A survey of 2046 Australian adults by researcher Qualtrics commissioned by financial comparison website Canstar found that 40% of young Australians invested in the share market in 2020. Forty-four percent of respondents aged 26-40 and 42% aged 18-25 participated in the share market for the first time. Out of the total of these two age cohorts 58% directly invested in shares and 30% invested via a managed fund.
It is therefore timely that this column should be addressed to not only these younger first time investors but also the significant numbers of older investors and retirees who became first time investors seeking to switch out of term deposits and other low interest earning investments in the hope of generating higher returns from investing in shares and other equity investments.
Share investors from a tax point of view fall into two distinct categories namely:
1) investors inclined to hold their shares for the long term with a focus on generating wealth from growth in the market value of their investments, and
2) investors wanting to generate an income stream from the short term by attempting to buy shares when they are perceived to be undervalued and selling out and taking a profit when their shares have increased in value. This approach is known as share trading.
This month’s column will address how income tax impacts on share investors who fit into the first category and my March column, Part B will focus on the taxation of those investors that fit into the second category and are deemed to be share traders for tax purposes.
There are two different types of taxes that category 1 investors need to be aware of namely income tax and capital gains tax.
Income Tax
Income tax is levied on ordinary income which includes dividends and short-term capital gains on shares that are held for no more than one year. Due to space restrictions this month’s column will focus on dividend income only and capital gains will be covered in the March issue.
Dividends
Dividends are paid to investors usually half yearly out of a company’s after tax profits and are accompanied by a dividend or distribution statement setting out the amount per share, the gross payment, the franked amount, the unfranked amount and the franking credit.
In your tax return you are required to include at Item 11 Dividends, the unfranked amount, the franked amount and franking credit at labels S T and U. If you have not advised the company of your tax file number then the amount of tax withheld by the company from your dividend must also be reported at Item 11. You must also advise the company of your bank details so your dividend can be deposited directly into your bank account.
Some companies have a dividend reinvestment plan (DRP) which offers you the choice of reinvesting your dividend in additional shares. If you have advised the company of your intention to participate in the DRP your dividend notice will also include the price per share and the number of participating shares you have received.
The amount of taxable income included in your tax return is the same irrespective of whether you elect to receive cash or reinvest in additional shares.
Franking Credits
The franking credits disclosed on your dividend statement are included in your taxable income on your tax return because it represents the company tax already levied on your company at the standard rate of 30% .
In order to avoid double taxation of your dividend, your taxable dividend income is effectively adjusted back to the pre-company tax amount of your dividend which is then taxed to you at your personal tax rate. To avoid your share of the company’s net income being taxed firstly at the company rate and again at your personal tax rate your tax assessment will show a Franking Tax Offset equal to the amount of the franking credit which either reduces your tax payable or is refundable to you as part of your refund.
Regardless of whether your franking credit offset results in a full refund of the franking credits or a reduction in your tax payable your return on your shares investment is the total of the gross dividend received plus your refundable franking credits.
Example
Fred aged 30 and unemployed decided to withdraw money he had on term deposit earning a mere 1.5% before tax and used the cash to purchase 1000 shares in the ABC company on 1st July 2020 at a cost inclusive of brokerage of $18,640. On 30th September he received a fully franked interim dividend of $0.70 per share totaling $700 with franking credits of ($700/.7x .3) = $300. He also expects ABC will pay a final dividend of the same franked amount in March 2021.
Being unemployed Fred believes his taxable income for 2020/21 will be below the tax free threshold of $18,200 and therefor expects his franking credits will be fully refunded. Fred is curious to know how the expected annual rate of return on his share investment will compare with the 1.5% he was earning on his term deposit.
Fully franked dividend (700 x 2)/18640 = 7.51%
Refundable franking credits (300 x 2)/18640 = 3.22%
Grossed up annual return 10.73%
This is not the full story as we have not taken into account any movement in the price of the ABC shares which may result in an unrealized capital gain or loss.
The taxation of capital gains will be covered in Part B of this column in the March issue.
Disclaimer:
The content of this article is not intended to be used as professional advice and should not be used as such. Some aspects of this topic can be quite complex, so if you are a share investor or contemplating investing in shares you should consult a registered tax agent, a financial advisor or your broker.
Brian Spurrell FCPA CTA Director, Personalised Taxation & Accounting Services Pty Ltd. 0412 011 946
Email bspurrell@ptasaccountants.com.au,
Web www.ptasaccountants.com.au