When are you liable to pay tax when investing in shares?
The taxation of investments is an eternal topic. It should be addressed by anyone who wants to avoid any problems with the tax office. That's why it's good to know what the time test is, up to what amount you don't have to tax anything, or how to include income from investments in your tax return. Let's take a look at it.
The first thing to mention is at what rate investment income is actually taxed. There is a 15% tax on stocks, bonds, or mutual funds. Is it income from capital assets, or other income. The same tax applies to cryptocurrencies, but for them the calculation of the tax base (what you take money out of) is a bit more complicated. I'll cover the taxation of cryptocurrencies separately in a future post.
Before we get into taxation, let's note the scenarios where we are exempt from tax altogether.
The time test
By definition, the time test is the necessary holding period for securities to be exempt from paying personal income tax.
It is nothing more than the fact that after buying a stock, you must hold it for three years in order to not have to tax its sale at all. You don't even have to declare your gain anywhere on your tax return, so it's worth investing for the long term from that perspective alone.
The CZK 100,000 threshold
In the second scenario, you don't have to pay taxes or file a tax return if your investment income is below CZK 100,000. Here it is important to define what is meant by income. It is not profits, i.e. the difference between the amount invested and the amount sold. It is the amount you sell it for. Let's explain this with examples.
- Example 1: You buy shares for 50,000 CZK, you sell them for 95,000 CZK. You don't have to pay any tax or report anything on your tax return. The threshold of CZK 100 000 is not exceeded when the sale is made.
- Example 2: You buy shares for CZK 50 000 and sell them for CZK 105 000. You declare the full amount of the income (CZK 105 000) in your tax return, but of course you only tax your gain. In this case, the profit is CZK 55 000, which you tax at 15%. Your tax should therefore be CZK 8250 and the net profit CZK 46 750.
- Example 3: You buy shares for CZK 110 000 but sell them for CZK 105 000. You make a loss of CZK 5,000 but still have to declare the full amount of income (CZK 105,000) on your tax return. Of course, you do not tax the loss.
There is no such thing as shares.
But there is one important thing to mention and that is fractional shares. These are very popular with smaller investors like me. They are offered by eToro, Trading 212 and many other brokers. You want to buy a stock but it is worth say $400, which you don't currently have, so you simply buy a fraction of the stock you have chosen. You know.
But here's where you run into a problem, as fractional shares don't offer the advantages of classic shares, i.e. those you buy in pieces (1, 2, 3,...). Neither the time test nor the CZK 100,000 threshold apply to fractional shares. This is because the shares are owned by a broker who will sell you the pieces of the shares you want. You then have a claim on the broker, which is not a security of course. This topic was addressed on Twitter by tax advisor Peter Frisch.
The solution to this problem is simple. Choose a broker that doesn't offer fractional shares at all.
For dividends, it's the same, again a 15% rate. But here too it is important to know your broker. Some brokers tax dividends more than you would like. It is common for up to 30% to be deducted from dividends, while Czech stocks are taxed as high as 35% at some brokers. A month ago I did a little review of how individual brokers feel about the W-8BEN form, which just prevents double taxation.
Income from stock sales, as we defined it earlier, is reported as Other Income under Section 10 of the Income Tax Act. The resulting tax is payable on the profit, i.e. income net of expenses. Cost is mainly the cost of buying the share, or fees if you paid them separately and they were not already included in the price or sale of the share.
If the profit exceeded 48 times the average monthly salary for the whole year (the figures are from February this year), which is around CZK 1.7 million, the 23% tax rate applies. This rate is applied to the profit that exceeded CZK 1.7 million. Let's use an example where you have to file a tax return, pay taxes and you have a profit over CZK 1.7 million.
- Example. In 2021, you sell these shares at a large appreciation for CZK 2,500,000. In your tax return, you report the income from the shares worth CZK 2,500,000, and you report the purchase price of CZK 500,000 as an expense. The net profit is therefore CZK 2 000 000. There is still CZK 300,000 of the tax base, which you tax at 23%, the tax comes to CZK 69,000. In total, you pay CZK 324 000.
With dividends, a lot depends on the origin of the company paying it. A dividend from a Czech company is not subject to the need to declare it in the tax return. A foreign dividend that is not double-taxed must be reported on the tax return. On the line for the partial tax base on capital assets under Section 8 of the Act, you enter the gross dividend (what the company itself pays out). You then fill in the annexure to the tax return, take advantage of the credit option and the tax is deducted from the gross dividend.
As always, it is extremely important to have your broker thoroughly researched, you will then save yourself a lot of work. The last thing you want to deal with is running to the tax office. So keep an eye on the 100k threshold, use time tests, have signed W-8BEN forms and think about whether I want to invest in fractional shares or not.
If you have any insights on this article, I'd love to hear from you in the comments 😄