A big part of portfolio adjustment is always going to be about buying and selling shares in an effort to ensure adequate diversification. And if they are selling assets that have realised a loss or a gain then investors should be looking to see if they can offset those losses or gains.
The accountantsRus chief executive and author of 101 Ways to Save Money on Your Taxes – Legally!, Adrian Raftery, says one of the best ways to reduce your capital gains tax bill is to offset any gains that you have made during the financial year with any losses incurred on other share investments.
It is important to note that the losses must be crystallised (or realised) in order for them to be offset against any capital gains made. You cannot claim a loss in your return until the year that you actually dispose of the investment.
“It is good tax-planning practice to see if there is an opportunity to reduce the tax on gains made earlier in the year by selling a few non-performing shares. This is particularly relevant if the sharemarket is performing like a roller-coaster and there is a slump after a big rise earlier in the year,” Raftery says.
“Obviously, if you haven’t made any gains in the year then there is no need to crystallise any losses that you are currently carrying in your share portfolio,” he says.
Raftery says while it is possible to buy back the shares that you realised for the loss, it’s not advisable.
Dangers of washing
“Although yet to be challenged in the courts, the ATO has warned that the practice of ‘wash sales’ – where you sell shares and buy them back straight away for the purposes of realising capital losses to offset against other capital gains – could be considered an avoidance of income tax under Part IVA of the tax legislation. This comes with some hefty tax penalties.”
If you are considering such a scenario, ensure that you purchase a different number of shares from the number you originally sold. Or if your portfolio simply needs to be rebalanced in a particular industry, then buy a similar stock instead.
For example, if you sell your Westpac shares to crystallise a capital loss, buy a different bank stock as a replacement.
Raftery says capital losses must be applied against capital gains prior to any 50 per cent discount being applied to shares held for more than 12 months.
Prescott Securities principal Nick Loxton says that June is a traditional tax-loss selling period for fund managers, and at that time of year it may be possible to pick up some good-quality companies at a good price.
If fund managers are selling at a loss to reduce their tax liability then that may create a buying opportunity, he says.
Loxton says someone looking to take profits on a stock should closely watch trading on the ASX in the final week of June, when a lift in price can often occur as buyers come back into the market.
As a large amount of investment is in pooled funds, both inside and outside superannuation, it is worth understanding how your managed funds may be working.
That way you can make your own assessment of whether your money is invested appropriately for you.
Before and after
Russell Consulting’s director of after-tax investment strategies Raewyn Williams says there are two types of fund manager: those with a pretax focus and those with an after-tax focus.
While investors would like to think their personal tax position was top of mind for fund managers, the truth is most fund managers are focused on the pretax outcomes of their fund.
Williams says there are ways fund managers can and do improve the after-tax outcome of the fund but tax should never be the focus of a fund. “I’d be very cautious of a fund manager with a focus on tax. There are some fund managers who focus on tax-driven strategies but generally you want one that uses all the levers available to give a better after-tax outcome,” she says.
Williams says one of the things that managers of pooled investor funds need to watch out for are large redemptions close to year-end.
This is because to fund those redemptions they will need to sell assets which can in turn lead to excessive realised capital gains for the fund. These capital gains are then passed on to all the members of the fund whether they want them or not.
Williams says a good fund manager will be mindful of any large redemptions and will be looking to make special distributions to those investors who are redeeming units.
This way other investors in the fund won’t get a spike in taxable distributions.
“If you have a fund manager who isn’t looking at this issue, then an investor can be expecting a small taxable distribution from their fund when all of a sudden, through no fault of their own, they may get a much larger taxable distribution because one member has redeemed their units.”
Williams says fund managers can further help investors to pay less tax by choosing whether to buy and sell assets before or after year-end.
“If they are expecting to make gains on a particular asset then it makes sense to sell it after year-end to defer the tax payable on it.
“If they expect to make a loss, then an astute fund manager might be willing to sell before 30 June so the loss is offsettable or deductible in that financial year.”
Williams says for retail investors in a managed fund it can make a lot of difference as to which assets a manager sells when.
Assets held for less than a year that are sold will be fully taxed in the hands of the investor (non-discounted capital gains).
However, assets held for more than 12 months that are sold will be concessionally taxed (discounted capital gains).
“A fund manager can think about which assets they trade,” Williams says.
“A good fund manager will offset the capital losses it makes against the non-discounted capital gains which would otherwise be fully taxed and not the discounted capital gains of concessional amounts,” she says.
Williams says investors themselves may be able to take control of the tax they pay on distributions by a managed fund.
An investor who leaves a fund before year-end, that is they redeem their units in a fund, will get a distribution that is classed as a capital gain which may have associated discounts.
Capital gains tax
Assets held for more than 12 months receive a 50 per cent discount on the capital gains tax payable for retail investors and a one-third discount for superannuation investors.
The capital gain may also be able to be offset against any existing losses.
Williams says distributions from a fixed-income fund such as a bond fund are treated as fully income taxed in the hands of the investor, unless the units are redeemed, in which case they become subject to capital gains tax.
Franking credits are valuable to most investors. Essentially they are getting a refund on the tax already paid by the company they are invested in.
For a fund manager to distribute the franking credits which has been paid by some Australian companies, it must have at least $1 of taxable income in the fund.
If a fund is making losses then it can’t make a distribution and the franking credits will be lost.
“A good fund manager with Australian equities will be making sure the fund is in a taxable income or gain position so it can make a distribution and pass out the franking credits. It can do this, within certain limits, by deferring expenses and bringing forward income to make those distributions.”
Williams says changes to the foreign investment fund rules may lead to changes in the way fund managers manage their offshore investments.
It is no longer the case that fund managers need to actively offload offshore investments to avoid the tax, she says.