Your share portfolio and tax

Dividends |  Dividend imputation |  Disposal defined |  Deductions |  Foreign investments |  Other deductions |  Dealing with losses

There's a warning that sharemarket investors will hear at least once in their lives in some form or other ­– base decisions on investment merit, not on trying to save tax. It's a maxim that has been put a more colourful way: Don't let the tax tail wag the investment dog.

Wise words; but don't wipe 'tax' off the whiteboard just yet. It is still an important element to factor into your total investment outcome.

There are taxation consequences for everyone who earns assessable income, and that includes profits made from sharemarket investments (both from dividends and increases in market value that have been realised through share sales).

If you buy and then sell a parcel of shares and they have gone up in price, you will make a capital gain. Tax will usually have to be paid on this gain. And if in the interim you have received dividends on those shares, there may also be tax to pay. However the amount of tax payable (or refundable) depends on how much tax, if any, the issuing company has already paid on the underlying profits from which the dividends are paid – that is, whether they are unfranked, partly or fully franked dividends.

Dividends
You will be required to declare all dividend income on your tax return, even if you actually did not receive the dividend in cash but used it to buy more shares (through a dividend re-investment scheme for example).

In any financial year there can be both interim and final dividends, and they may not necessarily be paid but 'credited' to you. The shareholder dividend statement from the issuing company will have all the details you need.

Even if you re-invest dividends to buy more shares, make sure you keep records of market value, as this will be needed when you eventually dispose of them for capital gain (or loss) calculation purposes. Any other payments or benefits from a company of which you are a shareholder (and, in some cases involving an unlisted company, an associate of a shareholder) can potentially be treated as though they are dividends, and therefore be taxable.

Dividend imputation
Dividends are taxed under an 'imputation' system. This just means that the dividends are paid out of profits on which the company has already paid tax, and the company attributes or assigns that underlying tax (imputes it) to the receiving shareholder. The dividend comes with a 'franking credit' representing that company tax paid, which the shareholder can use to offset their own tax liability.

Dividends can be fully franked (that is, franking credits have been attached to 100% of the dividend paid), partly franked (franking credits have been attached to a portion of the dividend paid) or unfranked (no credits attached). Your dividend statement should spell out the percentage to which the dividend is franked.

All these details will be needed for your income tax return. Include both the amount of the dividends and the amount of the franking credits attached to them. The information will be used to work out your franking tax offset. If the total of your franking credits plus any other tax offsets and credits you are entitled to is more than your tax liability, your unused franking credits may be claimed as a refund if you are an individual, or can be converted into tax losses for a company.

But be aware that you can only claim franking credits attached to a dividend if you held the shares for at least 45 days (not including the dates you bought and sold them) at the time the dividend was paid. (This rule doesn't apply if your total franking credits for the year are $5,000 or less.)

If you are in a partnership or are the beneficiary of a trust that holds shares, you may also receive dividends or capital gains as distributions. Here, you would be taxed as though you held the shares yourself. Franking credits generally flow through the partnership or trust as well, but certain trusts need to make a 'family trust election' before you are able to claim the franking credits.

Disposal defined
Disposing of shares includes selling them of course, but for tax purposes, a disposal can also happen under other circumstances, such as when a company goes into liquidation or is subject to a takeover. Disposal by whichever means will result in either a capital gain or a capital loss. Broadly, this is the difference between what you paid to get the shares and what you get when you dispose of them (in whichever manner), and comes with CGT implications.

A liquidator can declare shares worthless (so the capital loss, which can at least be used to reduce capital gains made on other investments, might be some consolation), and transferring shares into someone else's name will be treated the same as an on-market third party sale. But if you've owned your shares for more than 365 days, there is a tax concession available to individuals whereby 50% of the capital gain is tax-free – the CGT discount.

Deductions
Expenses that are generally deductible in full in the year incurred include management fees or retainers paid to manage your investments, and interest on money borrowed to buy the shares. Any expenses related to making this borrowing, such as legal expenses and establishment fees, are unlikely to be immediately deductible but may be deductible over the lesser of five years or the term of the loan at a proportional amount per year.

Finally many other expenses, such as stamp duty, are not available as stand-alone deductions but may form part of the CGT cost base of the shares to reduce the overall taxable capital gain that selling them may generate.

Also if you have to travel to service or maintain your investment portfolio, say to consult with a broker or be present at a company meeting or stock exchange engagement, you may be able to claim these travel expenses.

Foreign investments
If you hold shares in foreign companies, dividends received and capital gains made will still be subject to Australian tax.

With dividends, many countries impose a dividend withholding tax. You receive the dividend net of that tax, but should not be liable for any more tax on the dividend in the foreign country. You will be subject to Australian tax on the full amount (that is, before the withholding tax amount) but should be able to credit the withholding tax against your local liability.

If you dispose of foreign shares, you will generally be subject to Australian tax under the usual CGT rules. However if an Australian company (say, your family business) owns at least 10% of a foreign company, the capital gain may be partially or wholly tax-free to the Australian company.

Other deductions
The cost of specialist publications or subscriptions to market information services may be deductible. And internet access costs (limited to the extent that you use it for directly managing your investments, say if you use an internet broker for example) may be another deduction. And the decline in value of the computer equipment (again, limited as above) may be deductible as a depreciation charge where it is used to administer your portfolio.

Remember to keep sufficient records (such as buy and sell prices) as well as recording deductible expenditure to make sure you can claim everything you're entitled to.

An asset register may be a good consideration. There is commercially available software, but it can be a simple spreadsheet that records all manner of details that are handy for more than taxation matters. Record dates of purchase and disposal, values, depreciation and even details like computer serial numbers, make and model.

Dealing with losses
If the amount of allowable deductions you claim for financial investments is more than the gross income you get back from these investments, you will have made what is known as a 'total net investment loss'.

The net investment loss could be important. From July 1, 2009, the income tests for the Medicare levy surcharge, and for  entitlement to certain government support schemes (such as the senior Australians tax offset, dependents offsets and higher education loan schemes) may be affected by your investment-related income.

Specifically, the income tests will include any 'total net investment loss' for the year. The calculation of your 'taxable income' is not affected, and the net investment loss does not include capital gains or losses.

It is also important to be aware that if you start conducting your share trading activities in a business-like manner, you may find yourself subject to different tax consequences than those discussed here (see Trader or investor?).

Further reading:
Growth versus income
What's an asset class?
Compound interest
What a balance sheet will tell you

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