Tax considerations

Investing in ASX shares can be a great way to earn additional income and build your net wealth over time. Shareholders can benefit from both dividends and, potentially, capital gains. Dividends are payments of company profits to shareholders. Capital gains represent an increase in the share price between the time a shareholder buys the shares and the time they sell them. 

Dividends and capital gains are a form of income, so investors must pay tax on these earnings. However, the tax treatment of dividends and capital gains differs, and this may become a factor in your investment decisions, depending on your overall investing strategy.

Taxes on share investments

Let's explore how the Australian Taxation Office (ATO) calculates taxes on shares.

How much tax you pay on your share investments each year will depend on several factors. These include how much income you earned from shares, whether it was from dividends or capital gains, when you earned the income, and how much other income you earned. 

Assuming you are an individual earning a salary, the investment income earned each financial year will count towards your assessable income. Your assessable income is your gross, or total, income from all sources before allowable deductions. Assessable income includes both dividends and net capital gains. 

Your taxable income is the total of your assessable income less allowable deductions. Allowable deductions are expenses you incur in producing assessable income. For example, as an investor, you may subscribe to a news service to keep up to date on financial markets. The cost of that subscription would be an allowable deduction. 

Know your marginal tax rate

The tax treatment of capital gains and dividends differs, as outlined below, but to the extent investment income contributes to taxable income, it will be taxed at your marginal tax rate. 

Marginal tax rates for individual Australian residents in the 2023-24 financial year are:¹

The above rates do not include the Medicare levy of 2%.

How much tax will I pay on my dividends?

Dividends are the payment of profits by a company to its shareholders. Dividends can be franked or unfranked. Franked dividends are profits the company has already paid tax at the Australian company tax rate of 30% before distributing dividends. Because tax has already been paid, the shareholder can claim a credit when calculating their tax liability. This is called a 'franking credit'. 

Franking credits reduce the tax payable by the shareholder on the dividend. Unfranked dividends are dividends paid by an Australian company on which no company tax has been paid. This means there are no franking credits to offset the tax payable on the dividend by the shareholder. 

Franking credits in action

Assume you own shares that pay a fully franked dividend of $700. Your dividend statement shows there is an associated franking credit of $300. This means the dividend would have been $1,000 (the 'grossed up' dividend) before company tax was deducted. 

At tax time, you will need to declare the $1,000 as part of your taxable income. If your marginal tax rate is 32.5%, you will be taxed $325 for the dividend. But because the company has already paid $300 in tax, you only need to pay an extra $25 individually. If your marginal tax rate is 45%, you are liable for $450 tax on the dividend. You will then need to pay an extra $150 in tax. 

Franking credits can result in tax refunds for those shareholders in lower marginal tax brackets. For example, if you received the $700 dividend above ($1,000 grossed up) and had a marginal tax rate of 19%, you would only be liable to pay $190 in tax. Because the company has already paid $300 in tax, you would get a tax refund on the difference, being $110. 

Franking credits can therefore be very useful to investors who rely on dividends to fund their lifestyle. Shareholders who reinvest their dividends to buy more shares and grow their wealth still need to pay tax on these dividends as if they were paid in cash. 

How much tax will I pay on my capital gains? 

Capital gains tax is levied at an investor's marginal tax rate. A discount of 50% can be applied to capital gains if you have owned the investment for more than 12 months.  

For example, if you made a $10,000 capital gain on the sale of shares you had held for more than a year, you would be taxed on a capital gain of $5,000 rather than $10,000. The difference can be significant. Suppose you had a marginal tax rate of 37% and sold the shares after 11 months. Your tax liability would be $3,700. If you, instead, sold the shares after 12 months, your tax liability would be $1,850. 

Because capital gains are taxed at your marginal tax rate, investors with high marginal rates may be tempted to delay selling shares that have performed strongly if they anticipate their marginal tax rate will decrease in the future.

What about capital losses?

Capital losses can also offset capital gains. Suppose an investor makes a capital gain on shares but has also made a capital loss (on the same or different shares or other investment asset sales like property). In that case, the investor can deduct the capital loss from the capital gain, with tax levied on the net gain. 

Capital losses can be carried forward to future financial years. If you make a capital loss but have no capital gains to offset them in a particular year, you can carry the capital loss forward and set it off against capital gains realised in future years. 

Capital gains tax is not payable until investments are actually sold. Therefore, unrealised capital gains can allow for faster compounding of returns. This benefits long-term investors, who hold their positions for years or even decades. Well-run companies tend to become more valuable as their earnings grow. Over time, growth in earnings can compound at impressive rates. 

Investors seeking capital gains often look to growth shares, which are companies expected to grow their profits faster than the general market. Companies that can do this over an extended period often see an increase in their share price, resulting in capital gains for investors.  

What tax will I pay on shares held in super?

Many investors hold shares within their superannuation funds. Superannuation is subject to a different taxation regime than that which applies to individuals. How much tax you pay on your superannuation will depend on your age and total superannuation amount. 

When you're working and making contributions to your superannuation, investment earnings are taxed at a maximum rate of 15%. Superannuation funds also benefit from a discount on capital gains if any assets sold have been held for longer than 12 months. Tax on these gains is effectively reduced to around 10%. 

The tax you pay on superannuation withdrawals will depend on whether you withdraw your superannuation as an income stream or lump sum. If you're aged 60 or older and withdraw money via a superannuation income stream, this income will generally be tax-free. If you withdraw a lump sum instead, you don't pay any tax when you start from a taxed super fund, but may pay tax if you withdraw from an untaxed super fund, such as a public sector fund.

Once you reach retirement age, you can maintain up to the transfer balance cap in the retirement phase, which will be tax-free. The transfer balance cap is currently $1.7 million. You can make transfers into the retirement phase as long as you remain below the transfer balance cap.

What if I'm not an Australian resident? 

Tax rates for non-Australian residents differ and depend on whether Australia has entered into a double tax agreement with the country where the foreign resident resides. Foreign residents do not benefit from the tax-free threshold available to Australian residents. 

Marginal tax rates for foreign residents in the 2023-24 financial year are:²

Foreign residents are also generally unable to claim franking credits on Australian shares. The franked amount of their dividends will not be subject to Australian income and withholding taxes, but any unfranked amount will be subject to withholding tax.

Foreign residents generally cannot use franked dividends to reduce the tax payable or get a refund on a franking credit.

Taxes on shares in Australia 

Investors should consider the taxes they will have to pay on their shares when making investment decisions, as they could impact overall returns. Dividend and capital gains taxes are calculated differently, so it is vital to understand this to work out your tax liabilities correctly. 

You should also be aware of your eligible deductions, being the costs associated with buying, selling, and owning shares. These may include management fees and the interest paid on borrowings you have used to invest in shares. 

While it is important to understand the tax you may be liable for on investments, each individual's situation is different. The advice in this article is general in nature and should not be relied upon to make personal investment decisions. You should always check with your professional tax or financial advisor for specific advice that takes into account your individual circumstances. 

Want to learn more about investing?

You've come to the right place!

This article is part of Motley Fool Australia's comprehensive Investing Education series, covering everything from budgeting and saving to basic investing concepts and how much money you'll need to start.

Packed with easy-to-understand and regularly updated information, our articles contain the answers to your most frequently asked questions about share market investing.

Motley Fool's Education series is tailored for beginner and experienced investors alike and also includes helpful tools and resources, an A-Z glossary of Investing Definitions, and guides to specific topics of interest, including retirement planning, gold and property investment.

• The previous article in this section dives into common investing mistakes
• Check out our article on investment strategies in the next education section