With the end of the tax year almost upon us, a common question is cropping up in investment forums – does the tax department want a slice of any gains made from selling shares?
The glib response is “of course” given the magical threshold of $200 of reportable income in a year triggers the need to file a tax return, although it’s a little trickier than that and the Inland Revenue Department has a handy factsheet to help people along the way.
The starting point is intent.
“Amounts received from the sale of shares are taxable when an investor acquired the shares for the dominant purpose of disposal, has a share dealing business or the shares are part of a profit-making undertaking or scheme,” the tax department’s interpretation statement says.
In the dry language of the tax department, that means that if the primary reason an investor bought the shares was to book a profit when selling them, they’ll attract a tax obligation.
In saying that, the tax department recognises that investors can have multiple reasons to buy something, such as attracting dividends, getting voting rights, long-term investing, or diversifying a portfolio.
Show don't tell
While an investor might have to prove that they didn’t buy a stock simply to speculate on a quick gain, they don’t have to prove what the alternative primary goal was.
To make things tricky, the IRD doesn’t have a brightline test for share sales that will trigger their all-encompassing eye to bear down on a retail investor, so there’s no rule of thumb on the length of time between buying and selling or a specific number of trades to be aware of.
“It is advisable for investors to keep records to support their stated purpose at the time they bought shares,” the tax department says, pointing to the types of documents an investor might collect when deciding on what to invest in, such as company materials, financial advice, an investment plan and any notes relating to the purchase.
And if that dominant purpose gets tested by the tax department, they’ll weigh that up against the particular type of asset, such as whether it pay dividends, the length of time the shares were held, and the circumstances of the transaction.
A February bulletin has some helpful examples.
The fictional Charlie buys and sells every now and then on an online investment platform, searching for stocks using a filter with the biggest price change and selling when he considered the price was high. He'll face a tax bill for the gains on his sales.
Megan invested in one company for its dividends and another because her fund manager neighbour said it was a good short-term investment, ended up selling both to shift her money into a managed fund. She'll need to pay tax on the gain she reaped from the second company as she bought it with the purpose of selling, but not on the gain from the company she bought for its dividends.
In the beginning
And the tax department is clear that it’s the original purpose of the investment that counts.
If an investor buys something with the express purpose of selling, then changes their mind and decides to hold on to them as a long-term investment, they’ll still face a tax obligation if a change of circumstances prompts a sale.
Conversely, the gain from a sale of what was initially going to be a long-term investment before an investor soured on the company’s direction wouldn’t be taxable.
And, in an example that won’t cool the generation wars, buying shares with the goal of selling them at a profit to fund, say, a house deposit will attract a tax obligation because a sale was the main purpose of the purchase.
Ultimately, if in doubt, the best thing for an investor to do is seek advice – an accountant’s bill is typically cheaper the falling foul of the tax department and definitely comes with fewer headaches.
Reporting by Paul McBeth. Image from Jakub Żerdzicki on Unsplash.