Interest income
Interest income is earned through depositing or lending money to others. Interest can be earned on investments such as guaranteed investment certificates (GICs), income payments from government or corporate bonds or T-bills, certain mutual funds, etc. Investors in an iShares ETF can earn interest income through their investment if the iShares ETF earns interest income through its underlying holdings and distributes this interest income to its investors.
Interest income is normally taxable at the individual’s marginal tax rates. These rates can be in excess of 50% for the highest income earners in some provinces. In order to avoid a tax deferral when earning interest, it is usually taxed on an accrual basis. That is to say, interest income is generally taxed as it is earned day by day, not upon ultimate receipt.
Canadian dividends
Individuals that invest in shares of Canadian corporations, either directly or through a mutual fund or ETF which holds shares of such Canadian corporations, can earn Canadian dividends. These dividends represent the distribution of corporate profits to the shareholders.
Recognizing that corporations already pay income tax on the profits they earn, dividends paid to shareholders can receive favourable tax treatment. This is achieved through a dividend gross up and dividend tax credit for individuals. Generally, dividends paid by Canadian public corporations will be considered eligible dividends while dividends paid by Canadian controlled private corporations are ineligible dividends. The effective tax rate of eligible dividends for individual investors is normally lower than that of ineligible dividends.
Foreign non-business income
Foreign non-business income is earned when an iShares ETF receives dividends from, or interest on, non-Canadian investments. Investors in an iShares ETF may earn foreign non-business income if the iShares ETF earns such income and distributes this foreign non-business income to its investors. They are fully taxable at an investor’s marginal tax rate. However, to the extent that the iShares ETF has paid foreign withholding tax on the foreign non-business income earned, the fund may designate gross foreign income earned and its associated foreign withholding tax paid to investors so that investors may be able to claim a foreign withholding tax credit when filing their own personal income tax returns.
Capital Gains
Capital gains represent the growth or increase in value realized on the sale of a capital asset such as a stock or a bond etc.
Capital gains distributed by an iShares ETF represent the net capital gains realized by the fund. Only 50% of capital gains realized are subject to tax.
ROC
Return of Capital (“ROC”) represents the amount of a distribution that is in excess of an iShares ETF’s earnings (income, dividends and capital gains). For tax purposes, ROC is essentially an investor’s own invested capital.
ROC is not taxable immediately in the year received, but reduces an investor’s Adjusted Cost Base (“ACB”) of a particular iShares ETF, which generally results in a larger capital gain or a smaller capital loss when the iShares ETF is sold. In the event ROC causes the ACB to be negative, the negative ROC will be required to be recognized as capital gains and ACB will be reset to zero.
