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Tax and Corporate Actions
Types of Tax
When it comes to Corporate Actions events there are two generic types of Taxes involved:
1) Income tax
Income tax is tax that needs to be paid on any form of income, i.e. dividend payments, interest payments among others. For example if a shareholder holds 100 shares that each pay out a GROSS dividend of EUR 0.50 then a percentage needs to be paid in tax.
2) Capital Gains Tax
Capital Gains Tax is tax that needs to be paid over any gains in capital, in other words; tax needs to be paid over the difference in the price at which securities are sold and the price at which they were bought. For example: if an investor buys 10 shares of EUR 100 each and he sells them a while later for EUR 110 each, then he needs to pay a percentage of tax over the difference (110-100=10).
Global Custody and Tax
Today's globalised financial markets add an extra dimension to taxes in relation to corporate actions events because tax rules of more than one country can be applicable per event.
Take for example an English investor who holds securities in the Netherlands via his english global custodian. Let's say he holds 500 shares of Kon. Philips N.V. and the dividend payment has been announced as 0.40 per share, whereas current tax rates are 20% in the Netherlands. (figures are for example purposes only).
What will happen in the event of the dividend payment, is the following:
* Company (Kon Philips N.V.) pays out (500 shares x EUR 0.40) = EUR 200 Gross
* Foreign Witholding Tax (as a form of income tax in the country where the issuer is domiciled) will be deducted at source in the Netherlands: (20% of 200) = EUR 40. This will, depending on the country of the issuing company, be deducted at source or to be paid by the beneficial shareholder.
* In case of deduction at source, the company will pay the net dividend of EUR 160 to the global custodian, who in turn will pay the net dividend to the shareholder. The global custodian will also send a tax voucher to the shareholder as a prove that tax was deducted in the Netherlands.
* The shareholder will then have to establish how much tax needs to be paid in his own country of domicile in the example in England. Let's say that he is high earner and therefore falls in the 40% income tax bracket. In that case he will have to pay (EUR 160 x 40%) = EUR 64 to the UK tax authorities. The payment in EUR will somehow have to be converted to GBP, for which rates and value dates have to be established.
* The total net payment the shareholder would receive is therefore (EUR 200 - EUR 40 - EUR 64) = EUR 96.
In the above example the shareholder is paying tax twice: in the Netherlands and in England. This is not very attractive and in order to stimulate cross-border investments, many countries have signed so called "Double Taxation Treaties" with eachother.
Let's say that the English and the Dutch tax authorities have agreed a Double Taxation Treaty in which English investors who hold dutch stock and who normally would fall in the 40% income tax bracket under English tax law, are being made exempt of their 40% tax obligation, but will have to pay a 10% income tax rate instead. In that case the shareholder has to pay (EUR 160 x 10%) = EUR 16 to the English Tax Authorities and the total net proceeds he would receive would be (EUR 200 - EUR 40 - EUR 16) = EUR 144.
The challenge for the investors and market players in the securities industry is to apply all the rates in all Double Taxation treaties that were signed between all countries. And moreso, to keep track of all the changes as those treaties keep being revised and re-negotiated on a regular basis.
Corporate Actions Events and Tax
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