2. Unique Structural Set Ups
ETF's structure is the second source of ETFs’ tax efficiency - ETF companies work with specialized dealers (aka Authorized Participants) to create and destroy shares based on supply and demand.
When an ETF investors pull money out, the ETF manager can deliver a basket of shares to the specialized dealer, who then sells them. This is referred to as “in-kind” redemption. That doesn’t qualify as a taxable event for shareholders, hence the greater tax efficiency.
On the other hand, mutual funds must meet investor withdrawals by unloading shares in the open market, creating taxable events.