The concept of Return of Capital (ROC) can sometimes trip up even savvy advisors and investors. In taxable accounts, it’s important to understand how ROC impacts taxes payable, and when. In tax-sheltered accounts such as RRSPs and TFSAs, this discussion is not applicable.

ROC adjusts an ETF’s original purchase price down,

potentially affecting future capital gains taxes when the ETF is sold

Tax-Efficiency through the Return of Capital

Adjusted Cost Base (ACB): ROC requires investors to reduce the cost basis (or price) that the ETF was purchased for by the cumulative amounts of ROC received since purchase.

Investors do not typically pay tax on ROC distributions. Tax is payable on Capital Gains, Eligible Canadian Dividends and Foreign and Other Income.

Positives	Negatives
ROC can help to maintain stable distribution, which allows for easy planning of cash flow needs	Administrative efforts to record ACB decreases
ROC distributions are not typically* taxed, making them the most tax-efficient form of distribution	Reduces the net asset value (NAV) of the ETF, which reduces assets available to generate returns

*Should the ACB be reduced to 0 over time, any future ROC distributions would be taxed as capital gains.

Covered Call investors are seeking monthly income above what can be generated by non-Covered Call market beta solutions. Income investors understand they are potentially giving up some positive market performance in return for higher monthly income. They also understand that these strategies can lead to some of the monthly distributions including their money back in the form of ROC. Covered Call investors could benefit from the tax deferral effect of ROC distributions.

Investors who are seeking full exposure to markets and themes can benefit from core beta products, which may have some distributions and Corporate Class Total Return ETFs (TRI ETFs) which are not expected to make taxable distributions.

Why does Horizons ETFs distribute ROC on covered call solutions?

• Consistent with the income needs of covered call investors
• Consistent with offering innovative solutions in a tax-efficient way
• Consistent with our ETF Distribution Policy

No Crystallization + no Capital Gains to Pay Out = ROC:

Underlying Holdings Are Up: If the ETF Manager does not sell the positions (crystallization), there are no capital gains to pay out. This leads to distributions that are ROC.

Options Exercised: If gains from premiums are limited by being exercised, the ETF Manager will have to buy them back with no capital gains attributable to the ETF. When call options are exercised and there is no crystallization (as explained above), the ETF Manager will buy the options back with no corresponding capital gains attributable to the ETF, this leads to distributions that are ROC. Tax-efficient capital gains are received if written call options expire worthless.

TRI ETF Holdings: Covered Call ETFs can hold a TRI ETF for its exposure goals. Since no dividends or income are received, positions can be sold down to . If the positions are not sold down, there will be no capital gains to pay out which will lead to distributions that are ROC.

What is Bad ROC? All ROC is generally non-taxable immediately, as it reduces the ACB of an ETF. If a covered call ETF is consistently not generating enough income and dividends and options premiums received are not enough to complete the distributed amount, ROC may be distributed to make up the difference.

This can happen over short periods where a covered call manager seeking total return performance identifies strong underlying market conditions and chooses to write fewer call options to participate more in the performance of the underlying holdings. This can also happen when there is a sustained change in options premium volatility, leading to lower premiums. In such cases where this is expected to persist for a longer period, the ETF distribution amounts will be reevaluated per the ETF’s Distribution Policy.