Ron Wyden
US senator Ron Wyden says that loopholes in the current system allow those at the top to pick and choose when and whether to pay tax © Getty Images

A proposal has been drafted to change the law eliminating exchange traded funds’ chief tax advantage in the US by levying taxes on in-kind redemptions.

The bill, floated last week in the Senate by finance committee chair Ron Wyden, if passed, would no longer allow ETFs and other regulated investment companies to be exempt from recognising gains when distributing property in kind to a redeeming shareholder — something ETFs do routinely when managing their securities baskets.

The amendment to the law is one among a series of proposals that Democratic congressional leaders are pitching to help fund a $3.5tn budget package. The proposal would also eliminate the pass-through tax treatment applicable to master limited partnerships and other publicly traded partnerships, reaping a projected $172bn in total savings.

“Complexity allows the wealthiest individuals and most profitable corporations to decide when, and whether, to pay taxes at all,” Wyden said in a statement. “This proposal simply reduces complexity by closing loopholes that allow those at the top to pick and choose when, and whether, to pay tax.”

This article was previously published by Ignites, a title owned by the FT Group.

The bulk of the savings would come from new taxation on ETFs. The 25 biggest ETFs alone distributed tax-free securities with unrealised gains of almost $60 billion in 2015, according to a 2017 study from a professor at the Fordham University School of Law. Last year, just 5 per cent of the almost 1,400 ETFs run by the 12 largest sponsors had year-end taxable distributions, according to Morningstar data.

ETFs’ tax efficiency is the driving force behind a rising wave of mutual fund conversions, led by Guinness Atkinson and Dimensional Fund Advisors. However, it is also said to have opened a rift within the industry, reportedly spurring some mutual fund providers to push for ending the exemption.

The Investment Company Institute opposes the move to change the law.

“We do not support proposals that would increase the tax burden on Main Street families investing for the long-term,” said ICI president and chief executive Eric Pan. “With this in mind, we are currently studying Senator Wyden’s bill and its impact on investors.”

Before the draft’s release, however, finance committee Republicans already signalled stiff opposition, issuing a letter earlier last week warning of the Democratic-led committee’s “far-reaching and potentially highly disruptive agenda, with trillions of taxpayer dollars at stake”.

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