ETF LICs vs VAS - Taxation for non resident

Hi @mtat and @FredBear,

Thanks so much for your kind advice. I appreciate that you're trying to help. I consider myself a newbie in investing, at least when it comes to knowledge.

I admit that I've always been overly optimistic in Australian economy and Australia as a country. Having a strong belief that Australia is a very lucky country, I never thought I need to diversify outside of it. Thanks for underlying the importance of it.

WGB looks interesting however I'm struggling to find it's dividend history graph. Have you come across one yet? Spot yield looks much higher than what I anticipated.

 

What I meant here is, LICs provide higher income than EU indices, equal capital bases assumed, and this delta is higher than the loss caused by currency conversion.

I'm aiming for sufficient capital base to live comfortably even if dividends drop by 50% and my withdrawal rate needs to be 2%. This wouldn't be hard as the country has relatively low costs of living.

So fully franked dividends won't be taxed in Australia. Montenegro will tax the income at 11% or 9%, a bit unclear. Calling tax guru @FredBear here, mate could you confirm if the tax will be 9% or 11%? I read the tax rules so many times and I find it confusing.

This could be my bad, but I have always had strong belief in Australia as a lucky country and have always have strong level of confidence investing in it, especially in the LICs being very diversified baskets of shares effectively representing the Australian economy.

 

According to the information I have (Deloitte's country tax summary) salary is taxed progressively at 9% then 11% for the part over the average salary in the last year (about 750€ per month); dividends, interest and capital gains are taxed at 9%.

 

Thanks mate, really appreciate it. I found the actual law and read it thoroughly. You're right, it's 9% which made me happy as I expected 11%

There is the following section in the mentioned law:
"A resident taxpayer who earns income outside Montenegro and who pays income tax to another country is granted a tax credit in the amount of income tax paid in that country."

Does it mean I can use franking credits?

 

No

 

As Terry says, non-residents loose franking credits.

However, your country of residence may view franking credits in different ways:

1. Under our tax agreement with Australia, Australia is entitled to tax 15% of dividend income. They have taken 30%, which is more than they are entitled to. You should claim the different back from the ATO (fat chance of this happening)

2. We will assume that Australia has taken the 15% they are entitled to in the tax agreement, and will give credit for this 15% amount.

3. We won't give any credit for franking, and will tax the dividends fully according to our tax rate.

Australia's system of franking credits is quite unique so is not well understood by other tax jurisdictions.

As a resident of a country without a tax agreement with Australia, unfranked dividends will be subject to 30% withholding tax.

 

Hi mate. Hope you've been well. Sorry to bother you with this again. I've been thinking of investing in VGS going forward instead of lic's. From what you mentioned, the dividends from VGS would be taxed at 30% by Australia (when I move to Montenegro). Could you please confirm this?

I must be really stuborn.. but i can't find a good reason to invest in anything else apart from LICs. The only concern I have is the manager risk, but then I'm thinking, these lic's have survived wars and all sorts of recessions, what's the chance of any of them going bust?

 

Hi mate, I'd appreciate if you could explain this further. I'll state this as an example. Say there is a big recesion, like GFC, or Covid, touch wood. Share price drops significantly, say 30-40% or so. And this has been common for international shares, LICs, ETFs. So if i need to sell some shares to top up my income, I'd be selling shares at very low prices. I'd need to sell more shares to obtain the desired income which would erode the capital base.

Let's look at the exact same scenario where I'd be holding mostly lic's. In the past recessions, LICs share price has also significantly dropped however dividends have decreased only 10-15% or so and in some cases there has been no decrease in dividends (like whf, aui). This means i could live off dividends without selling shares.

 

When you cease to be a resident, you have two options:
1. Realise capital gains - either by selling (and you can buy again if you like) or by just paying out the CGT in a tax return; or
2. Delaying your payment of capital gains until a later date.

If you do the first, then after that point you could rebuy/hold VGS and not have to pay anything to the ATO because your income is just seen as passing through Australia. Alternatively, you could buy the equivalent Ireland domiciled fund and similarly not pay tax to the ATO (you can see why it would be pointless for the ATO to try tax it anyway). You still need to check the tax laws in your home country.

If you do the latter, your shares are considered TAP (Taxable Australian Property) and you continue to accrue capital gains tax until you sell, which is seldom good for you as you will be owing even more tax, and all the additional capital gains will not receive the 50% CGT discount either due to not being a resident.

Because you are concentrating your portfolio in a tiny market that has half the entire index in 10 companies and 2 sectors? Ever heard of concentration risk? Examples - UK stock market early 70's, Japan last 3 decades, Germany 1945, Argentina 2002, Iran 1979, Thailand 1997. Oh and here's a lovely article on Italy, Spain, and Greece's stock markets that will make you puke. What do they all have in common? Single country risk.

Oh and of course, since you will be in an entirely different currency, you face periods where the AUD is low and your home currency is high, exacerbating the risk.

The idea that you can't find a good reason to invest in anything apart from LIC's is a bit like saying you can't find a good reason not to pick up pennies in front of a moving bulldozer. Maybe look a little harder for reasons because they're in front of you.

 

A dividend is merely a movement of capital from the company (i.e. the price of the share) to your bank account.

If you reinvest the dividend, nothing has changed (besides tax consequences).

If you do not reinvest the dividend, you have taken money out of your shares while they are down the same way you would if you sold.

Where exactly do you think dividends come from if not from the value of your shares?

 

Here's the info from the ATO website:

Interest, unfranked dividends and royalties

Unfranked dividends are taxed at 30% for residents of non-treaty countries.
So your investment in VGS would be taxed at 30%. You would be better off investing in an equivalent fund based in Europe. Check out Vanguard FTSE All-World UCITS ETF as an example. Remember there are three levels of taxation:
- The withholding tax paid by the underlying shares in their home country, e.g. US tax paid by the US companies
- The withholding tax paid by the ETF in it's country of domicile, e.g. Ireland
- The final tax paid in your country of tax residence
By choosing an ETF domiciled in Ireland where there is no witholding tax for foreign investors you could reduce your overall tax bill. It gets very complicated so do your own research for your own situation. In my situation my tax residency country has a treaty with Australia which reduces withholding to 15%. Normal taxation here is 30%, and credit is given for the 15%. So for me it doesn't make any tax difference if the fund is domiciled in Australia or Ireland, the final tax is the same. I look at other factors, such as currency exposure and MER.

 

This is not correct with regards to a person who owns non-Australian shares (including those in a trust structure like VGS) where they were a non-resident the whole time. I suggest you speak to an accountant. Or at least do a search for Conduit foreign income.


From the ATO:
Dividends paid or credited to non-resident shareholders
Under "unfranked dividends" (bold added by me):

The other type of dividend a resident company may pay or credit to you is an unfranked dividend. There is no franking credit attached to these dividends.​

Unlike a company, a trust structure such as an ETF is just a pass-through structure, so since VGS holds international shares, they are not resident companies. and therefore for non-residents, the dividends fall under conduit foreign income rather than unfranked dividends.

 

I'll try to clarify my understanding a bit more. There is this in the ATO quote:

The whole or a portion of an unfranked dividend may be declared to be conduit foreign income on your dividend statement. To the extent that the unfranked dividend is declared to be conduit foreign income, it is not assessable income and is exempt from withholding tax.

The unfranked dividend needs to be declared to be conduit foreign income. In the case of VGS, if we look at the tax distribution breakdown (available from the ASX website), for example the period ending 31st March, it specifically says that the unfranked CFI is 0.

However if we look at ETFs that do own some Australian shares, then there can be a (often small) portion of unfranked CFI in the distribution. For example VDHG declared 0.22% as unfranked CFI for the period ending 31st March.

VAS being all Australian shares, has a higher unfranked CFI of 12.47% for the period ending 30th June.

So in general, if the ETF owns Australian shares, and those companies have operations abroad, then there can be unfranked CFI in the distribution. VGS doesn't own Australian shares, so no unfranked CFI.

 

Thanks so much mate! Finally got it haha! Really good explanation

 

Hi mate! If i never sell shares and decide to go for option 2 above, I never really need to pay cgt? Could you please confirm this?

 

CGT is only triggered on a disposal but can also happen if a trust is declared, or becoming a non-resident.

 

Thanks mate. So if i move overseas, and decide to defer the payment of CGT, and never sell my shares.. i guess I never need to pay any CGT?

 

potentially not. But the beneficiaries of your estate will potentially.

 

Check the rules in the country that you move to, if you every move on elsewhere from there. More and more countries are implementing so called exit taxes of their own. In Australia you have the option of deferring the tax by having the property classed as TAP (Taxable Australian Property), so the CGT becomes payable when actually sold. Some countries with exit taxation don't give you that option. Basically "you leave you pay, NOW".

 

Thanks for your advice, always very helpful

You mean if I leave Montenegro I may need to pay exit taxes in Montenegro? I had a quick look and it doesn't look like they have exit taxes. I most likely won't leave Montenegro anyway. I'm summary, I'll just defer payment of CGT, which means shares will become ATP and I will never sell, hence no CGT to Australia.

I have been doing some research on Ireland domiciled ETFs and I am close to buying VWRL (all world etf). From I can see:
- when I move to Montenegro, I don't need to pay any CGT on sale of shares,
- whether I decide to stay in Australia or move to Montenegro, I don't need to pay any tax on dividends to Ireland. I will need to pay 9% tax to MNE,
- because of treaties between USA and Ireland, USA withholds only 15% tax on dividends from underlying USA shares (which is the same as for USA citizens),
- no estate tax for Ireland domiciled funds,
- it seems that it is better for me to buy VWRL than VGS because when I leave Australia I would be paying CGT on sale of VGS.

Would you know if the above points are correct?