Many people have invested in shares in recent years as the stock market has boomed. But with markets proving extremely volatile in recent months, have you decided enough is enough or will you be hanging on in the hope of ever-increasing returns? Here’s what you need to know about your tax position if you buy, sell or hold shares writes Mark Chapman, director of tax communications at H&R Block (NYSE:HRB).
Receiving income from shares
The most common way for companies to pay returns to shareholders is by way of a cash dividend.
Significantly, whether you hold shares in a private company or a publicly listed one, the rules about how you’re taxed on any dividends you receive as a shareholder are essentially the same.
Dividends are paid out of profits which have already been subject to Australian company tax which is currently 30% (or 25% for small companies). Recognising that it would be unfair if shareholders were taxed again on the same profits, shareholders receive a rebate for the tax paid by the company on profits distributed as dividends.
These dividends are described as being 'franked'. Franked dividends have a franking credit attached to them which represents the amount of tax the company has already paid. Franking credits are also known as imputation credits.
The shareholder who receives a dividend is entitled to receive a credit for any tax the company has paid. If the shareholder’s top tax rate is less than 30% (or 25% where the paying company is a small company), the ATO will refund the difference.
Disposing of your shares
When you dispose of shares, assuming you are an investor, not a trader (see below), you will normally have to pay CGT on any profits.
Typically, CGT arises when you sell shares but can also happen if you give them away or you stop being an Australian resident. CGT taxes any increase in value from the time the share was acquired.
Your capital gain for a share is worked out like this:
- Deduct the cost base from the sale proceeds. The cost base is the price you paid for the share, plus incidental costs.
- Next, take away any capital losses.
- Then, discount the gain if you’re eligible. Individuals are entitled to a 50% discount. The asset must have been held for 12 months or more for the discount to be available.
- The resulting figure is your net capital gain. This is subject to tax at your marginal income tax rate.
TIP: Any shares acquired before September 20, 1985, are not subject to CGT.
Sometimes the proceeds and cost base of the share are not what was actually paid and/or received, but rather, the market value of the asset. This is typically to prevent people from minimising their tax by, say, selling the share to a relative for a low price.
What happens if you make a loss on share disposal?
If your sale proceeds are less than your cost base, you will make a capital loss. These losses can be offset against capital gains arising in the same year and to the extent they are not used up, they can be carried forward indefinitely until capital gains arise to absorb them.
Capital losses can only be offset against capital gains. They can’t be offset against any other form of income.
TIP: If you dispose of an asset during the year for a capital gain, you might want to consider disposing of any other assets you own which are sitting at a loss. That way, the capital loss can be offset against the capital gain. This is a popular year-end strategy with share investors. Be careful though, if you sell loss-making shares to crystallise a capital gain just before the end of the tax year and then buy the shares back again at the start of the new tax year. The ATO generally regards this as an artificial contrivance or deliberate tactic to generate capital losses.
Are you a share trader?
If you dabble regularly in buying and selling shares, you could be deemed a share trader, rather than a share investor. If that’s the case, the tax you pay could look very different.
A share trader is someone who buys and sells shares purely for short-term profits. Signs that you’re a trader include:
- Lots of transactions.
- A clear profit-making intent.
- You run your activities in a business-like manner (eg, a large investment of capital, a well-developed business plan, extensive research and properly maintained books and records).
Someone who buys and sells shares as part of a business will treat those shares as trading stock, and gains or losses on them will be taxed as ordinary income (effectively as business profits/losses) rather than capital gains/losses.
The key tax advantage for a trader is that losses can potentially be offset against other income (subject to certain anti-avoidance provisions).
What happens when you inherit shares?
Inheriting shares from a deceased person does not in itself have any immediate tax consequences for you. You will not, for example, have to pay CGT until you actually dispose of the shares.
When you inherit the shares, the deemed cost at which you inherit them (which will be deducted from your proceeds when you choose to sell to give you a capital gain or loss) depends on when the deceased first acquired them:
What to do now
First of all, work out if you have a net capital gain from shares you’ve already sold. If so, you should be looking through your portfolio for stocks with losses that you could sell to offset paying tax on the gains.
Make sure that you have the necessary information about all your share sales so you can report this to the ATO. You’ll need details of the original purchase cost, the sales proceeds, the dates of acquisition and sale and any associated costs (eg, brokerage fees).
Remember that tax on shares is complicated and to avoid ATO penalties and possible audit, it pays to take advice from a tax agent to make sure you report your share transactions accurately and fully.