ETFs after one year tax-free?

The exemption of gains on the sale of ETFs after one year of holding has become a recurring theme in our country. Instead of myths and half-truths, we offer one pragmatic framework: with ETFs, it is the tradability (liquidity) and structure of the instrument that determines whether it “replicates an index”, not whether it “replicates an index”. In this article, we summarize the key takeaways from the Highgate Talks episode with Michal Majek (Tatra Asset Management) and supplement them with our legal and tax perspective.

What is an ETF and why is it not “just a passive index fund”

An ETF is an exchange-traded fund – as opposed to a traditional mutual fund, which an investor enters/exits once a day through a manager. With an ETF, you can buy and sell throughout the day, with instant liquidity. The first ETF was created in 1990 (Canada), in the US the iconic SPY on the S&P 500 in 1993; today there are thousands of them around the world, covering stocks, bonds, commodities, even bitcoin.

Important: the historical link “ETF = passive” is no longer valid. In addition to index ETFs, there are a number of actively managed ETFs that do not blindly seek to mirror an index, but actively select a portfolio – while retaining the advantage of exchange liquidity.

Key feature for practice: marketability and structure

The ETF must be listed on an exchange and its mechanics are based on “authorized participants” (large brokers) who create and “redistribute” the fund’s holdings. The ordinary investor trades shares on the secondary market – they don’t buy/redeem them directly from the fund, as is the case with mutual funds. The structural difference is therefore fundamental.

Practical implication: if you took a “classic” UCITS mutual fund and floated it on an exchange, it would not become an ETF overnight – the withholding tax regime would still apply on redemption; it is a different legal and operational organism.

From this perspective, it is misleading to judge an ETF only by what it invests in (“is it an index?”). Exchange tradability and liquidity are relevant to classification and tax impact; an “LLC that purchases index ETFs” is not an ETF – if only because its shares are not normally tradable on a liquid exchange.

ETFs and liberation after a year: where the bread is broken

The Slovak law exempts the sale of securities held for more than 1 year if they are traded on a regulated (or similar foreign) market. In practice, therefore, the question is not “is it an ETF or not”, but:
a, Is the subject of the sale a security under our Securities Act?
b, Is it traded on a regulated/common market?

Note the terminology: international “securities” is a broader term than the Slovak “securities” (it also includes derivatives or other instruments). Therefore, the mere fact that something is a “security” on a foreign exchange does not automatically mean that it is our “security”. It is necessary to return to the Slovak catalogue of securities.

What about the old FS opinion from 2021? Although it was later withdrawn, the “sentiment” persisted. Arguing that the exemption should not apply because “the ETF platform is not a taxpayer” (unlike a transparent mutual fund) doesn’t hold water – with an ETF, you are selling to a third party in the market, not to the fund itself; moreover, our law also recognizes exemptions for the sale of units (subject to certain conditions), so a blanket exclusion of ETFs doesn’t make sense.

Practical conclusion: if you sell a security (e.g. an ETF holding/listing that meets our definition of a security) traded on a regulated/common market and have held it for more than 1 year, the exemption should apply by default. There are situations where the ETF is not covered by the above exemption after 1 year. However, it is not our opinion that this is the case for the reasons presented by the Treasury Department.

Moreover, in the context of proving whether or not an ETF qualifies for exemption, the constitutional context is necessary in arguments with the tax administrator and possibly the courts. And this prescribes a certain degree of proportionality and reasonableness in the requirements imposed on the taxpayer in proving certain facts (such as the nature of the ETF). And to simplistically turn the burden of proof on retail investors (to carry a “legal opinion” on the legal form and market for each ETF) would be disproportionate and hardly compatible with the rule of law.

Policy mismatch: why ‘single stock’ is favoured over funds

The purpose of the exemption was to encourage capital market and household savings. Reality? The Bratislava Stock Exchange has not been affected, and we are paradoxically disadvantaging small savers, both regulatorily and tax-wise, if they invest through diversified funds – while speculating in a single stock is exempt after a year. This is illogical from a savings security perspective.

A solution that makes sense across assets: simple, uniform and predictable taxation with a distinction between long vs. short term holding (lower rate/exemption for long term investing, higher for short term trading), rather than today’s patchwork of exemptions based on the legal form of the vehicle.

Summary for investors and accountants

• ETF ≠ always a passive index. The bottom line is that it is exchange traded and operates through authorized participants.
• The tax regime follows our Securities Act. You verify that you are selling a “security” and that it is traded on a regulated/common market; if so and held > 1 year, exemption is warranted.
• The tax administrator should not shift to itself burdens of proof that do not pass the proportionality and reasonableness test. Requiring a retail investor to investigate the foreign legal form of an ETF in depth is unreasonable.

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At Highgate Group, we have long been involved in the topic of ETFs, capital markets and the taxation of investments – legally, fiscally and regulatorily. If you need to review the tax implications of a particular portfolio or set up an internal methodology to make your decisions predictable and defensible, we are here to help.

Click here to watch our Highgate Talks podcast with Michal Majek.

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