How to Tax Investments? Taxation Rules for ETFs, Stocks, and Dividends

Tax rules are indeed very complex, so we will base our assumptions on the following:

• You have a permanent residence in Slovakia, you live in Slovakia, and you have your center of vital interests here, meaning you are a tax resident of Slovakia.
• As part of investing, you are increasing your personal capital or investing in assets that are not part of your business and have not been included in your trading property.

For those of you seeking a brief answer to tax-related questions, we have prepared a simplified summary at the beginning. The next part of the article goes into more detail on the topic and provides examples that may be relevant to your situation.

Summary

In simple terms, income from investments in ETFs must either be taxed or exempt from taxation. Even if you have taxable income, you do not need to pay taxes if your total income (all gross income, i.e., before deductions) is below the limit of 2,461.41 EUR (for 2023).

There are two types of income that can be generated from ETF investments:

• Dividend income, which is considered capital income and is always subject to taxation at a rate of 19%.
• Income from the sale of ETFs. This income is exempt from taxation if more than one year has passed between the purchase and sale of the ETF.
• If you sold a specific ETF within a year, a tax exemption of 500 EUR per year can be applied to the profit from the sale. If the profit exceeds 500 EUR, only the amount above this limit is taxable.
• Losses from the sale cannot be considered when calculating the tax liability.

The general principle is already known, but, as is often the case with taxes, even small details can play an important role.

How to Check the Valuation?

As an investor, you likely check the value of your portfolio regularly or the total amount of the current prices of all your securities. In the case of investing, the portfolio's value reflects the current value of purchased ETFs and the remaining cash, including accrued dividends, all converted to euros at the current exchange rate. If you subtract the amount you invested, you'll see how your portfolio is performing in real-time. A positive growth of your investment account does not mean that this growth should be taxed. At the same time, it's possible that you may have tax liabilities even if your current total valuation is negative.

What's the Catch?

The investor and the tax authorities view profits and losses from different perspectives. Let's shift from the investor's viewpoint to the tax perspective. In this case, the key question is when profits (or losses) from securities transactions are considered realized. This happens at the moment of receiving dividends or bond interest or when a security is sold.

Dividends from ETFs

Some ETFs, like stocks, may pay dividends, which are a share of the profits. However, dividends paid by ETFs can differ from those paid by stocks. This difference arises when ETFs take the form of sub-funds, meaning one legal entity creates multiple funds, the shares of which are traded.

For tax purposes, this means that income from ETF dividends is taxed not as dividends at a 7% rate, but as capital income at a 19% rate.

Dividends from ETFs are paid regularly, sometimes multiple times a year. Your income is recognized at the moment it is credited to your investment account, even if you haven't transferred the money to your current account.

Dividends may be paid in a different currency, such as U.S. dollars or Japanese yen. In this case, the income must be converted to euros.

How to Convert to Euros?

Dividends received in foreign currency can be converted to euros for tax purposes in several ways:

• The average exchange rate for the calendar month in which the income was received, or
• The exchange rate on the day the income was received, or
• The average annual exchange rate for the relevant year, or
• The average of the average monthly exchange rates for the calendar months in which the taxpayer received income, for which the tax return is filed.

The choice of the specific exchange rate is up to the individual. For ETF dividends, the average annual exchange rate is used, and the specific conversion can be found in your tax report.

Sale of ETFs

Another moment when profits (or losses) are realized is the sale of a specific ETF (security). In the case of investing, the sale also occurs as part of portfolio rebalancing. To determine the profit or loss from the sale, you need to identify which specific ETF from your portfolio was sold.

However, you may own multiple identical securities that were purchased on different days and at different prices. If you sell one of them... How do you know which one was sold? The first one bought? Or the last one bought?

How to Match Purchases and Sales?

Tax rules do not regulate the matching method, so you can choose any method and apply it consistently for all income in that year. There are several approaches, but the two most well-known are:

• FIFO (First In, First Out) — a method where the first purchased security is sold first.
• LIFO (Last In, First Out) — a method where the last purchased security is sold first.

In practice, the FIFO method is most commonly used, as it helps to understand how long you held a particular security and how much profit or loss you made on it.

Exemption of Income from the Sale of Securities (Including ETFs)

It is very important for an investor to know that long-term investments in publicly traded securities have tax benefits.

There are two types of exemptions:

1. Income from the sale of ETFs is exempt from tax if more than 1 year has passed between the purchase of the ETF and its sale.
2. If you sold a specific ETF within 1 year, an exemption of 500 euros can be applied. The following rules apply:

• The exemption applies to the profit from the sale (sale price minus purchase price and expenses related to the sale).
• If the profit from the sale exceeds 500 euros, only the amount exceeding 500 euros is taxable.
• If you have other types of income eligible for the 500-euro exemption, the exemption is applied to them in the total amount of 500 euros, meaning the 500-euro exemption can only be applied once.

Other types of income to which the 500-euro exemption also applies include:

1. Income from the sale of any securities (except ETFs, this also includes the sale of stocks, bonds, and others);
2. Income from the transfer of options;
3. Income from the transfer of shares in commercial companies;
4. Income from rental of real estate;
5. Income from incidental activities without contractual relationships.

How to Calculate Taxable Income from the Sale of ETFs and Profit for Taxation?

We are now approaching the most important point. Income from the sale of ETFs that cannot be exempted from tax falls under the category of "other income" according to § 8 of the Income Tax Act. Specifically, it refers to the type of other income called "sale of securities." Under this category, all profits and losses can be offset against each other.

As already mentioned with the FIFO method, the total realized profit or loss from investing for a given calendar year is calculated for all sold securities (income) by matching them with the corresponding purchase prices (expenses). The total result is the sum of all profits and losses from all securities in that year.

Additionally, the total profit (tax base) can be reduced by any commissions paid, which may be part of the related expenses. You can include commissions for the purchase and sale of ETFs sold in the given calendar year. Commissions for the purchase of securities that the investor still holds cannot be included. In general, this refers to commissions related to trading on the stock exchange. Asset management fees are considered as management fees. Experts' opinions on whether these fees should be included in related expenses vary, but including them in the tax base could cause issues with tax authorities.

If there are matched sales and purchases of securities, as presented in the tax statement, you can sum up all the sale prices of ETFs, which constitute income from the sale of securities. Then, sum up all the purchase prices (costs) of ETFs and any associated commissions, which allows you to calculate the related expenses. Under this type of income, other taxable sales of securities in the given calendar year must also be considered. All of this is reported in one section of the tax return.

Finally, it is worth noting that under the category of other income, it is not possible to calculate a total loss. If such a loss has occurred, the related expenses should be calculated up to the level of income, with the final result for taxable profit being zero.

Example

Compensation of profits and losses in practice looks as follows: There were two ETF transactions — a sale for 6,000 EUR with corresponding expenses of 4,000 EUR (profit of 2,000 EUR), and a second sale for 2,000 EUR with expenses of 2,500 EUR (loss of 500 EUR). In addition, you sold stocks for 1,000 EUR with expenses of 800 EUR (profit of 200 EUR), and then another stock sale for 2,000 EUR with expenses of 2,500 EUR (loss of 500 EUR). The last stock sale passed the time test because it occurred more than a year after the purchase. The other sales do not pass the time test.

Assessment: The sale of ETFs and the first sale of stocks for 1,000 EUR are not exempt from tax due to the time test. The total taxable income from the sale of securities will be 9,000 EUR. Related expenses amount to 7,300 EUR, and the total taxable profit is 1,700 EUR. The 500 EUR loss from the second ETF transaction offsets other profits.

From this amount, the 500 EUR exemption can be applied, provided you don't choose to use it for other types of income (such as rental income).

What should be considered when taxing investment income in practice?

• The first group consists of investors who, for some reason, are required to file a tax return. Typically, these are entrepreneurs or real estate landlords. Such investors must include foreign (ETF) dividend income in their tax returns, regardless of the amount. These are considered income from capital assets (according to § 7 of the Income Tax Act). Income from the sale of securities (ETFs) is included in the tax return as other income, but only if it is not exempt from tax.
• The second large group consists of investors who were not previously required to file a tax return. The law sets an income threshold below which filing a tax return is not necessary. For 2023, this threshold is 2,461.41 euros. Next year, this threshold will be slightly higher as it is based on the minimum living standard, which increases annually. This threshold includes all income that is not tax-exempt and is subject to income tax. It is important to emphasize that this threshold applies to taxable income, not profit or tax base!

In simpler terms, an investor must file a tax return due to investment income if they:

• Received dividends and/or
• Have non-taxable income from the sale of securities (ETFs).

If an investor is required to file a tax return, they will proceed similarly to an investor filing for other reasons. They will include all foreign dividend income and non-taxable income from the sale of securities in their tax return.