International shares and tax

There have been changes proposed by the Labor party to imputation credits. We have put together a quick series looking at a number of aspects for investors:

  • In Part 1 (link) we looked at the winners and losers from the proposed changes
  • In Part 2 we look at some peripheral issues (a) at how management cheat by using buy backs (link) to inflate the value of their own options (b) (this post) the tax effectiveness of international shares for Australian investors.
  • In Part 3 (next week) how companies allocate capital and how franking distorts the process for Australian companies
  • In Part 4 (next week) tax decisions that Australian investors should consider – can you get in front of any changes?

Tax effectiveness of international shares

International shares have a poor reputation for tax effectiveness that doesn’t match the reality – and if Labor’s imputation reforms go through then the difference between an Australian investment and an international investment will be negligible:

Tax effectiveness of international shares

Source: Nucleus Wealth

Let me start by saying that investing for tax reasons is fraught with danger.

You should always start with investing for returns – tax is (at best) a secondary consideration. If you expected even a 2% better return from international shares over Australian shares then there is no tax scenario that would make you prefer Australian shares.

If your assets are in a superannuation fund in pension mode

Under current tax laws,  then Australian shares will return about 1.5% more than international shares. The difference arises as you are not paying tax and you will get cash back from franking credits.

Under Labor’s proposed changes there will be no difference between investing in Australian shares and investing in international shares if you don’t qualify for a pension.

If your assets are outside of superannuation

Under current tax laws, if you are on the maximum marginal tax rate, there is no significant difference between the tax position – Australian shares give you a very slightly higher return, but international shares give you better timing as let you defer your tax payment until you sell the shares.

At a 39% marginal tax rate (i.e. earning $80k-$180k) there is about a 0.4% difference. Again Australian shares give you a higher return, but international shares give you better timing as let you defer your tax payment until you sell the shares.  I would contend that anyone who thinks they can forecast Australian vs International returns to within 1% is having themselves on.

Finally, at a 0% marginal tax rate the effect is the same as for a superannuation fund in pension mode: a 1.5% benefit under current tax laws falling to no difference under Labor’s proposed changes.

Conclusions

Under current taxation, anyone in pension mode or on a 0% tax rate should have a slight tax preference for Australia shares over International shares worth about 1.5% per year. But to put that into context,  in the last month alone Australian shares have underpeformed international shares by almost 2%.

Under Labor’s proposed tax changes, anyone on 0% or the top tax rate should have no tax preference for international vs Australian shares.

Someone in a middle tax bracket can get a gain of around 0.5% per annum by investing in Australian shares, but you would have to know that you will continue to be in that tax bracket when you sell the shares as otherwise the calculation changes.  So, at best, a very minor preference for Australian shares.

Simply put, don’t invest for tax – invest for returns.

Damien Klassen is Head of Investments at Nucleus Wealth.

The information on this blog contains general information and does not take into account your personal objectives, financial situation or needs. Past performance is not an indication of future performance. Damien Klassen is an authorised representative of Nucleus Wealth Management, a Corporate Authorised Representative of Integrity Private Wealth Pty Ltd, AFSL 436298.

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Damien Klassen

Damien has a wealth of experience across international equities (Schroders), asset allocation (Wilson HTM) and he helped create one of Australia’s largest independent research firms, Aegis Equities. He lectured for over a decade at the Securities Institute, Finsia and Kaplan and spent many of those years as the external Chair for the subject of Industrial Equity Analysis.
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Comments

  1. “Simply put, don’t invest for tax – invest for returns.”

    That you have to spell this out shows that there is something seriously wrong about the collective Australian psyche.

    But then again, this may be because Australians are good at thinking small. After all, an American dream means owning a corporate empire and an Australian dream means owning a modest family home.

    Managing expectations, you know!!!

    • truthisfashionable

      I’ve noticed alot of people in Sydney praise the way the Scandinavian countries provide for their citizens. Mention that most Scandinavian’s happily contribute taxes to provide these services and suddenly they aren’t so smart and don’t deserve the praise.

      I’d love for someone to figure out where Australia learnt to be anti-tax. Especially when the majority of people support and promote our Medicare system and aged dole payments (“pension” for those who don’t like to offend their elders).

      • It is called cognitive dissonance. You can see it everywhere in Australia. Not only about tax but also about immigration, income inequality, etc.

        Where else on earth do people need to be taught that making money and paying tax is better than losing money and paying no tax?

  2. “Australian shares give you a very slightly higher return, but international shares give you better timing as let you defer your tax payment until you sell the shares.”

    This doesn’t make sense.

    • Australian shares pay dividends. International (US in particular) shares, may not, but generally return the money through share buybacks and price appreciation.

      You can choose when to sell, and hence choose when to pay the tax. You can’t choose when to receive the dividend.

  3. Why is the CGT cost the same for a 47% investor when the international shares have a bigger gain and the ALP are reducing the discount to 25%?

    • Damien KlassenMEMBER

      You are right that the capital gains tax much higher for the International investor – the one shown is under the current system and the difference is hidden by the rounding. I didn’t show the one including the changes to the capital gains because I wanted the table to be simpler and adding in the effect of the capital gains might have confused people.

      If Labor’s capital gains is also adopted then the after-tax returns for both the Australian and the International investments will fall by 0.1% – so the new numbers are 5.0% and 4.8% which I didn’t think changed the story enough to warrant adding 2 more columns.

  4. “I would contend that anyone who thinks they can forecast Australian vs International returns to within 1% is having themselves on”

    This is really the key thing to note in my opinion. I think the challenge is though that so many personal investors and pensioners don’t look international.

  5. If you are a self funded retiree and hold the shares for longer term, then the simplest solution to labour tax is to lend your shares out to short sellers.

    Under this arrangement, the short seller will reimburse you the value of dividend and value of franking credit. Plus you earn a return for lending of the stock.