Taxation of ETFs

ETF taxation at a glance

In general, we recognise two scenarios for ETF taxation:

• Short-term holding (less than one year) – Capital gains from ETFs are taxed at %/25% rate + 15% health insurance;
• Long-term holding (one year or longer) – Capital gains from ETFs can (should) be exempt from income tax. For more information on why and when, watch the Highgate Talks video podcast on the taxation of ETFs.

What is an ETF?

“An ETF (Exchange Traded Fund) is an exchange-traded fund that tracks multiple assets in a single fund, such as stocks, bonds or commodities. They are traded on an exchange like a stock and offer investors an easy way to diversify their portfolio and invest in different asset classes under one roof.

ETFs are similar to mutual funds, but there are some key differences. ETFs are traded on an exchange throughout the day, while mutual funds are only valued once a day. ETFs also tend to have lower fees than mutual funds.

Benefits of investing in ETFs:

• Diversification: ETFs offer an easy way to invest in a variety of assets, which can help reduce your overall risk.
• Low costs: ETFs tend to have lower fees than mutual funds, which can help you keep more of your returns.
• Tradability: ETFs are traded on exchanges throughout the day, so you can buy or sell them at any time.
• Transparency: ETFs are transparent investment products, so you can easily see what you’re investing in.

Which are index funds?

Examples of some of the best known index funds:

• SPDR S&P 500 ETF (SPY): tracks the S&P 500 index, which is composed of the 500 largest companies in the U.S. It is one of the most popular and liquid ETFs in the world.
• iShares Core S&P 500 ETF (IVV)
• Vanguard Total Stock Market ETF (VTI): tracks the entire U.S. stock market, including small, mid and large cap companies.
• iShares MSCI Emerging Markets ETF (EEM): tracks emerging equity markets.
• Invesco QQQ Trust (QQQ): tracks the Nasdaq-100 index, which is composed of the 100 largest companies traded on the Nasdaq stock exchange.

These are just a few examples of the many ETFs available. When choosing an ETF, it is important to consider your investment objectives, risk tolerance and time horizon.

ETFs and compound interest?

ETFs (exchange-traded funds) can have compound interest. Compound interest is achieved when interest is reinvested, increasing the underlying investment and generating even more interest.

Compound interest is a phenomenon where interest is calculated not only on the original investment but also on the interest already accrued. This leads to exponential growth of the investment over time.

What are capital gains?

Capital gains are the profits you make from selling securities such as stocks, bonds, mutual funds, real estate and cryptocurrencies. They arise when the price of a security when sold is higher than its cost basis.

There are two types of capital gains

• Short-term capital gains: these gains are taxable if you have held the security for less than one year. The tax rate is 19% or 25%, plus health levies.
• Long-term capital gains: these returns are normally tax-free if you have held the security for one year or more.

Dividends from ETFs

Dividends from ETFs (exchange-traded funds) are taxed in the standard way as other dividends. For us, it is taxed at 10% for FOs and 0% for POs. Of course, withholding tax in the source country can increase the total tax liability on dividends. In Slovakia there is no special tax relief for dividends from ETFs.

Taxation of dividends in Slovakia

Dividends are a share of the profits paid by a company to its shareholders. In Slovakia, dividends are taxed in two ways:

1. Withholding tax:

• Withholding tax is automatically paid when the dividend is paid.
• The withholding tax rate is 10% or 35% for FOs; there is no withholding tax for POs (except in special cases); this may not apply if the recipient of the dividend is a foreign person;
• Withholding tax is the final tax for tax residents of the Slovak Republic;
• Non-residents of the Slovak Republic can normally offset withholding tax against income tax in the country where they are tax resident.

2. Tax return:

• Dividends from abroad are included in the taxable income of the taxpayer in the year in which they are credited to his account or possibly set off against a further deposit (i.e. reinvested).
• Dividend tax is 10% or 35% for FOs; for POs (except in special cases) there is no tax.

Is there a difference in taxation of ETFs as a natural person vs. a legal entity

There are quite a lot of differences in the taxation of ETFs between an individual and a corporation, in general:

Individual:

• Gains from the sale of ETF shares are taxed as capital income at a 19%/25% tax rate and a 15% health insurance premium;
• However, gains from the sale of ETF shares may be exempt from both income tax and insurance premiums;
• Dividends from ETF shares are taxed as standard dividends;
• The tax is taxed on the sale of ETF shares through the tax return;
• Dividends are taxed through the tax return anyway (unless they are hypothetically Slovak ETFs), but often withholding tax is applied in the source country;

Legal entity:

• Gains from the sale of ETF shares are taxed as taxable income at the %/21% tax rate.
• Dividends from ETF shares are taxed as taxable income at a 0%/35% tax rate.
• The tax is taxed on the sale of ETF shares through the tax return;

What is the time test and how to save on income tax and health insurance premiums?

Time test and income tax

The time test is a condition for exemption from income tax on the sale of securities such as stocks, bonds and units.

Length of time test

• Time test 1 year: if you hold the security for one year or more, the income from its sale is exempt from income tax.
• Time test of 3 years: it was supposed to be introduced for some types of securities, but eventually did not come into force in 2024

How to save on income tax

Watch the video podcast on the taxation of ETFs.

What are the types of funds and how are they taxed

There are several types of funds in Slovakia that differ in their investment strategy, risk and return. In terms of taxation, funds fall into two categories:

1. Mutual funds

Mutual funds pool money from investors and invest it in different types of securities such as stocks, bonds and money market instruments. The profit from the investment is distributed to investors in proportion to their share of the fund.

Taxation of mutual funds:

• “Dividends” from mutual funds are actually income and are taxed as capital gains at 19%.
• The sale of units between Slovak residents is tax exempt;
• The redemption of a unit is subject to income tax at a rate of 19%;

2. ETFs (exchange-traded funds)

ETFs are funds that are traded on a stock exchange like stocks. They invest in different types of securities and track a selected index, sector or commodity.

Taxation of ETFs:

• Dividends from ETFs are taxed as standard dividends;
• Capital gains on ETFs are taxable if the ETFs were held for less than 1 year.
• Long-term holding (1 year or longer) capital gains from ETFs can (should) be tax-free.

Fund types by investment strategy

• Equity funds: invest in equities and are suitable for investors with a higher risk profile and an expectation of higher returns.
• Bond funds: invest in bonds and are suitable for investors with a lower risk profile and an expectation of lower returns.
• Mixed funds: equities and bonds, offer a balanced risk/return ratio.
• Money market funds: are short-term money market instruments and are suitable for investors who want to “park” their money in the short term.

In which country is it worth taxing ETFs?

There is no clear answer to this question and it depends on various factors such as:

• Country of tax residence: investors pay income taxes in the country where they are tax resident. There are a number of criteria that define tax residence and these vary from country to country
• ETF type: different types of ETFs (equity, bond, mixed) are taxed at different rates.
• Amount of income: the tax rate may vary depending on the investor’s income.
• Length of ETF holding: capital gains on ETFs held for more than one year are tax-free in some countries.
• Tax breaks: some countries offer tax breaks for ETF investors.

Example of standard ETF taxation in some countries

• Slovakia: dividends from ETFs are taxed at 10% for FO. Capital gains from ETFs may be exempt from tax if the ETFs have been held for one year or longer.
• Czech Republic: dividends from ETFs are taxed at 15%. Capital gains from ETFs may be exempt from tax if the ETFs have been held for three years or longer.
• United States: dividends and capital gains from ETFs are taxed according to the amount of the investor’s income.

Tax havens for ETFs

A tax haven is a jurisdiction that has low or no taxes and is usually considered to be secret. Tax havens are often used by individuals and businesses to reduce their tax burden.Here are a few countries that are often considered tax havens for ETFs:

• Bermuda: a British Overseas Territory with a 0% income tax rate for companies.
• Cayman Islands: a British Overseas Territory with a 0% income tax rate for companies.
• Cyprus: an EU country with a 12.5% corporate tax rate.
• Malta: an EU Member State with a corporate tax rate of 35%, but there is an imputation system that can reduce taxable income to 5%.
• Switzerland: is outside the EU and has tax rates that vary by canton. However, Switzerland is known for its banking secrecy and political stability.

What is the risk if you don’t tax ETFs?

Failure to tax ETFs can have material consequences. Depending on the severity and the taxpayer’s intent, it can threaten:

1. Penalty: the Financial Administration of the Slovak Republic may impose a penalty of 10% to 100% of the unpaid tax.
2. Interest on late payment: the taxpayer is liable to pay interest on late payment of unpaid tax. Interest is calculated from the date the tax is due until the date of payment.
3. Criminal prosecution: in serious cases, the taxpayer may face prosecution for one of the tax frauds.

How the tax administration oversees the taxation of ETFs

The Slovak Financial Administration oversees the taxation of ETFs in various ways:

1. Checking tax returns:

• The tax authorities check investors’ tax returns to make sure they have taxed their ETF income correctly.
• In case of any doubts, the financial administration may call on the investor to provide evidence of its investment.

2. Control of banks and investment firms:

• The Treasury inspects banks and investment companies to make sure they withhold tax on dividends and profits from ETF sales.
• The Financial Administration can impose fines on banks and investment companies that do not comply with tax rules.

3. International cooperation:

• The Treasury works with tax authorities in other countries to make sure investors pay taxes on ETF income in accordance with tax treaties.
• The Financial Administration automatically receives information from most foreign financial institutions about Slovak taxpayers;

4. Tax audits:

• The tax authorities can carry out tax audits on investors to make sure they have correctly taxed their income from ETFs.
• A tax audit may include a review of bank statements, investment statements and tax returns.

In conclusion

The taxation of ETFs is a complex topic that can vary depending on the type of ETF, the tax status of the investor and the country in which the ETF is traded. Before investing in an ETF, it’s important to consult a tax advisor to make sure you understand the tax implications.