Summary
Although UK resident tax-exempt shareholders lost the right to repayment of tax credits on dividends paid by UK resident companies in July 1997, they could continue to receive tax credit repayments in respect of dividends received from Irish resident companies until December 1998. In July 1997 the rate of tax credit on Irish companies' dividends was 21%, and this was reduced to 11% in December 1997. We obtain insights into the incentives and behaviour of UK tax-exempt investors in response to these changes in the relative 'tax attractiveness' of investments in Irish resident companies. We find that only at its highest rate, 21%, was the level of dividend tax credit on Irish companies' dividends sufficient to induce changes in UK tax-exempt shareholders' investment strategies; and that the propensity for dividend capture by tax-exempt investors is heightened when the dividend tax credit yield is of the order of 0.8% or more and dividend yield is of the order of 2.6% or more.
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Extract
Dividend Valuation, Trading and Transactions Costs: The 1997 Partial Abolition of Dividend Tax Credit Repayments
(ProQuest-CSA LLC: ... denotes formulae omitted.)
1. IntroductionThe payment of dividends represents an important, predictable interaction between companies and shareholders. Numerous effects or 'non-effects' have been attributed to dividend policy. Modigliani and Miller (1961) demonstrate that, under certain market assumptions, firm value is independent of dividend policy, though unanticipated changes can impose tax and adjustment costs on shareholders. Conversely, in a setting characterised by information asymmetry between managers and shareholders, dividend policy can increase firm value by reducing agency costs (Rozeff, 1982) and revealing managers' inside information to the capital markets (Ross, 1977). Other value relevant effects have been attributed to differential investor level marginal tax rates as between dividend income and realised gains, and to tick size, settlement costs, uncertainty in ex-dividend prices and market microstructure. These effects are not wholly mutually exclusive and, therefore, one or more of them can interfere with and confound attempts to examine in isolation any other. For example, a hypothesised tax-induced effect may not occur due to the existence of transactions costs. Alternatively, the culmination of a number of tax changes may be sufficient to outweigh the transactions costs. Thus care is needed to avoid spurious empirical detection and overstatement of the value of one of the changes.In a market valuation context, investor level tax considerations are only important when they impose costs or benefits on the 'price setting' or marginal shareholder and, therefore, influence their pricing decisions. This paper investigates a change in the dividend-related cash flows accruing to tax-exempt institutional investors. In the UK, institutional investors dominate the London Stock Exchange (LSE) in terms of the volume and value of shares owned and traded; and, more importantly, tax-exempt institutional investors dominate in terms of price setting (Bell and Jenkinson, 2002).The UK Finance (No.2) Act 1997 abolished the right of UK resident tax-exempt shareholders (predominantly UK pension funds and UK insurance company tax-exempt pension businesses - hereafter referred to as 'TEPIC investors') to claim r...See the full content of this document
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