Taxes
The way taxes on ETNs are treated is one of the greatest advantages ETNs have over mutual funds, and to some degree even ETFs.
Investors can look at ETNs as a kind of prepaid forward contract. An ETN issuer will basically pay the note holder a dollar amount equal to the value of the benchmark at some agreed-upon future date. As a result, potential returns received from the difference between the sale of the ETN and the purchase of the ETN will be categorized as capital gains or loss upon the sale, redemption or maturity of the note. Consequently, ETN investors may defer the recognition of income until the contract matures and eliminate ordinary interest income factor that comes with normal debt contracts.
Foreign-currency ETNs, or foreign-currency –based prepaid forward contracts, are taxed as debt for U.S. tax purposes. Accordingly, amounts repaid to a currency ETN investor would be equal to the change in the foreign currency exchange rate, plus interest, minus fees. Foreign-currency ETNs are treated as debt instruments, and the revenue ruling does not mention other ETNs, like those linked to commodities or stocks. Currently, the government is requesting public comments on the proper tax treatment of all ETNs.
ETNs are more commonly used in investment portfolios with a long-term time horizons due to its capital gains treatment. The capital gains are deferred until the securities the ETN holds either matures or the ETN is sold. It should also be noted that ETNs do not offer distributions.
The Internal Revenue Code can be pretty tricky and complicated, and for this reason we suggest consulting a tax advisor, as we are not accountants and this should not be construed as tax advice.
The ETN Biz
There are currently around 135 ETNs with total assets under management of about $16 billion, as provided by PowerShares, iPath, UBS, ELEMENTS, Barclays, Market Vectors, JP Morgan, Credit Suisse, Claymore, Goldman Sachs and VelocityShares. The ETN products cover a lot of aspects of the marketplace, including equities, bonds, commodities, foreign economies and sectors, among other asset classes. In addition, leveraged/inverse ETNs are available for those who want to implement specific fund strategies.