TAX PROGRESSIVITY AND MARGINAL TAX RATE
In the Swiss tax system, tax is said to be progressive. We speak of the progressivity of income tax. In broad terms, this means that the tax rate is not the same for high incomes as for moderate incomes. Expressed even more simply, a salary of 100,000 francs is not taxed twice as much as a salary of 50,000 francs, but much more.
What does this mean? Mr. Dupont actually pays 23,24% in taxes on his salary of 100,000 francs. On the other hand (and this is where the perversity of the tax system lies), he will pay much more than 23,24% in taxes on any additional income: we are talking about marginal tax rate.
In our example, Mr. Dupont's marginal tax rate is 36.04%. This means that any immediate additional income to his salary of 100,000 francs will be taxed at this other so-called marginal rate.
Thus, an increase of 100 francs in his income will no longer be taxed at 23.24 but at 36.04 francs. If Mr. Dupont receives 10,000 francs in ordinary dividends per year, he will pay 3,604 francs in additional taxes on this passive income and not 2,324 francs! His net income will not have increased by 10,000 francs. It will not have increased by 7,676 fr. (10,000 - 2,324), but only 6,396 fr (10,000 - 3,604).
Seeing these figures, Mr. Dupont might well throw himself off... the bridge!
Let's calculate what this means in dividend terms: For Mr. Dupont, it is equivalent (fiscally speaking) to receive a distribution taken from the reserves resulting from capital contributions of 2,56% (36,04% less than 4%) as an ordinary dividend of 4%!
Read the previous sentence again until it becomes part of your DNA!!!
The situation is similar from the point of view of dividend growth: For Mr. Dupont, an annual increase of 4.5% (36.04% less than 7%) of a tax-exempt dividend is fiscally identical to a growth of 7% of an ordinary dividend.
CONCLUSION
I teased the muse of the tax authorities, what am I saying, wrote this pamphlet on taxes, with the aim of making you aware of the importance of the tax aspect when choosing your investments.
Of course, taxation should not be the only criterion or even the determining factor when analyzing a stock.
Don't get me wrong: A regular dividend from a high-quality company is still far preferable to an untaxed dividend from a crappy company. The poor-quality company is at risk of reducing or suspending its dividend at any moment, and its stock price falling.
However, In the presence of companies of equal quality, dividend taxation can be a decisive criterion in deciding in which one to invest. With tax-free dividends, things become as simple and childish as in Donald Trump's head: gross yield = net yield.
All things being equal, a tax-free dividend of 4% is preferable to an ordinary dividend of 4%. Mr. Dupont's numerical example even shows that a tax-exempt distribution of less than 3% is more profitable than a taxable dividend of 4%!
Tax burdens are eating away at your nerves and your stock market performance. It is in your best interest to minimize the impact as much as possible. Reducing your taxes allows you to increase your passive income and therefore achieve your dream of financial independence more quickly..
I will end this article by throwing a spanner in the works (with the aim of creating debate, self-reflection and perhaps even a questioning of one's own certainties): Having observed in recent years the significant portion of my dividends that only served to oil the tax machine, I have come to think today that a private Swiss investor wishing to one day live off his dividends should aim to build up over the long term a portfolio of which approximately one quarter to one third of the securities are composed of companies making untaxed distributions.
EPILOGUE
Jean wants to eat a good ice cream. He orders three flavors: Nestlé, Roche and Novartis. As soon as he left the store, he noticed with sadness thata ball fell on the ground. He didn't even have time to give it a first lick, and yet he already only has two scoops left. Jean is upset, he forgets to enjoy the good weather and, strangely, his ice cream tastes bitter. This story really pisses him off...
Jacques enters the same store, but chooses other flavors: SFPI, Galenica and VAT. He goes to recharge his batteries in nature, enjoys the sun that warms his heart and listens to the birds singing. He savors his ice cream for a long time and each of the three balls is delicious. In fact, they have a kind of scent of freedom.
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Thank you dividinde for this enriching series of articles. It is true that the tax impact is a criterion to take into account.
As far as I'm concerned, I take this into account especially for income from work, because the latter is taxed much, much, much more than capital.
I talk about it at length in several articles on my site as well as in my e-book. Between taxes, social security and income acquisition costs, the income we have left is miserable!
The marginal rate that you are talking about very rightly here is indeed perverse that most people are unaware of, especially when it is added to all the other social deductions. This is particularly the case when you are in the middle class.
These people often feel like they are working more and more, having more and more responsibilities, and that in the end there is nothing left for them.
This is normal. A raise of 400.- which would be given following a promotion only gives in the end 200.- of additional income, with infinitely more worries.
The good news is that it works the other way around too. Lowering your activity rate by 20% doesn't mean a loss of 20%, but rather 10%.
So past a certain point, there is no point in working more (quantitatively and qualitatively speaking).
It is therefore important to be able to save, not only to invest, but also to be able to live on less income and therefore be taxed less.
Since capital is taxed much less than labour, what we manage to invest compensates for the loss of income from work much more efficiently.
For me, this is what is most important: more income from capital and less from work. This is where we can gain, especially from a tax point of view.
As for the choice of stocks, it is more debatable in my opinion. Many people are obsessed with the tax criterion when investing and unfortunately this is sometimes to the detriment of the judicious choice of the companies in which they invest.
For me, the tax criterion is certainly to be taken into account, but it will always remain secondary. The most important thing in fact is the selection of quality securities, not too expensive and which pay increasing dividends.
With such investments, you will always be able to catch up fairly quickly on the "delay" due to taxes. It's a bit like the hare and the tortoise. Indeed, thanks to the increasing dividends, the yield increases each year. The current yield loses its importance in favor of the yield on purchase cost. For example, a yield of 2.5% which increases by 10% per year will be worth more than 5% in 8 years and more than 10% in 15 years. Enough to make you forget the tax constraint very easily.
From an investment horizon of 7-10 years, growing dividends perform better than higher yields, which is also the minimum holding time required when investing in stocks. Seeking to maximize the yield (gross or net) is therefore not the best solution. It is preferable to choose quality stocks, not too expensive and whose dividend increases over the long term.
It is certainly possible to find high net yields, of quality and not too expensive (low distribution ratio), but they are rare. By focusing primarily on net yield, whether for tax reasons or simply because of the attraction of large dividends, we deprive ourselves of an enormous choice. Unfortunately, there are few securities that offer capital distributions.
I even have doubts about the sustainability and continued growth of untaxed dividends (in the form of capital repayment).
I believe that traditional dividends have more predictability and consistency. Time will tell.
Thanks again for this series!
You are quite right, the tax aspect is still much more important for income from work than for income from capital. However, this does not mean that we should neglect the way our dividends are taxed.
The main message of this series of articles was not to automatically dismiss quality stocks like Zug Estates or BVZ on the pretext that their dividend yield is too low. It is especially interesting to note that the gap between an untaxed dividend of 2% and an ordinary dividend of 3% narrows when the tax impact is included in the equation.
The best of both worlds is obviously to find Swiss Life shares that combine a high, tax-free and growing dividend, all with a share that is not too expensive. Unfortunately, this type of share is a rare commodity.
In summary, we arrive at the same conclusion by different paths: focusing on performance is misleading because we de facto forget other, even more important criteria, such as dividend growth, the distribution ratio, the fundamentals of the company... and taxation.
Thank you for this very interesting series of articles!
I still have a question: how do you identify these tax-exempt dividend stocks?
Thanks David! I presented a list in the comments of part 2/3. It is neither exhaustive nor perfectly up-to-date, but it is a good basis to start your research.
Great, thanks a lot
As an investor living in Switzerland, if I buy foreign dividend-paying shares, am I subject to double taxation?
Are there any countries where I don't have to pay any taxes (dividends or capital gains) if I own and sell shares?
Thank you for your clarifications 😉
No double taxation. Basically, to put it simply and generally, you will have a withholding tax of 15% at source in the country of the action and 15% in CH (by Swiss withholding tax to be announced and recovered during taxation).
In CH you never pay capital gains tax (unless you are a professional), no matter where the stock comes from.
On the London Stock Exchange there is no withholding tax on dividends (but the income will still have to be declared when taxed – automatic exchange of information requires this).
More info:
https://www.dividendes.ch/forum-2/topic/fiscalite-dividendes/
Thanks Jerome! It's true that there are already a lot of answers in the forums, I'll go there more often!
Thank you Jerome
Are scripted dividends, i.e. receiving shares instead of cash, considered as securities yields?
In Switzerland, no. In France, obviously, it is taxed (but the company that pays it can enter an amount less than the value of the shares).