you fail to do so, you’ll end up paying more capital gains tax than necessary when your shares or units are eventually sold.
The ACB resulting from a phantom distribution can be calculated as follows:
New ACB = (Previous ACB) + (Reinvested Distribution)
A phantom distribution is not usually specified on T3 or T5 tax slips, nor is it indicated on statements from your brokerage. As a result, the onus is often on the investor to determine whether a phantom distribution has occurred.
How do you determine whether a phantom distribution has occurred? One way is to consult the web site of your ETF or fund provider. For example, iShares issued a press release listing the reinvested distribution amount per unit for each of its funds for 2013. More than two dozen of iShares’ funds had a reinvested or phantom distribution in 2013, and some of the amounts were significant.
For example, we see from this press release that “iShares S&P/TSX Capped REIT Index Fund” (XRE) incurred a reinvested distribution of $0.62205 per unit in 2013, with a record date of December 31, 2013. This amount is reinvested into the fund, but investors did not receive any additional units.
AdjustedCostBase.ca is a web application that can be used to assist investors in calculating ACB including when phantom distributions occur. A phantom distribution can be specified by adding a “Reinvested Capital Gains Distribution” transaction. For the case of XRE in 2013, this would be done as follows:
Note that for this case you should enter “0” for the “Additional Shares Purchased/Received” because this is a phantom distribution where no additional shares are received.
In this case, the reinvested distribution has a corresponding capital gain associated with it. When using the “Reinvested Capital Gains Distribution” transaction type, the capital gain will be displayed automatically:
If a reinvested distribution were to occur without a corresponding capital gain, then you could use a “Buy” transaction instead, again setting the “Shares” amount to zero.
Another way to check if a fund you own incurred a phantom distribution is to consult the CDSInnovations.ca web site. Steps on how to find this information can be found here. Here is a snapshop of the year’s final distribution that includes the $0.62205 per unit phantom distribution:
The “Total Non Cash Distribution ($) Per Unit” row indicates that a phantom distribution of $0.62205 per unit has occurred. With this information, you can then add the “Reinvested Capital Gains Distribution” transaction on AdjustedCostBase.ca as shown above.
Note that there is a capital gain in this column equal to $0.65302 per unit. Since this capital gain is greater than the phantom distribution, there’s a residual capital gains distribution equal to ($0.65302 — $0.62205 = $0.03097) per unit. This would be entered into AdjustedCostBase.ca as a “Capital Gains Dividend” transaction as follows:
In some cases, the reinvested distribution, or a portion of it, is not in the form of a capital gain (for example, interest income). In these cases, you can enter the distribution using AdjustedCostBase.ca as a “Buy” transaction (and setting the number of shares to zero if no additional shares are received). A special case occurs when a reinvested distribution is in the form of return of capital. The reinvested distribution and the return of capital effectively cancel each other out: the ACB gets decreased by the return of capital amount, and then increased by the reinvested distribution amount. On AdjustedCostBase.ca, this can be entered as 2 separate transactions: a “Return of Capital” transaction and a “Buy” transactions.