It’s all very well to talk about buying overseas shares, but what about the tax issues? As one of our readers pointed out, two issues that may impact negatively on Australians investing in foreign shares are our dividend imputation system, and the foreign with-holding taxes on dividends and capital gains.
Let’s deal with the second issue first.
It’s true that when you receive dividends on an overseas share, your dividend is generally subject to a with-holding tax by the host country’s revenue office. In general that’s around 15% of the dividends, but it can be as much as 30%. Earn a $100 dividend from your shares in Walmart (WMT:NYSE) for instance, and the US Internal Revenue Service will clip $15 off that for themselves. Meanwhile here in Australia you are again taxed on everything you’ve earned – whether it’s from Australian shares or shares in companies based in the Czech Republic.
But in real life it’s not as dire as it sounds. There are investors all over the world investing in foreign companies, and most major economies have stgeloped international tax treaties to ensure that investors aren’t subject to double taxation. Australia has tax treaties with 43 of our major trading partners. The list is on the ATO’s website here:
ATO tax treaties
As you can see, the list covers most of the countries you’re likely to be investing in: the UK, the US, Japan, Hong Kong (under China) and Singapore. Even the BRIC countries are represented. Those countries we don’t have a tax treaty with generally withhold around 30% tax.
What this means is that you get credit for any tax already paid (or withheld) on overseas dividends when you put in your tax return. The end result, points out Mark Morris, senior tax counsel with CPA Australia, is that you pay no more tax on a dividend on an international share than you would on an Australian share.
Here’s an example that Morris put together:
Kevin Costello, an Australian resident on the highest tax bracket, holds shares in UK company Blair Enterprises Ltd. The amount of the dividend he receives on December 1 2007 is equivalent to A$100. Blair Enterprises Ltd remits A$15 of this amount to the UK Inland Revenue and pays the $85 balance to Kevin. When he prepares his income tax return, Kevin includes the entire ‘grossed up’ $100 dividend in his taxable income for the year ended 30 June 2008. However, he will be able to reduce his $46.50 tax liability on the dividend by his A$15 withholding tax credit, making the net amount of tax payable on the dividend A$31.50
If you have a DIY super fund, which is subject to a 15% tax, your tax payable on the overseas dividend is neutralised by the 15% already withheld from your dividend payout by the overseas revenue office. If you’re on the lowest tax rate you’ll need to pay only the extra 2% or so for the medicare levy.
Capital gains (or losses) on overseas shares are taxed here in Australia rather than in the host country, so it makes no difference to you tax-wise. The same rules apply on overseas and domestic shares in that you need to hold them for more than 12 months to get the 50% discount, and if you’re a frequent trader your capital gains will be taxed as income (get advice on how this works from a tax expert.) DIY super funds work the same way as individual investors.
Of course what you won’t get when you invest overseas is the benefits of our imputation system. Which leads us to our reader’s second concern. Many Australia companies attach franking credits to their dividends, which reflect the fact that tax has already been paid on the earnings by the company at its company rate of 30%. As an investor you can use those franking credits to offset against your tax payable on any other income, or even to get a rebate if your tax rate is lower than 30% – say if you have a self-managed super fund, or you’re on the lowest tax rate. The end result is that a franking credit on a fully franked dividend can add as much as a percentage point to a dividend earning. (Other countries have similar franking credit systems, but as an off-shore investor you won’t benefit from them.)
Take our example of Kevin Costello. As Morris explains it, if our Kevin received a fully franked dividend on his Australian shares on December 1 2007 he would receive a credit of A$30 and A$70 of net dividend. When he lodges his income tax return for 30 June 2008 he would include a ‘grossed up’ dividend of A$100 and obtain a credit for A$30 to offset against his tax payable of $46.50. That means he would only have to pay top up tax of A$16.50.
But not all dividends on Australian shares are fully franked, and many are not franked at all. On an unfranked dividend our Kevin would have to pay tax of A$46.50 on the A$100 dividend received, more than if he’d invested in overseas shares.
The point is that you shouldn’t make an investment decision because of tax anyway. Choosing to invest overseas is a strategy decision, made because you believe you need to diversify outside of the small world of the Australian sharemarket, or because you’ve identified particular growth opportunities offshore. While it’s worth knowing how the tax rules work on international shares – and as we’ve seen they’re not as complex as they first might seem – tax is certainly no reason to hold back from investing offshore.