Journal of Indexes
2008
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Representatives of the Internal Revenue Service (IRS) and the Department of the Treasury met in October to discuss the issue of how exchange-traded notes (ETNs) should be taxed. Most ETN providers have so far argued that ETNs should be treated like risk-sensitive structured products, which would give them a significant tax advantage over ETFs.
For instance, the prospectus for the iPath Dow Jones AIG Commodity Index Total Return ETN (NYSE: DJP) states that the note should be treated as a prepaid contract with respect to its underlying index. That means that all the interest income and spot return on the index will be rolled up into the value of the note, and investors will only pay taxes when they sell or when the notes reach their 30-year maturity. By comparison, a commodity ETF like the iShares GSCI Commodity ETF (GSG) or the PowerShares DB Commodity ETF (DBC) gets hit with a double whammy on the tax front: First, any interest income in the fund is paid out and taxed as regular income; second, the funds are “marked-to-market” at the end of the year, meaning the IRS treats the funds as if you sold them on December 31 ... even if you didn’t. If the fund is up, you pay capital gains taxes, with 60 percent treated as long-term gains and 40 percent treated as short-term gains. Similar—and indeed more favorable—treatments apply to the currency ETNs. Some argue that this amounts to a tax dodge, and that regulators should crack down and put the notes on par with ETFs on the tax front. Others note that the fact that ETNs have credit risk shows that they are truly different products, and deserve different tax treatment. There was no official report coming out of the meeting. |
