Vanguard International Value Fund tax distributions

The Vanguard International Value Fund is a problematic candidate for placement in taxable accounts. The fund possesses the advantages of allowing a foreign tax credit and under current law, lower tax rates on dividend and long term gains distributions. However, the distribution of realized gains is considerably higher than distributions from international index funds, and the dividend yield is also relatively high. Thus, the fund is usually recommended for placement in tax-advantaged accounts.

The fund is the only available Vanguard option for investors desiring an international value tilt in a strategic asset allocation. The table below summarizes the fund's relation to a number of tax factors.

The following tables provide long term data on the fund's history of both dividend and capital gains distributions. The first table also provides an estimate of the foreign tax credit. The second table provides a database of the fund's accounting figures: the annual level of realized and distributed gains; its level of unrealized gains and loss carryforwards; as well as the annual in-kind redemption gains the fund has realized. These figures highlight the level of a fund's tax liabilities.

Because both manager turnover of securities inside the portfolio and investor turnover of fund shares can affect the level of gains realization, a third table provides historical turnover ratios.

Distributions

 * FY 2012 - Elimination of 2% transaction fee on redemptions of shares held < 2 mos.
 * FY 2003 - Introduction of 2% transaction fee on redemptions of shares held < 2 mos.

Accounting data
The accounting figures and associated ratios (tables 2 and 3) can help one visualize some of the major determinants of a fund’s tendency to distribute taxable gains. These determining features include:

Turnover: The rate at which a fund manager sells securities within the fund has a major effect on potential gains realization. Single digit annual fund turnover percentages result in a low rate of realized gains. Similarly, fund shareholders' sales flows have major effects on a fund’s distribution tendencies. Net flows into the fund have the following effects:


 * 1) Constant inflows allow a fund manager to purchase a wide range of price lots for shares. The manager can select high basis shares when forced to sell a stock (this may realize a loss). The manager can also select low basis shares when redeeming a stock in-kind (a non-taxable transaction that can remove an unrealized gain out of the portfolio.)
 * 2) A large and growing net asset base serves to diffuse any realized capital gains across a large base of shareholders and reduces the per share gain distribution. Large outflows have the opposite effect; any gains realized are spread across a smaller asset base and result in higher per share distributed gains.

The level of unrealized gains and carryover realized losses in a fund: A fund which defers gains realization accumulates unrealized appreciation, which when distributed, will be taxed; thus the unrealized gain/loss figure shows the potential gain (or loss) that would be realized if the portfolio was to be entirely liquidated. Any loss carryovers a fund possesses can be used to offset future realized gains (carryovers have an eight year expiration period). The second tab on the Table 2. spreadsheet shows the data in percentage of total assets form.

Turnover statistics
In response to the early 2000's mutual fund market timing scandals, Vanguard introduced a 2% early redemption fee on Vanguard International Value Fund shares sold less than two months after purchase. Prior to this policy change, shareholder turnover (R/ANA) in the fund ranged between 30% - 89%. After the change, shareholder turnover has ranged between 13% - 24%.

Tax rates
Mutual fund distributions will be taxed according to the tax laws governing the investment over the holding period of the investment, which are subject to change. The actual tax imposed will depend upon each individual's tax rate and the timing of purchases and sales. The federal tax rates applicable to mutual fund distributions and investor sales of securities for the period 2013 onward are outlined below. Keep in mind that investment income may also be subject to state and local taxation.
 * 1) Short-term capital gains distributions are made from realized gains on securities held for one year or less. Short-term gains are taxed at ordinary income tax rates up to 39.6%. Mutual fund short-term gain distributions are included in a fund's ordinary dividend distribution; therefore, capital losses may not be subtracted from these distributions when computing taxes.
 * 2) Long-term capital gains distributions are made from realized gains on securities held for more than one year. Long-term gains are taxed at 0% for taxpayers in the 10% and 15% tax brackets, at 15% for taxpayers in the 25%, 28%, 33%, and 35% tax brackets, and at 20% in the 39,6% tax bracket. They are reported on tax Schedule D along with any other capital gains, and can be reduced by capital losses.
 * 3) Qualified dividends are the ordinary dividends that are subject to the same tax rate that applies to long-term capital gains. They should be shown in box 1b of the Form 1099-DIV you receive.
 * 4) When you sell at a loss you will either offset capital gains which would have otherwise been taxed at your capital gains rate or you will offset income (up to $3,000 maximum per year) which would have otherwise been taxed at your marginal income tax rate, or both. If you offset capital gains that would have otherwise not been taxed at all (because your capital gains tax rate is 0%) then this part of the tax loss harvest may be an outright loss.
 * 5) The Affordable Care Act imposes a Medicare surcharge of 3.8% on all net investment income (NII) once the taxpayer's adjusted gross income exceeds $200,000 (single) or $250,000 (married); while this tax is not part of the income tax, it has the same effect on investors as a higher tax rate. The NII tax begins to apply to individuals falling in the 33% tax bracket. Thus the top effective marginal tax rate is 23.8% on qualified dividends and long-term gains, 43.4% on ordinary investment income.

Tax analysis
Over the period (1996 - 2014) the Vanguard International Value Fund regularly distributed both short-term and long-term gains to shareholders, with the exception of years (2002 - 2005; 2009 - 2014) in which the fund possessed loss carryforwards. Over the 2004 - 2012 period, the fund provided an average 74% qualified dividend distribution to shareholders.