Proposed changes to capital gains tax (CGT) mean investors must sharpen their criteria for ASX dividend shares, says one expert.
Drew Meredith, a principal adviser at Wattle Partners, says the proposed 30% minimum CGT "changes the dividend playbook".
The Federal Government proposes to replace the 50% CGT discount with cost-base indexation and a minimum 30% CGT from 1 July 2027.
In an article on The Golden Times, Meredith says this has narrowed the long-standing tax advantage of capital growth over dividends.
The implication for portfolio construction is significant.
Fully franked dividends, taxed once inside the company at 30 per cent and refundable for the low-rate beneficiary, retain every tax advantage they had.
Capital gains, which previously qualified for the 50 per cent discount, lose meaningful ground.
The relative case for dividend-paying Australian shares has just strengthened.
Meredith said ASX dividend shares must pass five tests to make it into your portfolio.
Image source: Getty Images
1. High franking
Meredith points out that fully-franked dividends remain the most tax-efficient income that investors can receive.
He says the new hierarchy for ASX dividend shares is clear:
Fully franked first. Partially franked only if the underlying earnings justify it. Unfranked, almost never.
2. Sustainable payout ratio
Meredith defines a sustainable payout ratio as 60% to 80% of earnings.
Any higher than that, and a profit dip will usually force a dividend cut.
He says:
Commonwealth Bank of Australia (ASX: CBA)'s payout ratio sits around 75 per cent, fully covered.
Magellan Financial Group Ltd (ASX: MFG) paid out more than it earned for two consecutive years.
The difference shows up in the yield, and then in the cut.
3. Real earnings growth, not just dividend growth
Meredith says a growing dividend without growing earnings is a dividend "borrowed forward".
He advises investors to research an ASX dividend share's earnings per share (EPS) growth over five years.
If EPS has been flat or falling while the dividend has been growing, the gap will close. It always does.
Wesfarmers Ltd (ASX:WES) EPS has compounded at around 7 per cent a year for a decade. The dividend has followed.
Telstra Group Ltd (ASX: TLS)'s dividend was flat from 2018 to 2024 because EPS was flat. The dividend only started growing again when the earnings did.
4. A moat that survives AI
Businesses across the board are being reshaped by artificial intelligence (AI).
AI is raising productivity within many organisations, while also threatening to make some companies' services almost redundant.
This is why a company's moat — or competitive advantage — is now key when assessing an ASX dividend share's longevity.
Ask one question of each holding. If a competitor with access to a US$60 billion AI infrastructure budget wanted to enter this market tomorrow, how hard would it be?
The harder the answer, the safer the dividend, and the better the chance the share price compounds with the dividend rather than against it.
Meredith says examples of ASX dividend shares with strong moats include infrastructure owners and operators, regulated utilities, miners with low-cost reserves, banks with sticky deposits, and specialised manufacturers.
5. Dividend growth and trap detection
Meredith says a company's dividend growth trajectory matters much more than its dividend yield today.
This is especially the case for retirees with a 20-year drawdown on their superannuation or personal portfolios ahead of them.
He explains:
A 4 per cent yield growing at 7 per cent a year compounds into 7.9 per cent yield-on-cost inside 10 years.
A 7 per cent yield growing at zero stays at 7 per cent forever and loses ground to inflation.
Meredith says ASX dividend shares that are 'dividend traps' tend to have five characteristics: a payout ratio of 100% or more, declining earnings, a regulated revenue cap, a strained balance sheet, and a dividend yield well above its listed peers.
Three of those together and the trap is likely. Four, and it is confirmed.
Magellan Financial, Yancoal Ltd (ASX: YAL), AMP Ltd (ASX: AMP), Star Entertainment Group Ltd (ASX: SGR) and several of the listed property trusts have shown three or more of these signals over the past three years.
The yield was the bait. The cut was the trap.
Foolish Takeaway
Wattle Partners is a specialist in retirement wealth planning.
Meredith points out that pensioners are exempt from the proposed 30% minimum CGT tax rate.
For all other investors, Meredith offers a final word of advice:
The 30 per cent minimum CGT rate does not start until 1 July 2027 and may yet be modified during the legislative process.
The portfolio response is to plan now and shift gradually, not panic.
Check out the current trailing dividend yields for the top 10 ASX 200 shares by market capitalisation.
