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Dividend stripping is the practice of buying
shares In financial markets, a share is a unit of equity ownership in the capital stock of a corporation, and can refer to units of mutual funds, limited partnerships, and real estate investment trusts. Share capital refers to all of the shares of an ...
a short period before a
dividend A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re-in ...
is declared, called cum-dividend, and then selling them when they go
ex-dividend The ex-dividend date, also known as the reinvestment date, is an investment term involving the timing of payment of dividends on stocks of corporations, income trusts, and other financial holdings, both publicly and privately held. The ex-date o ...
, when the previous owner is entitled to the dividend. On the day the company trades ex-dividend, theoretically the share price drops by the amount of the dividend. This may be done either by an ordinary investor as an
investment Investment is the dedication of money to purchase of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort. In finance, the purpose of investing is ...
strategy, or by a company's owners or associates as a
tax avoidance Tax avoidance is the legal usage of the tax regime in a single territory to one's own advantage to reduce the amount of tax that is payable by means that are within the law. A tax shelter is one type of tax avoidance, and tax havens are jurisdict ...
strategy.


Investors

For an investor, dividend stripping provides dividend
income Income is the consumption and saving opportunity gained by an entity within a specified timeframe, which is generally expressed in monetary terms. Income is difficult to define conceptually and the definition may be different across fields. For ...
, and a
capital loss Capital loss is the difference between a lower selling price and a higher purchase price or cost price of an eligible Capital asset, which typically represents a financial loss for the seller. This is distinct from losses from selling goods below ...
when the shares fall in value (in normal circumstances) on going ex-dividend. This may be profitable if income is greater than the loss, or if the
tax A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity) by a governmental organization in order to fund government spending and various public expenditures (regional, local, or n ...
treatment of the two gives an advantage. Different tax circumstances of different investors is a factor. A tax advantage available to everyone would be expected to show up in the ex-dividend price fall. But an advantage available only to a limited set of investors might not. In any case, the amount of profit on such a transaction is usually small, meaning that it may not be worthwhile after brokerage fees, the risk of holding shares overnight, the market spread, or possible slippage if the market lacks
liquidity Liquidity is a concept in economics involving the convertibility of assets and obligations. It can include: * Market liquidity, the ease with which an asset can be sold * Accounting liquidity, the ability to meet cash obligations when due * Liqu ...
.


Tax avoidance

Dividend stripping or cum-ex trading can be used as a
tax avoidance Tax avoidance is the legal usage of the tax regime in a single territory to one's own advantage to reduce the amount of tax that is payable by means that are within the law. A tax shelter is one type of tax avoidance, and tax havens are jurisdict ...
strategy, enabling a company to distribute profits to its owners as a capital sum, instead of a dividend, which offers tax benefits if the effective tax rate on capital gains is lower than for dividends. For example, consider a company called ProfCo wishing to distribute D, with the help of a stripper company called StripperCo. : 1. StripperCo buys ProfCo shares from their present owners for X+D. : 2. ProfCo, now owned by StripperCo, declares a dividend of D, which is paid to StripperCo. : 3. StripperCo sells its shares back to the owners for X. The net effect for the owners is a capital gain of +D and a dividend distribution of -D. The net effect for StripperCo is nothing; the dividend it receives is income, and its loss on the share trading is a deduction. StripperCo might need to be in the business of share trading to get such a deduction (i.e. treating shares as merchandise instead of capital assets). Many variations are possible: * StripperCo might buy different "class B" shares in ProfCo for just the D amount, not the whole of ProfCo. * Such class B shares could have their rights changed by ProfCo, rendering them worthless, instead of StripperCo selling them back. * ProfCo might lend money to StripperCo for the transaction, instead of the latter needing bridging finance. The tax treatment for each party in an exercise like this will vary from country to country. The operation may well be caught at some point by tax laws, and/or provide no benefit.


Australia

In Australia, ordinary external investors are free to buy shares cum-dividend and sell them
ex-dividend The ex-dividend date, also known as the reinvestment date, is an investment term involving the timing of payment of dividends on stocks of corporations, income trusts, and other financial holdings, both publicly and privately held. The ex-date o ...
, and treat the dividend income and
capital loss Capital loss is the difference between a lower selling price and a higher purchase price or cost price of an eligible Capital asset, which typically represents a financial loss for the seller. This is distinct from losses from selling goods below ...
the same as for any other investment. But schemes involving a deliberate arrangement by a company's owners to avoid tax are addressed by anti-avoidance provisions of Part IVA the
Income Tax Assessment Act 1936 The ''Income Tax Assessment Act 1936'' (Cth) is an Act of the Parliament of Australia. It is one of the main statutes under which income tax is calculated. The Act is gradually being rewritten into the Income Tax Assessment Act 1997, and new ma ...
.


Investors

Dividend stripping by investors has the general advantages or disadvantages described above, but in addition in Australia there are franking credits attached to
dividend A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re-in ...
s under the
dividend imputation Dividend imputation is a corporate tax system in which some or all of the tax paid by a company may be attributed, or imputed, to the shareholders by way of a tax credit to reduce the income tax payable on a distribution. In comparison to the c ...
system. Those credits can only be used by eligible investors (see the
dividend imputation Dividend imputation is a corporate tax system in which some or all of the tax paid by a company may be attributed, or imputed, to the shareholders by way of a tax credit to reduce the income tax payable on a distribution. In comparison to the c ...
article), so there's a tension between different investors for the amount shares should fall when going ex-dividend. A rationally priced drop for one group is a bonus or trading opportunity for the other. But the difference is not large. In a franked dividend, each $0.70 cash has $0.30 of franking attached (at the 30% company tax rate for 2005). To eligible investors it's worth $1.00, to others it's worth only $0.70 (of before-tax income in both cases). A typical half-yearly dividend (in 2005) of 2% of the share price would mean an extra 0.85% in franking credits, an amount which might easily be swamped by brokerage and the general risks noted above.


Tax avoidance

The kind of dividend stripping
tax avoidance Tax avoidance is the legal usage of the tax regime in a single territory to one's own advantage to reduce the amount of tax that is payable by means that are within the law. A tax shelter is one type of tax avoidance, and tax havens are jurisdict ...
schemes described above presently fall under anti-avoidance provisions of the Income Tax Assessment Act part IVA amendments introduced in 1981. Part IVA is a set of general anti-avoidance measures addressing schemes with a dominant purpose of creating a tax benefit. Section 177E specifically covers dividend stripping. That section exists to avoid any difficulty that might arise from identifying exactly where a tax benefit arises in dividend stripping. Dividend stripping will generally result in money to owners being taxed as dividends, irrespective of interposed steps. Section 177E also applies to related schemes which draw off profits from a company, benefitting its owners, not just to the formal payment of a dividend. For example, * The stripper receiving a non-recoverable loan, instead of a dividend from the target company. * The stripper selling a worthless asset to the company. * Owners (without a separate stripper) selling a part interest in an asset to the company, but later changing the terms to reduce its value. Losses in the company for such related schemes may be recognised immediately in its accounts, or only booked progressively over future years, the latter being various "forward stripping" schemes. Both are caught by section 177E.


Sources

* Income Tax Assessment Act 1936, Part IVA (inserted 1981

in particular section 177

And the explanatory memorandu

*
Australian Taxation Office The Australian Taxation Office (ATO) is an Australian statutory agency and the principal revenue collection body for the Australian Government. The ATO has responsibility for administering the Australian federal taxation system, superannuation ...
taxation determination TD 95/37 (1995

*
Australian Taxation Office The Australian Taxation Office (ATO) is an Australian statutory agency and the principal revenue collection body for the Australian Government. The ATO has responsibility for administering the Australian federal taxation system, superannuation ...
taxpayer alert TA 2004/3 (2004


United States

In the
United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country primarily located in North America. It consists of 50 states, a federal district, five major unincorporated territo ...
, dividends may qualify for a lower rate. However, among other things, the stock must be owned for more than 60 days out of a 121-day period around the ex-dividend date.


See also

*
Asset stripping Asset stripping is a term used to refer to the practice of selling off a company's assets in order to improve returns for equity investors. In many cases where the term is used, a financial investor, referred to as a 'corporate raider', takes con ...
* The
CumEx-Files The CumEx-Files is an investigation by a number of European news media outlets into a tax fraud scheme discovered by them in 2017. A network of banks, stock traders, and lawyers had obtained billions from European treasuries through suspected f ...
are a 2018 investigative report that made public a decade long dividend stripping tax-avoidance scheme in which several European countries incurred tax loss damages totaling more than 60 billion Euros


References

{{stock market Stripping Tax avoidance