If you are looking for a way to earn additional income along with building your net wealth over time, there can be nothing better than investing in shares.
As a shareholder, you can not only benefit from dividends but also from capital gains. Since both dividends and capital gains are a form of income, investors are obligated to pay tax on these earnings. However, the tax treatment of both differ.
As the saying goes, “knowledge is power,” and when it comes to your financial future, understanding the tax implications of your share investments can make all the difference. So here’s our guide to help you understand everything when it comes to tax and shares in Australia.
Taxes on share investments
Let us pay attention to how the ATO (Australian Taxation Office) calculates taxes on shares.
There are several factors that will determine how much tax you will have to pay on the share investments every year. For instance, how much income you earn from shares will be the prime factor in deciding how much tax you will pay.
Other factors include when you earned the income, if the income was from capital gains or dividends, and how much you earned.
The investment income earned by an individual who earns a salary in each financial year is added to the assessable income. The assessable income is the total or gross income from every source before allowable deductions. Thus, it includes both the net capital gains and dividends.
You will have to pay tax on shares when you receive dividend income or make a capital gain. As mentioned before, different type of share income attracts different tax rules.
The first kind of share income or taxable income is the dividends paid by the company. Another type of share income is capital gains (when an individual purchases a share and sells it for more money than the purchase price). You must have also heard about ETFs (exchange-traded funds).
Let us look at these in detail.
Dividends are the payments of profits made to the shareholders by a company. When a company pays a dividend to its shareholders, they are required to report it to the Australian Taxation Office. It gets added to their taxable income. In other words, the dividends from shares must be included as a part of the ATO tax return.
Dividends can either be franked or unfranked. What is the difference between franked dividends and unfranked dividends?
These are the dividends with a tax discount. The company has already paid some tax on the profits it shares with you. When you receive these, you get a credit for the tax the company paid. It’s like the company saying, “We’ve paid some tax on this money, so you don’t have to pay as much tax on it when it comes to you.”
Franking credits reduce the amount of tax you have to pay on the dividends you receive from the company. Since the tax on company profits has been paid, the shareholder can claim a credit while calculating their tax liability. (Read our complete blog on franking credits to know more about it.)
Unfranked dividends, on the other hand, are just like regular dividends that do not offer any tax discount. In this case, the company has not paid any tax on the profits before distributing them to the employees.
Capital Gains Tax
When an investment is sold for a higher cost than it was acquired for, capital gain is made. Capital Gains Tax or CGT is levied at the marginal tax rate of an investor.
We all know that investing for the long term can be helpful in generating better investment returns. But did you know that it can also help with the tax situation when you sell those investments?
A capital gains discount of 50% can be applied when an investor sells an investment that was held for at least 12 months. In simpler terms, it means that you will have to pay tax on half the net gain on the asset. For the investors that deal with much bigger gains, the CGT discount can help them save a lot of tax.
What about capital losses?
Since not all investments can work out positively, sometimes it is the right decision to exit an investment at a loss.
What if the amount you sold your investment for is less than the cost you acquired it for? In such a case, you make a capital loss. Capital losses can be used to offset capital gains. However, these losses cannot offset any other types of income, for instance, wages or interests.
What if you do not sell the investment?
The points discussed above are after an investor sells the investment. But what if an investment hasn’t been sold, but the investment has gone up?
You would be happy to know that the Australian taxation system does not tax unrealised gains. You are going to be taxed only when you sell your investment, which is yet another reason for a lot of investors to go with long-term investing.
In trusts, distributions are paid to the investors before tax has been paid. Thus, investors can get the ETF distribution and pay the appropriate amount of tax at their marginal tax rate.
ETFs or Exchange-traded funds can pay different types of income, such as capital gains, distributions and (sometimes) foreign income. Each of these kinds of income has to be reported on a different part of your tax return.
An ETF provider will provide you with an annual take statement that discloses how much income you have received and where it should be reported on your tax return.
Did you know about the ‘pre-fill’ services of ATO? If you are a share investor, the pre-fill services can help you with your tax return. While doing your tax return yourself, the pre-fill services can help you partially complete your tax return with the help of financial information the ATO received from employers, government agencies, banks, funds, ETFs and the ASX shares that paid dividends.
However, it is your responsibility to check that the pre-fill information is correct.
Although a lot of pre-fill details are available by late July, it can take a bit longer in case a particular company or ETF has not provided the details to the ATO.
If your investment pre-fill details are missing, you will have to either enter the information yourself or wait until it is available to pre-fill.
It is pretty unusual for the pre-fill information to be wrong. But if this occurs, you should contact the organisation that provided the details to the ATO and ensure that the organisation sends the correct details.
“What records do I need to keep for my investments?” If this is a question you wish to ask, here’s the answer.
You will need to keep a record of everything that would be counted as taxable income, along with records of anything that may be a possible deduction.
Some of the most common records when it comes to shares are distribution statements from ETFs, dividend statements from companies, the purchase price, the sale price for the investments and how long you held the investments.
It is always better to keep a record of any capital losses that you can carry forward.
Although you can take care of your tax matters on your own, sometimes it could be better to just have a professional take care of these matters for you. Especially for people who have too complicated tax matters, which makes it harder to navigate the complex world of taxation, it is suggested to reach out to a professional.
Not only can an experienced accountant help you with capital gains discounts or ETF distributions, but such a professional can help you understand the tax effect if you decide to sell an asset.
Professionals like Clear Tax Accountants can help you make smart choices when it comes to your investments and also take care of your tax affairs.
Disclaimer: The information on this website is for general purposes only and should not be relied upon for making legal or other decisions. The advice provided in this article is general in nature and is not subject to the personal financial situation and needs of any individual. Clear Tax tries to keep the information accurate and up-to-date; however, you should bear in mind with changing circumstances, the accuracy and reliability of the information will not necessarily remain the same. The information is by no means a substitute for financial advice.