October 29, 2012
The imminent closure of a tax loophole driving the so-called “dividend arbitrage” business in European equities will cut off a major source of ancillary revenues for the region’s ETF issuers, says Josh Galper, managing principal of Finadium LLC, a consulting firm.
Dividend tax arbitrage—moving equity holdings between different jurisdictions, often via securities lending or derivatives transactions, to capitalise on the different tax treatment of dividends in different countries—is a business worth up to €500 million a year, estimates Finadium. This sum is earned by institutions involved in the tax arbitrage business and is effectively lost to national treasuries.
Dividend arbitrage also constitutes around 40-45 percent of the securities lending revenues of large equity portfolios, including UCITS funds and ETFs, estimates Finadium. This percentage has risen in recent years, says the consultant, as other drivers of securities lending revenue, such as short-selling and mergers and acquisition activity, have fallen.
In a new report, “Regulation, Taxation and the Outlook for Lending in European Securities”, Finadium produces data showing that the volume of European equities on loan typically doubles in April and May each year, coinciding with the dividend payment season for many European companies, and a sign that tax arbitrage is driving lending activity.
A recent European Court of Justice judgement that ended France’s discriminatory tax treatment of non-resident funds owning French equities is likely to lead to the elimination of similar policies in Germany, Spain, Belgium and Poland, notes Finadium.
Before the ECJ’s ruling, France had taxed dividends accruing to domestic mutual funds at 0 percent, while taxing dividends accruing to non-resident owners of French equities at 25 percent. A classical tax arbitrage trade would therefore involve a foreign owner of a French equity lending it to a French institution over the dividend season (and thereby avoiding dividend taxation), with both parties sharing the resulting tax savings.
JOURNAL OF INDEXES EUROPE