Capital gains tax on shares in Australia - explained
Disclaimer: The below article is for informational purposes only and does not constitute a product recommendation, or taxation or financial advice and should not be relied upon as such. Please consult with your financial adviser or accountant to obtain the correct advice for your situation.
In Australia, when investors sell shares and other listed securities for a price higher than they paid, the profit or capital gain may be subject to a capital gains tax. Capital gains taxes are common globally, but Australia’s implementation is considered one of the world’s most complex, and the nuance in this regulation can have significant implications at tax time. As a result, investors need to understand how their trading activity during the year will impact their capital gains position in their tax return at the end of the financial year.
The amount of tax an investor ultimately pays on their capital gains in Australia depends on a number of factors, which are discussed in this article. This includes whether they are holding shares as an investor or trading shares as business, how long they have owned the shares, their marginal tax rate, and whether they also made capital losses. Broadly, investors need to include all investment income in their tax return. Tax on investment income is set at the investor’s marginal tax rate. This includes what is earned in:
- managed funds distributions
- capital gains
Capital gains or losses on investments in Australia
If an investor sells an investment for more than the cost to acquire it, they have realised a capital gain. This will need to be reported in their annual income tax return. Although it's referred to as capital gains tax (CGT), this is actually part of the income tax regime and not a separate tax.
Because capital gains are added to assessable income and are taxed at the marginal income tax rate, this may increase the tax an investor needs to pay and reduce the net return from investing significantly. As tax is not withheld for capital gains like it is for PAYG employee income, it is a good idea for shareholders to work out how much is likely to be owed on an ongoing basis and set aside sufficient funds to cover this.
While investors need to include all capital gains in their tax return for the year they sell the shares, a discount applies for longer-term investments. Investments held for more than 12 months are only taxed on half of the capital gain. The is known as the capital gains tax (CGT) discount. Investors must also be mindful that capital gains can be offset against capital losses when calculating CGT, with investors sometimes adopting what is known as tax loss selling in order to net out their capital gains where practical.
An investor makes a capital loss on shares if they sell them for less than they paid for them. As noted above, it is important to be aware that a capital loss can be used to reduce the tax on a capital gain in the same income year. In some cases this loss can be carried forward to offset future capital gains.
For example, if an investor makes a capital loss in a financial year and doesn’t realise a capital gain, they can generally carry the capital loss forward and deduct it against any capital gains they make in future years. If an investor in shares makes a capital loss:
it can only be offset against capital gains
it can't be offset against income, including income from other sources
it can be carried forward to offset against future capital gains
it can't be converted to revenue losses in future years, even if you haven't been able to offset it against a capital gain.
CGT events affecting shares
Generally investors have to pay tax on any capital gain they make on shares or units when a CGT event occurs, most commonly when an investor chooses to sell shares they own. However, a CGT event is also triggered when the change of ownership of an investment is involuntary.
One example is when a company in which an investor holds shares is acquired by, or merges with another company. This may result in a capital gain or loss. A CGT event may also occur when an investor:
- switches units in a managed fund to another fund
- receives a distribution (other than a dividend) from a unit trust or managed fund
- receives non-assessable payments from a company
- owns shares in a company that has been placed in liquidation or administration.
Calculating the cost base of investments for CGT in Australia
When selling part of a shareholding, where investors have bought multiple parcels over time at different prices, several factors need to be considered. Investors will need to be able to identify and nominate exactly when the shares of the holding they’ve sold were purchased to determine the cost base because this will affect the realised capital gain or loss and any CGT discount that applies. The cost base of a CGT asset is generally the cost when bought by the investor, plus certain other costs associated with acquiring, holding and disposing of the asset.
Where an investor can not identify when a bundle of shares were purchased, the ATO allows for a "first in, first out" (FIFO) method and average cost method in certain circumstances.
Cost base using the FIFO method
Using the FIFO method means the sale of stock will be allocated to the shares the investor bought earliest.
Example of FIFO method
Paul bought 1,000 shares in ABC Ltd on 15 September 2012. He then acquired another 3,000 shares in the company on 17 July 2015. In December 2015, ABC Ltd issued Boris with a CHESS statement for his 4,000 shares.
Paul then sold 1,500 of the shares on 27 January 2020 but wasn't sure whether they were the shares he bought in 2012 or whether they included the shares bought in 2015. Because he could not identify the particular shares he sold, he decided to use the FIFO method and nominated the 1,500 shares sold be made up for 1,000 shares bought in 2012 plus 500 of the shares bought in 2015. Paul would also be expected to keep a record of the composition of his remaining shares in future.
Cost base using the average cost method
The Australian Tax Office will also accept an average cost method to determine the cost of the shares disposed of if:
the shares are in the same company
the shares were acquired on the same day
the shares have identical rights and obligations
investors are not required to use market value for cost base purposes.
ATO methods to calculate capital gains
There are potentially three methods by which Australian investors can calculate their capital gains tax. It helps to be organised and have an exact record of when each shareholding was bought or sold. Here’s how the three methods may be applied.
CGT discount method
Generally, investors adopt the CGT discount method for investments held for more than 12 months, and the other methods for investments held for less than 12 months. Individual investors can get a 50% discount on their capital gains - once capital losses have been added - if they owned their shareholdings for more than 12 months before selling them.
This method is available to investors if the shares were acquired before 21 September 1999 and they have owned them for 12 months or more before a CGT event. The indexation factor is worked out using the consumer price index (CPI) as a multiplier to account for inflation. This may be an option for investors who are carrying forward any capital losses for assets held before September 1999.
The ‘other’ method is the simplest of the three methods for calculating a capital gain. This method is applied if investors have held shares for less than 12 months before the CGT event. This method is applied by subtracting the cost base from the capital proceeds, with the remainder being the capital gain (or loss).
Shareholding as investor or share trading as business?
The tax treatment of shares depends on whether the holder is considered to be an investor or carrying on a business as a share trader. The ATO defines a shareholder as a person who holds shares for the purpose of earning income. For a shareholder:
- the purchase of shares cannot be offset against current year income, but is a capital cost
- receipts from the sale of shares is not assessable income. However, any capital gain on the shares is subject to capital gains tax
- a net capital loss from the sale of shares can't be offset against income from other sources, but can be offset against another capital gain or carried forward
- the transaction costs of buying or selling shares is not an allowable deduction against income, but are taken into account in determining the amount of any capital gain.
On the other hand, a share trader is defined by the ATO as a person who carries out business activities for the purpose of earning income from buying and selling shares. For a share trader:
receipts from the sale of shares constitute assessable income
purchased shares are regarded as trading stock
costs incurred in buying or selling shares – including the cost of the shares – are an allowable deduction in the year in which they are incurred.
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