I'm doing my taxes these days and part of that is to report the gain on some iShares Exchange Traded Funds (ETFs) that I sold in 2006. There's a tricky bit involved in that process which I figure is worth noting in case anyone might end up paying tax twice on their gains. Though mutual funds and ETFs are substantially similar in that they pass through capital gains and income to unit owners, there is a particular and important difference when it comes to the reinvestment of distributions. In mutual funds, the reinvestments show up as additional units and a higher adjusted cost base (ACB) for those units but with ETFs they do not. You must keep track yourself of the reinvestments and the higher ACB for ETFs. Otherwise, if you just take your original purchase cost for the ETF as the ACB, you will end paying tax again on the reinvested distribution that you already pay each year when taking figures from the T slips. I know my discount broker BMO Investorline does not keep track of the higher ACB when it shows my cost in account listings or statements. Probably none of the discount brokers do and I'm not sure all full service brokers do. It's worth checking. The iShares website has a good FAQ on the subject with more detail and a side-by-side example of the ETF vs mutual fund method. Here is another good explanation how this works for mutual funds from McColl Turner Chartered Accountants. Update January 14, 2008: Note that a return of capital distribution reduces the cost of an ETF and it is necessary for an individual investor to subtract it to properly track ACB. The proper formula for ACB, as explained by Howard Atkinson on page 160 of his excellent book on ETFs, The New Investment Frontier III, is: ACB = (total purchases + acquisition costs + reinvested distributions - return of capital) / units purchased. The main iShares page has a link labeled iShares CDN Funds - 2006 Tax Characteristics which shows all the iShares Canadian ETFs and their reinvested distributions; for earlier year breakdowns, go into the individual fund info and look for the Distribution History link on the left hand side e.g. this page for the Energy sector XEG fund.
I have to admit that despite my general preference for ETFs, this is an advantage of mutual funds over ETFs in the calculation convenience and the avoidance of costly oversights. Over a long holding period this can be significant. Even in the short space of two years from 2004 to 2006, the iShares TSX 60 XIU that I sold increased by almost $3 per unit in ACB. I'd be paying our friends at CRA quite a bit more if I simply used the original purchase cost.