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Dividend Taxation: the Implications for Cross Border Investments and A Dividend Taxation: The Implications for Cross-Border Investments and a Search for the Optimal Investment Route Martijn N.A. Vennik Department of Economics University of Amsterdam Master’s Thesis (15 ects) ID number: 9933077 Supervised by: Prof. Dr. J.A. McCahery (UvA) 2nd Examiner: Prof. Dr. S.J.G. Van Wijnbergen (UvA) F. Van Deth (Oyens & Van Eeghen) Hand-in final version: 18 May 2007 CONFIDENTIAL This paper has been made by order of Oyens & Van Eeghen Wholesale Brokerage. Please handle this document carefully. Oyens & Van Eeghen N.V. WTC, H-Tower, 15th floor Zuidplein 124 1077 XV Amsterdam PO Box 79089 1070 NC Amsterdam The Netherlands Phone: +31(0)20 514 16 16 Fax: +31(0)20 638 84 80 E-mail: [email protected] Internet: www.oyens.com - 2 - Dividend Taxation: The Implications for Cross-Border Investments and a Search for the Optimal Investment Route Abstract The European Union (EU) strongly tends to uniformity, even in taxation legislation. In 2006 the European Commission (EC) has urged six EU-countries, including the Netherlands, to change their dividend rules. According to the EC these EU-countries tax dividend payments to foreign investors more heavily than dividend payments to national investors. The Dutch government responded to the unequal treatment of home and foreign shareholders of companies incorporated in the Netherlands by introducing a new taxation legislation 2007. This development is a first step towards a uniform EU dividend taxation system. Meanwhile, the market opportunities are not being used optimally as a consequence of the differences in rules and taxation between countries. The main issue in this survey is the search for an optimal investment route concerning the differences in international dividend taxation and whether this will be profitable. The analysis puts emphasis on the foreign institutional investors who invest in Dutch corporations. Keywords: Dividend Taxation, International Investments, Government Policy and Regulation, Brokerage JEL codes: F32, F51, G18, K34 - 3 - Contents SUMMARY - 6 - 1. INTRODUCTION - 7 - 2. THE DUTCH DIVIDEND TAXATION LEGISLATION - 12 - 2.1 DIVIDEND WITHHOLDING TAX ACT 1965 - 12 - 2.1.1 THE LEGISLATION - 12 - 2.1.2 TRANSITION TO NEW LEGISLATIVE REGIME - 13 - 2.1.3 CALCULATING AND DISTRIBUTING THE DIVIDEND - 14 - 2.2 UPDATING THE REGIME: THE DIVIDEND TAXATION LAW 2007 - 16 - 3. THE INTERNATIONAL DIVIDEND TAXATION - 19 - 3.1 THE EU-COUNTRIES - 20 - 3.1.1 BELGIAN DIVIDEND TAXATION - 21 - 3.1.1.1 THE BASICS - 21 - 3.1.1.2 BILATERAL TREATY WITH THE NETHERLANDS - 22 - 3.1.1.3 EXEMPTIONS - 22 - 3.1.1.3.1 THE PARTICIPATION EXEMPTION - 23 - 3.1.1.3.2 THE VVPR-STRIP - 24 - 3.1.2 FRENCH DIVIDEND TAXATION - 24 - 3.1.2.1 THE BASICS - 24 - 3.1.2.1.1 FRENCH RESIDENT SHAREHOLDERS - 25 - 3.1.2.1.2 NON-RESIDENT RECIPIENTS - 26 - 3.1.2.2 BILATERAL TREATY WITH THE NETHERLANDS - 26 - 3.1.3 GERMAN DIVIDEND TAXATION - 27 - 3.1.3.1 THE BASICS - 27 - 3.1.3.2 BILATERAL TREATY WITH THE NETHERLANDS - 28 - 3.1.4 DIVIDEND TAXATION IN THE UNITED KINGDOM (UK) - 29 - 3.1.4.1 THE BASICS - 29 - 3.1.4.2 BILATERAL TREATY WITH THE NETHERLANDS - 30 - 3.1.4.3 EXEMPTIONS - 31 - 3.1.5 DIVIDEND TAXATION IN LUXEMBOURG - 31 - 3.1.5.1 THE BASICS - 32 - 3.1.5.2 BILATERAL TREATY WITH THE NETHERLANDS - 32 - 3.1.5.3 A SPECIAL CASE; THE ‘HOLDING’ COMPANY LAW - 33 - 3.2 EU DIVIDEND TAXATION RULES - 34 - 3.2.1 EU CORPORATE DIVIDEND TAXATION RULES - 34 - 3.2.2 EU DIVIDEND TAXATION RULES OF INDIVIDUALS - 37 - 3.3 THE NON EU-COUNTRIES: SWITZERLAND AND THE UNITED STATES - 39 - 3.3.1 SWITZERLAND - 40 - 3.3.1.1 THE BASICS - 40 - 3.3.1.2 BILATERAL TREATY WITH THE NETHERLANDS - 40 - 3.3.1.3 A SPECIAL CASE; THE SWISS HOLDING COMPANY - 41 - 3.3.2 THE UNITED STATES - 44 - 3.3.2.1 THE BASICS - 44 - 3.3.2.2 BILATERAL TREATY WITH THE NETHERLANDS - 45 - - 4 - 4. A LEGAL FRAMEWORK TOWARDS OPTIMALITY - 48 - 4.1 CROSS-BORDER DIVIDEND WITHHOLDING RATES - 49 - 4.2 THE STRATEGY - 54 - 4.2.1 A CASE STUDY - 54 - 4.2.2 DIVIDEND STRIPPING AS A TAX AVOIDANCE - 55 - 4.2.2.1 FORMS OF DIVIDEND STRIPPING - 56 - 4.2.2.2 STATUTORY REGULATIONS AGAINST DIVIDEND STRIPPING - 57 - 4.2.2.3 SOLUTION TO AVOID ANTI-DIVIDEND STRIPPING MEASURES - 59 - 4.3 THE STRUCTURE; DIVIDENDS AND DERIVATIVES - 60 - 4.3.1 AEX-INDEX FUTURE SWAP - 60 - 4.3.2 SALE / REPO OR LENDING? - 62 - 5. CONCLUSIONS AND RECOMMENDATIONS - 64 - REFERENCES - 66 - ADDITIONAL LITERATURE - 67 - - 5 - Summary Recent developments in the international dividend taxation legislation show changes in the taxation of dividends on cross-border investments. Especially the European Court of Justice has made some important judgments in this context. On national level, the Netherlands has adjusted its taxation legislation to international standards as well by reducing the dividend withholding rate from 25% to 15% since 1 January 2007. Although the international dividend taxation legislation tends towards uniformity, there are still major arbitrage opportunities to investors. The international taxation legislation practices strict rulings concerning cross-border transactions, but there are opportunities for investors to avoid dividend withholding though. Low tax jurisdictions i.e. already provide advantages for certain types of investors to either reduce or avoid dividend tax. The paper searches for an optimal investment route by reducing or avoiding dividend tax for cross-border investors. Cross-border transactions in combination with derivative hedging shows there are arbitrage possibilities to investors by covering the share lending with derivatives. In contrast with selling and repurchasing shares, lending is inexpensive, does not affect exposure to the stock and is not a taxable event. In the long run, however, dividend tax will be possibly reduced to zero because of conflicting international rules in dividend taxation legislation. Still, many countries discriminate foreign investors by levying a higher dividend withholding. Instead, domestic investors face lower dividend withholding rates. According to European Law, this conflicts with the free movement of capital. In consequence, international barriers will be removed to avoid double taxation on cross-border investments. It is important to note that dividend taxation is subject to continuous changes in legislation, meaning that the advantageous dynamic feature of avoiding dividend taxation can be disadvantageous as well. Governmental regulations play an important role in this matter incase any arbitrage opportunity exists. Then, laws will be updated and less arbitrage opportunities will be upheld for investors. - 6 - 1. Introduction The Netherlands has a relatively small-scale but very open economy. It has always recognized that the tax system should not impede the international expansion of business. Consequently, the Dutch tax system has many features that make the Netherlands an attractive location for businesses operating on an international scale. Examples include the tax treatment of business profits, the participation exemption, the large number of tax conventions to which the Netherlands is a signatory and the absence of withholding taxes. The dividend tax is an exemption, however. A dividend is a taxable payment declared by a company’s board of directors and approved by shareholders, which is distributed to shareholders of record out of the company’s retained earnings, usually on a quarterly basis. Dividends supply investors with an incentive to own stock in stable companies even if they are not experiencing significant growth. Clearly, companies are not required to pay dividends. However, the companies that typically offer dividends are companies that have progressed beyond the initial growth phase, and no longer benefit sufficiently by reinvesting their profits, and consequently choose to pay them out in order to attract new investors. A high dividend payout is important for investors because dividends provide certainty about the company’s well being. Dividends are also attractive for investors looking to secure current income. Also, there are many examples of how changes in dividend distributions can affect the price of a security. Companies that have a long-standing history of dividend payouts would be negatively affected by lowering or omitting dividend distributions. Conversely, these companies would be positively affected by increasing dividend payouts. Furthermore, - 7 - companies without a dividend history are generally viewed favourably when they declare new dividends. Double taxation of dividends is a major concern for investors. For some scholars, there are few justifications for allowing home country taxation of dividends since the company has already been taxed. The most important reason for justification is the fact that a legal persona and legal entity are required to pay tax when their income in terms of dividends increases. In particular, a company must pay corporation tax and a shareholder is compelled for payment of the dividend tax. In this respect, the company is obliged to deduct the dividend tax from the total dividend payout to the shareholders. In the international context, the existence of dividend taxation is more practical than fundamental. The taxation of company dividends paid to foreign institutional investors is not easily justified because in principal, foreign income of dividends needs to be paid to the foreign government. However, like many other governments, the Dutch government justifies its taxation of dividends paid to foreign investors on the basis of the non-reinvestment of Dutch profits into the Dutch economy. Since other countries tax dividends, the Dutch government taxes dividend as well in order to maintain its competitive negotiating power vis- à-vis third counterparts. We can see the importance of remaining competitive as the expected total dividend tax income for the Dutch government in 2007 amounts to 2.8 billion Euro, which covers 1.78% of the total governmental income tax in 2007 (Ministerie van Financiën, 2006).
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