When dealing with shares there are two times share taxation events occur: When you sell shares and when you receive a dividend.
Selling your units may result in you either receiving a profit which is a capital gains event or may result in a loss which can be declared as a capital loss (Share capital gain tax).
Any amount of dividends received are also assessable income for the year they were paid to you, these must be declared. Even if you elect to reinvest your dividends (DRIP), from a taxation perspective this is the same as receiving cash and reinvesting that cash.
Share Capital Gain Tax
You must report a capital gain or capital loss as part of your tax obligation for the income year in which it occurred. Capital gains will be taxed and may be discounted. Capital losses can be used to offset capital gain tax (CGT) obligations but no other form of tax obligations. If you have no CGT obligations for that income year it may be possible to carry losses forward to future years.
CGT is a component of your usual income tax. You are taxed on your capital gains at your income tax rate. When calculating the cost basis of buying and selling shares you can add the amount of brokerage paid.
Net Capital Gains= Total Capital gains-total capital losses (and any unapplied capital losses from earlier years)-any discounts
There are three methods for calculating capital gains;
The main methods are the second two; the discount method and the other method. The basis of this information is that if you hold a company for over 12 months you can discount it at 50%, if you hold it for under 12 months the entire amount is taxable.
Things to be aware of:
When reading over this information you may think of a simple tax scam. What if I sell my shares to claim a capital loss then rebuy them? This is known as a wash sale. The ATO keeps track of this to ensure people aren’t claiming these capital losses. This applies to selling and rebuying the same share or even selling and rebuying similar equities. Such as selling one ASX index fund and rebuying another.
Share Tax: CGT Examples
An investor buys shares on-market for $1000 and 6 months later he sells them at $5000, both times he paid $15 brokerage. He has no capital losses. In this case the investor has made $3970 profit (1000-5000-30). In this case the investor would declare $3970 as a capital gain and pay income tax on this amount subject to their personal tax rate.
An investor buys shares on-market for $1000 and 15 months later he sells them at $5000, both times he paid $15 brokerage. He has no capital losses. In this case the investor has made the same $3970 profit, but is now subject to the discount method, meaning they will declare $1985 as capital gains and pay income tax on this amount subject to their personal tax rate.
An investor buys shares on-market for $1000 and 15 months later he sells them at $5000, both times he paid $15 brokerage. He also has $1000 in capital losses. In this example we take the $3970 profit and subtract the capital losses, leaving us with $2970. Since the investor has held investment for over 12 months, they are subject to the discount method, meaning they will pay tax on $1485 subject to their personal tax rate.
Dividends paid by Australian companies are taxed under an imputation system. As the company has already paid some tax attributed to its earnings this tax can be allocated to shareholders by franking credits, this stops the double taxation of earnings.
Franking credits can be used to offset some or all the tax payable by dividends. And some individuals may be eligible for a refund of any excess franking credits. Australian companies are taxed at a rate of 30%, this is an important piece of information when it comes to dividends and franking credits. It means that for a franked dividend the company has already paid tax on 30% of those earnings.
Dividends can be fully franked, that is the whole amount carries a franking credit, or partially franked, meaning the dividend is composed of a franked and unfranked amount. All the important information will be contained within the dividend statement that the company will issue you.
The entire amount of the dividend and franking credit is treated as assessable income. These amounts are treated the same as your usual income tax and are taxed at the same amount. From the overall tax amount, your franking tax offset amount is then subtracted. Additionally, if you have excess franking credits, they may be used to offset other types of personal tax obligations or if you have no tax obligations will be refunded to you as a tax refund.
This means that if a person was not supposed to pay tax at all due to being a low-income earner they would receive a refund of the entire franking credit as this is the amount that the company theoretically paid on their behalf. If the investor was a high-income earner, they would still pay the difference between the corporate tax rate of 30% and their personal income tax rate for the franking credit amount. Basically, it follows the formula taxable income= franked amount + unfranked amount + franking credit
Tax payable = (taxable income-deductions) ×Income tax rates) – deductions (e.g. franking credits)
Let’s look at some examples;
An investor receives a partially franked dividend. The unfranked amount she received was $200, the franked amount was $700, and this had $300 in franking credits attached. At tax time she would declare income of all these amounts of $1200. Her tax obligation for the
dividend would then be at her income tax rate. Finally, the franking credit offset is subtracted from her tax payable. Here’s how that would look for each income tax bracket
The Franking Credit Debate:
Recently there has been political debate surrounding the current franking credit system. There have been talks of stopping it, as its been wrongly accused of giving free, or government money to “rich” shareholders. The simplest way to consider this is realizing where the money has come from and why the imputations system exists.
Dividends arise from a company’s earnings; companies are pay 30% tax on their earnings. However, as shareholders, we are part-owners of the company and part-owners of the earnings it creates. Thus, when its earnings are passed onto us in the form of dividends some tax has already been paid on these earnings, to then further tax shareholders on these dividends without accounting for the 30% tax rate would effectively double tax shareholders.
Also, when we receive franking credit refunds this isn’t money from the government, this was money that the company created but had withheld, just like when an individual works they some of their money may have withheld.
Consider a pool of money, this represents the company’s earnings. In effect all the shareholders own a small a proportion of this pool. If the government then takes some of this amount decreased. Once the amount is paid out to shareholders if the government then takes a further percentage then the individual has been double taxed. The imputation system stops this.
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We are not qualified taxation professionals and cannot give specific taxation advice. The information throughout this article is for general information purposes only. It is not intended as legal, financial, taxation, or investment advice. Prophet is not liable for any loss caused, whether due to negligence or otherwise arising from the use of, or reliance on, the information contained in this article. Please do your own research. Ensure to consult with your own personal taxation professional before making any decisions or commitments. Some information may be out-of-date or inaccurate.