Chapter 1: The Australian tax system and shares
If you want to make money investing in shares itās essential that you have a general understanding of how the sharemarket operates and how your share transactions are taxed. In this chapter I cover the basics and guide you through the key taxation issues associated with investing in shares.
Investing in shares: back to basics
Under Australian corporations law a company is a separate legal entity. This means it has an independent existence and can carry on a business in its own name. Shareholders appoint company directors to manage and run the companyās day-to-day business activities on their behalf. Under Australian tax law a company must appoint a public officer within three months of commencing business for the purposes of complying with the Income Tax Assessment Act.
A company can be either listed or unlisted. A listed company is a public company thatās listed on the Australian Securities Exchange (ASX). Listed companies have the capacity to raise capital to fund their business operations through the issue of shares. It also gives shareholders the ability to quickly buy and sell their shares on the ASX (see chapter 3). Incidentally, when a company is floated on the ASX, you can buy the shares direct from the company. This is referred to as buying shares in the primary market. Youāll need to read the companyās prospectus and complete an offer application form to get these shares. Once the company is listed you can only buy shares in the secondary market (namely, on the ASX). In contrast, an unlisted company is one thatās not listed on the ASX, which means you may not be given the opportunity to invest in these companies.
The All Ordinaries index (comprising the top 500 companies listed on the ASX) and the S&P/ASX 200 index are the two key indices Australia uses to measure the market direction of companies listed on the ASX. The S&P/ASX 200 index (comprising more than 90 per cent of total market capitalisation) is also a major investment benchmark index thatās used to measure the performance of Australiaās leading managed funds such as share trusts (see chapter 4).
When you buy shares listed on the ASX youāll become a shareholder (or part owner) of a major public company (such as BHP Billiton or CBA). After you buy your shares the company will issue a āholding statementā setting out the number of shares you bought (see chapter 3). The shares you will normally buy and sell are ordinary shares. Ordinary shares give shareholders certain rights, such as:
ā¢ receiving a copy of the companyās annual report and vote at the annual general meeting
ā¢ receiving a distribution of company profits, referred to as dividends, plus franking credits if the dividends are franked. Under Australian tax law you will need to include both the dividend and franking credit as part of your assessable income, and you can claim a franking credit tax offset (see chapter 5)
ā¢ receiving a return of capital to shareholders. Under Australian tax law you will need to adjust the cost base and reduced cost base of the shares you own for capital gains tax (CGT) purposes. If the return of capital is more than the cost base the difference is treated as a capital gain (see chapter 6). Incidentally, the Tax Office has ruled moneys paid by a company to its shareholders as a capital return do not ordinarily constitute a dividend (see chapter 5)
ā¢ the ability to purchase additional shares direct from the company by participating in the companyās ādividend reinvestment planā and ārights issuesā. These shares are normally issued to shareholders at a discount and no brokerage or GST is payable (see chapter 5).
How the Australian tax system works
Under Australian tax law, tax is levied on your taxable income. The Australian taxation system uses the following formula to calculate taxable income.
Total assessable income - allowable deductions = taxable income.
At the end of the financial year ā which commences on 1 July and ends on 30 June ā Australian residents are required to disclose the taxable income they have derived from all sources, whether in or out of Australia. This means if you receive a foreign dividend youāll need to disclose the amount in your individual tax return (for more details see chapter 5). On the other hand, if youāre a non-resident of Australia, youāre only required to disclose taxable income that has an Australian source (for more details see appendix B).
For individuals, tax is levied on your taxable income on a progressive basis. This means the more income you earn the more tax youāre liable to pay. The amount of tax payable depends on your marginal rates of tax (which can vary between 0 per cent and 45 per cent). If you are an Australian resident the tax payable is reduced by any domestic tax offsets or credits you may be entitled to claim (for instance, dividend franking credits). Incidentally, if you derive a foreign dividend and tax was withheld from the payment you can claim a foreign tax credit (see chapter 5). You may also be liable to pay a Medicare levy if your taxable income is above a statutory amount. The Medicare levy is 1.5 per cent of your taxable income. On the other hand, a company pays a flat 30 per cent rate of tax on the taxable income it derives and no Medicare levy will apply. (At the time of writing, the Federal Labor Government has proposed to reduce the company tax rate to 29 per cent in the 2013ā14 financial year and to 28 per cent in the 2014ā15 financial year.)
At a glance: how youāre taxed
This is how the Australian tax system works:
ā¢ Resident individuals pay tax on a progressive basis at their marginal rates of tax; the first $6000 you earn is tax-free.
ā¢ Capital gains are liable to tax at your marginal rates of tax, but you can claim a 50 per cent CGT discount if you hold CGT assets (for instance, shares) for more than 12 months.
ā¢ Australian residents are liable to pay a 1.5 per cent Medicare levy.
ā¢ Australian residents can claim certain tax offsets (for instance, dividend franking credits and a low income tax offset).
ā¢ Companies pay a flat 30 per cent rate of tax on the entire amount of taxable income they derive (see chapter 4).
ā¢ A partnership is not liable to pay tax; all income and losses must be distributed to the individual partners (see chapter 4).
ā¢ A trust does not pay tax; all income is assessed to either the trustee or beneficiaries (see chapter 4).
ā¢ Complying superannuation funds pay a flat 15 per cent rate of tax; but the rate is 45 per cent if the fund is a non-complying superannuation fund (see chapter 4).
Coming to terms with self-assessment
Australiaās tax system operates on a self-assessment basis. Under self-assessment, when you lodge your annual tax return for individuals the Australian Taxation Office (ATO) will ordinarily accept its contents as being true and correct. Apart from correcting any noticeable errors or omissions no further action is taken. Shortly after you lodge your tax return the Tax Office will issue a notice of as...