How to compute unit average cost after capital gain distributions?

Question

My question is about how and why the average cost of a stock is re-computed after the capital gain distributions of the corresponding fund. I'll give the actual example that confuses me to ground the discussion but I think this is quite general.

Concrete example:

I bought VSP stocks for 62.65$ per unit (say 10 units). In late December, Vanguard has announced the annual capital gain distributions for 2020. The average cost of these same units is now displayed at 65.06$ per unit on my brokerage account (original price of 62.65$ + 2.40$ of capital gain per unit). This is the press release:

https://www.newswire.ca/news-releases/vanguard-investments-canada-announces-final-2020-annual-capital-gains-distributions-for-the-vanguard-etfs-r--885051798.html

In particular, in the above press release, they mention that these amounts have been automatically "re-invested and the resulting units immediately consolidated so that the number of units held by each investor will not change".

Questions:

1. Shouldn't capital gain distributions lower the average unit cost rather than increase it? I would have expected my new average cost to be 62.65$ - 2.40$ = 60.25$ per unit.

2. How is this updated average cost going to impact me in practice? Since the transaction had already occurred (10 units for 62.65$ each), now that they compute they were "bought" for 65.06$ each, am I owning a debt towards Vanguard?

3. What does it mean to have the additional units (from the reinvestment) "consolidated" with the original units?

4. When I sell, I'll just sell the 10 units for the current market price of the stock, so what does it matter that the average cost was updated?

Answer 1

1- No. You now have spent more on average for the etf units. Vanguard just did this for you.

3- That's how Vanguard did this. They had money to re-invest (from selling certain stocks that went up and weren't in the index anymore - or maybe CAD forwards, I dunno) but instead of giving you this money they kept it and bought more stocks. In order to not increase the number of units you hold they just changed the price, called consolidation - the opposite of a split.

2- In case you haven't noticed you are going to have to pay tax on this "phantom" distribution. You will receive a T3 by the end of Mar. This is the entire reason for all the paperwork, they have to flow through all distributions. If this is in a tax sheltered account then nothing happens and nothing matters.

4- If this is in a taxable account then you don't want to pay the cap gains tax twice so you increase the cost base by the amount already paid. This is obviously equal to the amount Vanguard re-invested and consolidated.

edit, just thought I would say that if you happened to buy this in Dec. in a taxable account you are still responsible to pay all the capital gains tax for the whole year when you didn't even own the fund. All etf providers will give an estimate late in the year of what to expect so you won't get a nasty tax surprise.

Imagine you received the cg distribution of $1 from a $10 fund, now the fund is worth $9 and you have $1 (exactly like a dividend distribution). So you re-invest your $1 and you have 1 + 1/9 shares now (1.111). So you ask the fund to do a consolidation of 1.111 to 1 and you have 1 share now but the price is 9 * 1.111 or $10. The same thing happens when the fund does it without your involvement.