Tax from owning shares

As shares are a form of capital gains and income, there are tax implications when both owning and disposing of shares. This includes when receiving dividends.

When you own shares, there are tax implications from the following:

Receiving dividends

You are required to declare all of your dividend income on your end of financial year tax return, even if you use your dividends to purchase more shares. This is called the dividend reinvestment scheme.

A dividend is assessable income throughout the year it was paid or credited to you. You will have access to something called a dividend statement, which shows the relevant dates of dividend payment.

Dividends are paid to the investor out of company profits which have already been subject to Australian company tax, which is currently 30% for large companies and 25% for small companies. The ATO recognised that it would be unfair if shareholders were taxed again on those same profits. Therefore, shareholders are now able to receive a rebate for the tax paid by the company on profits distributed as dividends.

The term “franked” is used to describe these dividends. A franking credit (also known as an imputation credit), which reflects the amount of tax the corporation has already paid, is added to franked dividends.

Any taxes the business has paid may be credited to the shareholder who received the dividend. The ATO will reimburse the difference if the shareholder’s top tax rate is less than 30% (or 25% if the paying company is a small corporation).

For instance, let’s say a tax-paying shareholder holds 1000 shares of Medibank Pty Ltd. Each share of Medibank Pty Ltd generates a profit of $10. It must pay 30% tax on the earnings, which is $3 per share, leaving $7 per share to be retained by the business or given out as dividends to shareholders. Medibank Pty Ltd decides to keep 50% of profits within the company and distribute the remaining $3.50 to shareholders as a fully franked dividend. The shareholders will receive a 30% imputation credit, which although not actually received by the shareholders, must be reported as income on their tax return. This can then potentially be reclaimed as a tax return. The taxpayer therefore receives $5000 taxable income from Medibank Pty Ltd, being $3,500 dividend income and $1500 franking credit.

Dividend reinvestment scheme

The dividend reinvestment scheme is when shareholders are given the opportunity to reinvest their dividends in additional shares of the business, instead of receiving cash payments. If the shareholders decide to reinvest their dividends, for tax purposes, the transaction is treated as though they had received the cash dividend and then used it to purchase more shares.

This means:

For example, let’s say Michelle owns 1,500 shares in a company. In December 2022, the business declared a dividend of 50 cents per share. Michelle was offered the choice of taking the dividend as a cash payment of $750 (1,500 × 50 cents) or reinvesting the dividend to acquire 83 more shares at $8 per share ($750 ÷ $9). Michelle decided to utilise the dividend reinvestment plan and received 83 new shares on the 23rd of December 2022. Michelle must treat the transaction as though she received the dividend in cash and used it to buy more shares. This means she must declare the $750 dividend as assessable dividend income in her 2022–23 income tax return. For capital gains tax purposes, she acquired the 83 new shares for $750 on the 23rd of December 2022.

Bonus share scheme

Bonus shares are extra shares a shareholder receives in exchange for their current holding of stock in a corporation. If you decide to sell bonus shares that were received on or after the 20th of September 1985, you make a capital gain. Therefore, you are required to pay tax on that gain as it is a form of taxable income.

The paid-up value of bonus shares is no longer typically deductible as a dividend due to changes in tax and corporate legislation. You may have the option between receiving a cash dividend and receiving shares via a dividend reinvestment plan; this rule is an exception. The value of these shares is treated as a dividend, and it is added to your taxable income.

Selling shares

As mentioned, there are also tax implications when selling shares. When selling shares, investors are subject to capital gains tax at their marginal tax rate.

If you’ve owned the investment for more than a year, you can get a 50% reduction on capital gains. For instance, if you sold shares you had held for more than a year and generated a capital gain of $10,000, you would only be taxed on a capital gain of $5,000 rather than $10,000.

Sometimes, this difference may be substantial. Let’s say that you sold the shares after 11 months and your marginal tax rate was 37%. The amount of tax you would owe is $3,700. Instead, if you sold the shares after a year, you would be responsible for $1,850 in taxes.

Due to capital gains being taxed at your marginal tax rate, investors with high marginal rates may be tempted to delay selling shares that have performed strongly if they anticipate their marginal tax rate will decrease in the future. However, this can also work negatively for the investor if the share price decreases over the extended period. The decisions are very situationally dependent and can vary from person to person.

Investments are not subject to capital gains tax until they are actually sold. Unrealised capital gains can therefore enable returns to compound more quickly. Long-term investors who maintain their investments for years or even decades profit from this. As a company’s earnings increase, it usually becomes more valuable. Earnings growth may compound at remarkable rates over time.