With the world’s ever-expanding data matching abilities, it’s important to be aware of the implications for you and your business.
An increasing number of Government bodies and regulators are obtaining and processing mass data in an attempt to find gaps and tighten compliance. This includes non-compliance due to deliberate avoidance, as well as inadvertent errors. It is therefore important to be aware of your reporting obligations across all such regulators, to minimise costs and time spent once you are embroiled in an audit or review due to suspected non-compliance.
We highlight below one such topic that has recently been flagged as an area of interest, however you should keep data matching in mind when dealing with any Government agency or regulator.
First time investor: beware!
According to the Australian Securities and Investments Commission (ASIC), during the 2020 calendar year, there were 435,000 investors who placed their first trade on the share market. With the significant increase in investors, the ATO have issued new guidance on understanding tax obligations for the reporting of income and capital gains from investments. If the ATO is publishing guidance on this topic, it is likely to be a target area for their reviews as well, so investors should be extra vigilant in preparing their returns.
If you are new to the world of investing, or even as a health check for existing investors, it is important to understand the tax obligations that arise from your investments. Arm yourself with an understanding of tax implications so you don’t get caught in an ATO audit.
What does the ATO know?
Notably, the ATO has access to data to feed into their systems to review and look for discrepancies. The ATO receives a large amount of data from ASIC, brokers, exchanges and share registries. This data includes dividend payments, and the purchase and sales of shares, which will appear on the ATO’s reports used to prepare tax returns.
The ATO therefore expects the tax return will show at least the same amount of income which appears on these reports. Where these data matches indicate shortfalls of income being reported, a review of the tax return may be triggered. Although such differences may be appropriate, it is important to review and keep records in case the ATO asks any questions.
So where do first time investors commonly make mistakes in their tax returns?
Exchange Traded Funds (ETFs)
ETFs are an increasingly popular investment choice due to the diversification they offer, as well as the ease of purchase (as investors can buy in with small cash amounts).
Unlike shares which pay dividends, ETFs pay distributions which may contain different tax components. The ETF will provide an annual tax statement after the end of the financial year which contains a summary of the income distributions, and these generally need to be declared in your tax return. Differences between these reports and lodged tax returns could raise red flags with the ATO.
Both shares and ETFs commonly provide investors with an option to reinvest their dividends or distributions. This means that instead of receiving cash, the investor will receive additional shares or units.
Reinvested dividends/distributions are still classed as income, and investors are generally required to declare these as income in their tax returns, despite not receiving any cash.
Investors who sell shares or units will need to calculate their capital gain or loss and record it in their tax return (subject to various exemptions). Importantly, a capital gain or loss is generally only triggered when the investment is sold or a change in ownership occurs. Therefore investors cannot claim losses if the share price drops while holding the share, which is referred to as a paper loss, or unrealised loss.
Further, capital losses can only be offset against capital gains, or carried forward to offset future capital gains. The ATO utilises sophisticated data analytics which can identify returns where paper losses are used to offset capital gains, or where capital losses are being used to offset other types of income.
Additionally, investors receiving distributions (as opposed to dividends) will need to consider any tax deferred, return of capital or other such cost base adjustment amounts reported in their tax statements (including in current and prior years) when calculating realised capital gains/losses.
Errors in tax returns can result in delays in the ATO paying refunds, or even trigger a review of your tax return. Penalties can also apply where an investor’s tax position has been understated.
Investors need to be aware of how to appropriately report their investment activities for tax purposes, however things can become tricky when dealing with reinvested funds, complicated annual tax statements from funds, and calculating capital gains/losses. Consider reaching out to an advisor to get guidance and assistance with preparing your tax returns.
Another key way to minimise errors is to keep good records. Recording all the details about investments, including dates, dollar values and any special events or notices, will greatly assist in piecing together the correct information to report.
If you would like to know more about the tax implications of investing in shares or ETFs or require assistance, please contact Murray Howlett, Angela Stavropoulos, Kristy Baxter or your Pilot advisor on (07) 3023 1300.