ETFs and Tax

Understanding how your ETF investments are actually taxed is just as important as understanding how they make money. There are two separate ways your ETF earnings get taxed: capital gains (when you sell) and income (while you hold).

This is general information only, not personal tax advice. Everyone’s situation is different, so speak to a registered tax agent or accountant about your specific circumstances.

Capital Gains Tax (CGT) on ETFs

Capital Gains Tax applies when you sell your ETF units for more than you paid for them. The profit you make is added to your taxable income for that year and taxed at your marginal tax rate.

The 50% CGT discount
Under the current rules, if you’re an Australian resident individual and you’ve held your ETF for more than 12 months before selling, you can generally reduce your taxable capital gain by 50%. So if you made a $10,000 capital gain on units held for over a year, only $5,000 of that gain gets added to your taxable income.
This is a significant incentive to hold your investments for the long term rather than trading in and out.

A change worth knowing about
Worth flagging here: the government has legislated a change to this system. From 1 July 2027, the 50% CGT discount will be replaced with cost base indexation, where your original purchase price is adjusted upward for inflation before your gain is calculated, rather than automatically halving your gain. This change is now law, though it doesn’t affect anything sold before that date. If you’re holding ETFs long term, it’s worth keeping an eye on how this plays out and getting personalised advice closer to the date if it’s relevant to you.

Tax on Distributions

Even if you never sell a single unit, you’ll still owe tax on the distributions your ETF pays out each year. This applies whether you take the distribution as cash or automatically reinvest it through a DRP. As far as the ATO is concerned, reinvested distributions are still income you received, so they’re taxable in the year they’re paid.

Your ETF provider will send you an annual tax statement each year, breaking your distribution down into its different components, which might include:

  • Australian sourced income
  • Foreign sourced income
  • Capital gains the fund itself has realised
  • Franking credits

This is where things can get a little more complex than owning a single share, since an ETF can be earning income from many underlying companies at once, each contributing to your annual statement.

What Are Franking Credits?

Franking credits are one of the more Australia specific quirks of investing, and they’re genuinely valuable once you understand them.

When an Australian company pays tax on its profits (generally 30%, or 25% for smaller companies), and then distributes some of that after tax profit to shareholders as a dividend, it can attach a franking credit to that dividend, representing the tax it’s already paid.

Because ETFs hold shares in these companies, when the ETF receives franked dividends, it passes those franking credits through to you via your distribution.

Here’s how it works in practice:

  1. You receive a cash distribution with franking credits attached.
  2. You “gross up” that dividend, adding the franking credit back on top, to work out your total assessable income. For a fully franked dividend from a company taxed at 30%, the formula is: cash dividend x 30/70.
  3. You declare this grossed up amount as income.
  4. You then apply the franking credit as a tax offset against the tax you owe.

If your marginal tax rate is lower than the company tax rate, you’ll typically get some or all of that franking credit refunded to you as cash. If your marginal tax rate is higher, the franking credit reduces the extra tax you owe, but you won’t be fully covered.

Case Example

Let’s say your ETF passes through a fully franked cash distribution of $700 for the year.

  • Franking credit = $700 x 30/70 = $300
  • Grossed up income you declare = $700 + $300 = $1,000
  • You apply the $300 franking credit as a tax offset against your tax bill

If your marginal tax rate is lower than 30%, you’ll likely get some of that $300 refunded as cash once you lodge your return. If it’s higher than 30%, the $300 still reduces what you owe, just not by the full amount of tax you’d otherwise pay on that income.

Summary

Your ETF earnings get taxed in two separate ways: capital gains tax when you eventually sell, and income tax on your distributions each year, whether you take them as cash or reinvest them. Franking credits can meaningfully reduce (or even eliminate) the tax you pay on Australian sourced distributions, which is one of the quieter but genuinely valuable perks of investing in ETFs holding Australian shares. Keep your annual tax statements organised, and when in doubt, run your numbers past an accountant.