Cross-Border Investing with Tax Arbitrage: The Case of German Dividend Tax Credits

German dividends typically carry a tax credit which makes thedividend worth 42.86% more to a taxable German shareholder thanto a tax-exempt or foreign shareholder. This results in a penaltyfor foreign investors who buy and hold German dividend-payingstocks. I document that, as a result of the credit, the ex-daydrop exceeds the dividend by more than one-half of the tax credit,and show that futures and option prices embed more than one-halfof the tax credit. The existence of the credit creates opportunitiesfor cross-border tax arbitrage—in which foreign holdersof German stock transfer the dividend to German shareholders—andimplies that it is tax efficient for foreign investors to holdderivatives rather than investing directly in German stocks.The empirical findings are consistent with costly tax arbitrageactivity by German investors, who face tax risk due to antiarbitragerules. Since dividend tax credits exist in many other countries,the findings are potentially of broad interest.     

Currency Denomination of Intercompany Debt and Multinational Taxes

For multinational companies (MNCs) with foreign subsidiaries, the currency denomination of intercompany debt can have important effects on both taxes and financial statements. This paper analyzes the choice between an intercompany loan denominated in the home currency and one denominated in the subsidiary's functional currency. Using U.S. rules for financial accounting and taxes, the author demonstrates the expected impact of the loan's currency denomination on the expected level and variability of an MNCs overall taxes in the case where it has excess foreign tax credits.
The author's analysis shows that the foreign currency loan denomination leads to lower expected tax if the foreign withholding tax rate on interest is higher than the parent's home income tax rate. At the same time, the parent currency denomination leads to lower expected taxes if the parent's home income tax rate is higher than the foreign withholding tax rate on interest. Moreover, if an MNCs excess foreign tax credits are attributable to the subsidiary, the foreign currency loan denomination leads to lower variability in overall taxes. But in cases where the excess foreign tax credits arise from other foreign operations, the parent currency denomination leads to lower variability of overall tax.     

Dividend valuation,trading and transactions costs: the 1997 partial abolition of dividend tax credit repayments

Although UK resident tax-exempt shareholders lost the right to repayment of tax credits on dividends paid by UK resident companies in July 1997, they could continue to receive tax credit repayments in respect of dividends received from Irish resident companies until December 1998. In July 1997 the rate of tax credit on Irish companies' dividends was 21%, and this was reduced to 11% in December 1997. We obtain insights into the incentives and behaviour of UK tax-exempt investors in response to these changes in the relative ‘tax attractiveness’ of investments in Irish resident companies. We find that only at its highest rate, 21%, was the level of dividend tax credit on Irish companies' dividends sufficient to induce changes in UK tax-exempt shareholders' investment strategies; and that the propensity for dividend capture by tax-exempt investors is heightened when the dividend tax credit yield is of the order of 0.8 or more and dividend yield is of the order of 2.6% or more.     

“You Can Enter but You Cannot Leave…”: U.S. Securities Markets and Foreign Firms

Although a number of prior papers have argued the benefits to foreign firms of cross‐listing their shares in the U.S., the number of foreign firms exiting U.S. capital markets has been increasing. This has occurred despite the difficulties foreign firms face in deregistering from the Securities and Exchange Commission (SEC). This paper examines the reasons underlying this trend. One of our main findings is that the passage of the Sarbanes‐Oxley Act has reduced the net benefits of a U.S. listing and registration, particularly for smaller foreign firms with lower trading volume and stronger insider control.     

Effects of investor tax heterogeneity on stock prices and trading behaviour around the ex-dividend day: the case of Australia

Using a sample of Australian stocks during the 1996–2014 period, this study examines how tax heterogeneity between domestic and foreign investors affects trading behaviour and stock prices around the ex-dividend day. Domestic investors prefer dividends and tend to buy stocks cum-dividend and sell them ex-dividend whereas foreign investors tend to trade in the opposite direction. Abnormal trading turnover increases with tax heterogeneity. Moreover, stocks with a larger domestic investor base are associated with a higher price drop-off ratio on the ex-dividend day and higher market value of franking credits. Overall, our findings support the dynamic dividend clientele hypothesis.     

Escape from New York: The market impact of loosening disclosure requirements

We examine the first significant deregulation of U.S. disclosure requirements since the passage of the 1933/1934 Exchange and Securities Acts: the 2007 Securities and Exchange Commission (SEC) Rule 12h-6. Rule 12h-6 has made it easier for foreign firms to deregister with the SEC and thereby terminate their U.S. disclosure obligations. We show that the market reacted negatively to the announcement by the SEC that firms from countries with weak disclosure and governance regimes could more easily opt out of the stringent U.S. reporting and legal environment. We also find that since the rule's passage, an unprecedented number of firms have deregistered, and these firms often had been previous targets of U.S. class action securities lawsuits or SEC enforcement actions. Our findings suggest that shareholders of non-U.S firms place significant value on U.S. securities regulations, especially when the home country investor protections are weak.     

Can a stock exchange improve corporate behavior? Evidence from firms' migration to premium listings in Brazil

Because Brazil's legal system lacked protection for minority shareholders and trading of Brazilian shares flowed to U.S. exchanges, in 2001 the São Paulo Stock Exchange, Bovespa, created three premium exchange listings that require more stringent shareholder protections. This paper examines the effects of a commitment to improved corporate disclosure and governance by firms' voluntary migration to these premium listings. Our analysis finds that a firm's migration brings positive abnormal returns to its shareholders, particularly when its shares did not have a prior cross-listing on a U.S. exchange and also when the firm chooses a premium listing with the highest standards. Migration to a premium listing also leads to a significant increase in the trading volume of non-voting shares. Firms that choose a premium listing tend to have growth opportunities that they finance with subsequent seasoned equity offerings. These results suggest that a premium listing is a mechanism for bonding to improved corporate behavior that can be less costly than cross-listing on a U.S. exchange.     

Changes to Income Trust Taxation in Canada: Investor Reaction and Dividend Clientele Theory

Abstract:  This paper explores the relationship between tax-induced dividend clientele theory and the recent changes to the taxation of income trusts in Canada. On October 31, 2006, the Canadian government announced the Tax Fairness Plan ( TFP ) calling for the elimination of the considerable tax advantage enjoyed by income trusts. Generally, distributions from income trusts are now taxed at rates comparable to those imposed on corporate dividends. We examine market reaction to the  TFP  to address three issues: first, whether the valuation effect of a dividend tax increase is consistent with the traditional or the new view of dividend taxation; secondly, whether the market reaction to tax increases has a differential impact on firm value that is related to the tax preferences of taxable, tax-exempt, and foreign investor tax clienteles; and thirdly, whether firms change their dividend policies in response to the preference of institutional investors (tax-based dividend policy effect) or whether institutional investors are sorting themselves across firms based on their dividend policies (investor sorting effect). Our results provide strong evidence as follows. First, the valuation effect in reaction to the  TFP  announcement is consistent with the traditional view of dividend taxation – i.e. that taxes on dividends reduce the net return to investors, increase the firm's cost of capital and lower the firm's ability to access capital markets, thereby discouraging investment and savings. Secondly, we saw that trusts with a larger percentage of their units held by tax-exempt, low-tax, and foreign investors had a higher decline in value when compared with trusts held mostly by ordinary taxable investors. These results support dividend tax clientele theory. Finally, we observed changes in institutional investor clienteles consistent with the investor sorting effect.     

Transparency and Tax Evasion: Evidence from the Foreign Account Tax Compliance Act (FATCA)

We examine how U.S. individuals respond to regulation intended to reduce offshore tax evasion. The Foreign Account Tax Compliance Act (FATCA) requires foreign financial institutions to report information to the U.S. government regarding U.S. account holders. We first document an average $7.8 billion to $15.3 billion decrease in equity foreign portfolio investment to the United States from tax-haven countries after FATCA implementation, consistent with a decrease in “round-tripping” investments attributable to U.S. investors’ offshore tax evasion. When testing total worldwide investment out of financial accounts in tax havens post-FATCA, we find an average decline of $56.6 billion to $78.0 billion. We next provide evidence of other important consequences of this regulation, including increased expatriations of U.S. citizens and greater investment in alternative assets not subject to FATCA reporting, such as residential real estate and artwork. Our study contributes to both the academic literature and policy analysis on regulation, tax evasion, and crime.     

Structuring a tax efficient international operation

International taxation is rapidly increasing in importance in the U.S. business environment. As a student preparing for a career in public accounting or industry, it is vital that you have familiarity with key international tax issues. In this case, you will participate in a detailed tax-planning exercise involving a multinational corporation that is restructuring its tax operations. In the process, you will be exposed to a wide-ranging array of real-world tax issues: tax theory, source of income, transfer pricing, foreign tax credits, the foreign earned income exclusion and Subpart F income. The case also incorporates questions designed to help you explore the financial accounting implications of tax planning. The case consists of three tax modules and each module emphasizes two to three specific tax issues. Two of the modules also contain a subset of tax-related financial accounting questions. To complete the case successfully, you will be required to understand basic international tax theory, to engage in the tax research process and to apply your theoretical knowledge in analyzing complex business scenarios.     

Innovation quality of firms with the research and development tax credit

This paper examines innovation quality of U.S. research tax credit users (i.e., firms with currently earned research tax credits). Prior literature reports that the research tax credit is effective in increasing research and development (R&D) expenditures and reducing managers’ myopic behavior. However, little is known about the real (or economic) effect of R&D tax credits, as most of these findings have been based on estimated R&D tax credits rather than actual R&D tax credits. Additionally, some researchers and the government still have concerns about the real effect of R&D tax credits by criticizing the ambiguity and complexity of the tax codes (IRC Section 41). Therefore, I use actual R&D tax credits identified in firms’ 10-K and state R&D tax credits as identification tests to reduce endogeneity issues. My results indicate that research generating R&D tax credits contributes to better innovation quality and higher return volatility but lower pre-tax profitability. Overall, these findings imply that enacting the R&D tax credit provisions would trigger better innovation.     

Impact of foreign operations on reported effective tax rates: interplay of foreign taxes, U.S. taxes and U.S. GAAP

Effective tax rates can have a significant effect on a firm’s cash flows and reported earnings. As the operations of U.S. companies become increasingly global in scope, an important issue is how their foreign operations impact their effective tax rates, and, in turn, their reported earnings. This study describes how foreign taxes, U.S. taxes, and U.S. accounting principles interact to determine the impact of foreign operations on a firm’s effective tax rate. This analysis will assist users of financial statements in assessing the quality of earnings, making interfirm comparisons, evaluating the performance of management, judging the risks of additional tax assessments, and predicting future effective tax rates.     

Short-Term External Debt and Foreign Exchange Rate Volatility in Emerging Economies: Evidence from the Korea Market

Abstract:

We empirically analyze the main determinants of foreign exchange rate (FX) volatility in emerging market economies using the data of Korea corporations and financial institutions. We find that short-term external debt is more important than trading volume of foreign investors in explaining FX volatility. Our results suggest that short-term debt-controlling measures, such as a tax levy on short-term borrowing, can be more effective in moderating FX volatility than can the measures affecting the trading volume, such as a Tobin tax.     

Multi-market trading in the Eurodollar futures market

On March 18, 2004, the London International Financial Futures and Options Exchange launched trading in Eurodollar futures contracts in an attempt to compete with a U.S. rival, the Chicago Mercantile Exchange. The Chicago Mercantile Exchange responded to the challenge by introducing several policy changes that aided the transfer of its trading volume in Eurodollar futures from open outcry to the electronic trading platform, Globex, thereby retaining its market share. We compare trading volume, effective spread, and price discovery in Eurodollar futures at the Chicago Mercantile Exchange before and after the London International Financial Futures and Options Exchange began trading the same contract. We find a general increase in trading volume on Globex beginning October 2003, way before the London International Financial Futures and Options Exchange launched its contract. Globex provides greater price discovery than open outcry during the entire time period under study. Our research thus supports the global trend of conversion of traditional open outcry systems into electronic exchanges.     

Using Financial Accounting Data to Examine the Effect of Foreign Operations Located in Tax Havens and Other Countries on U.S. Multinational Firms' Tax Rates

This paper investigates the effect tax havens and other foreign jurisdictions have on the income tax rates of multinational firms based in the United States. We develop a new regression methodology using financial accounting data to estimate the average worldwide, federal, and foreign tax rates on worldwide, federal, and foreign pretax book income for a large sample of U.S. firms with and without tax haven operations. We find that on average U.S. firms that disclosed material operations in at least one tax haven country have a worldwide tax burden on worldwide income that is approximately 1.5 percentage points lower than firms without operations in at least one tax haven country. Our results also show that U.S. firms face a 4.4% current federal tax rate on foreign income whether or not they have tax haven operations. Finally, we find that U.S. firms with operations in some tax haven countries have higher federal tax rates on foreign income than other firms. This result suggests that in some cases, tax haven operations may increase U.S. tax collections at the expense of foreign country tax collections.     

Effect of ownership,governance, and transparency on liquidity – Chilean evidence

Companies with relatively thin trading, a high concentration of insider ownership, and a privatized pension system characterize Chile’s Santiago Stock Exchange. Within this setting, we study the relationship between ownership concentration, corporate governance, and stock market liquidity. Our results suggest that board independence, corporate disclosure and outside monitoring by institutions help moderate the effects that insiders have on trading costs and liquidity. We also find that market makers with inventory reduce the informational component of trading costs. Finally, the trades of insiders provide price guidance to market makers, while traders employ a follow-the-insider strategy when transparency is low.     

R&D tax credits,technology spillovers,and firms' product convergence

Using a difference-in-differences (DiD) setting that leverages the staggered adoption of R&D tax credits across the U.S. states, we show that after a firm receives the tax credits, products of its peers become significantly more similar to the recipient firm. Such product convergence is particularly strong when peer firms face greater pressure from market participants to uphold short-term performances. We further show that the effect of R&D tax credits likely works through the increased technology spillovers, which motivate peers to imitate instead of differentiating. Accordingly, we show that peer firms shift their patent composition from breakthrough to incremental innovations following the R&D tax subsidy.     

Government intervention in the housing market: Who wins,who loses?

Many U.S. government policies aim to encourage homeownership. We use a general equilibrium model with heterogeneous agents to consider the effects of temporary homebuyer tax credits and the asymmetric tax treatment of owner-occupied and rental housing on prices, quantities, allocations, and welfare. The model suggests that homebuyer tax credits temporarily raise house prices and transaction volumes, but have negative effects on welfare. Removing the asymmetric tax treatment of owner-occupied and rental housing can generate welfare gains for a majority of agents across steady states, but welfare impacts are substantially more varied along the transitions between steady states.     

Taking the Long Way Home: U.S. Tax Evasion and Offshore Investments in U.S. Equity and Debt Markets

We empirically investigate one form of illegal investor‐level tax evasion and its effect on foreign portfolio investment. In particular, we examine a form of round‐tripping tax evasion in which U.S. individuals hide funds in entities located in offshore tax havens and then invest those funds in U.S. securities markets. Employing Becker's ( 1968 ) economic theory of crime, we identify the tax evasion component by examining how foreign portfolio investment varies with changes in the incentives to evade and the risks of detection. To our knowledge, this is the first empirical evidence of investor‐level tax evasion affecting cross‐border equity and debt investment.     

Transfer Pricing Practices and Regulatory Actions in the U.S. and U.K.: A Cross-Country Comparison and Analysis

With the continued globalization of world markets, transfer pricing has become one of the dominant sources of controversy in international taxation. Cross-country differences in transfer pricing practices and regulations present challenges to taxing authorities and multinational enterprises (MEs). In the last two decades, tax authorities in the United States (U.S.) and other countries have brought major court cases against MEs accused of underpayment of taxes through transfer pricing practices. This paper discusses transfer pricing practices, regulatory agencies, penalties related to violations, and proper documentation required in the U.S. and one of its major trading partners, the United Kingdom (U.K.). The paper also examines the acceptable valuation methods allowed as a surrogate for arm's-length transactions as established by the country's regulatory agency. Finally, the paper discusses the similarities and differences between the major court cases related to transfer pricing in the two countries.