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Investing in overseas shares sounds so easy. But if you don’t watch out, you could pay a lot more tax.
Investing in Overseas Shares
Investing in overseas shares takes you into the realm of international tax law. In this episode Clint Harding of Arnold Bloch Leibler will tell you what to look out for.
Here is what we learned but please listen in as Clint explains all this much better than we ever could.
To listen while you drive, walk or work, just access the episode through a free podcast app on your mobile phone.
Investing in Overseas Shares
Let’s say you invest $1m into Tesla shares and they pay you $100,000 of dividends. How much of this will actually land in your back pocket? If you structure this the wrong way, you will see very little of it.
Three Levels Of Tax
Investing in overseas shares, there are three or four levels of tax, depending on how you structure it.
Foreign Corporate Tax
It starts with foreign corporate tax. The company overseas will pay corporate tax in addition to any state and county taxes. That tax is lost to you. There is no franking regime as there is in Australia and New Zealand, so those taxes are a sunk cost to you.
Foreign Income Tax
Next comes foreign income tax. It would be completely impractical for all small foreign investors holding a small slice of publicly listed companies to all lodge a tax return in that jurisdiction. So you don’t and instead the company collects withholding tax on your behalf to satisfy your tax obligation overseas.
In the US the withholding tax is 15%. Not every country claims withholding tax. The UK and Hongkong for example don’t, but the US does.
So of the $100,000 Tesla dividend only $85,000 will arrive in Australia. What happens now will depend on who owns the shares.
Australian Corporate Tax
Let’s assume you bought the shares through your small company. Bad move as you will see later. But right now all looks fine.
Your company receives a foreign income tax offset for the tax it paid overseas and so you only pay top-up tax of 4% being the difference between the corporate tax rate of 25% in Australia and the 21% corporate tax rate in the US.
That means of the $100k you still got $81k. Sounds ok. But now you distribute the $81k to yourself and this is where things turn south.
Australian Individual Tax
Let’s assume you earn well over $180k, so your marginal tax rate is 47%. You receive $81k plus franking credits of $4k.
You don’t receive any credit for the withholding tax your company paid since it wasn’t you who paid it. This is also called withholding tax leakage.
The Australia income tax on your $85k dividend is $39,950. You only have $4k of franking credits and hence pay an additional $34,950.
So all up you paid $54,950 of tax on the $100,000 dividend and you walk home with $45,050 in your pocket. Not a great outcome.
Direct Investor’s Individual Australian Tax
So now let’s assume that you bought the shares in your individual name or through a discretionary trust. So you are a direct investor rather than going through your company.
As before $85k arrives in Australia, but this time you own the shares and it is you who paid the withholding tax. And because it is you, you receive a foreign income tax offset for the withholding tax you paid.
So of the $85k you receive your tax liability is still $39,950, but you receive a foreign income tax offset of $15k. And so you only pay $24,950 in Australia.
So all up you pay $39,950 in tax and walk home with $60,050.
Trust
If you hold the shares through a discretionary trust, the mechanism is the same. The dividends just first pass through the trust tax return. And are then distributed to you including withholding tax. The end result is the same.
You don’t have to lodge a tax return overseas if you just hold a small percentage of listed companies. Tax collectors overseas would go crazy if you did.
Withholding Tax
The withholding tax liability is actually a tax liability on the investor. It is the investor who pays the withholding tax. The company just withholds the tax on behalf of the investor.
This is very important for foreign income tax offsets (‘FITO’) because one of the key requirements in claiming any sort of FITO is that the entity claiming the FITO is also the entity who paid the withholding tax.
Withholding tax is just a collection mechanism because obviously once the money leaves the country, it is very difficult for tax authorities to collect any tax that is owed.
Withholding tax is a final tax. Once you paid it, there is nothing else to do in that country. There is no need to lodge a tax return in the foreign jurisdiction.
Withholding Rates
How much is actually withheld depends on the double tax treaty between the country and Australia. And it also depends on the size of your investment.
If you take the US as an example. The withholding tax for a small interest is 15%. But if you hold more than 10% of the voting rights in a US company, the dividend withholding tax rate drops to 5%. And if you hold at least 80%, then the rate drops to 0% . And the withholding rate is also 0% if the Australian shareholder itself is a listed company or controlled by a listed company.
Summary
So all up there might be other reasons why you would want to buy overseas shares through a company. But if you just focus on tax it isn’t a good idea. You pay significantly more tax.
So just for tax invest in your own name or through a discretionary trust, but not a company.
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Disclaimer: Tax Talks does not provide financial or tax advice. All information on Tax Talks is of a general nature only and might no longer be up to date or correct. You should seek professional accredited tax and financial advice when considering whether the information is suitable to your or your client’s circ*mstances.
Last Updated on 02 September 2021
Tax Talks spoke to Clint Harding - Tax Partner at Arnold Bloch Leibler - for more details.
