- Increases in share price from the time you purchase to the time you sell
- Dividends you receive while owning the shares
When you watch a movie about the share market, they are almost always talking about buying shares and selling them at a profit – buy low, sell high! Which is a great way to make fast money if you can accurately predict what the shares are likely to do – and therein lies the problem. There are so many variables that go into the value of shares that it is extremely difficult to predict what any given company’s shares will do. Additionally, because shares are a capital asset, you will also be subject to capital gains tax on the sale. As share increases in the short-term may not be significant, this additional tax can turn a potentially profitable sale into an unprofitable one once trading costs are accounted for. You can reduce your CGT burden by 50% if you keep the shares for more than a year, but this limits your capability to make quick sales on the back of favourable price changes. While CGT is separated from your other income insofar as capital gains and capital losses can only be used to offset one another, the amount of tax you pay once your total CGT obligation is determined is relative to the overall income tax bracket you are in. Basically, your capital gain – once capital losses are deducted – is added to your other income to determine your assessable income.
The other income stream from shares is dividend payments. Dividends are not compulsory, but the majority of profitable companies will distribute a portion of their capital back to investors. While share sales are taxed under CGT only at the point of sale, dividends are taxed as income in the year they are earned. As a result, the amount of tax you pay will be dependent on your income in the year you received the dividend.
As you can see, the different tax treatments of share sales and share dividends can be a factor in your strategy. For example, suppose you are currently have a high-income job but would like to retire early, you may look for companies that are more likely to retail capital and grow in size (and share value) rather than companies that are paying higher dividends. Why? Because additional dividends while you are in a high tax bracket will be heavily taxed, while capital gains once you are retired are more likely to attract lower tax expenses.
By Jennifer Lowe