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Cross-Border Investing with Tax Arbitrage: the Case of German Dividend Tax Credits, Review of Financial Studies

Abstract

German dividends typically carry a tax credit which makes the dividend worth 42.86% more to a taxable German shareholder than to a tax-exempt or foreign shareholder. As a result of the credit, the ex-dividend-day share price drop exceeds the amount of the dividend. I document that the ex-day drop reflects approximately one-half of the tax credit, and show that futures and option prices embed approximately one-half of the tax credit. The existence of the tax credit creates possibilities for cross-border tax arbitrage and also has implications for market integration, market efficiency, tax policy, and tax-efficient foreign investment. In particular, it is tax-efficient for foreign investors to hold DAX index futures rather than investing directly in the DAX cash index.

Type

Article

Author(s)

Robert L. McDonald

Date Published

2001

Citations

McDonald, L. Robert. 2001. Cross-Border Investing with Tax Arbitrage: the Case of German Dividend Tax Credits. Review of Financial Studies. 14(3): 617-657.

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