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In here it is stated that

An investor holding mutual fund shares in a taxable account may owe tax on any net capital gains realized from the sale of his fund shares during the calendar year. In addition, he may also have to pay taxes on his proportionate share of the fund's capital gains. The law requires a mutual fund to distribute capital gains to shareholders if it sells securities at a profit that cannot be offset by losses

Questions:

  1. Is this the same for ETFs? In other words, if the funds sell some of the goods it is holding, do investors need to pay capital gain taxes proportional to their shares in the ETF?

  2. Since the index fund needs to distribute "dividend" to its investors if some of the goods are sold at a net gain, does this mean that the investors will pay capital gains tax when the goods are sold and then again when they receive the "dividend" from the fund?

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Yes, you pay capital gains tax on ETF holdings just like mutual find holdings, but you are not "double taxed".

Say you buy a fund at the beginning of the year and sell it at the end of the year. Say also that the NAV (the value of all of its holdings, less expenses) of the fund goes up by $5 per unit over the year, and realizes and distributes $1 per unit of capital gains at the end of the year. The NAV (and hence the price per unit) of the fund is then reduced by $1. So you would pay tax on the $4 of realized capital gains from selling your holdings, and the $1 that was distributed to you.

In other words, the capital gains are either distributed to you at the end of the year, or they are reflected in the price of the fund, but not both. So the capital gains tax you pay when you sell your holdings is separate from the tax you paid on the distributions (and they are not double-counted).

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    I wasn't talking about selling my shares. When ETF manager sells the stock the fund it holding, the fund has to pay taxes from the realised earnings, but that decreases net gain made by the fund, hence less to distribute or to reinvest. – Our Apr 7 at 21:00
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    @Our: ETFs (and mutual funds) do not pay taxes when they sell their holdings. Instead, shareholders pay tax on capital gains distributions. – user2357112 supports Monica Apr 8 at 10:42
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When it comes to funds there are two competing concepts. There is the concept of pooling your money with other investors, known as the mutual fund. In this case, realized gains are taxable (in most countries) when they occur as one can always redeeem the current value of the mutual fund.

The other way - ETFs - is best thought of as an investment company whose shares is traded on an exchange. An ETF unit is a closed system, a unit represents a certain asset allocation, typically tracking an index, at a certain time that can be traded. Additionally, some market participants ("authorized participants") can trade in a basket of shares for units of the ETF (or vice versa) which makes sure that the ETF is always closely tracking its holding. As the value of an ETF is determined by its price on the exchange, gains are only realized by selling ETF units.

With regard to dividends, they will be either distributed by the ETF or accumulated by reinvesting them into the underlying assets. An ETF will not sell assets to pay out dividends

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    Your description of how ETF gains work isn't quite right. If an ETF sells shares it's holding at a gain, it will have to distribute capital gains to shareholders. However, in practice, ETFs mostly don't sell shares they're holding at a gain; they use the heartbeat trade loophole to dump those shares without realizing capital gains. – user2357112 supports Monica Apr 7 at 9:18
  • Fun fact: some mutual funds are exchange traded as well. ETF is usually taken to mean "index tracker", or at least that's the idea I get. Both mutual funds and ETFs are just containers of a bunch of stock (the latter either virtual (which is more "dangerous"/volatile, or physical in the exact same way as a mutual fund). Both ETFs and mutual funds can have accumulatiion and distribution variants, so your sentence about dividends seems wrong to me. – rubenvb Apr 8 at 10:24
  • @rubenvb: What? No, a fund that tracks an index is an index fund. Whether a fund tracks an index has nothing to do with whether it's an ETF. You've got your concepts mixed up. – user2357112 supports Monica Apr 8 at 10:28
  • @rubenvb: The accumulation vs distribution thing may apply in jurisdictions other than the US, but in the US, dividend distributions are mandatory. – user2357112 supports Monica Apr 8 at 10:32
  • @user2357112supportsMonica Europe's stock exchange does not make the distinction any easier. Here's listed mutual funds on EuroNext, and here's the separate list of actual ETFs listed on Euronext. In Europe, as far as I can tell, accumulation funds reinvest dividends directly, which means you're not taxed on these as you otherwise would be if these dividends were paid out to you in cash (you're only taxed on the capital gains when you sell fund shares). I didn't know this was Europe specific... – rubenvb Apr 8 at 10:45
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Mutual funds are required to distribute profits back to its shareholders at least once a year (capital gains, dividends and interest).

ETFs are considered "pass-through" investment vehicles and generally, ETFs shareholders do not incur capital gains when the ETF buys and sells shares. However, ETFs can generate shareholder capital gains in certain circumstances. For example, the ETF must rebalance due to substantial changes in the underlying benchmark.

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