ETFs and how the dividends are distributed

Many companies pay dividends to their shareholders, so what happens if the shares are held within an ETF?

ETFs also pay dividends to investors

Many companies pay dividends to their shareholders, so what happens if the shares are held within an ETF (exchanged traded fund)?

In short, investors still receive the dividends but as part of scheduled payments from the ETF called a distribution. Many — but not all — ETFs also offer a dividend reinvestment program (DRP) just like traditional shares.

How it works

The ETF holds the shares on behalf of its investors, so any dividends that might apply from the underlying companies are paid ­directly to the ETF.

The ETF collates any income the assets generates, including dividends, interest, capital gains and any other items and pays this out to investors as part of a regular distribution rather than immediately as the dividends are received. The timing for this is outlined in the ETF’s product disclosure statement, ranging from monthly to annually.

One regular payment can be an advantage to an investor. To put this in content, imagine it from the perspective of being invested in the companies in the S&P/ASX 200. An investor could receive up to 200 small pro-rata payments, each with different tax implications, on different dates. One payment with one statement from an ETF is an appealing proposition.

Tax implications

ETF distributions are subject to tax, with the level depending on the investor’s individual circumstances, marginal tax rate and factors like jurisdiction or income classification. For example, dividends from international companies have a different tax classifi­cation and potentially a different rate compared to those paid by domestic companies where the franking regime exists.

Retired investors who rely on franking credits as part of their income may be relieved to find it is still possible to accrue these in an ETF. If the underlying companies offer franked dividends, then a pro-rata share of credits is available to investors depending on their individual circumstances.

This is all outlined in the statement investors receive following the end of each tax year — usually towards the end of July.

The statement breaks down the distribution into its relevant tax portions such as: capital gains, foreign income and foreign income tax offsets, franked dividends/franking credits and tax deferred distributions.

At the end of the day, the ETF is a “look through” to the underlying companies. Anything that happens to the company is passed on by the ETF to the holder.

Sara Allen is head of content at ETF Securities Australia.

www.etfsecurities.com.au