Capital Gains vs Dividends
By The Accrual World on The Capital
These two sets of investments offer various advantages that you can play suit depending on your circumstances and time horizon. In this post I will outline the differences between these two strategies.
Capital Gain
It is the profit realised when you sell the capital asset you have been holding on for a period of time. It is only considered a gain upon liquidation on asset (that is when you sell), and not based on mere valuation. Say if you bought a share at $1 and you sold it at $2, your capital gain will be $1 (prior to considering brokerage). The share price movement depends on various macroeconomic factors and company’s growth potential. A classic example of a company with capital growth is A2 Milk, listed on ASX: A2M. The company was listed on the ASX back in 2015 at $0.56 and today it is priced at its all-time high of $19 mark. Imagine purchasing this share even during 2017 at $ 7 which could have seemed hefty comparing to its inception.
Taxation for capital gains is treated differently depending on your tax residency in Australia. If you are a non-resident for tax purposes, you will not be taxed on the capital gain on shares because it is not classified as a “taxable Australian property” by the Australian Taxation Office. Hence, any gains made will not be taxed in Australia. Please note you might still be required to declare this income and pay taxes in your country of tax residence.
A side note for my Malaysian readers, you do not have to declare this in your income taxes in Malaysia because:
- Capital gain on shares is not a real property and hence not chargeable to income tax; and
- It is a foreign source income thus an exempt income since 2004
If you are a resident for tax purposes, the capital gain on shares is taxed on top of your marginal income tax rates. However different tax treatment applies depending on the timeframe you have been holding on to the asset. If you hold the asset for less than 12 months, you will be taxed at 100% of the gains. However if you hold the asset for more than 12 months, you will only be taxed at 50% of the gains.
Continuing from the example above where you’ve bought the share at $1 on 1st January 2019, the timing of acquisition starts on the next day after purchasing the asset, i.e. 2nd January 2019. If you sell the asset on or before 2nd January 2020, you will be taxed on the full $1 capital gain, as you fail to satisfy the one-year holding period. If you sold the share on 3rd January 2020 for $2, you will only be taxed on $ 0.50 as you will be eligible for the 50% CGT discount. Any capital losses that you have accumulated will offset against the full capital gain amount and can be carried forward indefinitely.
Dividends
These are part of the earnings distributed from the company to shareholders. The amount of dividends usually depends on the company’s management and is often on a periodic basis. Companies that often pay high dividends are usually blue-chip companies, especially the big four banks with a trailing dividend yield of about 7%. A company’s willingness to pay regular dividends over time often send a message about its solid financial strength and confidence in future expected earnings.
If you are a non-resident for tax purposes, you will not have to be taxed on franked dividends as it has already been taxed. If it is an unfranked dividend, it may be subjected to a withholding tax of 30% (may vary depending on tax treaty). The withholding tax is a final tax and is deducted by the company prior to payment of the dividends. Hence there is no additional tax liability on your end.
If you are a resident for tax purposes, franked and unfranked dividends are added on to your income and taxed at marginal levels. Click here to find out more about how franking credit works and if it works in favour of you.
There is no ultimate saying in which is better over the other. But my personal preference is to invest actively in capital growth shares, as I get to time the exit and sale of shares. The ultimate goal here should be wealth creation. After all, we are just trying to invest and putting our money to work.
