If an ETF does not have UK reporting status, formerly known as distributor status, an investor will have both income and gains taxed as income.
With reporting status, income is taxed as income and gains taxed as capital gains.
For a higher rate taxpayer this seemingly minor detail is a big deal, since there is a danger gains will be taxed at 40% or 50% instead of 28%.
For a standard rate taxpayer the discrepency is smaller, 20% instead of 18%, but still worth being aware of.
The reporting status system took over distributor status in December 2009 and HMRC has experienced backlogs in trying to grant all applying funds compliance.
The main difference between the two systems is that providers used to have to reapply each year for compliance and now only need to apply once in the fund’s lifetime.
This meant in January 2010 many providers block-submitted all their funds for approval.
Caroline Shaw, fund manager at Courtiers, said: "Not all ETFs have reporting status. Many ETFs haven’t sought reporing status. I hear there has been (maybe still is) a backlog at HMRC, which wouldn’t be surprising at all given the huge number of new entrants into this fast growing market.
"With increased publicity, many ETF providers that hadn’t previously sought to get reporting status are maybe doing so to improve their attractiveness."
The competitiveness of TERs in the ETF arena is well known, and investors and advisers alike are familiar with the practice of comparing TERs.
The issue of tax considerations and reporting status of ETFs is one that could easily fall under the radar, however.
Leslie Gent, global head of capital markets and product research at Coutts, said: "For taxable investors it is absolutely critical that they understand the importance of this issue.
"It’s one of the requirements we need to see before we invest on behalf of our UK client base. They started as an institutional product and most providers didn’t really understand some of the important attributes needed for a retail investor, or taxable investor."
Gent said she has more confidence in the system since it switched from the distributor status regime because providers no longer have to apply on an annual basis.
"Clients were always at risk that their fund could go from a CGT to income taxable event. Now it is more predictable and more transparent," she explained.
Once an ETF is assigned reporting status it dates back to when the fund was launched, but there is a risk to investing in a fund that is waiting to receive compliance.
Most of the big ETF providers are familiar with how the new regime works and know there are some funds that will not qualify for UK reporting status.
They tend to clearly state on the fund’s literature if it has reporting status or not. For investors and advisers it is vital to look out for this information and if it is not explicitly stated, seek it out.
US-listed funds should always be avoided as they cannot get UK reporting status.
If advisers find an ETF that is intended mainly for the European market and lacks UK reporting status, an approach can always be made directly to the provider.
Gent said she has had some success with this tactic, but it depends on whether the asset manager is starting to target the UK retail market or not.
