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Investors should consider these eight tax issues in the lead-up to June 30.
By Ali Suleyman, Pitcher Partners
Albert Einstein once said "the hardest thing in the world to understand is the income tax." Although this might provide some cold comfort for investors worldwide, it remains prudent to conduct a regular review of your tax affairs, particularly as June 30 approaches.
This article provides information on eight key tax issues that individual investors should consider.
1. Investor or trader definitions
Many shareholders routinely assume that transactions of their listed securities result in a capital gain or loss. However, shares can be held for either investment or trading purposes, and the treatment of gains and losses under either circumstance can differ markedly.
A capital gain or loss typically arises on the sale of a share held as an investment and tax treatment applies to a person who invests in shares (share investor) with the intention of earning income from dividends and similar receipts. A share investor is someone who is not carrying on a business of buying and selling shares and also does not have the requisite profit-making intention in acquiring shares. Such investors will generally have a long-term outlook in holding shares.
In contrast, a share trader is generally someone who carries out business activities for the purpose of earning income from buying and selling shares. They will generally derive income (not capital gains) from the sale of shares, and their purchased shares would be regarded as trading stock, or part of a profit-making enterprise.
There are many different pointers for identifying a share trader compared to a share investor, including the nature and scale of the investment, the investment style, the length of time the assets are held, and the repetition and regularity of buying and selling. It is important that shareholders review this classification of activities annually to ensure it remains appropriate.
The classification makes a number of key distinctions. For example, a share trader will not qualify for the 50 per cent capital gains tax discount, explained below. For share investors, capital losses can only be used to reduce capital gains, whereas revenue losses by share traders can be applied against any income or gain.
2. Capital gains tax (CGT)
Where an individual is a share investor, it is important to consider CGT implications before the end of the tax year. The tax system generally imposes CGT on those profits that have been realised. Similarly, capital losses will not arise until the losses have crystallised by realisation (or a declaration by a liquidator or administrator that the shares are worthless).
The timing of a capital gain (or loss) can mean significant after-tax cash differences. An individual qualifies for the 50 per cent CGT discount (reducing the capital gain subject to tax by half) when they have owned the relevant asset for more than a year. Of course, the decision to hold a share also requires consideration of the commercial risks.
A capital gain on the sale of an investment asset typically arises at the date of contract for the sale. Accordingly, when the sale occurs after June 30, tax may not be payable until the following year.
Finally, an investor can only use a realised capital loss against a capital gain; otherwise such losses are carried forward.
3. 'Wash sales'
Investors must be careful not to undertake "wash sale" arrangements under which they bring forward a capital loss by selling a listed security and then immediately repurchasing the same, or substantially the same, asset. Under this arrangement there is effectively no change in the economic exposure of the owner to the asset.
The Australian Taxation Office (ATO) seeks to apply tax-avoidance rules to "wash sale" arrangements and will deny the capital loss (or trading loss) to the investor. There are only limited circumstances in which such arrangements will be acceptable. For example, it may be possible for an investor to dispose of shares in one company and purchase shares in a competitor company that carries on a similar business, without attracting the ire of the ATO.
4. Dividends and franking credits
Investors often seek to use the franking credits distributed by companies paying dividends. However, where a company has declared a franked dividend, an investor may not be able to use any of the franking credits associated with the dividend if they sell the share parcel on which the dividends are paid within 45 days of acquisition. Individuals may qualify for the small-shareholder exemption from this holding rule if their total franking credits are less than $5000 in a tax year, or if they acquired the shares before May 13, 1997.
5. Prepayment of expenses
For individuals not carrying on a business, the prepayment of expenditure for a period of up to 12 months may be deductible. This can include interest, internet fees, subscriptions to investment journals and other publications, seminars and training courses.
An investor who prepays interest is often induced to do so, on the basis of favourable lending terms, such as reduced interest rates or increased principal amounts. It is important to note that if prepayments are solely motivated by the tax advantages that can be obtained, tax-avoidance rules may apply.
6. Capital acquisitions
If you use a computer to maintain investment records relating to your investment or income-earning activities, the costs are potentially deductible. A capital acquisition used for income-producing activities costing more than $300 can be depreciated. Capital items costing less than $300 (such as calculators, printers or software) may be deductible in full when incurred by individual investors not also carrying on a business.
7. Trusts as investors
The information above focuses on an individual investor. Many of the tax principles mentioned also apply equally to trusts, but there are some key differences. There are different rules relating to prepayments, family trust election requirements for franked dividends, and distribution issues relating to capital gains and dividends (including streaming and ensuring eligibility for the 50 per cent CGT discount). Trustees of trusts must also conform with the trust deed, especially in any year-end income or capital distribution resolutions or determinations.
8. Other considerations
Although obtaining tax benefits or outcomes should never be the sole driver of an investment decision, they can be an important consideration. The above outline is not and exhaustive list of different tax issues that should be considered by individual investors before June 30.
Other tax matters for investors in listed securities include the deductibility of costs incurred in relation to capital-protected products, and the implications of company restructures including scrip-for-scrip rollovers, share buybacks and capital reductions.
Given the ever-growing and complex taxation landscape, it is wise to consult an accountant or tax professional for advice specific to your circumstances.
About the author
Ali Suleyman is Director, Tax Consulting, at Pitcher Partners.
ASX Online Shares Courses are a great way to access free education about share investing. There are 11 courses to complete online, each taking about 10 minutes on average. Topics include:
- What is a share?
- Why and how to invest
- Risks and benefits of shares
- What to consider in an investment
- How to buy and sell shares.
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