Chapter 10

Taxing Matters

IN THIS CHAPTER

Understanding how franking credits work

Sharing your capital gains with the tax office

Using tax strategies wisely

Shares generate income for their owners through the flow of dividends paid out of the company’s profits. Before you get too excited about this, remember that the Australian Taxation Office (ATO) takes its cut of this income, too. Not only are your dividend payments part of your assessable income, but the tax office also claims a cut of any money you make when you sell your shares. Because of this, shares play an important part in managing your tax affairs.

In this chapter, I explain the system of dividend imputation, which gives Australian investors a tax credit for tax paid by the company on its profit. I describe how you can use fully franked dividends for tax-effective investing, particularly in a self-managed superannuation fund (SMSF). I also cover how your capital gains on shares are taxed, and how you can manage capital gains tax (CGT) and try to offset losses against gains.

Benefiting from Dividend Imputation

Dividend imputation allows investors who’ve been paid a dividend to take a personal tax credit on the tax already paid by the company. The rebate, known as the franking credit or imputation credit, can be used by a shareholder to reduce their tax liability. In some cases — depending on the marginal tax rate — the franking credit can offset the individual’s total tax liability. In certain circumstances, excess franking credits (after the total tax liability has been extinguished) can be claimed as a refund.

For Australian resident investors, franking credits are the third element of total shareholder returns, after capital gains and dividends. Over the long term, franking credits add about 1.4 per cent to 1.5 per cent to the total return (capital gain plus dividends) from Australian shares.

For an investor with a SMSF that is in the ‘accumulation’ phase — that is, all members still contributing — dividend imputation is particularly important. First, because it can snuff out the tax liability on the fund, levied at 15 per cent. Properly balanced, a flow of imputation credits can offset the tax on contributions to the fund, which is a practical and legitimate form of tax planning. Second, once the fund moves into ‘pension phase’ — that is, begins paying a pension to all members — no tax is paid on the income or capital gains from the assets and any unused franking credits can be refunded fully in cash.

Franking credits made easy

Australian companies that are part of the 3,000 largest companies by employment (which effectively covers the stock market’s dividend-paying companies) pay corporate tax at the full rate of 30 per cent. When one of these companies pays tax, it builds up credits in its franking account. The company’s ability to frank its dividend depends on the credit balance in this account. With a surplus available in the franking account, the company may declare a fully franked dividend; if the credit balance isn’t large enough, a partially franked dividend may be paid.

Unfranked dividends are paid out of company profits that have not been subject to the full Australian corporate tax rate. Such dividends don’t have any franking credits associated with them, and are taxable at the shareholders’ marginal tax rate. When the company makes a loss, it pays no tax that year, and doesn’t receive any franking credits. The only way the company can pay a franked dividend the following year is if it has sufficient franking credits in its franking account from prior periods.

Legally, companies can pay franking credits only by attaching them to cash dividends, whether ordinary, special or the deemed dividend components in off-market share buybacks. Franking credits are of no value to companies — they are only valuable in the hands of shareholders. On average, about 90 per cent of credits are distributed. The Australia Institute notes that about $25 billion to $30 billion in franking credits is distributed each year, split equally three ways between households; superannuation funds, charities and trusts; and other companies.

In 2019, Australia’s top 200 companies paid out almost $80 billion in dividends, not including the benefits of franking credits. According to funds manager Janus Henderson, 40 per cent of that payout came from the banks. On the back of the COVID-19 pandemic’s economic impact, Janus Henderson expects Australian dividends to fall by between 33 per cent and 50 per cent in 2020.

In 2019, franking credits became a federal election issue, with the Australian Labor Party running on a policy to disallow tax refunds on franking credits for those on zero tax rates. Companies responded by significantly ramping up off-market share buybacks and special dividends to try to get their franking credits into their shareholders’ hands, given the uncertainty around tax policy. Due to the strong opposition to Labor’s proposal, and the party’s subsequent defeat in the 2019 election, tax refunds on franking credits look set to remain, into the near future at least.

In 2020, Australian companies held a stockpile of franking credits estimated at about $20 billion, which would be worth about $9.6 billion in shareholders’ hands. The stockpile arises because Australian companies generally pay out about two-thirds of profit as dividends, and the excess franking credits go into franking accounts. One way to distribute excess franking credits is to mount an off-market share buyback where part of the buyback price is identified as a deemed dividend (see the section ‘Biting on a buyback’, later in this chapter).

Fully franked dividends

Shareholders who receive fully franked dividends must add the imputation credit on the dividend to the amount of dividend in order to arrive at the taxable income represented by the dividend. This procedure is called grossing up the dividend.

With the company tax rate at 30 per cent, dividends are grossed up by $30 for each $70 of dividends received. This means that Australian companies that pay tax at the 30 per cent company tax rate have $428.57 of attached franking credits for every $1,000 of fully franked dividends they pay out.

As a shareholder, you have to include the grossed-up dividend amount in your assessable income. You receive a tax credit of $30 for each $100 of grossed-up franked dividend included in your assessable income.

After the tax liability on the grossed-up amount is worked out, the imputation credit is subtracted from the tax liability, to give the actual tax payable. Table 10-1 shows the situation where an investor on the current top marginal tax rate of 45 per cent (plus the 2 per cent Medicare levy) invests $10,000 in shares and receives fully franked dividends of $700.

TABLE 10-1 Tax Liability ($700 Dividend Fully Franked)

Investment	$10,000
Fully franked dividend income	$700
Gross yield	7%
Imputation credit $700 × 30/70	$300
Included in taxable income	$1,000
Tax payable at 47%	$470
Less imputation credit	$300
Tax payable	$170
After-tax income	$530
After-tax equivalent yield	5.30%

The franking credit reduces the investor’s tax liability on the cash amount of dividend received from 47 per cent to 24.28 per cent ($170 of the $700 received). At the same time, the 7 per cent dividend yield becomes the equivalent of an after-tax yield of 5.30 per cent. If the income came from fixed interest or rent, the 7 per cent yield after tax would reduce to 3.71 per cent.

Partially franked dividends

Depending on its franking account, a company may declare a partially franked dividend or an unfranked dividend. An unfranked dividend carries no tax credit and is simply added to the investor’s assessable income. A partially franked dividend carries a partial imputation credit. To calculate the tax payable, the franked portion is grossed up by the proportion of tax paid. In the example shown in Table 10-2, it’s again assumed that the marginal tax rate is 45 per cent, plus the Medicare levy (2 per cent), and the dividend received is $700. This time, however, it’s 80 per cent franked.

As shown in Table 10-2, the franking credit reduces the investor’s tax liability on the cash amount of dividend received from 47 per cent to 28.8 per cent ($201.80 of the $700 received). At the same time, the 7 per cent dividend yield becomes the equivalent of an after-tax yield of 4.98 per cent.

TABLE 10-2 Tax Liability ($700 Dividend Partially Franked)

Investment	$10,000
Dividend income	$700
Franked income = 80% of $700	$560
Gross yield	7%
Imputation credit $560 × 30/70	$240
Included in taxable income	$940
Tax payable at 47%	$441.80
Less imputation credit of	$240
Tax payable	$201.80
After-tax income	$498.20
After-tax equivalent yield	4.98%

Franking credit refund

Taxpayers (including superannuation funds) can claim cash rebates on any excess franking credits. Excess franking credits arise when the shareholder’s marginal tax rate is lower than the corporate tax rate of 30 per cent.

For investors on a marginal tax rate higher than 30 per cent, imputation credits reduce the tax liability on the dividend. For those on a marginal tax rate of less than 30 per cent, excess imputation credits may be offset against tax payable on other income in the year of receipt, or be claimed as a cash rebate if no other tax is payable.

Investors on the 15 per cent tax rate (for example, a SMSF in the ‘accumulation’ phase) actually get a tax refund of $215 for every $1,000 of fully franked dividends they receive, because this amount is not needed to offset tax on the dividends. For such investors, a dollar of fully franked dividend income is effectively worth more than a dollar.

Even better is when a SMSF moves to ‘pension’ phase; that is, you can choose to have your fund pay you a pension. In this case, the assets are held in the fund’s ‘pension account’, which means they’re being used solely for the purpose of paying out a pension. In this case, no tax is payable on the income or capital gains from the assets, and the franked dividends can actually be refunded fully by the ATO.

Table 10-3 shows the effect of the franking credit rebate on the tax status of individuals on the four individual marginal tax rates above the tax-free threshold. (Not included in the table is the 15 per cent rate paid by a SMSF in ‘accumulation’ phase; once the fund moves to ‘pension phase’, its tax rate is zero.) The workings ignore the Medicare levy of 2 per cent.

TABLE 10-3 The Benefits of Dividend Imputation^*

	Nil taxpayer	19% taxpayer	32.5% taxpayer	37% taxpayer	45% taxpayer
Dividend	$1,000	$1,000	$1,000	$1,000	$1,000
Grossed-up dividend	$1,429	$1,429	$1,429	$1,429	$1,429
Gross tax payable	Nil	$271	$464	$529	$643
Franking credit rebate	$429	$429	$429	$429	$429
Tax payable	$429 refund	$158 refund	$35	$100	$214

* Amounts rounded

 

Coalition government policy at the time of writing is that from 2024–25 only three personal tax rates will apply above the tax-free earning threshold — 19 per cent, for people earning up to $45,000; 30 per cent, for people earning between $45,001 and $200,000; and 45 per cent, for people earning over $200,000.

Obeying the 45-day rule

Shareholders who receive more than $5,000 worth of franking credits in a tax year must own each stock in their portfolio for more than 45 days (not counting the day of purchase or sale) before being entitled to a franking tax offset from dividends paid or credited on the shares. For preference shares, the holding period is 90 days. The rule was introduced to prevent tax-driven investors from trading shares merely to gain the imputation credits on fully franked dividends, and so lower their tax liability. (In fact, because the days of purchase and sale aren’t counted, the rule could more accurately be called the 47-day rule.)

Watching Your Capital Gains

As part of the tax system, Australia has a capital gains tax (CGT), which taxes the gains made on the sale (or disposal) of shares (and other assets), at the individual’s marginal tax rate; although you may get a tax discount depending on how long you’ve held the shares. CGT isn’t payable on shares bought before 20 September 1985, but if you’ve bought any shares since then and sold them for a gain, that gain will be taxed.

Calculating your liability

You’re liable for CGT if your capital gains exceed your capital losses in any income year. When filling out your annual tax return, you add up your capital gains and capital losses. Your net capital gains (capital gains minus capital losses) figure is added to your taxable income, and taxed at your marginal tax rate.

If you have a net capital loss figure, you can carry the amount forward to help offset future capital gains, but your loss can’t be used to offset any other income received for that year. Capital losses can be offset only against capital gains, but can be carried forward indefinitely until fully used up by being offset against future capital gains. Nobody likes to sell a share for a loss, but reducing the tax office’s take of your capital gains helps to lessen the pain of buying dud shares.

Reducing the tax office’s take

If you hold shares for at least 12 months, you pay CGT on only half of the profit made, which makes receiving a capital gain much more attractive than receiving income. For shares bought and sold within a year, CGT is levied on the entire capital gain at the individual’s marginal tax rate.

Say you’re on the top marginal tax rate of 45 per cent, plus the Medicare levy of 2 per cent; for the 2020–21 tax year, this rate cuts in at $180,001 of income plus taxable gains. Say you also achieve a capital gain of $50,000 on an asset you’ve owned for a year and a day. This means you’re eligible for the CGT discount. Your gain is halved to $25,000, and the tax rate of 47 per cent is applied, meaning that CGT payable on the gain is $11,750. On the $50,000 capital gain, the tax incurred is 23.5 per cent of the gain.

Although the Medicare levy itself isn’t halved, in effect the maximum CGT rate for assets held for at least a year is 23.5 per cent, which is half of the top marginal rate plus Medicare levy. But the discount doesn’t technically apply to the individual’s tax rate; it’s a discount on the gain taxed.

If you own shares that you bought between 20 September 1985 and 21 September 1999, you have a choice of methods to calculate your CGT liability. You can use inflation indexation (using the consumer price index or CPI) with indexation frozen at 30 September 1999. This way, you’re taxed only on the real, or after-inflation, capital gain that you made. No corresponding inflation adjustment is available for losses. With the other method, you can elect to have half of your net capital gain taxed. You don’t get this concession, however, if you choose the indexation method.

You’re within your rights to use the method that gives the tax office the least. Given that asset price inflation was far more dominant in the 2000s than inflation, most people will find that they get a better result using the 50 per cent discount method.

A SMSF that is in ‘accumulation’ phase, in which its tax rate is 15 per cent, earns a one-third CGT discount if it holds an asset for more than 365 days. This means the gain made on the subsequent sale of the asset incurs CGT at 10 per cent, unless the asset has been transferred into the pension account of the fund, at which point the tax rate on income and capital gains from the asset becomes zero.

If you have different parcels of a shareholding that have been acquired at different times and for different prices, it’s necessary to keep track of these ‘tax lots’, since the capital gain or loss may be different for each. The shareholder can choose to their advantage; for example, selling a parcel with a capital loss to realise the loss immediately, or keeping particular parcels until they’ve been held for one year, to qualify for the discounted CGT rate. Some portfolio management software systems can help with this task. Most online brokers offer clients a tax monitoring tool that keeps track of ‘tax lots’.

As always, investors should think investment first, and tax considerations second. Shares can change in value very quickly, and with some shares waiting until your shareholding is a year old just to qualify for the CGT discount is pointless — because the ‘CG’ part may have disappeared by then! Having to pay CGT should be viewed as a good thing, because it means you’ve made a capital gain. That’s what sharemarket investing is all about.

Although you don’t have to be an accountant to benefit from the tax treatment of shares, talking to an accountant at least once a year helps. Chances are your accountant can help you keep more of your investment gain from the tax office — perfectly legally, of course.

Taxing Tactics

You can use your share portfolio to make strategic tax decisions. You can sell shares before the end of the tax year to crystallise a capital loss and take a tax liability on a capital gain made in the same year. But while tax can play a big part in your buying and selling decisions, it should never be the sole reason for buying or selling a share.

Tax-loss selling

Nobody likes making a capital loss on a share, but using it to soak up a capital gain that you’ve (hopefully) earned elsewhere in your portfolio is a perfect way to ease some of the pain. Rather than moaning about shares that have fallen in value, investors should look to use this situation to reduce the tax office’s take of their capital gains.

If you have a $10,000 loss on a stock that has gone down and a $10,000 profit on a stock that has risen, and you sell both, you’re square with the ATO. Tax-loss selling is common in June, towards the end of the tax year, when people are looking to crystallise capital losses to offset against gains. You can make good use of the fact that your shares have fallen in value.

When using a capital loss to offset a capital gain, a good idea is to use it to offset a capital gain on a stock that you’ve held for less than 12 months — where you pay CGT at the full rate — rather than the discounted CGT. That way, you get the full value of the loss offset.

You can always buy a stock back if you really want to hold it for the long term. Selling the stock gives rise to a handy tax loss that can be offset against a capital gain on another share. If you buy it back at a lower price, you’ve lowered the average buying price of your long-term holding.

You can’t buy back a stock you’ve sold too quickly. People used to sell on a Monday and buyback on the Tuesday; as long as two separate trades were registered, they had crystallised a tax loss. But this was red-carded by the ATO in 2008. It said that if it considered this kind of wash sale (sale and purchase within a short period of time) as being done to obtain a tax benefit, it would deny the loss.

You’re allowed to change your mind and buy back into a stock, but to avoid an ATO rejection of your capital loss you may need to show that the sale has another purpose, such as restructuring your portfolio, or that the repurchase has been made because the market has changed, or on the basis of new research. If in doubt, consult your accountant.

Another possible strategy is to sell capital loss-making shares to a SMSF or a discretionary master trust that handles direct shareholdings. This is an in specie transfer where you as an individual are deemed to have disposed of the shares for a capital loss, which you can use in your tax return for this year. The shares then become the property of the super fund or master trust, at the price on the day. Shares can also be transferred in this way to a company, or into a spouse’s name.

Using a delisted dog

Generally speaking, shares make a remarkably successful investment asset, but occasionally companies go bust, as shareholders in the likes of high-profile collapses such as ABC Learning Centres, Dick Smith Holdings, RCR Tomlinson and Virgin Australia know only too well. It happens occasionally. Nobody wants to see a share they buy end up in the company graveyard with these stocks, but some benefit can be extracted from the disaster if the capital loss is claimed.

The firm handling the burial of your unbeloved ‘dog’ — its administrator, receiver or liquidator — has to ascertain how much the company’s secured and unsecured creditors are claiming before it declares the shares worthless, allowing you to claim the capital loss. Unfortunately, this can take years.

The problem is that if the company has collapsed, its shares will be suspended, and you have no way to sell them in order to gain the capital loss. Normally a capital loss (or a capital gain) for tax purposes only occurs after a CGT event. Common CGT events include the sale of shares or units, distribution of a capital gain by a managed fund, declaration by an administrator or liquidator that they have reasonable grounds to believe shareholders are not going to receive any further distribution, or the creation of a trust over a CGT asset and deregistration of a company.

The creation of a trust has been used extensively (since an ATO Determination in 2004) to facilitate the crystallisation of losses in companies suspended from ASX quotation and in administration. As shares can no longer be sold on the market, shareholders may enter into an agreement to dispose of their shares and create a trust over those shares until the transfer of ownership can be registered. This is the only way to achieve effective change of ownership pending the subsequent registration of an accompanying transfer when and if the company emerges from administration. These transactions have to be at ‘arm’s length’ and should be executed professionally to satisfy taxation and other requirements.

The creation of a trust doesn’t help with companies in liquidation but it does with those suspended from quotation and in administration, which covers most of them.

A helpful service is provided by the website www.delisted.com.au, which tracks what’s going on with the hundreds of companies trapped in administration, receivership or liquidation limbo. Many of these companies eventually return to the stock exchange lists as ‘shell’ companies, through a ‘backdoor’ listing. The website keeps in touch with the administrators and posts any news on delisted stocks so that shareholders know whether a recovery is possible — or, at least, the latest developments during an administration.

This website also operates a service whereby it buys worthless shares — in companies that have collapsed, entered administration, have been suspended for many years — through a mechanism whereby shareholders essentially transfer their stocks into a trust, meaning that it acquires the stocks pending the registration of the transfer, which satisfies the ATO that the shareholders can claim a loss. This service comes at a cost, which works out to be about $151 per parcel of shares that delisted.com.au acquires, but in return, you may have a potential capital loss worth thousands to put to work in your tax return.

Biting on a buyback

Although they were prohibited until 1989 — and then heavily regulated until 1995 — share buybacks have become a common feature of the Australian sharemarket. In 2019, ASX-listed companies bought back more than $50 billion of their own shares.

Companies undertake share buybacks as part of their capital management strategy. They may want to improve earnings per share (EPS), return on equity (ROE) for shareholders or return on assets (ROA), or they may want to return surplus capital or franking credits to shareholders.

The company can either buy back its own shares on-market, or conduct an off-market buyback, inviting eligible shareholders to offer to sell their shares within a certain time frame, and usually at a discount to the current market price. The shares bought back are cancelled, reducing the number of shares the company has on issue.

When you sell shares into a buyback, you must work out the capital gain or capital loss on the sale of your shares to include in your tax return. You may also have to include in your tax return a dividend as part of the buyback — in an off-market buyback, part of the buyback price including a fully franked dividend is common. This is not an actual dividend, but a deemed dividend that is the difference between the capital component of the buyback price and the actual price. The ability to deem part of the price to be a dividend enables companies to distribute their excess franking credits to shareholders. In an on-market buyback, the proceeds are treated as a return of capital only.

The tax consequences of a share buyback depend on what kind of buyback it is. If you’re looking at an off-market buyback where part of the price is treated as a franked dividend at below the prevailing market price, the buyback may be unattractive to a retail shareholder on the highest marginal tax rate, but very attractive to lower taxpaying shareholders (for example, a superannuation fund) receiving a large distribution of franking credits, as well as a capital loss to use in offsetting capital gains.

The company may make special arrangements with the ATO to reduce the amount of tax that shareholders accepting its buyback offer will pay. The ATO often provides fact sheets on its website (www.ato.gov.au) that spell out the consequences for different taxpayers of buyback proposals in the market.

Borrowing a tax deduction

If you borrow to invest in shares or use an instalment warrant, the interest costs are tax-deductible because the borrowing is used to produce assessable income. If you negatively gear a share portfolio, meaning that you pay more in interest than you get back in dividends, you can also claim this difference against your other income. The loan product may also allow you to pre-pay interest before the end of the current tax (financial) year, no more than 12 months in advance, and claim the full amount as a tax deduction in the current financial year.

Keeping tax breaks in perspective

Your decision to buy or sell an investment should never be driven by tax considerations. Always use investment factors when you decide to trade shares and let any tax benefits come as a bonus. If you have some poorly performing stocks in your portfolio, and you’re convinced that they’re not going to recover in the near future, sell them to realise some capital losses to offset your capital gains. However, when you try to create losses by selling shares you don’t want to sell, you can encounter problems.

Buying and selling for tax advantages can be complicated. You can sell your shares at a loss and then buy them back afterwards. However, because you’re buying the shares again, at a lower price, you now have a lower cost-base for CGT purposes. You have deferred CGT, but any recovery in the share price is taxable when you eventually sell the shares. When you buy the shares again, you have to keep them for at least 12 months to be eligible for the CGT discount of only half your capital gain being taxed (which effectively halves your CGT rate).

Similarly, you don’t want to take a share loan or buy a structured product, such as an instalment warrant, just to get a tax deduction. The share portfolio you buy with the loan, or the shares your instalment warrant is based on, may fall in value. In these situations, you can lose money — perhaps more than you saved with the tax deduction the loan gave you.

Trading as a business

The ATO treats individuals who conduct a business of buying and selling shares differently from ordinary investors. If you meet certain criteria set by the tax law and the ATO’s guidance, you may be classified as a professional trader, and the profit you make from share trading will be treated as ordinary income, not capital gain. With this classification, you may be able to claim expenses, such as brokerage, as a tax deduction. You cannot declare yourself a trader — your level of activity dictates whether the ATO treats you as such.

To be a share trader means that you’re in the business of trading shares for gain. As such, you’re allowed to use all the provisions that relate to business, one of which is that your shares are treated as trading stock.

Traders are taxed on the income derived in the course of carrying out their business of trading in shares (dividends or profitable sales) and are allowed to offset any losses incurred in their share-trading business against any gains made in that business, any capital gains from other sources and indeed, any other income.

For traders, gains are not actually ‘capital’ gains because the trader isn’t assessed under the CGT regime. Any change booked in the value of a trader’s stock is either assessable as income or deductible as a loss. This means that unrealised losses may be claimed in a tax year, but gains don’t have to be brought to account until they’re realised.

For all other shareholders, capital gains incur CGT and the only losses that can be claimed are realised capital losses, which can be offset only against realised capital gains, in the same year or future years. Net sale value is minus brokerage paid. The cost of buying shares isn’t an allowable deduction and profit from sales isn’t assessable income.

Traders are allowed to value their closing stock at the lower cost — what the shares cost to buy — or net realisable value, which is the market price on the last day of the tax year (the financial year). Say that you own shares that cost you $100 when you bought them on the first day of the year, and the market value of the shares at year-end was $75. If you’re classified as a trader, you can write down the value of the holding to $75, and claim a loss of $25.

Assume that at the end of year two you still hold the shares, but their market value is $150. You make no stock adjustment at all, and the holding remains valued in your books at $75. The stock has doubled to $150, but you have no assessable gain. You don’t have to mark up the value, because you hold it at the lower of cost or net realisable value.

At the end of year three, you sell the shares for $125. You then have an assessable gain of $50, but on income, not capital. You incur tax on this income at your full marginal tax rate.

The introduction in 1999 of the 50 per cent CGT discount applying to assets held for more than 12 months took away much of the perceived advantage of professional trader status. When a trader sells shares, the profit is liable for income tax at up to 47 per cent, whereas for an ordinary investor on the top marginal tax rate, if the shares have been held for longer than 12 months, only half of the capital gain incurs CGT, meaning that the investor pays CGT effectively at a maximum rate of 23.5 per cent.

Potentially, investors using the CGT regime may fund share purchases through debt, gaining an interest deduction of 47 per cent, yet pay CGT at only 23.5 per cent on any gains — an extremely profitable arrangement! Whether being treated as a share trader is best for you depends on your marginal tax rate and your level of trading activity.

If you want to be classified as a trader, you have to meet various criteria set by tax law and interpreted by the ATO. No specific law on share traders exists, but the ATO publishes a fact sheet with guidelines based on previous court rulings (see www.ato.gov.au). The ATO website says that the following factors have been considered in previous court cases:

• Amount of capital employed
• Nature of the activities, particularly whether their purpose is making a profit
• Organisation in a businesslike manner, the keeping of books or records, and the use of a system
• Repetition and regularity of the activities
• Volume of the operations

The ATO needs to satisfy itself that you’re running a business dealing in shares. You have to show regular activity employing substantial capital. You should possess or have undertaken the following:

• A business plan (your trading strategy written down), with profit targets, budgets and records, and details of any software systems used
• A detailed trading history of profits and losses, dividend income, bonus issues and changes to capital structure (for example, splits, consolidations, share buybacks and capital returns)
• A financial year statement with opening and closing inventory
• Relevant educational courses and/or qualifications gained

A possible alternative to seeking trader status is to conduct your share trading activities through a SMSF. Your share profit within the fund is taxed at a maximum of 15 per cent, regardless of whether the profits are treated by the tax office as income or capital. The drawback in this case is that losses are quarantined within a superannuation fund and can’t be used to offset tax on your other income or capital gains.

Keeping a record

For CGT purposes, you need to maintain a share register. Often shares in the same company are purchased at different times. You must maintain separate records in order to calculate correctly the total CGT liability when the shares are eventually sold.

Sufficient records for tax purposes include:

• Brokerage charged on each transaction
• Company name
• Date of transaction
• Incidental expenses
• Number of shares or units bought or sold
• Price per share on buy or sell transactions
• Type of transaction (buy or sell)

You usually include as incidental expenses any expenditure the ATO allows as furthering your investment knowledge, such as the cost of financial books, and subscriptions to magazines and financial websites. Other items may include money spent travelling to annual general meetings of companies in which you own shares, or even visiting your companies’ factories and mines. However, this will depend on the facts of each case. Always check with your accountant or tax adviser about what to include in your record keeping. At worst, a taxpayer can use the system of private rulings to get an ATO determination on their particular circumstances — or circumstances they’re contemplating.