‘Hearbeat Trades’
Some ETF managers use so-called heartbeat trades to increase the amount of withdrawals and erase all of a fund’s taxable gains. A friendly bank moves a pile of cash into a fund before almost immediately pulling it out, allowing the ETF to shed stocks that have gone up in value without incurring a taxable gain.
“This particular proposal simply applies the same rules already in place for corporations to regulated investment companies, so wealthy investors can no longer avoid all tax on their gains,” Wyden said in his statement Tuesday. “We’re only talking about the taxable accounts of the wealthiest investors.”
A summary of Wyden’s proposal mentions heartbeat transactions in particular, although he proposes to erase the entire provision that allows RICs to avoid recognizing gains. The proposal “would repeal the exception for RICs, aligning RICs with the general requirement that gain be recognized upon distribution by a corporation of built-in gain property,” the summary said.
That’s a potential industry game-changer. While ETFs tend to have several advantages over mutual funds—like the ability to trade all day and generally lower fees—research has shown the tax loophole is a key driver in the long-term trend of cash flowing from mutual funds into ETFs. As that has gathered pace, U.S. issuers are this year for the first time directly converting mutual fund assets into ETFs.
The final package of tax hikes, including ones on corporations and wealthy individuals, may takes weeks to develop.
“Wyden right now is coming up with his own provisions that could fit into that” final legislation, said Nathan Dean, a government analyst at Bloomberg Intelligence. “Think of this as something to have in his hip pocket when the Democrats start negotiating.”
The odds may be against the ETF-related legislation ever passing, Dean said. First, because so much negotiation is still ahead, and second because it would directly impact ETFs, which are very popular with consumers. However, with so much currently up for discussion, it could slip through as a smaller provision not well-understood by lawmakers, he said.
Senderowicz thinks the legislation has a low chance of succeeding because of the potential damage to many small investors—but he also doesn’t rule it out.
--With assistance from Zachary R. Mider and Erik Wasson.
This article was provided by Bloomberg News.