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Tax implication when 100% dividend payout is actually ROC
March 29, 2021
8:28 am
savemoresaveoften
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Not sure if I am thinking through properly under this scenario:
A div stock pays eligible div but its 100% (I just picked 100% for simplicity) classified as ROC. Also assume the stock has no growth whatsoever so the stock price will just go down by the amount of the dividend pay out each year (since its 100% ROC)

Since its a dividend nonetheless, one pays tax on it every year (of course there is the dividend tax credit).
You have a ROC adjustment each year, but since the stock price goes down by same amount, there is no capital gain when you sell it at the end.
So net net, one is losing out cuz one is paying tax on money that earns zero income after all.

Am I missing something ? I am starting to pay attention and avoid stocks (esp REIT) that pays high dividend but a good % is actually ROC.

Or the ROC portion is actually NOT count as taxable dividend ?

March 29, 2021
9:02 am
Doug
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savemoresaveoften said
Not sure if I am thinking through properly under this scenario:
A div stock pays eligible div but its 100% (I just picked 100% for simplicity) classified as ROC. Also assume the stock has no growth whatsoever so the stock price will just go down by the amount of the dividend pay out each year (since its 100% ROC)

Since its a dividend nonetheless, one pays tax on it every year (of course there is the dividend tax credit).
You have a ROC adjustment each year, but since the stock price goes down by same amount, there is no capital gain when you sell it at the end.
So net net, one is losing out cuz one is paying tax on money that earns zero income after all.

Am I missing something ? I am starting to pay attention and avoid stocks (esp REIT) that pays high dividend but a good % is actually ROC.

Or the ROC portion is actually NOT count as taxable dividend ?  

The return on capital portion does not count towards the portion which is eligible for a dividend tax credit.

I wouldn't say you should avoid all stocks or REITs which pay any ROC distributions. Some of it is merely an accounting thing. What you should focus on is the sustainability of the REIT's or corporations distributions, their revenue, their balance sheet, and all of those other metrics. But if they're paying a large portion of their distributions as ROC, that's almost always not a good sign, and you would be wise to avoid those.

The exception to the above would be flow-through investment vehicles, such as mortgage investment corporations, which pay nearly all or all of their cash flows to holders of shares. Such payments are treated as interest income. They do carry inherently higher risk than buying shares in, say, blue chip TSX 60 companies, but they're still a bit different.

In short, do do your research and don't try and substitute research for broad, all encompassing statements.

Hope that helps.

Cheers,
Doug

March 29, 2021
9:06 am
Bill
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Deleted, Doug's answered.

March 29, 2021
9:44 am
Norman1
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A previous discussion explored what return of capital, for tax purposes, is.

Distributions classified as return of capital are not always the return of the original investment principal.

March 29, 2021
10:06 am
savemoresaveoften
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Doug said

The return on capital portion does not count towards the portion which is eligible for a dividend tax credit.

Doug  

So the ROC portion is not taxable annually and its only tax at the end when one dispose the stock (one time capital gain/loss since it reduces the ACB) ?

March 29, 2021
1:36 pm
AltaRed
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savemoresaveoften said

So the ROC portion is not taxable annually and its only tax at the end when one dispose the stock (one time capital gain/loss since it reduces the ACB) ?  

Yes until such time your ACB becomes zero by holding it forever, and then it is taxed as a capital gain thereafter.

To Norman's point, ROC can be an accounting item such as DD&A (depreciation of buildings in REITs for example). These are non-cash items while the overall property continues to increase in market value and REIT unit prices continue to climb.

It is 'bad' ROC when one's actual capital is handed back to them and that often happens in high yield funds where there is insufficient income generated to fund the distribution. Beware ROC in high yield funds.

March 30, 2021
7:01 am
savemoresaveoften
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AltaRed said

To Norman's point, ROC can be an accounting item such as DD&A (depreciation of buildings in REITs for example). These are non-cash items while the overall property continues to increase in market value and REIT unit prices continue to climb.
  

If its depreciation of buildings inside the REIT, wouldnt the effect be negative ? I have only seen positive ROC tho so a little confused by the concept ? I thought ROC is usually when they dispose assets ?
Are there actually negative ROC that may be reported ?

March 30, 2021
7:24 am
AltaRed
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Think of a rental property one has. One takes non-cash CCA (depreciation) each year on a building which is a return of capital for a number of years. Then when the property is sold for a higher price, there is then capital gains. That is why on a T3 tax slip for REITs there is often both Return of Capital (Box 42) and also Capital Gains (Box 21) due to a REIT selling a property.

Take a look at https://en.wikipedia.org/wiki/Return_of_capital

March 30, 2021
11:19 am
RAV4guy
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savemoresaveoften said;
"Not sure if I am thinking through properly under this scenario:
A div stock pays eligible div but its 100% (I just picked 100% for simplicity) classified as ROC."

I suggest one refer to the income from an investment in an ETF, a REIT or a Mutual Fund as a distribution rather than a dividend. A distribution can be 100% ROC but it cannot be both an eligible dividend and ROC simultaneously. Listed are 5 types of investment income:
1. eligible dividends
2. other than eligible dividends
3. capital gains
4. ROC
5. everything else (interest, foreign income, other income etc.)
Each of these is subject to different rules when calculating the tax owing. Items 1-4 are taxed less onerously than item 5.

ROC has the advantages that tax is deferred until the investment is sold or the adjusted cost base of the investment becomes less than zero and that when it is eventually taxed ROC is taxed as capital gain.

You are right to be concerned that ROC is not mostly just the return of your original investment. I believe that with most REITs the ROC is an advantage to the tax payer and I own several. As always research or investment advice is required

There is another tax matter that has been discussed elsewhere in this forum. That is when you are taxed on more income than you actually receive from the investment. That is sometimes called a "Reinvested Distribution". The owner of the investment should then increase the adjusted cost base of the investment so that when it is sold the negative tax impact is reduced. It is my expereince that investment account providers are good at adjusting the ROC for your investments but less are accurate when Reinvested Distributions are involved. It is to your benefit to handle this correctly.

Please write your comments in the forum.