The Character and Determinants of Corporate Capital Gains

This paper analyzes how corporate capital gains taxes affect the capital gain realization decisions of firms. The paper outlines the tax treatment of corporate capital gains, the consequent incentives for firms with gains and losses, the efficiency consequences of these taxes in the context of other taxes and capital market distortions, and the response of firms to these incentives. Despite receiving limited attention, corporate capital gain realizations have averaged 30 percent of individual capital gain realizations over the last fifty years and have increased dramatically in importance over the last decade. By 1999, the ratio of net long-term capital gains to income subject to tax was 21 percent and was distributed across a variety of industries suggesting the importance of realization behavior to corporate financing decisions. Time-series analysis of aggregate realization behavior demonstrates that corporate capital gains taxes impact realization behavior significantly. Similarly, an analysis of firm-level investment and property, plant, and equipment (PPE) disposal decisions and gain recognition behavior similarly suggests an important role for these taxes in determining when firms raise money by disposing of assets and realizing gains.Capital gains; capital gains taxation; corporate taxation;

Capital Gains Taxes, Irreversible Investment, and Capital Structure.

This paper studies the corporate policy distortions caused by realization-based capital gains taxation at the personal level in a dynamic trade-off theory model. The Lock-in effect of embedded capital gains creates severe conflicts of interest between incumbent and new investors. The firm's optimal policy exhibits path-dependency and non-stationarity, since the taxe basis of the firm's owners is a valuable conditioning variable for corporate decisions. Ex-ante identical firms follow very different investment and financial policies depending on their stock price evolution. Firms delay irreversible investment further the lower tax basis of their owners falls. The reason is the investment hedge provided by personal tax loss offsets weakens as investors reset their basis. Capital gains taxation also creates incentives to time equitzy issues. Firms employ more equity in their capital structure the higher the stock price-to-basis ratio, since locked-in investors with out-of-the-money tax timing options value the firm less than the market. The value gain from conditioning on the owner's tax basis is substantial. Using simulated data I show the combined effects are consistent with recent empirical evidence on the relation between leverage, Tobin's Q, and past performance.Capital Gains Taxation, Real Options, Capital Structure, Trade-off Theory, Market Timing.

Hold or sell? How capital gains taxation affects holding decisions

Investments with exit flexibility require decisions regarding both the investment and holding period. Because selling an investment often leads to taxable capital gains, which crucially depend on the duration of an investment, we investigate the impact of capital gains taxation on exit timing under different tax systems. We observed that capital gains taxation delays exit decisions but loses its decision relevance for very long holdings. Often the optimal exit time, which indicates the maximal present value of future cashflows, cannot be determined analytically. However, we identify the breakeven exit time that guarantees present values exceeding those of an immediate sale. While, after-taxes, an immediate sale is often optimal, long holding periods might also be attractive for investors depending on the degree of income and corporate tax integration. A classic corporate tax system often indicates holdings over more than 100 periods. By contrast, a shareholder relief system indicates the earliest breakeven exit time and thus the highest level of exit timing flexibility. Surprisingly, high retention rates are likely to accelerate sales under a classic corporate system. Additionally, the worst exit time, which should be avoided by investors, differs tremendously across tax systems. For an integrated tax system with full imputation, the worst time is reached earlier than under partial or non-integrated systems. These results could help to predict investors' behavior regarding changes in capital gains taxation and thus are of interest for both investors and tax policymakers. Furthermore, the results emphasize the need to control for the underlying tax system in cross-country empirical studies. (authors' abstract)Series: WU International Taxation Research Paper Serie

Demystifying Income Trusts

Income trusts are one of the major investment vehicles for Canadians with an estimated 2004 market capitalization of $118.7 billion. This study aims to outline the nature of income trusts and the standing of trusts in the current financial environment. To that end, the study offers an overview of income trusts, discusses tax implications in a corporate, income trust and mutual fund structures, and reflects on recently proposed increase the dividend tax credit. The analysis shows that two most unique features of income trusts are their tax treatment and the high yield cash distributions. The recently proposed increase of the dividend tax credit may reduce the tax on dividends for a top earner and bring it in line with the current effective capital gains tax. However, these changes may be unevenly distributed across provinces and may distort investment decisions as different parts of the country react differently to different types of investment opportunities.income trusts, mutual funds, investment decisions, rating practices, dividend tax credit, capital gains tax, taxation

Capital gains taxation under different tax regimes

This paper investigates the influence of different systems of current income and capital gains taxation on investor's decision to either carry out an investment in corporate shares or to invest funds alternatively on the capital market. Three basic tax systems are analyzed, a classical corporate tax system with double taxation of profits on corporate and personal level, a shareholder relief system, that reduces double taxation completely. It can be shown that general analytical solutions for the investment problem for different categories of tax regimes, even under certainty, cannot be derived. Applying a growth model, we find under rather restrictive assumptions that the shareholder relief system invokes more severe distortions than the full imputation system. Trying to prove this in a more realistic setting with uncertainty we employ Monte Carlo Simulation for random rates of return and random income tax rates. In many cases, the degree of tax-induced uncertainty is significantly lower under a shareholder relied system than under full imputation. Furthermore, it can be shown that under uncertainty full imputation causes more severe distortions than shareholder relief whenever personal income tax rates are low. In light of international tax competition this is an important result as a reduction of tax rates is taking place or is likely to take place in several countries. Furthermore, the simulation clarifies the trade-off of the opposing effects, i.e. tax and interest rate effects, and the overwhelming impact of capital gains taxation. Apart from tax parameters, we identify the dividend rate and the point in time of selling the shares as important value drivers

The Start-Up and Growth Stages in Enterprise Formation: The “New View” of Dividend Taxation Reconsidered

Early-stage uncertainty makes the initial cost of capital greater than the expansion-stage one. Tax effects on enterprise formation, entrepreneurial effort and quality, and on capital costs are derived. For an incorporated enterprise (i) the entrepreneur’s ability threshold rises with the tax rate of the corporate form, (ii) the initial cost of capital due to a dividend tax is above the old view double-tax one, (iii) the start-up investment is not affected by undervaluation, but the discouragement engendered by dividend taxation is compensated by realization-based capital gains tax, (iv) with undervaluation, the expansion-stage cost of capital corresponds to the Johansson-Samuelson tax which is lower than the new view suggests, (v) without undervaluation, the dividend tax boosts expansion investment.taxation of start-up enterprises

Taxation and Ownership Structure in Supplying Foreign Markets

We examine the impact of taxation on foreign direct investment (FDI) flows. Previous research has focused on the impact of the corporate income taxes on aggregate FDI flows. We contribute in the relevant literature in three areas. First, the flows of FDI are classified in two categories according to parent company’s share of ownership of its foreign subsidiary receiving the FDI flow: FDI to majority owned (MOS) and to minority owned subsidiaries (MIS). Second, three different taxation schemes in the host country are considered: the corporate income taxes, the capital gains taxes and the dividend withholding taxes. Third, we study the interactive impact of multiple taxations on FDI flows. Our empirical results indicate that both individually and interactively, the three tax rates have a strong and statistically significant impact on FDI flows to MOS and a much weaker impact on FDI flows to MIS.

Economic Integration and Redistributive Taxation: A Simple Model with Ambiguous Results

The rise in foreign direct investment and the increasing activity of multinational firms expose national corporate tax bases to cross-country profit shifting, but also lead to rising profitability of the corporate sector. We incorporate these two effects of economic integration into a simple political economy model where the median voter decides on a redistributive income tax rate. In this setting economic integration may raise or lower the equilibrium tax rate, depending on whether the higher excess burden of the tax or the larger redistributive gains from the perspective of the representative worker are the dominant effect. Our simple model holds several implications for future empirical work on the relationship between globalization and the effective rate of capital taxation.redistributive taxation, multinational firms, profit shifting

The Start-Up and Growth Stages in Enterprise Formation : The "New View" of Dividend Taxation Reconsidered

Early-stage uncertainty makes the initial cost of capital greater than the expansion-stage one. Tax effects on enterprise formation, entrepreneurial effort and quality, and on capital costs are derived. For an incorporated enterprise (i) the entrepreneur's ability threshold rises with the tax rate of the corporate form, (ii) the initial cost of capital due to a dividend tax is above the old view double-tax one, (iii) the start-up investment is not affected by undervaluation, but the discouragement engendered by dividend taxation is compensated by realization-based capital gains tax, (iv) with undervaluation, the expansion-stage cost of capital corresponds to the Johansson-Samuelson tax which is lower than the new view suggests, (v) without undervaluation, the dividend tax boosts expansion investment