Tax on funds: where the relief works and where it does not

A fund's tax structure often outweighs its fee, yet the fee is usually all anyone discusses.

What happens inside a fund

When a fund sells a security at a profit and buys another, no tax arises for the unit holder. A fund's internal operations create no taxable base for the owner of a unit.

That means rebalancing inside a fund is free in tax terms, while the same rebalancing in your own portfolio means selling and paying tax on the gain.

What happens when you sell a unit

Ordinary income from securities transactions arises. Both offsetting and long-term ownership relief apply here — Long-term ownership relief: paying no tax without arranging anything in advance, provided the fund qualifies.

Dividends inside a fund

If a fund reinvests income rather than distributing it, no separate dividend base arises for the holder — the income is reflected in the unit price. A fund that distributes creates a tax at the moment of payment.

The first structure defers tax, the second delivers money sooner. Which is better depends on whether you need the current income.

A caveat

A particular fund's tax treatment depends on its type and jurisdiction; what is described here applies to Russian exchange-traded and open-ended funds. How the funds themselves work: BPIF, ETF and mutual fund: three forms of one idea.