Choosing the right currency ETF can come down to the tax man.
The growing number of currency-focused exchange-traded products has opened up the world of currencies to individual investors. But like commodity funds, currency funds also come in various structures, and their tax implications can be quirky in taxable, nonretirement accounts.
Therefore, if you’re thinking about investing in currency ETPs, understanding these differences can help you determine the right fund for your investment objectives, and can also help avoid unpleasant surprises when tax time rolls around.
Currency ETPs come in four different structures: open-end funds, grantor trusts, limited partnerships and exchange-traded notes.
| Currency Funds and Their Structures | ||||||||
| Issuer | Rydex | WisdomTree | ProShares | |||||
| Product Line | CurrencyShares | WisdomTree Dreyfus | ProShares | |||||
| Popular Tickers | FXA, FXC, FXF | CYB, CEW, BZF | EUO, YCS, ULE | |||||
| Holdings | Currency Notes | Forward Currency Contracts, Swaps, Repos, Money Markets, Treasurys | Futures | |||||
| Legal Structure* | Grantor Trust | Open-end Fund | Limited Partnership | |||||
| Current Tax Implication for Selling Shares | Taxed at ordinary income rate | 15% for LT gains/Ordinary income rate for ST | 60% of gains taxed as LT/40% taxed as ST (ordinary income) | |||||
| Tax Reporting | 1099 | 1099 | K-1 | |||||
| *For ETNs, the issuer listed in the table may not be the issuing bank of the actual note. Investors should refer to the prospectus for details regarding issuer risk. | ||||||||
| Currency Funds and Their Structures | ||||||||
| Issuer | Invesco PowerShares | Van Eck | Barclays Capital | |||||
| Product Line | PowerShares DB | PowerShares DB | Market Vectors | GEMS | iPath | |||
| Popular Tickers | UDN, UUP, DBV | UUPT, UDNT | CNY, INR | AYT, PGD, JEM | ERO, JYN, GBB | |||
| Holdings | Futures | N/A | N/A | N/A | N/A | |||
| Legal Structure* | Limited Partnership | ETN | ETN | ETN | ETN | |||
| Current Tax Implication for Selling Shares | 60% of gains taxed as LT/40% taxed as ST (ordinary income) | Taxed at ordinary income rate | Taxed at ordinary income rate | Taxed at ordinary income rate | Taxed at ordinary income rate | |||
| Tax Reporting | K-1 | 1099 | 1099 | 1099 | 1099 | |||
| *For ETNs, the issuer listed in the table may not be the issuing bank of the actual note. Investors should refer to the prospectus for details regarding issuer risk. | ||||||||
Open-End Funds
WisdomTree is currently the only issuer with currency ETFs structured as open-end funds that are registered under the Investment Company Act of 1940. The three other structures, which I’ll get to in a moment, are all registered under the Securities Act of 1933.
WisdomTree’s currency funds don’t hold currency notes or futures contracts. Instead, most of their funds hold the assets in U.S. Treasury bills and repurchase agreements (repos) while gaining exposure to the underlying currencies through forward currency contracts and swaps.
For example, the WisdomTree Dreyfus Emerging Currency Fund (NYSEArca: CEW), currently the largest currency-basket ETF, has more than $580 million in assets under management. It gives investors exposure to an equally weighted basket of 12 emerging-market currencies through nondeliverable forward contracts, while holding the assets in U.S. T-bills and repos.
However, WisdomTree’s euro and yen funds hold short-term money market debt instruments denominated in local currencies. But according to a supplement to their prospectuses, on Aug. 28, the euro and New Zealand dollar funds will be renamed and changed to debt funds holding longer-duration debt securities.
Distributions from WisdomTree funds are variously taxed as ordinary income, short-term gains, long-term gains or a combination of the three—depending on the fund’s holdings and how it gains exposure to its underlying currency. And, according to the prospectuses, any gains made by selling shares are taxed as long-term gains if held for more than one year.
Grantor Trusts
Rydex’s CurrencyShares are structured as grantor trusts. CurrencyShares gives investors 1-for-1 spot exposure to the underlying currency by actually holding notes of the given foreign currency in bank accounts. This structure is very similar to the SPDR Gold Trust (NYSEArca: GLD), which holds actual gold ingots in vaults.
The CurrencyShares Euro Trust (NYSEArca: FXE) was the first currency ETP launched in the U.S. Currently, their Canadian Dollar Trust (NYSEArca: FXC), Australian Dollar Trust (NYSEArca: FXA) and Swiss Franc Trust (NYSEArca: FXF) are the three largest currency funds in the country.
The taxation of CurrencyShares ETFs is straightforward. They’re taxed as ordinary income for interest income as well as gains from the sale of shares, regardless of how long they’re held by the investor.
