Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 231

LICs: Traders versus investors for tax purposes

The introduction of the Future of Financial Advice (FOFA) reforms and the increase in SMSFs has seen listed investment companies (LICs) surge in popularity over recent years. Investors can gain exposure to a diverse portfolio of assets through around 100 LICs listed on the ASX. These LICs can be categorised in various ways, including by their asset class, market cap of investee companies, investment style, and whether they are internally or externally managed.

Not commonly discussed is the distinction between LICs that are deemed by the ATO to be ‘investors’ for tax purposes, versus LICs that are ‘traders’. The key differences between these two types of LICs relate to tax, franking, and dividends.

Investors for tax purposes

Many of Australia’s older LICs are investors for tax purposes. These include AFIC (ASX: AFI), which was established in 1928, and Argo Investments (ASX: ARG), founded in 1946. Investors for tax purposes tend to buy investments and hold them for the medium-to-long term. To maintain their status as an investor for tax purposes, these LICs generally turnover 10% or less of their investment portfolios each year. This type of LIC is typically suited to investment managers with a long-term investment horizon and low portfolio turnover.

For accounting purposes, LICs that are investors for tax purposes record movements in the value of their investment portfolios through the balance sheet, rather than the profit and loss statement.

Tax and franked dividends

The franked dividends these LICs pay shareholders are primarily derived from franked dividends received from the companies in the investment portfolio. These dividends are sometimes called ‘flow through’ dividends. When a LIC which is an investor for tax purposes realises (sells) an investment for a capital profit, the LIC can potentially pay a dividend to shareholders that includes a capital gain component. This is called a LIC capital gain dividend. This allows shareholders to claim the capital gains tax (CGT) discount as though they directly owned and sold the shares in the LIC’s underlying investee company. Over and above the benefit of franking flowing through the cash yield paid by the LIC, the capital gain component can be used to further reduce shareholders’ tax liability.

Traders for tax purposes

Many of the ASX's newer LICs are traders for tax purposes. These include the LICs we manage at Wilson Asset Management, such as WAM Capital (ASX: WAM) and WAM Leaders (ASX: WLE). LICs that are traders for tax purposes typically have higher turnover of their portfolios and are often employed by managers with a more active investment style.

LICs that are traders for tax purposes record mark-to-market movements in the value of their investment portfolios through the profit and loss statement, as opposed to the balance sheet.

Tax and franked dividends

Traders for tax purposes can pay dividends out of profits from realised gains, mark-to-market movements in the value of the investment portfolio and dividend income from investee companies. This increases their ability to pay a steadily-increasing stream of fully franked dividends which is particularly appealing to SMSF investors seeking a consistent yield.

Traders for tax purposes rely predominantly on paying corporate tax on realised gains to generate franking credits to attach to dividends paid to shareholders. These LICs derive some additional franking and dividend income from Australian investee companies in their portfolio.

Summary of key differences

  Investors for tax purposes Traders for tax purposes
Turnover Typically low turnover of investment portfolio (below 10% p.a.) Higher turnover of investment portfolio
Portfolio movements Movements in the value of their investment portfolios through the balance sheet Mark-to-market movements in the value of their investment portfolios through the profit and loss statement
Franking credits Franking credits primarily generated from investee companies Franking credits primarily generated by paying corporate tax on realised gains
Sources of dividend payments Primarily derived from dividends received from investee companies Derived from dividends received from investee companies, realised gains, and mark-to-market movements on the investment portfolio
LIC capital gain dividend Can pay a LIC capital gain dividend Cannot pay a LIC capital gain dividend

Implications for investors

These different types of LICs provide advantages and disadvantages for shareholders and investment managers alike.

Investors should consider their financial objectives and circumstances, including tax implications of owning shares in each type of LIC. While investors for tax purposes and traders for tax purposes are distinct from one another in some regards, both offer the benefits of the LIC investment structure which make them popular with investors. These benefits include the ability to pay a steadily-increasing stream of fully franked dividends, transparency, accountability, and a closed-end pool of capital allowing the investment manager to make rational investment decisions.

[Register for our free weekly newsletter and receive our latest ebook, Cuffelinks Showcase]

Chris Stott is the Chief Investment Officer of Wilson Asset Management. This article is for general information only and does not consider the specific circumstances of any individual.

 

  •   14 December 2017
  • 7
  •      
  •   
7 Comments
Doug
December 14, 2017

Can you explain how mark to market movements generate franked dividends?
Thanks,
Doug

Graeme
December 14, 2017

Para. 2 indicates that it is the ATO that determines whether a LIC is a trader or investor for tax purposes. Do they decide this every year based on portfolio turnover for the latest financial year?

WAX was an investor up to and including 2013/14 and has been a trader each year since. Does this mean they have had a higher portfolio turnover for each of the last three years than 2013/14 and prior years? Would WAX be deemed to be to an investor for any low turnover year in the future?

Tom
December 14, 2017

Thanks Chris - good comparison. So if trading LIC's basically manufacture their yield, how sustainable is that in a market downturn?

Simon
December 14, 2017

Good point Tom. If and when we get to the point where there aren't enough profits to pay the dividends, those LICs trading at big premiums to NTA will swing to discounts, thereby inflicting a double whammy hit to shareholders - reduced or no dividend, and big capital erosion. Could end up like the way things panned out for Telstra holders who thought the dividend was bulletproof....

Graeme
December 16, 2017

Simon; Like all shares, the 'price' of a listed fund will usually trade at a premium or discount to its 'value', sometimes large. Even the non-trading ones may trade at a discount, albeit a smaller one, if dividends in general are cut, or even just not expected to grow in a recession. One of the charms of listed funds is to be able to take advantage of this. If you're worried about a "double wammy hit", then buy an unlisted fund.

Richard M
December 15, 2017

How does an intending purchaser of LIC shares determine whether the LIC is a trader for tax purposes or an investor?

Graeme
December 16, 2017

Best bet Richard is to contact the manager and ask them. They may, however, only be able to answer what historically has been the case, hence my questions above.

 

Leave a Comment:

RELATED ARTICLES

Why LICs may be close to bottoming

The fascinating battle between Nick Bolton and Magellan

Why LICs are closing and more should follow

banner

Most viewed in recent weeks

How cutting the CGT discount could help rebalance housing market

A more rational taxation system that supports home ownership but discourages asset speculation could provide greater financial support to first home buyers.

Is there a better way to reform the CGT discount?

The capital gains tax discount is under review, but debate should go beyond its size. Its original purpose, design flaws and distortions suggest Australia could adopt a better, more targeted approach.

Want your loved ones to inherit your super? You can’t afford to skip this one step

One in five Australians die before retirement and most have not set up their super properly so their loved ones can benefit from all their hard work and savings. 

Super is catching up, but ageing is a triple-threat

An ageing Australia is shifting the superannuation system’s focus from accumulation to the lifecycle of retirement. While these pressures have been anticipated for decades, they are now converging at scale and driving widespread industry change.

Has Australia wasted the last 30 years?

The 20 years after Peter Costello left Treasury have been deemed wasted...by Peter Costello. The missed opportunities for Australia began long before.  

Meg on SMSFs: Last word on Div 296 for a while

The best way to deal with the incoming Division 296 tax on superannuation is likely doing nothing. Earnings will be taxed regardless of where the money sits, so here are some important considerations.

Latest Updates

Taxation

3 ways to defuse intergenerational anger

With the upcoming budget increasingly likely to include bold proposals to alter the tax code I’ve outlined three incremental steps with fewer unintended consequences.

Economy

Why an extended US-Iran war will punish mortgage holders

The impact of the Iran War is far more than expensive petrol. Higher oil prices have secondary inflationary impacts that reverberate throughout the economy which could be bad news for Australians with mortgages.

Infrastructure

Don’t forget the yield

Global Listed Infrastructure dividends are forecast to grow 5-6% p.a over the next two years. After a hiatus, share buybacks are back on the agenda and will play an integral role in shareholder returns.

Iran war hands politicians free ticket to blame oil prices for inflation

Past oil shocks offer lessons for investors dealing with the fallout from the Iran War and the ongoing impact on inflation.

Economy

Japan 2026: A new PM heralds a new golden age?

Former Australian Prime Minister, Paul Keating, once said "When you change the government, you change the country." We're about to see whether that holds true in Japan.

Investment strategies

Why are central banks moving from US Treasuries to gold?

Central banks now hold more gold reserves than US Treasuries, signalling a shift in safe-haven asset strategy and portfolio diversification as geopolitical risks increase.

Strategy

Has global human wellbeing peaked? What the data reveals

Historically economic progress is measured by GDP growth but there is an increasing body of work that explores quantitative measures of wellbeing.

Sponsors

Alliances

© 2026 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.