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Article
Publication date: 13 November 2017

António Martins

In Portugal, between 1989 and 2010, capital gains from corporate shares were exempted, while gains from other instruments, like limited liability companies (LLC) equity…

Abstract

Purpose

In Portugal, between 1989 and 2010, capital gains from corporate shares were exempted, while gains from other instruments, like limited liability companies (LLC) equity stakes, were taxed. Inevitably, this non-neutral tax treatment originated a notorious tax arbitrage, consisting in the transformation of the legal status of a LLC into a corporation, the subsequent share sale and tax exemption. In tax litigation, many arbitration rulings were delivered, with widely divergent decisions. The purpose of this paper, using a blend of the legal research method and case analysis, is to discuss three research questions. Should the general anti-abuse clause (GAAC) be applied to this tax planning operation? Why the divergence in arbitration rulings? Is this anomalous arbitration outcome because of the wording the GAAC and its complexity or, contrarily, does it emerge from the disconnection between the set of rules governing capital gains taxation and the legislative intent that is behind such rules?

Design/methodology/approach

The methodology used in this paper is based on a mix of the legal research method and case analysis. In the case of legal research, a hermeneutic approach – meaning that documents, texts and their interpretation can produce important fruits to the development of the field – is a tested and fruitful approach. Besides being a hermeneutic discipline, it is an argumentative one. By exposing arguments that confirm or deny particular solutions, legal research (e.g. in criminal, business or administrative law) can influence better legislative choices by political actors. Advantages of case analysis include lessons learned from observation. The author discusses if the application of the GAAC to an arrangement that originated a tax exemption can be validated by the usual interpretative lines that doctrine sustains should be observed when a GAAC is used to void legal schemes. The pros and cons of tax arbitration are also highlighted.

Findings

The conclusion of this paper is that the GAAC is not the crux of the problem. Instead, a contradictory or, at least, disconnected relation between the expressed intent of legislators and the wording of capital gains tax clauses is, in our view, the main reason for such divergent arbitration rulings on the same issue.

Practical implications

The author believes that the paper is a contribution to the literature, given the global use of anti-abuse clauses and the interpretative complexities they originate. Moreover, the analysis in this paper is carried out in a legal setting where a disconnection is detectable between the expressed legislative intent and the legal drafting of personal income tax rules related to the exemption of capital gains. Studying the complexity added by this feature of the Portuguese legislation serves as a reminder of the importance of careful and well-crafted wording to achieve consistent court outcomes.

Originality/value

The paper has value to governments, tax authorities and tax managers, given the ever-increasing use of anti-abuse clauses in many countries, and the potential use of arbitration in similar settings.

Details

International Journal of Law and Management, vol. 59 no. 6
Type: Research Article
ISSN: 1754-243X

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Article
Publication date: 1 February 2000

Alvin Cheng, Keith Hooper and Howard Davey

This paper discusses the designing of a capital gains tax for New Zealand. The essential question is not why such a system is needed but what type of system should be…

Abstract

This paper discusses the designing of a capital gains tax for New Zealand. The essential question is not why such a system is needed but what type of system should be implemented. The paper ignores the political discussion of whether such a tax is necessary and concentrates on design and implementation issues. Drawing from other tax jurisdictions, chiefly the United Kingdom and Australia, this article discusses the merits of tapering relief; indexation (now frozen in Australia); specific exemptions (e.g. owner occupied property); and of re‐defining capital assets into discrete categories which may be treated differently. The aim of the study is to open up the issue of capital gains for informed discussion: how such a tax should be administered, and the possibilities and likely difficulties involved in implementing such a tax.

Details

Asian Review of Accounting, vol. 8 no. 2
Type: Research Article
ISSN: 1321-7348

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Article
Publication date: 1 February 2005

Horn‐Chern Lin and Tao Zeng

This paper provides evidence suggesting capital gains tax affects stock returns and trading volume. The Canadian federal government budget of May 23, 1985 provided…

Abstract

This paper provides evidence suggesting capital gains tax affects stock returns and trading volume. The Canadian federal government budget of May 23, 1985 provided individual taxpayers with a cumulative tax exemption for capital gains, up to a lifetime limit of $500,000. The empirical results, using daily stock return and trading volume data from the Toronto Stock Exchange, show that stock prices decreased three days before the announcement of the lifetime capital gains exemption. The empirical results also show that stock trading volume increased two days and four days before the announcement and five days following the announcement. These results are consistent with the argument that the capital gains tax constrained some individual shareholders from selling appreciated shares (often called “lock‐in effect”).

Details

Review of Accounting and Finance, vol. 4 no. 2
Type: Research Article
ISSN: 1475-7702

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Article
Publication date: 6 July 2010

Jeff Whitworth and Yi Zhang

The purpose of this paper is to show how recent capital gains affect ex‐dividend stock pricing. Traditional models assume that investors are motivated to sell a stock…

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1102

Abstract

Purpose

The purpose of this paper is to show how recent capital gains affect ex‐dividend stock pricing. Traditional models assume that investors are motivated to sell a stock before its ex‐date to avoid paying higher taxes on dividends. However, if a stock has appreciated significantly, stockholders have an offsetting incentive to delay the realization of capital gains by continuing to hold the stock in spite of the higher dividend tax rate.

Design/methodology/approach

This paper develops a model showing that ex‐dividend price drops should be greater in the presence of larger accrued capital gains. The model was tested by regressing ex‐day pricing measures on the relative size of the recently accrued gain, along with other control variables.

Findings

Empirical tests confirm that accrued gains reduce the magnitude of the ex‐day effect, increasing the price drop ratio (ΔP/D) and reducing ex‐day returns. Also documented was that ex‐day price drops are larger for stocks that have recently experienced positive gains, that the observed effect of recent price performance is stronger for higher‐yield stocks, and that share turnover is usually lower for stocks with greater gains.

Research limitations/implications

This paper's findings suggest that the results of existing empirical investigations of ex‐day pricing should be interpreted with some caution, and that future studies should control for gains that occur prior to the ex‐date.

Originality/value

While the tax clientele explanation of ex‐day pricing has been investigated extensively, this is the first study to show how accrued gains and losses impact ex‐dividend price changes.

Details

Managerial Finance, vol. 36 no. 8
Type: Research Article
ISSN: 0307-4358

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Article
Publication date: 14 June 2011

Richard M. Hervey

The purpose of this paper is to explain the Regulated Investment Company Modernization Act of 2010, P.L. 111‐325, signed into law on December 22, 2010.

Abstract

Purpose

The purpose of this paper is to explain the Regulated Investment Company Modernization Act of 2010, P.L. 111‐325, signed into law on December 22, 2010.

Design/methodology/approach

The paper summarizes the Act and provides a detailed explanation and analysis of each of the provisions in the Act.

Findings

An investment company registered under the Investment Company Act of 1940 may elect to be taxed as a Regulated Investment Company (RIC) under the Internal Revenue Code. A RIC that satisfies certain additional minimum distribution requirements is generally allowed to deduct the amount of dividends paid to its shareholders in computing the RIC's taxable income and gains, with the result that the RIC's distributed net income and gains can be passed through to its shareholders free of tax at the RIC level. The Act makes a number of changes to the provisions in the Code related to RICs.

Originality/value

The paper provides practical guidance from experienced financial services lawyers.

Details

Journal of Investment Compliance, vol. 12 no. 2
Type: Research Article
ISSN: 1528-5812

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Book part
Publication date: 4 December 2012

Stephen L. Liedtka and Nandkumar Nayar

The current and widespread view in option trading is that early exercise of call options is suboptimal unless there are large dividend payments on the underlying stock…

Abstract

The current and widespread view in option trading is that early exercise of call options is suboptimal unless there are large dividend payments on the underlying stock (e.g., Finucane, 1997; Hull, J. C. (2008). Options, futures and other derivatives (7th ed.). Upper Saddle River, NJ: Prentice Hall; Poteshman & Serbin (2003)). Our study substantially refines this view by demonstrating that U.S. tax rules governing capital gain holding periods can create incentives for early exercise under certain conditions. Hence, this study adds to the factors that investors likely consider when making option exercise decisions. We further note that recent research documents early exercises in the absence of large dividends, and refers to these option exercises as “clearly irrational.” Predictions of early exercise from our tax-based model are consistent with the observed patterns of early exercise, suggesting that the criteria for denoting an option exercise as “irrational” should be refined to incorporate capital gain holding periods.

Details

Advances in Taxation
Type: Book
ISBN: 978-1-78052-593-8

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Book part
Publication date: 21 August 2019

Peter Huaiyu Chen, Sheen X. Liu and Chunchi Wu

Current US tax laws provide investors an incentive to time the sales of their bonds to minimize tax liability. This gives rise to a tax-timing option that affects bond…

Abstract

Current US tax laws provide investors an incentive to time the sales of their bonds to minimize tax liability. This gives rise to a tax-timing option that affects bond value. In reality, corporate bond investors’ tax-timing strategy is complicated by risk of default. Existing term structure models have ignored the effect of the tax-timing option, and how much corporate bond value is due to the tax-timing option is unknown. In this chapter, we assess the effects of taxes and stochastic interest rates on the timing option value and equilibrium price of corporate bonds by considering discount and premium amortization, multiple trading dates, transaction costs, and changes in the level and volatility of interest rates. We find that the value of the tax-timing option accounts for a substantial proportion of corporate bond price even when interest rate volatility is low. Ignoring the timing option value results in overestimation of credit spread, and underestimation of default probability and the marginal investor’s income tax rate. These estimation biases generally increase with bond maturity and credit risk.

Details

Advances in Pacific Basin Business, Economics and Finance
Type: Book
ISBN: 978-1-78973-285-6

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Article
Publication date: 13 March 2009

Mason Gaffney

A tax based on land value is in many ways ideal, but many economists dismiss it by assuming it could not raise enough revenue. Standard sources of data omit much of the…

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3925

Abstract

Purpose

A tax based on land value is in many ways ideal, but many economists dismiss it by assuming it could not raise enough revenue. Standard sources of data omit much of the potential tax base, and undervalue what they do measure. The purpose of this paper is to present more comprehensive and accurate measures of land rents and values, and several modes of raising revenues from them besides the conventional property tax.

Design/methodology/approach

The paper identifies 16 elements of land's taxable capacity that received authorities either trivialize or omit. These 16 elements come in four groups.

Findings

In Group A, Elements 1‐4 correct for the downward bias in standard sources. In Group B, Elements 5‐10 broaden the concepts of land and rent beyond the conventional narrow perception, while Elements 11‐12 estimate rents to be gained by abating other kinds of taxes. In Group C, Elements 13‐14 explain how using the land tax, since it has no excess burden, uncaps feasible tax rates. In Group D, Elements 15‐16 define some moot possibilities that may warrant further exploration.

Originality/value

This paper shows how previous estimates of rent and land values have been narrowly limited to a fraction of the whole, thus giving a false impression that the tax capacity is low. The paper adds 14 elements to the traditional narrow “single tax” base, plus two moot elements advanced for future consideration. Any one of these 16 elements indicates a much higher land tax base than economists commonly recognize today. Taken together they are overwhelming, and cast an entirely new light on this subject.

Details

International Journal of Social Economics, vol. 36 no. 4
Type: Research Article
ISSN: 0306-8293

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Article
Publication date: 24 May 2013

António Martins

The purpose of this paper is to analyze how share buybacks can be, in Portuguese small privately held firms, a source of tax‐based conflicts between shareholders and tax

Abstract

Purpose

The purpose of this paper is to analyze how share buybacks can be, in Portuguese small privately held firms, a source of tax‐based conflicts between shareholders and tax administrations. Two issues are of particular relevance: the favored tax treatment of capital gains relative to dividends, and the use of valuation formulae to compute prices used in such transactions. The paper intends to present some advice to firms and consultants regarding equity valuation in privately held firms, to avoid tax based litigation. An extended analysis of the issue and its relevance to other jurisdictions is also presented.

Design/methodology/approach

The paper is based on a conceptual discussion of the usual approach taken by the Portuguese tax authorities to challenge share buybacks in small, privately held, firms. The arm's length principle in transfer pricing rules is the cornerstone of the topic analysed. The paper compares the merits of alternative pricing basis, and shows the economic and legal problems that each alternative presents.

Findings

The paper finds that the lack of tax neutrality between dividends and capital gains in Portugal can induce tax motivated transactions in small firms. The tax administration try to challenge these transactions on transfer pricing grounds. The alternative valuation strategy used by tax authorities is flawed, and puts the taxpayers in a good litigation position. However, a sensible valuation put forward by the firm can avoid such legal battles, which consume time and other resources of small owners.

Practical implications

The owners of privately held firms and the tax authorities should use valuation methods in very sensible terms. Cash flow valuation rests on several assumptions. These assumptions should not be used to produce prices that are easily questioned and increase litigation between firms and taxpayers.

Originality/value

The paper can be a source of practical advice for small business owners and advisors, as far as share transactions and share valuation are concerned. It is useful not only for the Portuguese managers and tax authorities, but also for any country where taxation of dividends and capital gains induces tax motivated buybacks.

Details

Journal of Applied Accounting Research, vol. 14 no. 1
Type: Research Article
ISSN: 0967-5426

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Article
Publication date: 1 April 2007

L. Olivier

Despite the South African legislature’s intention to introduce capital gains tax (CGT) as a simple and clear tax, it is an extremely complex tax. Several provisions of…

Abstract

Despite the South African legislature’s intention to introduce capital gains tax (CGT) as a simple and clear tax, it is an extremely complex tax. Several provisions of both the Eighth Schedule to the Income Tax Act 58 of 1962 and the Act itself have to be taken into account in determining whether a taxable capital gain or an assessed capital loss has arisen during the year of assessment. The application of these principles is often surrounded by uncertainty. Hence, the purpose of this article is not only to provide an overview of some of the different provisions that have to be taken into account and the interaction between them, but also to highlight some of the problems arising from the application of the principles themselves.

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