taxation on funds & shares

[wealthyjay]

Did a quick search and am still left with the question :confused:

I will be investing via index and mutual funds or similar. What are the potential tax implications arising from the dividends? Is there an appropriate way to structure such investments to minimise taxation ie avoid income tax rates?

Will structuring investments in this form produce a different result tax wise than directly investing in shares myself? Assume all assets are bought with cash, no loans involved.

I am of the basic understanding that a structure can be in place that the dividends are regarded as capital gains rather than income. I will readily admit my ignorance :p

I would just like a basic understanding to tide me over until I see an accountant in the near future. Being in the desert sucks sometimes :)

[Sim]

Wealthjay, I'm not aware of any such structure that allows you to consider dividends as capital gains. Personally I think dividends are better anyway, since you can offset them against other expenses. Capital gains can only be offset against capital losses.

About the only thing I could suggest is a discretionary trust - which would then allow you to direct income to a family member who was on a lower tax bracket than you, thus saving some tax.

Maybe someone else has some bright ideas that might help.

[wealthyjay]

Wealthjay, I'm not aware of any such structure that allows you to consider dividends as capital gains. Personally I think dividends are better anyway, since you can offset them against other expenses. Capital gains can only be offset against capital losses.

About the only thing I could suggest is a discretionary trust - which would then allow you to direct income to a family member who was on a lower tax bracket than you, thus saving some tax.

Maybe someone else has some bright ideas that might help.

Thanks for that Sim. i know that ownership of shares for greater than a year qualifies for a CGT discount, but am not sure in what context. Am just in the beginnings of getting a handle on the tax side of things while I am making plans. anyone else?

[austini]

Hi,

I'll have a go and maybe an accountant will pop in here later and clarify anything that's incorrect.

As far as I understand there is income and there is capital gains. Whether the dividends are from direct shares or distributed through a managed/index fund they are income and can't change their character to become capital gains.

Dividends that are fully franked (ie tax already paid at 30%) can be very tax effective in certain situations. For example, if you earn less than $58K (upper threshold for 30% tax bracket) you will pay no tax on fully franked dividends. Sim's suggestion of the use a disc trust is great as you can distribute the dividends to the lowest income earner. Fully franked dividends are also fantastic in reducing tax when the shares are held by a super fund. But if you are on the younger side you won't want to lock your money away till retirement.

A common trap for investors is not to compare the "after tax" return of their investment earnings. A lot of managed funds are very active traders and hence most of their profit is in the form of realised capital gains. Because quite often the shares weren't held longer than 12 months a tax payer on the highest tax rate will lose 48.5% of this in tax. Hence they are extremely tax inefficient. So it is really worth your while to make sure you understand this very well as from the investors point of view it is the "after tax" returns that count.

In relation to hidden managed fund costs and comparison of after tax returns the following may be useful:

www.vanguard.com.au/library/pdf/Understanding%20Costs.pdf

And on the tax side of things this publication will help you:

www.ato.gov.au/content/downloads/NAT2632-04.pdf

There are a few other very useful ATO publications which may be helpful. The above publication may direct you to further useful reading.

Finally don't restrict yourself to "unlisted" managed funds. You can buy shares directly in Listed Investment Companies. These are effectively managed fund listed on the ASX. However unlike most unlisted funds their costs are extremely low and many pay a fully franked dividend. A few of the more popular ones are (ARG) Argo Investments and (AFI) Aust Foundation Investments.

This publication is worth a read:

www.argoinvestments.com.au/report/ArgoOwnersManual_8_04.pdf

That should keep you busy and no doubt you probably wish I had never posted this message :rolleyes:

Cheers - Gordon

[Mry]

What are the potential tax implications arising from the dividends?

You add them to your income and up goes the tax bill! Of course if they are franked dividends (meaning company tax credits are attached to the payment), then your income also goes up by the imputation credit, and then you get a 100% rebate of that imputation credit. Its even refundable if you have more credits than tax payable!

Is there an appropriate way to structure such investments to minimise taxation ie avoid income tax rates?

I always think that if you are investing, a great structure is a discretionary trust so that you can throw income at low income spouses, children (you give them the max before 66% tax rates come in or if they are over 18 a whole lot), relatives, etc. This is just an idea.

If you have lots of cash and not many relations, and you don't mind not seeing the money for a LONG time, maybe self managed super funds are the way to go. Only the cash economy and the Cayman Islands can beat their tax rate.

Of course, if you are going to be borrowing a LOT of money to start investing, HDTs may come into play. It is best to discuss your situation with an accountant because structures really have to suit your personal situation and judge the level of risks that there may be. There are lots of options.

Will structuring investments in this form produce a different result tax wise than directly investing in shares myself? Assume all assets are bought with cash, no loans involved.

Structuring gives you the ability to distribute the income to someone on a lower income, protect the assets from creditors and provide for retirement. As I said earlier, a structure is really only useful if you have one that suits your situation. There are most assuredly tax benefits from structuring.

I am of the basic understanding that a structure can be in place that the dividends are regarded as capital gains rather than income. I will readily admit my ignorance :p

Yep, thats wrong. Sale of assets or distributions from trusts who have sold assets gives rise to capital gains, dividends are just cash distributions from companies.

[Andrew_A]

Wealthjay, I'm not aware of any such structure that allows you to consider dividends as capital gains. Personally I think dividends are better anyway, since you can offset them against other expenses. Capital gains can only be offset against capital losses.

About the only thing I could suggest is a discretionary trust - which would then allow you to direct income to a family member who was on a lower tax bracket than you, thus saving some tax.

Maybe someone else has some bright ideas that might help.Sim what expenses could you consider to offset a dividend?

Perhaps: Shares reading material? Courses? Software etc provided it had something to do with the market you are invested in?

[keithj]

I will be investing via index and mutual funds or similar. What are the potential tax implications arising from the dividends? Is there an appropriate way to structure such investments to minimise taxation ie avoid income tax rates?

Will structuring investments in this form produce a different result tax wise than directly investing in shares myself? Assume all assets are bought with cash, no loans involved.

I am of the basic understanding that a structure can be in place that the dividends are regarded as capital gains rather than income.
Could you be thinking of property funds or LPTs ? They sometimes convert income to capital gains.

LPTs don't pay dividends - they pay distributions. These distributions may be tax deferred - either fully or partly. This means that you don't count them as income and therefore pay no (or reduced) income tax. The downside is that you reduce your cost base by an equivalent amount, so when you sell you pay CGT on the profit (ie sale price less cost base). However, the upside is you'll probably get the 50% CGT dicount. And even better, if you (or your trust) never sell, you'll never pay tax:).

Seek advice from an accountant.

[Sim]

Sim what expenses could you consider to offset a dividend?

Perhaps: Shares reading material? Courses? Software etc provided it had something to do with the market you are invested in?

Interest on the loans (LOCs and/or margin loans) + other real estate holding expenses :D

[wealthyjay]

Thanks guys, that cleared up a lot for me. I hear a lot of misinformation floating around and its nice to hear some clear voices. I have a bit of reading to do :) But, its just one small step away from total ignorance.

A discretionary trust seems to be the way to go for much of this, so ong as I have a "poor" relation :) But, I will be speaking to an accountant shortly about these matters.

[Glebe]

Wealthjay,

Before speaking to your accountant, keeping reading and keep learning. Then you can really get value for money out of the accountant by asking curly questions, or questions more relevant to your needs.

[austini]

Glebe's comments are very worthy of note. Be very careful to choose your accountant carefully especially if you are considering using a Disc Trust. Prior to the accountant I have now I had a terrible time with accountants and lawyers. Finding a good one is not an easy task. However a quick search of this forum will steer you in the right direction based on a lot of peoplé's experiences.

I found it very wise as Glebe stated to do a lot of research prior to seeing an accountant as at least you will then have some chance of knowing if you are getting good advice. For that matter, in relation to trusts do a lot of reading here and you will probably know more about legal structures than most run of the mill accountants.

Cheers - Gordon

[wealthyjay]

Yeah, will keep reading and when the time comes I will be asking around for appropriate accountants. I do agree that education is the best cure for mistakes, we most of them anyway

[coastymike]

My understanding, and I would really appreciate feedback from Mry, Dale or Nick on this one, is that unless a family trust election is made then imputation credits from dividends from shares held in a trust are capped at $5,000.

Personally in these circumstances I don't mind making the FTE as the list of beneficiaries (although reduced) are the same beneficiaries that the clients wanted to distribute to in the first place.

I could be missing something here, and certainly hope I have, but I thought that when your clients have more than $5K in imputation credits then unless the FTE was made these would not be available for distribution. I must admit this is one aspect that has perplexed me for some time now.

[Mry]

My understanding, and I would really appreciate feedback from Mry, Dale or Nick on this one, is that unless a family trust election is made then imputation credits from dividends from shares held in a trust are capped at $5,000.

A taxpayer is only able to claim imputation credits if they have held the shares that paid the franked dividend for at least 45 days (90 days for pref shares). Since an individual receiving shares through a discretionary trust doesn't actually have a fixed interest in the trust, they are technically unable to satisfy this rule. They can avail themselves of the small shareholder exemption currently which allows them to avoid having to satisfy the holding period rule but they cannot claim more than $5,000 in imputation credits at present.

The only way around this is to make a family trust election. Unless necessary, accountants prefer not to do this as it limits your ability to distribute income and penalises you at 48.5% if it goes out of that group, and it is also irrevocable.

Thats the short explanation of the situation. There are a lot of other things to consider. You will need to speak to your accountant about if it is worth your while.