Valuation Effects of Recent Corporate Dividend and Income Trust Distribution Tax Changes

By Amoako-Adu, Ben; Smith, Brian F | Canadian Journal of Administrative Sciences, March 2008 | Go to article overview

Valuation Effects of Recent Corporate Dividend and Income Trust Distribution Tax Changes


Amoako-Adu, Ben; Smith, Brian F, Canadian Journal of Administrative Sciences


Abstract

We analyze the valuation effects of the Canadian federal government's announcement on November 23, 2005 of a reduction in the taxation of corporate dividends and the announcement on October 31, 2006 of a plan to eliminate the tax-deductibility of income trust distributions. Though high dividend stocks and income trusts reacted positively to the 2005 announcement, the abnormal returns were greater for income trusts. Conversely, both securities reacted negatively to the 2006 announcement with the decline bigger for income trusts. The larger price reactions of income trusts and the lack of statistical significance in the cross-sectional tests of the abnormal returns suggest that the popularity of income trusts in Canada was mostly driven by their favourable income tax status. The implications of these findings for scholarship and for practice are discussed.

Copyright © 2008 ASAC. Published by John Wiley & Sons, Ltd.

JEL Classifications: G14, H24, H25

Keywords: income trust, dividend yield, tax changes, announcement, valuation

Résumé

Cette étude analyse les effets des annonces faites par le gouvernement fédéral le 23 novembre 2005 et le 31 octobre 2006 et portant respectivement sur la réduction de l'imposition des dividendes des sociétés et sur un plan d'élimination de la déductibilité fiscale des répartitions de fiducies de revenu. Les résultats indiquent que les actions bénéficiaires élevées et les fiducies de revenu ont réagi positivement à l'annonce de 2005, et négativement à l'annonce de 2006. Par ailleurs, en 2005, les rendements anormaux étaient plus élevés pour les fiducies de revenu, et plus bas en 2006. Les grandes ripostes par les prix des fiducies de revenu et le manque de signification statistique dans les tests transversaux des rendements anormaux suggèrent que le succès des fiducies de revenu au Canada était surtout dû à leur statut fiscal favorable. L'étude s'achève par un examen de ses implications théoriques et pratiques. Copyright © 2008 ASAC. Published by John Wiley & Sons, Ltd.

Mots-clés : fiducie de revenu, rendement des actions, modification fiscale, annonce, valeur

(ProQuest: ... denotes formulae omitted.)

Since the mid-1990s, the favourable taxation of income trusts in Canada has been cited as a key factor in both their popularity and controversy.1 These flow-through entities were attractive financing and investment vehicles as they substantially reduced the combined amount of income tax that would otherwise have been paid by businesses and their owners. However, because of the potential loss of tax revenue, the proliferation of income trust conversions and IPOs in recent years has been a source of concern for the Canadian Federal government.2 As a result, within a period of one year, two successive Canadian Federal governments announced two diametrically opposing income tax policies. On November 23, 2005 the Federal Finance Minister, Ralph Goodale, announced a policy to substantially lower the personal tax on corporate dividends to a level resembling that of income trust distributions. However, this policy left unchanged the tax advantage of income trusts for both foreign investors and non-tax paying entities such as registered retirement savings plans (RRSPs) and pension plans. A year later on October 31, 2006, the new federal Conservative government Finance Minister, Jim Flaherty, addressed this disparity. He announced a plan to eliminate the tax-deductibility of income trust distributions (except those of Real Estate Investment Trusts - REITs) to equalize the total tax treatment between income trust distributions and corporate dividends for all investors.

The objective of this empirical research is to evaluate the valuation effects of the recent tax changes on income trusts and high dividend yield stocks. First, it is important to isolate the effects of changes in taxation as market observers and academics have attributed the popularity of income trusts in part to the reduction in taxes and in part to a number of non-tax factors. …

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