Most Tax-Efficient ETFs for Canadian Investors

One difference I’ve noticed talking with Canadian and U.S. investors is that Americans tend to focus much more on taxes.

That’s a point in Canada’s favour. With the tax-free savings account (TFSA), registered retirement savings plan (RRSP) and first home savings account (FHSA), Canadians have multiple ways to shelter investment gains from the Canada Revenue Agency (CRA). These registered plans generally offer more flexibility and contribution room than comparable U.S. options like 401(k)s or Roth IRAs, and if used strategically they can significantly reduce your tax bill.

Still, many Canadians eventually max out their registered accounts. Once that happens — and until new contribution room opens in January — the challenge becomes how to reduce taxes on investment income and gains held in non-registered accounts.

Some exchange-traded funds (ETFs) are more tax-efficient than others. Below is a practical guide to ETF tax efficiency in Canada and which types of ETFs are best suited to taxable accounts.

The ABCs of ETF taxation

ETF taxation resembles the tax rules for the underlying holdings like stocks and bonds. If you receive T3 or T5 slips, the categories on those statements will be familiar. A fund’s tax and distribution breakdown is usually published on the provider’s website; reviewing that breakdown is the easiest way to understand the tax consequences of holding a specific ETF.

As an example, consider the BMO Growth ETF (ZGRO), a globally diversified asset-allocation ETF holding roughly 80% equities and 20% fixed income. On ZGRO’s “Tax & Distributions” page you’ll find a table showing how distributions were classified. The most recent 2024 data lists total distributions of $0.467667 per unit, allocated across several tax categories:

• Eligible dividends ($0.082884): Usually paid by Canadian corporations and eligible for the dividend tax credit, which reduces the effective tax rate on that portion.
• Other income ($0.047890): Mainly interest from bonds inside the ETF. This income is fully taxable at your marginal rate, like salary or rental income.
• Capital gains ($0.157617): Often generated by portfolio rebalancing. Only 50% of capital gains are taxable, which mitigates the tax impact. You also pay capital gains tax when you sell ETF units for a profit.
• Foreign income ($0.169810): Dividends from non-Canadian companies held in the ETF. This income is fully taxable and is often subject to withholding (ZGRO shows a foreign tax paid line of −$0.018009), which may or may not be recoverable depending on the account type.
• Return of capital ($0.027475): A return of part of your original investment. It isn’t taxed when received but reduces your adjusted cost base, which increases the capital gain you report when you eventually sell.

Because each category is taxed differently, ETFs like ZGRO can be complicated to manage in taxable accounts. In registered accounts such as TFSAs or RRSPs, these tax details don’t apply, making asset-allocation ETFs like ZGRO easier to hold there. For tax-sensitive taxable accounts, simpler distribution profiles are often preferable.

What’s your goal: capital appreciation or income?

Determining which ETFs are tax-efficient starts with your objective. Are you seeking capital appreciation or steady income?

If you aim for long-term growth and don’t need regular cash flows, prefer ETFs that minimize distributions so gains accrue inside the fund as price appreciation. That defers taxes until you sell. Growth-oriented ETFs that hold companies which reinvest profits rather than pay dividends are one approach.

For example, the Invesco NASDAQ 100 ETF (QQC) provides exposure to U.S. technology names that typically pay low dividends and reinvest earnings. QQC’s trailing 12-month yield is low — around 0.42% and mostly foreign income — making its tax drag minimal.

If you want to avoid distributions altogether, certain ETF structures are designed for tax deferral. Corporate-class or swap-based ETFs — marketed by providers such as Global X in Canada — aim to deliver equity exposure with few or no distributions by using swaps or a corporate-class wrapper. Examples often used to assemble a diversified equity sleeve include:

1. HXS: Global X S&P 500 Index Corporate Class ETF
2. HXT: Global X S&P/TSX 60 Index Corporate Class ETF
3. HXX: Global X Europe 50 Index Corporate Class ETF

These structures can reduce taxable distributions, but they come with trade-offs: higher fees (management fees plus swap-related costs), greater trading expense ratios, and some counterparty risk because they rely on derivative contracts. They also cannot absolutely guarantee zero distributions — payout policies can be discretionary — and future tax-law changes could alter their effectiveness.

If you hold taxable accounts and want to delay taxes, these funds are worth considering, provided you understand their costs and risks.

Tax-efficient income funds

Personally, I prefer selling ETF units and reporting capital gains when I need cash, but many investors — retirees in particular — prefer regular distributions. That preference is often emotional: a dividend or distribution can feel more comfortable than selling shares even when the economics are the same. If you value steady distributions and want them taxed as efficiently as possible, favour funds that pay a high proportion of eligible dividends.

Canadian equity ETFs that emphasize eligible dividends and avoid REITs are typically the most tax-efficient for income in non-registered accounts. REIT distributions are frequently taxed as ordinary income rather than eligible dividends, making them less tax-friendly.

A strong example is the Vanguard FTSE Canadian High Dividend Yield Index ETF (VDY). Its trailing 12-month yield is about 3.67%, and it pays monthly. In 2024 VDY distributed $2.451389 per share, of which $2.157010 (88%) was classified as eligible dividends. Only $0.293669 came from capital gains and $0.000710 was return of capital, giving it a very tax-efficient payout profile.

VDY isn’t the most diversified fund — it holds roughly 50 large-cap Canadian stocks and has a heavy weighting to financials — but with a low management expense ratio (0.22%) and a tax-efficient yield it can be an excellent choice for taxable accounts, particularly if you use registered accounts for your international exposure. Despite its income focus, VDY has also delivered competitive long-term returns versus broader Canadian benchmarks.

Taxes matter, but they aren’t everything

In summary, here are the main tax categories ETF investors face in non-registered accounts:

1. Interest income — fully taxed at your marginal rate
2. Eligible dividends — taxed more favourably via the dividend tax credit
3. Capital gains — only 50% of gains are taxable
4. Foreign income — fully taxable and often subject to withholding taxes
5. Return of capital — not taxed when received but lowers your cost base

If your priority is capital appreciation, target growth ETFs that minimize distributions (for example, QQC) or consider swap-based corporate-class ETFs (such as HXS, HXT or HXX) to defer distributions. For income, focus on ETFs that distribute a high share of eligible dividends and avoid tax-inefficient sources like interest or significant foreign withholding.

That said, tax efficiency should not override the fundamentals. Over the long run, contribution levels, sound asset allocation, and staying invested through market cycles will typically matter more to your returns than small differences in tax treatment. In other words: don’t let the tail wag the dog — taxes are important, but they’re only one part of successful investing.

Read more about investing with ETFs:

• Updated for 2025: The ultimate couch potato portfolio guide
• Can you build a 40/30/30 portfolio with ETFs?
• ETFs are great for diversification, but check their holdings carefully
• Single-stock ETFs: Approach with caution