Phantom Distributions and Their Effect on Adjusted Cost Base

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.

XRE.TO Phantom Distribution

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:

XRE Reinvested Capital Gains Distribution

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:

xre_reinvested_capital_gains_distribution_transaction

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:

XRE Tax Breakdown from CDS Innovations

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:

XRE Capital Gains Dividend Transaction

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.

 

19 thoughts on “Phantom Distributions and Their Effect on Adjusted Cost Base

  1. Tyler

    Very useful post. I’ve noticed in the past that not all reinvested (or “phantom”) distributions are capital gains. BMO in particular seems to like doing this with their ETFs. I’ve seen reinvested interest (ZRR) and even reinvested return of capital (!) with ZCN.

  2. AdjustedCostBase.ca Post author

    Thanks, Tyler. I’ve added a note above to address these cases.

    When a reinvested distribution is in the form of return of capital, it’s a particularly interesting case. When investors are completely ignorant about the effects on ACB of both return of capital and reinvested distributions, two wrongs will make a right, since they cancel each other out.

    However, in the case where an investor notices the return of capital amount on their T3 slip and decreases ACB accordingly, but fails to increase ACB because the reinvested distribution isn’t listed on the T3, they’ll end up overpaying capital gains taxes when the shares are sold.

  3. neilsherri

    In discussion with CRA about interest paid to purchase mutual funds, the interest may or may not be eligible to claim as carrying costs, based on the premise that the mutual fund typically generates capital gains, not income. They said in that case, the borrowing cost could instead be included in the ACB.

    How would that be done in the adjustedcostbase interface? I’m thinking maybe a ‘buy’ transaction with an amount but zero shares?

  4. neilsherri

    I may have been mis-remembering an article I’d seen where one of the newer tax software applications did something like this, although perhaps not this exactly. Then when the CRA agent suggested it, that helped me convince myself it was real. I’ll see if I can find a better reference 🙂

  5. neilsherri

    After going back through everything, it seems it was only the CRA agent who said to do this.

    I think the article I’d seen was actually talking about adding superficial loss to the ACB, not adding carrying charges to the ACB.

  6. Grant

    A very helpful post. Thanks. Just to clarify, if on CDS Innovations, there is just a capital gain listed (with no non cash distribution), that amount should be recorded as a capital dividend?

  7. AdjustedCostBase.ca Post author

    Grant,

    I’m going to assume you mean Capital Gains Dividend/Distribution as “Capital Dividend” has a another special meaning.

    Yes, this should be recorded as a capital gains dividend. Assuming that there is no non-cash distribution, the amount should appear on CDS Innovations as a cash distribution.

  8. Grant

    Thanks, yes, I meant Capital Gains Dividend. In the instance I was looking at CDS Innovations (Dec 31, 2013 ishares MSCI emerging market IMI ETF), there is a capital gain of 0.00017 with no none cash distribution. There is a cash distribution of 0.17717, which I had assumed was all dividend, but I guess includes the capital gains dividend?

  9. AdjustedCostBase.ca Post author

    Grant,

    In that case, yes, you would record a capital gains dividend of $0.00017 per share. Note that there is also return of capital in the amount of $0.01665 per share. Aside from that, nothing else will affect ACB assuming the cash distribution is not reinvested.

  10. Grant

    Yes, I noticed that adding the Capital Gains Dividend did not change the ACB. So why bother adding it and why do you have that choice in the new transaction menu?

  11. AdjustedCostBase.ca Post author

    Grant,

    You’re correct that a capital gains dividend should not affect ACB. This transaction type is there for completeness (so that all capital gains can be compiled in one place), but it’s not necessary to track it on AdjustedCostBase.ca as long as your T slips are accurate and you include them when completing your tax return.

  12. Grant

    Thanks, that’s very helpful. So, from the point of items that appear on the CDS Innovation spreadsheet that will change the ACB, one only needs to record return of capital and total non cash distributions (recorded as reinvested capital gains). Would that be correct?

  13. AdjustedCostBase.ca Post author

    Grant,

    That’s almost correct. There are some cases where a non-cash distribution is not coupled with a capital gain (and some cases where it is only partially coupled). In those cases you would use a reinvested distribution transaction.

  14. sean

    OK am I understanding correctly? There are basically 5 scenarios when looking at the CDS sheets and phantom distributions:
    – a non-cash distribution with blank capital gain box
    – a non-cash distribution equal to capital gain box
    – a non-cash distribution with a greater amount capital gain box
    – a non-cash distribution with a lesser amount capital gain box
    – a non-cash distribution with an percentage (e.g. BMO ETFs) in the capital gain box

  15. AdjustedCostBase.ca Post author

    Sean,

    I believe that a non-cash distribution could be allocated in any way among the various categories (capital gains, return of capital, etc.). It is typically coupled with a capital gain of a equal amount, but the capital gain could be less than the non-cash distribution amount with the difference being allocated to other categories. I don’t think that the capital gain could be greater than the non-cash distribution amount, unless there’s an additional cash distribution amount combined into the same entry (typically the non-cash distribution is a separate entry at the end of the year, distinct from a cash component). The entries can be completed either with a dollar amount or a percentage of the total distribution.

  16. Wayne

    I am considering signing up for the paid version of this website but I am unclear if adjustedcostbase.ca automatically handles phantom distributions. Above their are instructions for using the CDSInnovations website for getting the data and entering a transaction into adjustedcostbase.ca. If I have entered all of my transactions into this website then why aren’t the phantom distributions calculated automatically? Can’t you just automatically download all of this info from CDS and apply it to my holdings, which you already know?

  17. AdjustedCostBase.ca Post author

    Wayne,

    The streamlined import feature for importing phantom distributions and return of capital transactions for ETF’s and other funds is described here:

    https://www.adjustedcostbase.ca/blog/streamlined-import-of-return-of-capital-and-phantom-distributions-and-for-exchange-traded-funds-etfs-publicly-traded-mutual-funds-and-trusts/

    With this feature you do not need to go through the process described above for phantom distributions (in addition to return of capital and capital gains distributions). You’ll still need to initiate the import process for each ETF each year, but the process is much less tedious and error-prone compared to the manual alternative.

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