We’re often asked how much tax our investors will pay on their sales of shares. It’s a question worth answering and the answer may be more complex than you think.
Investing in Australian Securities Exchange (ASX) listed shares can be an effective means of generating additional income and building wealth over the long term. Shareholders benefit from both dividend payments and potential capital gains. Dividends represent a distribution of company profits to shareholders.
Both dividends and capital gains constitute a form of income and therefore investors must pay tax on these earnings. However, the tax treatment of dividends differs from that of capital gains.
Tax on Share Investments
The amount of tax you pay on your share investments each year depends on several factors. If you earn income from shares in the form of dividends or capital gains, that investment income becomes part of your assessable income for the financial year as an individual earning a salary.
Your assessable income consists of your total income from all sources before deductions and includes both dividends and net capital gains. Your taxable income, which determines the amount of tax you owe, is your assessable income minus any allowable deductions.
Tax on Dividends
Dividends are a means for a company to distribute part of its profits to shareholders. There are two types of dividends: franked and unfranked.
Franked dividends are paid from profits on which the company has already paid Australian company tax. Since tax has already been paid at the corporate level, shareholders can claim a franking credit when calculating their own tax liability. The franking credit reduces the amount of tax the shareholder must pay on the dividend income.
Unfranked dividends are paid by an Australian company without any company tax having been paid first. As such, there are no franking credits available to offset the shareholder’s tax on the dividend.
Income tax on franked dividends
To understand the implications of franking credits on your dividend income, let’s consider a scenario where you own shares that pay a fully franked dividend of $700. Along with this dividend, your statement also shows a franking credit of $300. This credit indicates that the dividend would have been $1,000 (referred to as the ‘grossed up’ dividend) before the deduction of company tax.
During tax time, it is important to include the $1,000 grossed up dividend as part of your taxable income. If your marginal tax rate is 32.5%, you will be taxed $325 for this dividend. However, since the company has already paid $300 in tax, you will only need to pay an additional $25 individually.
On the other hand, if your marginal tax rate is 45%, you will be liable for $450 in tax on the dividend. Consequently, you will need to pay an extra $150 in tax.
Franking credits can lead to tax refunds for shareholders in lower marginal tax brackets. For instance, if you received the $700 dividend mentioned earlier ($1,000 grossed up) and your marginal tax rate is 19%, your tax liability would amount to $190. Since the company has already paid $300 in tax, you would be eligible for a tax refund on the difference, which in this case would be $110.
Capital gains tax on increases
The capital gains tax is based on an investor’s marginal tax rate, which means it is determined by the tax bracket they fall into. However, there is a special provision that allows for a 50% discount on capital gains if the investment has been held for more than 12 months.
Let’s consider an example. Imagine you made a capital gain of $10,000 from selling shares that you had held for over a year. Normally, you would be taxed on the full amount of $10,000. However, with the 50% discount, your taxable capital gain would be reduced to $5,000. This makes a significant difference in the amount of tax you owe.
Let’s delve deeper into the numbers. Suppose your marginal tax rate is 37% and you sold the shares after only 11 months. In this scenario, your tax liability would be $3,700. However, if you had waited just one more month and sold the shares after 12 months, your tax liability would be reduced to $1,850.
Pro Tax Tip: Capital gains are taxed at your marginal tax rate, however investors with higher marginal rates may be inclined to delay selling shares that have performed well until after 12 months of ownership as it results in a significantly lower tax liability.
Capital gains tax on losses
Let’s say an investor makes a profit from selling shares, but at the same time, they also incur a loss from selling other shares or investment assets like property. In this situation, the investor can deduct the capital loss from the capital gain, and the tax will be calculated based on the net gain.
Capital losses can be carried forward to future financial years. If an individual experiences a capital loss in a particular year but does not have any capital gains to offset it, they can carry the loss forward and use it to offset capital gains in future years.
Capital gains tax is only applicable when investments are actually sold. This means that unrealized capital gains, which are the gains that have not been realized through selling investments, can contribute to faster compounding of returns. This is particularly advantageous for long-term investors who hold their positions for extended periods, as well-managed companies tend to increase in value over time due to growing earnings. This growth in earnings can compound at impressive rates, leading to significant returns over the long term.
Tax on shares held in superannuation
Investors often hold shares within their superannuation funds, which are subject to a different taxation regime compared to individual investments. The amount of tax you pay on your superannuation depends on your age and the total superannuation amount you have.
The tax you pay on superannuation withdrawals depends on whether you choose to withdraw your superannuation as an income stream or a lump sum. If you are 60 years or older and withdraw money through a superannuation income stream, this income is generally tax-free. However, if you opt for a lump sum withdrawal, you won’t pay any tax if your super fund is taxed, but you may have to pay tax if you withdraw from an untaxed super fund, such as a public sector fund.
Once you reach retirement age, you can maintain an amount up to the transfer balance cap in the retirement phase, which is currently set at $1.7 million, and this amount will be tax-free. You can continue to make transfers into the retirement phase as long as you stay below the transfer balance cap.
Tax deductions on shares
Interest Income Expenses:
- You can claim a deduction for account-keeping fees on investment accounts, such as a cash management account. These fees can be found on your account statements.
- If you have a joint account, you can only claim your share of the fees, charges, or taxes on the account. For example, if you share an account with your spouse, you can only claim half of the allowable account-keeping fees.
- It is not possible to claim a deduction for interest incurred on a personal tax debt, such as a loan taken to pay personal tax debt.
- Attending an investment seminar related to an existing investment may entitle you to claim a deduction for a portion of the expenses incurred in earning investment income.
- However, you cannot claim a deduction for attending a seminar about an investment you are considering, even if you eventually invest in it.
Dividend and Share Income Expenses:
What you can claim:
- You can claim deductions for costs associated with investing in shares, including ongoing management fees, fees for advice on investment mix changes, and costs related to managing your investments (e.g., travel expenses to attend company meetings, specialist investment journals, borrowing costs, internet access, and computer depreciation).
- If you received a dividend from an Australian listed investment company (LIC) that included a LIC capital gain amount, you can claim 50% of that amount as a deduction if you were an Australian resident at the time.
What you can’t claim:
- Fees for creating an investment plan are generally not deductible unless you are conducting an investment business.
- Some interest expenses related to borrowing money under a capital protected borrowing arrangement to buy shares, units in unit trusts, and stapled securities are not deductible. These interest expenses are treated as part of the cost of the capital protection feature.
- Brokerage fees and other transaction costs cannot be claimed as deductions, but they can be included in the calculation of capital gains tax when you sell the shares.
Pro tax tip: You can’t claim a deduction for interest paid on borrowed money if you receive an exempt dividend or other exempt income.
Don’t forget to always keep accurate records and consult with a tax professional or refer to the relevant tax regulations to ensure compliance with the specific requirements.
Help is at hand
While understanding the potential tax liabilities on investments is significant, each individual’s situation is unique. The advice provided in this article is of a general nature and should not be solely relied upon for making personal investment decisions. It is always recommended to consult with a professional tax or financial advisor who can provide specific advice tailored to your individual circumstances.