Capital gains taxation and shareholder wealth in takeovers

Before December 1999, the capital gains of shareholders who sold their shares into Australian takeovers have been taxable irrespective of payment method. Subsequently, shareholders can elect to rollover capital gains in equity takeovers. We examine the effect of this change on the association between target shareholder capital gains and bidder and target firm shareholder wealth. The results indicate that prior to the regulatory change, cash consideration results in higher target shareholder returns for non‐taxation reasons. After the introduction of capital gains tax rollover relief, we find that target and acquiring firm shareholders earn lower returns when cash consideration is offered to shareholders with greater capital gains.     

Slowing Fossil Fuel Extraction: A Role for Taxation of Exports,Capital Gains and Interest Income

This paper develops a model of a growing open economy rich in non‐renewable resources, the extraction of which negatively impacts domestic productivity and whose sector competes with final production for capital. We analyse how tax rates on capital gains and interest income and the time trend of an export revenue tax rate could slow the extraction of resources for export. We find that taxing capital gains and interest income at the same rate and setting an export revenue tax rate to decline at the marginal social cost of extraction would defer extraction. An export revenue tax rate need not fall over time to curb depletion if capital gains are taxed at a lower rate than interest income, which is second best to taxing asset returns at the same rate when the resources sector competes for capital.     

Taxation of shareholder capital gains and the choice of payment method in takeovers

From December 1999, shareholders who disposed of shares in Australian takeovers in exchange for scrip could elect to defer capital gains taxation until the disposal of the shares received. We investigate payment method choice by acquiring firms before and after this regulatory change to assess whether target shareholder capital gains tax liabilities became an important factor considered in choosing the form of payment. The results show that, subsequent to the regulatory change, there is a significantly higher probability that equity will be offered as consideration where target shareholder capital gains are greater. This finding confirms the importance of shareholder level taxation in explaining corporate acquisition structure and adds to previous European and US evidence on factors associated with payment method choice in takeovers.     

Do active fund managers care about capital gains tax efficiency?

This study investigates the tax efficiency of actively managed equity funds by conducting a previously unaddressed natural experiment. Specifically, we examine whether asset sales were timed to take advantage of the introduction of a substantial discount to realized capital gains when the holding period was at least 1 year. Institutional equity fund management in Australia is principally focused on the pre-fee and pre-tax performance surveys of leading asset consultants. Given this industry setting, our study is important because tax efficiency is not accounted for directly in the reported performance numbers, and is thus opaque. We find that active fund managers overall have significantly increased the proportion of long-term capital gains realized after the change in taxation code, although there are significant variations across funds. We also find that active fund managers realize more long-term gains on both large capitalization and low volatility stocks.     

Fundamental Tax Reform in The Netherlands

The Netherlands has abolished the tax on actual personal capital income and has replaced it by a presumptive capital income tax, which is in fact a net wealth tax. This paper contrasts this wealth tax with a conventional realization-based capital gains tax, a retrospective capital gains tax with interest on the deferred tax, and a mark-to-market tax which taxes capital gains as they accrue. We conclude that the effective and neutral taxation of capital income can best be ensured through a combination of (a) a mark-to-market tax to capture the returns on easy-to-value financial products, and (b) a capital gains tax with interest to tax the returns on hard-to-value real estate and small businesses.     

Capital gains tax,supply‐driven trading and ownership structure: direct evidence of the lock‐in effect

This study investigates the effect of differential capital gains tax rates on investor trading and share prices in a unique market setting that facilitates the resolution of conflicting prior evidence of holding period tax incentives. In particular, we examine whether the concessionary tax treatment of long‐term capital gains increases the supply of shares that qualify for long‐term status, thereby causing downward price pressure. We find evidence of abnormal seller‐initiated trading following the 12‐month anniversary of listing for IPO firms that appreciate in price (‘winners’) and report no such evidence for firms that decline in price (‘losers’). Consistent with the tax concessions being greater for individual than institutional investors, we report that abnormal seller‐initiated trading is mitigated by higher levels of ownership by institutional investors. We also report limited evidence, for winners, of declining share prices upon qualifying for long‐term tax status.     

The Market Valuation of Cash Dividends and the Tax Differential Theory of Dividend Policy: A Case Revisited

One of the most controversial areas in finance concerns the relevance or irrelevance of dividend policy. Survey results reported by researchers indicate that corporate chief financial officers believe that dividend policy does affect stock prices. One factor that could cause dividend policy to matter is possible tax effects. However, although many maintain that tax treatment would favor low payout, Miller and Scholes argue that tax policy is irrelevant. The latest change in the tax code, which removed the lower capital gains tax rate, provides a unique opportunity to examine the relevance of tax policy alone. This study revisits the Citizens Utilities case, which was used by Long and Poterba. We conclude that the market for Citizens Utilities shares indicates that tax policy does influence value.     

Capital gains tax,managed funds and the value of dividends: The case of New Zealand

The taxation of capital gains for Managed Investment Funds in New Zealand was abolished in October 2007, putting these entities on a similar footing to private investors. Prior to this change most private investors were not taxed on capital gains from investments in New Zealand companies, whereas Managed Funds were taxed on these gains. New Zealand company dividends carry imputation tax credits and thus had a tax advantage for Managed Funds before October 2007. After the change the value of dividends relative to capital gains declined substantially for Managed Funds. The evidence is that the market value of the dividends, particularly for high dividends, also declined substantially subsequent to the tax change.     

Market Valuation of Tax-Timing Options: Evidence from Capital Gains Distributions

We examine a distribution that is taxed as a capital gain rather than as a dividend. Since the distribution induces a realized capital gain while the price change is an unrealized gain, ex‐day return behavior provides evidence of the value of tax‐timing capital gains. We show that investors are compensated 7¢ in unrealized gains for each dollar of realized capital gains, that is, $1 of realized capital gains is equivalent to 93¢ of unrealized gains. An investor with a tax rate on realized gains of 15% has an effective tax rate on unrealized capital gains of 8.6%.     

Payout Policy and Tax Deferral

Equilibrium in the standard finance model implies that value-maximizing firms make taxable equity payouts, even when deferral effectively allows complete tax escape. Since tax deferral and consumption deferral are inherently jointly supplied goods, an excess aggregate supply of future consumption would result if firms followed conventional wisdom and adopted low or zero payout policies to capture tax deferral benefits. The market provides incentives for firms to supply both taxable payouts and capital gains by overriding any tax deferral advantage, just as it provides incentives for equity financing by overriding the corporate tax advantage of debt in “Debt and Taxes.”     

FURTHER EVIDENCE ON DIVIDEND YIELDS AND THE EX-DIVIDEND DAY STOCK PRICE EFFECT

Ex-dividend day stock price behavior supports a tax clientele effect. This effect is still found after the Tax Reform Act of 1986. Results reflect an effective tax advantage for capital gains taxes payable at realization, versus dividend taxes due quarterly. Evidence also supports short-term trader participation in the ex-day phenomenon when the difference between dividend income and the ex-dividend-day price decrease exceeds transactions costs to trade. Results contradict prior research where a tax clientele effect is not found, but align with this prior research when including a small number of contaminated observations.     

How Big is the Tax Advantage to Debt?

This paper uses an option valuation model of the firm to answer the question, “What magnitude tax advantage to debt is consistent with the range of observed corporate debt ratios?” We incorporate into the model differential personal tax rates on capital gains and ordinary income. We conclude that variations in the magnitude of bankruptcy costs across firms can not by itself account for the simultaneous existence of levered and unlevered firms. When it is possible for the value of the underlying assets to jump discretely to zero, differences across firms in the probability of this jump can account for the simultaneous existence of levered and unlevered firms. Moreover, if the tax advantage to debt is small, the annual rate of return advantage offered by optimal leverage may be so small as to make the firm indifferent about debt policy over a wide range of debt-to-firm value ratios.     

Optimal tax-timing and asset allocation when tax rebates on capital losses are limited

This article studies the portfolio problem with realization-based capital gain taxation when limited amounts of losses qualify for tax rebate payments, as is the case under current US tax law. When the tax rate applicable to realized losses exceeds that on realized capital gains, it can be optimal to realize capital gains immediately and pay capital gain taxes to regain the option to use potential future losses against a higher tax rate. This incentive adds an entirely new and as yet unstudied dimension to the portfolio problem. It causes risk averse investors to hold more equity and attain higher welfare levels than is the case when trading under a tax system that seeks to collect the same amount of taxes, but does not allow for tax rebate payments. This is because the benefit to these investors from having their losses subsidized is greater than the suffering from having profits taxed at a higher rate.     

Neutral Taxation of Shareholder Income

A Norwegian tax reform committee recently proposed a personal tax on the realized income from shares after deduction for an imputed risk-free rate of return. This paper describes the design of the proposed shareholder income tax and shows that it will be neutral with respect to investment and financing decisions and decisions to realize capital gains, provided that full loss offsets are granted. Thus the tax allows some non-distortionary double taxation of corporate equity income. With an appropriate choice of tax rates, it also solves the problem of income shifting under a dual income tax. JEL Code: H24, H25     

Income Shifting in the Spanish Dual Income Tax*

Based on a model of behavioural response to taxes, and using the Taxpayers Panel from the Instituto de Estudios Fiscales for the period 1999–2009, we analyse whether the dual nature of the Spanish personal income tax (PIT), reinforced by the 2007 reform, has influenced taxpayers’ behaviour, causing them to convert part of their ‘general income’ (from labour, real estate or economic activities) into ‘savings income’ (from movable capital or capital gains). We also extend the analysis of income shifting and study whether Spanish taxpayers also responded to the different tax treatments given to the two types of savings income (from movable capital and capital gains) until 2007, transforming savings income from one type to the other. The results of our study demonstrate three facts. First, Spanish taxpayers did respond to the different tax rates, shifting income from the general base to different forms of savings, especially capital gains. The highest‐income individuals and the self‐employed and business owners are the groups where this behaviour was most marked. Second, the self‐employed and business owners also turned income from movable assets into capital gains, guided by their different tax rates. And third, we find signs of ‘anticipation’ and ‘learning’ effects caused by the 2007 tax reform. We believe that the results obtained will enrich the growing literature on income shifting.     

Shareholder Taxes in Acquisition Premiums: The Effect of Capital Gains Taxation

We exploit cross‐temporal differences in capital gains tax rates to test whether shareholder‐level capital gains taxes are associated with higher acquisition premiums for taxable acquisitions. We model acquisition premiums as a function of proxies for the capital gains taxes of target shareholders, taxability of the acquisition, and tax status of the price‐setting shareholder as represented by the level of target institutional ownership. Consistent with a lock‐in effect for acquisition premiums, results suggest a unique positive association between shareholder capital gains taxes for individual investors and acquisition premiums for taxable acquisitions, which is mitigated by target institutional ownership.     

Effects of Capital Gains Taxation on Life-Cycle Investment and Portfolio Management

We examine the impact of capital income taxation, both accrual forms of taxation and taxation of realized capital gains, on total savings and the demand for corporate financial instruments. We find that investors may hold both debt and equity in the face of effective collection of capital gains taxation even in a flat tax system. We also find that the two taxes will have substantially different effects on saving and consumption behavior, making it unlikely that the tax structure can be summarized by any single equivalent accrual tax rate.     

Cash dividends,stock dividends and subsequent earnings growth

This study examines the association between dividend payout ratios and subsequent earnings growth using a unique dataset on Taiwanese firms paying dual dividends. The practice of paying dual dividends, which is quite common in Taiwan, gives rise to a novel ‘balanced-dividend hypothesis’ to be addressed in this study. The main thrusts of the hypothesis are that high cash-dividend payouts may reduce agency costs, and that high stock-dividend payouts provide a signal of optimism. The empirical evidence shows that a significant positive association between dividend payout ratios and subsequent earnings growth exists only in the dual-dividend payouts sample. After further dividing the whole sample according to their cash-to-stock ratios, the significantly positive association between dual-dividend payouts and subsequent earnings growth is discernible only in the balanced-dividend sub-samples.     

Capital Gains Tax Overhang and Price Pressure

I study whether the capital gains tax is an impediment to selling by some investors and if so, to what degree associated delayed selling affects stock prices. I find that selling decisions by institutions serving tax‐sensitive clients are sensitive to cumulative capital gains, a pattern not observed for institutions with predominantly tax‐exempt clients. Moreover, tax‐related underselling impacts stock prices during large earnings surprises for stocks held primarily by tax‐sensitive investors. The corresponding price reactions are less negative (more positive) with higher cumulative capital gains. This price pressure pattern is more severe when arbitrage is more costly.