Tax may be one of life's two certainties, but some tips from George Liondis can help ease your pain.
A BOOMING Australian sharemarket is hardly a problem, but it is creating a few headaches for investors.
Many are wondering how to take sharemarket profits without triggering a crippling capital gains tax liability.
Here are six ways to minimise the profits that have to go to the tax office:
1. HARVEST LOSSES
Losing money on shares is never good news, but there is a silver lining – the fact that capital losses can be used to offset capital gains.
So, a $20,000 profit made by selling shares can be reduced by offloading loss-making stocks. If the loss is $5000, that leaves only $15,000 liable for capital gains tax.
The problem is that given the strength of the Australian sharemarket, loss-making shares will be hard to find this financial year.
"There have been very few stocks that have underperformed," says Pia Cooke, associate director at Macquarie Bank.
"In the S&P/ASX 200 Index, only a small number have fallen in the past 12 months. This strategy is not going to be easy this time around."
2. LIMIT TURNOVER
It's tempting when the market is rollicking along to buy and sell shares for quick profit.
But it's not always the smartest move when you include tax into the equation.
Stocks that are bought and sold within 12-months don't qualify for the 50 per cent capital gains discount.
That means investors pay CGT on the full-amount of their gain, rather than half if they owned the stock for a year.
Anne-Marie Esler, technical research manager at Centric Wealth, says investors who want to take profits should ideally be selling shares they have held longer-term.
"If people are in the sharemarket for the short term, that could be to their detriment," she says.
3. TAKE SCRIP
The takeover frenzy gripping the Australian sharemarket is good and bad news for investors.
The good is that even speculation of a likely takeover can send a stock through the roof.
The bad is that if a takeover succeeds, investors can be forced to sell and realise a capital gain, even if they don't want to.
In these situations, a "scrip for scrip" offer can be more tax effective than a cash bid. That's because shares are swapped for a stake in the acquiring company, which doesn't trigger CGT until you sell the new shares.
Scrip for scrip, or combined cash and scrip takeover bids, are common in Australia and are features of Wesfarmer's offer for Coles and Bank of Queensland's bid for Bendigo Bank.
But overseas buyers can be less willing to offer scrip – Mexican company Cemex's buyout of Australia's Rinker is cash-only.
Paul Zwi, head of equity strategy at Centric Wealth, says Australian investors are more likely to accept a takeover if there are no CGT consequences.
"The ability to offer shareholders some form of CGT relief can be a significant factor in how these acquisitions play out," Zwi says.
4. SUPER IDEA
You can't avoid CGT by making contributions to your super fund, but there are ways to use super to limit the CGT damage if you derive less than 10 per cent of your income from an employer, or you are retired and under age 65.
Esler says these two categories are lucky, because they get a tax deduction for making contributions to super. They still have to pay CGT when they sell shares. But if they put the proceeds into super, the CGT sting is eased by the tax deduction.
The same applies if shares aren't sold but transferred into a super fund "in specie"; again, CGT is triggered, but is offset by a tax deduction.
Once the money is in a super fund, earnings are subject to a generous 15 per cent tax rate. And after age 60, it can all be withdrawn tax-free.
5. BUYBACK OPTION
Seeking out off-market buybacks is one way to unload shares tax-effectively.
More and more Australian companies are offering them – BHP's recent $US2.5billion buyback was one of the biggest recent examples.
Off-market buybacks have a double-barrelled tax benefit. First, the company offers to buy shares for a discount of up to 14 per cent to their price on market. That way, investors can book a capital loss. Then, the company supplements the offer price with franked dividends to make up for the discount. So, as well as the dividend, investors get franking credits to reduce their tax bill.
"Generally, a feature of these buybacks is that they offer the opportunity to crystallise a capital loss, while also giving a large franking credit and that can be very tax effective," Zwi says.
But there is a catch: they tend to work only for investors in lower tax brackets, or through structures such as super funds which pay less tax. That's because the benefit from franking credits is much higher for those in the lower tax brackets.
In the BHP case, an analysis by Maquarie Equities showed the buyback was only worthwhile for investors in the 16.5per cent marginal tax bracket or less.
6. WARRANT CONSIDERATION
For investors comfortable playing the stock market with borrowed money, using instalment warrants is one way to extract money from a share position without incurring an immediate tax bill.
Instalment warrants are a type of financial instrument, where investors put up only a portion of the cost of buying shares and borrow the rest.
For the tax conscious, the key point is that shares can be converted into instalment warrants without triggering CGT.
So, $10,000 worth of Westpac Bank shares can be converted into $10,000 worth of instalment warrants covering Westpac Bank shares, without setting off a tax event.
But since instalment warrants are a geared instrument, there's no need to put up the full $10,000.
Instead, with a 50per cent gearing level, only $5000 would be needed to maintain the same exposure to Westpac Bank. Investors can then do whatever they want with the remaining $5000, including diversify into other shares.
Financial advisers call this the "cash extraction" strategy, for obvious reasons.
Of course, it's not a good plan if the reason for selling out of a stock is a belief that it will fall in value.
However, if the idea is to maintain exposure to existing shares, while freeing up money for other investment without triggering CGT, it's an approach to consider.
But remember that borrowing to invest always increases risk. And it can be costly too – you'll be charged between 8 and 13 per cent a year for an instalment warrant, depending on the level of gearing.
Things You Should Know Before Getting Into Bed With a Fund Manager
It's not only direct share investors who need to be wary of tax. Managed funds can have nasty tax consequences too.
Just like individuals, fund managers selling stocks trigger capital gains tax, which is passed on to investors.
The more a fund manager changes its stock selection, the bigger the tax liability. And the difference between high- and low-tax funds can be stark.
In the 2006 financial year, for example, Portfolio Partners' Elite Opportunities Shares Trust reported a solid 24.06 per cent return. But someone on the highest marginal tax rate would have received a mere 12 per cent after tax, an analysis by Morningstar indicates.
In comparison, the Goldman Sachs JBWere Australian Equities fund returned 20.46per cent – much less than Portfolio Partners. But its tax liability was negligible, so a high-rate taxpayer would have taken home 20.28 per cent.
Another important point for investors is timing. Managed funds pay income distributions – made up of realised capital gains and dividends – back to investors before the end of each financial year. So, investors who buy a managed fund now will get the distribution before June 30 and have to pay tax on it this financial year.
When you sell out of a managed fund, you pay tax on any capital gains, measured as the difference between the "unit price" of the fund when you bought in and the price when you sell. A fund's unit price reflects any unrealised capital gains – profits from shares the fund hasn't sold – and distributions not yet paid to investors.
Source: Sydney Morning Herald