I have 200 shares of Vanguard Growth ETF Portfolio in my RRSP. Earlier this year, my account showed an entry labelled “TXPDDV” for $56.47 and one labelled “DRIP” for minus-$56.47, so I did not receive a dividend at all. I read somewhere that minus-$56.47 is used to reduce the adjusted cost base of the shares held. Is that correct? And if so, how is it adding value to the shares?
No. In fact, the opposite is true: Although exchange-traded fund distributions in the form of return of capital can reduce your adjusted cost base, the distribution here would actually raise it if you held your ETF in a taxable account.
The account type is the key. Cost base adjustments are completely irrelevant for you because you hold your ETF in a registered account. But what exactly is going on?
For the less semiotically informed, TXPDDV is the TD Direct Investing code for “distribution,” and DRIP refers to “dividend reinvestment plan.” And although we’re discussing Vanguard, the same concepts apply to ETFs from other issuers, too.
What you’re seeing is a reinvested distribution of capital gains. Over the course of a year, your ETF could realize capital gains for a number of reasons, including rebalancing to bring it back in line with its target allocation, selling a security that has been dropped from an index it tracks, and corporate actions like mergers that might lead to a disposition of an underlying holding.
Instead of paying those capital gains out in cash, Vanguard may pay holders a distribution that is automatically reinvested into additional ETF units.
This can be confusing because you still hold the same number of units. Some investors also question why they see DRIP entries in their accounts when they haven’t enabled dividend reinvestment plans.
In the prospectus for its ETFs, Vanguard explains the process. Immediately after the distribution is reinvested, Vanguard consolidates the units outstanding so that the number held by each investor doesn’t change. The net asset value of each unit, Vanguard says, is the same as if the distribution hadn’t been paid. You’re left with the same number of units and seemingly no sign of what is commonly, and understandably, referred to as a “phantom distribution.”
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And if you’re holding your VGRO units in a registered account, you can safely ignore the ghost and carry on with your life.
It’s a different story if you hold it in a non-registered account, in which case this reinvested capital gains distribution would be taxable. It might seem unfair to be taxed on gains you don’t see, but remember the distribution raises the adjusted cost base of your investment.
When it comes time to sell, your capital gains will be assessed on this higher cost base, meaning a smaller taxable gain. In other words, you don’t get taxed twice.
But, and this is important: It’s best not to rely on your brokerage to keep tabs on phantom distributions and other transactions affecting your adjusted cost base, especially if you have holdings in non-registered accounts at different institutions.
In the case of VGRO, you’ll see this kind of distribution listed in the distribution history as “CGCA,” for capital gain cash adjustments. Multiply the distribution per unit by the number of units you held in non-registered accounts on the record date, and add the total to your adjusted cost base.
Some brokerages do a decent job of tracking this, but I prefer to spend some time every year on AdjustedCostBase.ca ensuring that when it comes time to pay taxes on capital gains, I don’t pay more than I should.
My tax professional made two mistakes last year, told me that my old accountant did everything wrong, then charged me a fortune for a bad explanation of the T5008, which they said took them “five months at college to understand.” I know the return of capital has to be added to the adjusted cost base, but is the number in box 42 on my T3 slip total or per share? What should I do?
Start with finding a new tax professional. As much as I have griped about the T5008 (Statement of Securities Transactions) in this space, it is not especially complicated. Digital brokerage Questrade has a nice summary of common questions that you can find online.
The T5008 is based on data provided by your brokerage, which may or may not accurately reflect your real adjusted cost base. As for the T3, the number in box 42 should be subtracted from, not added to, the adjusted cost base of your holding. It’s a total figure, not per unit.
While it’s not a replacement for a good tax professional, I’ve been very pleased with TurboTax over the past few tax seasons. It automatically imports the relevant data from your T-slips, but you’ll still want to keep track of adjusted cost base changes yourself.
E-mail your questions to agalbraith@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.