There’s a significant divergence of opinion regarding the UK tax treatment of gains from holding exchange-traded commodities (ETCs), based on the views of ETC providers contacted by IndexUniverse.eu.

ETCs are debt securities issued by a special purpose vehicle. They are widely used in Europe to track individual commodities and commodity groups (and, more recently, currencies). ETFs, by contrast, are funds, with almost all European-listed ETFs falling under Europe’s UCITS fund regulations. UCITS rules on diversification do not allow a fund to track a single commodity or groups of related commodities, which is one of the reasons behind the ETC market’s popularity.

European ETC assets totalled around US$18 billion at the end of the second quarter, compared to US$218 billion in European ETFs, according to research from BlackRock. The largest European ETC platform is run by London-based commodities specialist ETF Securities, although there is increasing competition from other firms. Source has offered ETCs to investors since 2009, while Deutsche Bank, UBS and Royal Bank of Scotland have all launched or expanded ETC ranges in 2010.

The tax treatment of profits from ETC holdings for a UK investor is potentially highly significant, particularly given the recent rise in the gold price and the substantial assets invested in ETCs tracking the precious metal. ETF Securities’ flagship gold bullion ETCs, ETFS Physical Gold (LSE: PHAU, PHGP) and ETFS Gold Bullion Securities (LSE: GBS) have a combined value of nearly US$10 billion (£6.6 billion).

ETCs are also heavily traded, implying that profits are being realised on a regular basis. According to the London Stock Exchange, PHAU and GBS were the second and third most traded exchange-traded products (ETPs) in the UK during the first half of 2010, each with a turnover in excess of £2 billion. The only UK ETP with greater exchange-based turnover during the period was the iShares FTSE 100 ETF.

There has been substantial recent media interest in the tax treatment of gains from exchange-traded funds for a UK investor. The press coverage has focused on the fact that up to a quarter of UK-listed ETFs have not been awarded so-called “distributor” status, which might lead to capital gains (otherwise taxable at 18% or 28%) being taxed at income tax rates of up to 50%. According to the Financial Times, UK ETF providers were deluged with calls from investors after the publication of several articles on the subject. This media coverage was focused, however, on exchange-traded funds specifically, and not on the wider question of the tax status of all exchange-traded products, including ETCs.

ETF Securities, like other ETP providers operating in the UK, issued a clarificatory statement following the distributor status controversy.

“[Following] recent reports that UK investors holding ETFs without ‘reporting’ or ‘distributor’ status are liable to pay income tax at 50%, ETF Securities confirms its products do not fall in this bracket. ETF Securities has applied for and has achieved ‘distributor’ or ‘reporting’ status for all its products listed prior to June 2010,” the company stated on its website on July 14.

“Reporting” fund status is a regime brought in by the UK tax authorities to allow offshore funds to “report” their attributable income for assessment at income tax rates, while any capital gains are then liable for capital gains tax treatment. Reporting fund status is in the process of replacing the previous regime of “distributor” status, where offshore funds had to physically pay out income from their underlying investments to achieve capital gains tax eligibility.

ETF Securities has reproduced the acceptance letters from the UK tax authorities confirming the reporting fund status of its ETCs on the company website. For ETF Securities’ Gold Bullion Securities ETC, for example, the acceptance letter from HM Revenue and Customs (HMRC), dated 7 April 2010, confirms that GBS was accepted into the reporting fund regime with effect from 1 January 2009.

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