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SEC Move To Improve Tax Transparency

Mike Godfrey, Tax-news.com, New York

23 January 2001

The SEC has adopted new rules designed to improve transparency in mutual fund investing, it was announced on Friday. The rules, due to come into effect in April, require funds (with the exception of money market funds, and funds designed for investors in tax-deferred arrangements such as 401(k) plans) to disclose their returns on an after tax basis, and must be presented in two ways.

Firstly, the fund prospectus (and any advertisement that includes performance information), must detail the effect of taxable distributions resulting from the portfolio manager's purchases and sales of securities in the fund. It must also show the effect of taxable distributions along with the 'tax bite' for the shareholder if he or she sold the fund. This information must be presented for 1, 5, and 10 year periods.

The ruling has disappointed mutual fund groups, as in calculating this information, they are obliged to use the highest applicable federal income tax rate for individuals, currently 39.6%, in order to provide the investor with a worst case scenario. But as John Collins, spokesman for the Investment Company Institute pointed out: 'Most mutual fund shareholders aren't in the highest bracket.'

However, this latest move towards the provision of improved information must be good news for US mutual fund investors, and if the results of a recent survey are anything to go by, it hasn't come a moment too soon! When questioned, 85% of fund investors stated that taxes played an important role in their investment decisions, but only 35% felt that they had any great understanding of this area, and only 18% were able to identify the maximum rate for long-erm capital gains.

The size of the tax bite varies considerably from fund to fund, and is dependent on many factors, including the level of portfolio trading, the amount of gains realised on trading, and the degree to which the manager uses portfolio losses to offset realised gains. However, recent estimates suggest that over 2.5% of the average stock fund's total return each year is lost to taxes, significantly greater than the amount lost annually to fees.

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