Articles

This is a reply to a forum in http://www.aussiestockforums.com Please go there for more like this.

It was written by Steve (AKA  LAKEMAC) and we do not take any credit for this information, you will still have to do your own research and check with your accountant to verify all information. 

+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++

Ok lets do a basic tutorial on taxation as it applies to Australian residents

(Disclaimer: I am not a financial planner, nor lawyer, nor accountant but I have had extensive exposure to, study of and involvement in taxation issues, structures and tax planning for my own investments spanning 30 years. As always seek your own professional advice. The following is a guide only. Yada yada yada...).

1. There are two tax acts of importance - the "1936 Act" and the "1997 Act". The 1997 Act was an (abortive) attempt to rewrite the 1936 Act. Both acts are current and both have application to share trading.

2. The 1936 Act (mainly) deals with INCOME issues. The 1997 Act incorporates the CAPITAL Gains Tax (CGT) regime. However there are major overlaps between both, so be warned.

3. Some tax accounting basics:
3.1 CAPITAL represents your assets eg. shares, businesses, real estate, art, collectibles, rights to intellectual property etc.
3.2 INCOME is what you earn (or lose) in a particular financial year from ALL sources any where in the world (this also means that adobee's Cayman Island idea will not work - cf the ATO's Wickenby taskforce - they are investigating this very issue).

4. INCOME in any particular financial year may include the gain (or loss) from the sale of a CAPITAL item. The CAPITAL GAIN or CAPITAL LOSS gets converted into an amount of taxable INCOME in the year you sell the CAPITAL item (ie shares or real estate or any other item of value).

5. Note that it is only when you sell (sometimes called "realise") a captial item that it must be treated as an income item. See the various CGT "events" in the 1997 Act. If you hold a CAPITAL item under our (current) tax system you do not (usually) pay tax on the "unrealised" capital gain. Not selling is by far the best way to avoid CGT.

Now the next question is how do you calculate your INCOME for a particular financial year which may include CAPITAL gains and/or losses.
(Note this is very simplified - always seek a competent accountant or read the tax acts yourself if you have the skill/time/need )

1. Firstly work out if you are a trader or investor or speculator.
As it says in the law - this is a matter of fact not form.
The basic rules (see the ASX website for some excellent white papers on this) are these:
a. if you have a "system", trade regularly throughout the year then you are a trader. Your gains/losses are treated as INCOME not CAPITAL and you can deduct the cost of trading in that year. To work out your gain/loss you subtract your buy price + cost of purchase (eg brokerage) from your sell price less costs of sale. There is no CGT "discount" as you are not deemed to be making any CAPITAL gain - you are only making INCOME.
b. if you hold for more than 12 months (or more) and trade rarely then you are an investor. When you sell you are making a CAPITAL gain (or loss). You may be entitled to claim the CGT "discount" when you calculate your INCOME for the year by adding in the CAPITAL gain (or loss) to your other INCOME. Normally you can't deduct the costs of brokerage in your INCOME it must be taken as part of the CAPITAL cost (called the "cost base") and can only be claimed when you sell the CAPITAL item. Similary the costs of selling the item are only deductable at the time of sale.
c. speculators fall in between these two. Typically they buy IPO's (new listings). Grey area. Seek professional advice.

By the way the above applies to real estate too (not that many people "trade" real estate).

Since the thread is about CGT we must be "investors" typically holding shares for longer than 12 months and not "traders" buying and selling on a "regular" basis. Notice I say typically. You could sell in less than 12 months but the CGT discount (currently 50%) would not apply to that sale.

What is the CGT discount? It is a tax concession handed out by the previous Howard government. Basically it arose because the amount of tax collected by CGT was obscenly more than they had hoped for. To assuage the voters they changed the tax acts so that anyone holding CAPTIAL assets for more than 12 months would be given a discount on the amount of tax paid on CAPITAL gains.

The way it works is that when you calculate your taxable INCOME for a particular year you add together INCOME items (wages, dividends etc) then add any CAPITAL gain (or loss) (the full amount of gain at this point in the calculation) then deduct expenses to work out your taxable INCOME. It is at this point you deduct 50% of the capital gain from your taxable INCOME. (There are complex reasons why the calculation is done this way - see the 1997 Act).

Now the tax on your "taxable" INCOME is calculated. This is where tax planning comes into play. The trick to tax planning is ALWAYS put the plan into action BEFORE buying your assets. Doing it after the asset has risen in value doesn't work.

1. There are three basic entities that the tax acts deal with: individuals, trusts and companies.

2. As previously pointed out not all individuals are treated equally. And as also correctly pointed out the reason children's "unearnt income" is taxed at a higher rate is to stop parents splitting their income to their children so as to minimise their tax obligation. However there is a tax loophole for those paying Child Support where "unearnt income" can be taxed at normal tax rates.

3. CAPITAL gains earnt by trusts are split according to the trust's deed (which may include discretionary powers for the trustee to determine the split). The CAPITAL gains thus split are treated as being attributed to the beneficiary (which could be a person, company or another trust). Thus if you are a beneficiary of a trust that has made a CAPITAL gain an it distributes you some of that CAPITAL gain then you include it in your INCOME for that year. If the trust has held the item for more than 12 months the CGT discount also attaches to your portion of the gain (there are some complexities here to do with Family Trust Elections etc. Seek expert advice). If the trust does not distribute it is taxed at the top marginal rate.

4. Companies don't recieve the 50% CGT discount when they sell a CAPITAL asset they own however their top tax rate is 30%. So if you think about it the top marginal rate is currently 46.5% with the 50% CGT discount you pay tax on your gain at 23.25%. Thus companies end up paying an extra 6.75% tax on gains they make (compared to the top marginal rate). Why use a company at all? Best reason: as a beneficiary of a trust they only pay 30% tax on ALL income. You park unused income from a trust there. But be careful there are many traps (109XA and Div7A in the 1936 Act are particularly tricky).

So to minimise your CGT:

1. Cayman Islands is out - ATO will be onto you faster than a randy bull on heat.

2. Hold the asset for more than 12 months - preferably in a trust then split the CAPTIAL gain to the lowest taxed INDIVIDUAL and apply the 50% CGT discount. Unused income should go to a corporate beneificiary.

3. If you have Child Support obligations consider a Child Maintenance Trust as being an option.

4. Keep good records of all the costs to buy and hold the CAPITAL asset. This will form your "cost base" which is deducted at the time you sell the asset. Note there are some tax rules for long term retention of records. Your accountant can create a "asset register" which the ATO will consider to be evidence of your "cost base" without having to keep originals - personally I keep the originals in a good filing system with photocopy backups.

5. Sell assets that have lost value ie. a CAPITAL loss. You can offset the CAPITAL losses against other CAPITAL gains (in most circumstances - again seek professional advice). Note you can't offset a CAPITAL loss against INCOME. It must be like with like, however the class of capital loss/gain can be different ie. you can offset a share CAPITAL loss against a real estate CAPITAL gain.

6. Place/grow assets in self managed super funds (SMSF). Note super funds can now borrow (with some real complications - yeah you know: seek professional advice). Super funds pay no CGT when the member retires after the age of 60 (at the moment - it will go up over time). Personally I don't like super - too much government red tape. I tend to favor (and use) trusts and companies. (By the way you can have multiple SMSF if you want to separate different assets).