There are two things certain in life – taxes and Mariah Carey at Christmas. This Rask Investor Guide explains how tax works when you’re investing or trading shares. If you’re new to investing in shares, planning to day trade, or just need to brush up, keep reading.
What does taxable income mean?
Taxable income is all of the income (after deductions) people need to report to the Australian Taxation Office (ATO) each year.
The types of things that count as taxable income include salaries and wages, bank interest, sole trader profits, capital gains, investment property rent, and so on.
Aussie taxpayers can reduce their taxable income by making sure that they claim all the deductions relevant to them – work tools, work phone calls, car travel to different work locations, using the private jet for work flights, that type of thing.
There are different tax rates depending on how much you earn. The more taxable income someone earns, the more tax they’ll pay on the higher levels of earnings.
Top shares for dividends
Here is a list of some of the top shares for dividend income:
- Vanguard High Yield Australian Shares ETF (ASX: VHY)
- BetaShares Australia 200 ETF (ASX: A200)
- Washington H. Soul Pattinson & Co. Ltd (ASX: SOL)
- BHP Group Ltd (ASX: BHP)
- Commonwealth Bank of Australia (ASX: CBA)
- Wesfarmers Ltd (ASX: WES)
- Australian Foundation Investment Company (ASX: AFI)
- Argo Investments Ltd (ASX: ARG)
- Woolworths Ltd (ASX: WOW)
- National Australia Bank Ltd (ASX: NAB)
Click on the links embedded in the ASX ticker to go to their research page.
Do I pay tax on shares?
In short, yes, you will pay tax on shares if you made a profit (capital gain) or received dividend income. However, it isn’t a blanket approach, different types of share income attract different tax rules.
One type of taxable income is dividends from companies. There’s a reason the phrase “it pays dividends” exists!
Another type of income is capital gains. That’s when someone has bought a share and then sold it for more money than they purchased for (making a profit).
The third type of income is distributions. These are sort of like dividends, but don’t come from companies. They come from trusts like exchange-traded funds (ETFs).
There are other types of investment income that get reported in different parts of the tax return, such as foreign income.
The dividends, capital gains, distributions and all other types of taxable income are added together in one big total, and then the taxes are worked out on that total (we’ll get to the tax return part later).
There are some important things to know about both dividends and capital gains in Australia, which are designed to reduce the tax burden on individuals.
How are share dividends taxed?
Dividends from shares will be taxed and included as part of your ATO tax return. When companies pay a dividend to shareholders, like you and me, we are required to report that dividend to the ATO, and it then gets added to our taxable income.
The dividend is then taxed at the ‘effective tax rate of the taxpayer’, whether that’s 20%, 30%, or whatever rate it works out to be. You can use Australia’s best investing and finance calculators*, which are on the Rask site to calculate tax. (*As voted by us)
For example, if Jill had a high-paying job at a tech company and had an effective tax rate of 40%, then a $70 cash dividend paid would mean Jill owes $28 of tax.
However, there are these great tax credits called franking credits (check out our guide). Franking credits reduce the amount of tax owed by the shareholding individual, by refunding some of the tax paid by the company. This investor-friendly system is essentially only available in Australia. It ensures company profits aren’t double-taxed.
The company may have started with $100 of profit before tax and paid $30 of tax, then paid a $70 dividend with $30 of franking credits attached to Jill.
Jill’s taxable income would be $100 with franking credits attached (made up by $70 cash dividend plus the $30 franking credits). Easy enough, right?
So, with an effective tax rate of 40%, she would be charged $40 of tax, but the $30 of franking credits reduces her taxes owed down to just $10. How great is that for Jill?
Capital gains tax on shares
Are capital gains made on shares taxed? Yes, you pay tax when you make a profit on shares. For example, when someone buys low and sells higher, the net gain is added to their taxable income.
For example, if Jill bought $1,000 of shares (including brokerage) and 10 months later sold those shares for proceeds of $2,000 (after brokerage), she would make a gain of $1,000. That $1,000 net gain is then added to her taxable income for the year. At a 40% effective tax rate, that would mean $400 of extra tax for Jill.
CGT discount explained
The Australian taxation system is designed to reward longer-term thinking. Investing for the long-term can usually help create better investment returns (woohoo) and it helps with the tax situation when selling investments.
A capital gains discount is when investors sell an investment that has been held for at least 12 months. The net gain that’s reported on the tax return is halved.
For example, let’s say tech worker Jill had held onto the shares for 13 months rather than 10 months. Assuming she received the same proceeds from the sale – $2,000 – then the initial net gain would still be $1,000. But here she is eligible for the capital gains discount, so the gain that is added to her taxable income is reduced to $500. Isn’t that great?
If you’re dealing with much bigger gains, then the discount can save you a lot of tax. If Jill’s numbers were 100 times bigger, reducing the net gain by $500,000 would be extremely beneficial for her.
Capital losses on shares
Not every investment works out positively. We wish losses never happened. But sometimes investors may decide the best thing to do is to exit an investment at a loss.
What happens with the loss? Well, the investor has lost the money because their investment went down. But, in tax return terms, that loss can be used to offset capital gains. It can’t be used to offset other types of income though (like wages or interest).
For example, if Jill had made a capital loss of $250 in the previous year on a different investment, then she could use that to offset a bit of the gain she’d made. Taking $250 off the $1,000 net gain would reduce the gain down to $750 (without the capital gains discount).
CGT: when taxes are incurred
Everything we’ve looked at so far, is for after an investor has sold the investment. What about when an investment has gone up, but it hasn’t been sold?
There are a few different ways people talk about this. Ways of describing this could be ‘unrealised gains’, ‘paper profits’ or capital gains that haven’t been ‘crystallised’.
Thankfully, the Australian taxation system doesn’t tax unrealised gains. You’re only taxed when the investment is sold. That can be another advantage for long-term investing (in the right shares).
Tax on ETF investing
Behind the scenes, the entity structure of an ETF is that it’s a trust.
Trusts pay distributions to investors before tax has been paid. So, investors can receive the ETF distributions and then pay the appropriate tax at their marginal tax rate.
ETFs can pay several different types of income, including distributions, capital gains and (sometimes) foreign income. Each of these types of income is reported at a different part of the tax return.
However, ETF providers provide an annual tax statement that tells investors how much income has been received and where to report it on the tax return.
ATO pre-fill for shares
Have you heard of the ATO’s ‘pre-fill’ service? The ATO pre-fill service can help fill in your tax return if you’re a share investor but be very careful.
If you are doing the tax return yourself, there is a cool ATO tool called pre-fill which partially completes the tax return with financial information that the ATO has already received from health funds, banks, employers, government agencies, ASX shares that paid dividends, and ETFs.
This is super handy for completing a tax return.
However, taxpayers should check that the pre-fill info is correct. Plus, the ATO doesn’t know about some types of income including sole trader business profits, cryptocurrency and capital gains.
Lots of pre-fill information is available by late July, but it can take longer if a particular company or ETF hasn’t sent the ATO the details.
If investment pre-fill details are missing, taxpayers need to either enter that information themselves or wait until it’s available for pre-fill.
In the very rare event that the pre-fill information is wrong, the ATO says that you should contact the organisation that provided the information and make sure that the correct details are sent through to the ATO by the organisation.
Tax records share investors
Being organised with your tax records will help you when it comes to doing the tax return. Having a folder (or e-folder) makes it easier for you, could save your accountant time (and save you money!) and gives you the best chance of ensuring you can claim all the deductions you’re entitled to.
You need to think like you’re the Marie Kondo of tax records (even if they don’t spark joy). Make those records easy, organised and accessible for yourself.
What records do you need to keep? The simple answer is – everything that would count as taxable income plus everything that would be a possible deduction. There’s a huge list of possibilities – it depends on what you do for work, whether you have health insurance and so on.
When it comes to shares, there are a few obvious ones, like dividend statements from companies, distribution statements from ETFs, the purchase price for your investments and the sale price for investments sold (and how long you held the investment for).
Plus, it would be a good idea to note down any capital losses you can carry forward to the next tax year.
Do I need to do a tax return?
Most working-age adults do lodge a tax return and lots of people are required to by the ATO’s rules.
People that have had tax withheld need to do a tax return.
If you earn more than the tax-free threshold (currently $18,200) then you need to do a return.
Investors that have franking credits should lodge a return.
Foreign residents that have earned more than $1 in Australia need to do a return.
And so on.
Most people usually get pinged by one of the ATO’s requirements. The ATO has a useful tool for working out whether you need to do a return.
For Aussies, one of the certainties of life seems to be doing tax returns.
How to report taxes on shares
There are different sections on the tax return that you need to enter in the applicable numbers. For example, there will be section for dividends, franking credits, trust/ETF distributions, capital gains and foreign income.
Hopefully, the pre-fill tool can do all the work for you. Otherwise, you’ll need those statements to fill in the necessary bits. Don’t forget that you can always hire a tax accountant.
Do I need an accountant?
If your tax affairs are a bit complicated, or the capital gain explanation has flown over your head, it could be worthwhile thinking about getting an accountant to help to make sure the tax return is correct.
Capital gains discounts, capital losses and ETF distributions should be simple stuff for an accountant to deal with. An experienced accountant can put your mind at ease.
Accountants can also help when it comes to understanding what the tax effect would be if you sold an asset, or other scenarios. It’s best to know about those impacts before you make a decision.
If you’re talking about large amounts of money (such as hundreds of thousands of dollars), an accountant may be able to advise if an investment entity (like a company or trust) may be useful, depending on the timescale of your plans.
23 shares for 2023
Finally, if you’re worried about paying tax on shares – don’t be. It means you’ve made a profit. As the saying goes, ‘I’d much rather split a profit with the ATO, than take 100% of a loss’.
There are many reasons the sharemarket has been the best investment of all time. Keep going, it’s worth it. Here’s a list of some of the top shares of 2023 — as predicted by our team at the beginning of the year.