One way exchange traded notes (ETNs) differ from exchange traded funds (ETFs) is that they convey no ownership or assets, just a promise from the issuer that a certain amount will be paid upon redemption or maturity. The value of the note is determined by the index it tracks and by the creditworthiness of the issuer. ETNs traditionally have two advantages over ETFs. First, an ETN’s returns are less likely to move out of line with its benchmark index because the tracking error for an ETN is the difference between the return of the benchmark and the management fee. Second, ETNs feature even better tax efficiency than ETFs. Investors don’t incur taxes until they sell them, potentially generating a capital gain.

However, the tax benefits that ETNs offer could be a thing of the past soon. A meeting is scheduled within the next few days where the Internal Revenue Service (IRS) and the Department of the Treasury will publicly discuss the ETN tax issue, says Heather Bell for Index Universe. One possible outcome is that the government could intervene with legislation to preserve the competition among ETNs and other funds. Similar actions have been taken in previous cases when tax disparities threatened competition.

However, some government tax collectors believe ETNs could become a sort of mass tax shelter. If assets grew considerably, the impact on tax revenues could become substantial. If ETN tax advantages were taken away, then their assets could decline and people might be less inclined to invest in them.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.