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Dividend stripping
Dividend stripping (also known as dividend arbitrage) is the practice of buying shares a short period before a dividend is declared, called cum-dividend, and then selling them when they go ex-dividend, when the previous owner is entitled to the dividend. On the day the company trades ex-dividend, theoretically the share price drops by the amount of the dividend.
This transaction may be done by an ordinary investor as an investment strategy, or used as a foundation for complex tax avoidance (such as cum-cum trading) or tax fraud (such as cum-ex trading) schemes by a company's owners or associates.
For an investor, dividend stripping provides dividend income, and a capital loss when the shares fall in value (in normal circumstances) on going ex-dividend. This may be profitable if income is greater than the loss, or if the tax treatment of the two gives an advantage.
Different tax circumstances of different investors is a factor. A tax advantage available to everyone would be expected to show up in the ex-dividend price fall. But an advantage available only to a limited set of investors might not.
In any case, the amount of profit on such a transaction is usually small, meaning that it may not be worthwhile after brokerage fees, the risk of holding shares overnight, the market spread, or possible slippage if the market lacks liquidity.
Dividend stripping can be used as a tax avoidance strategy, enabling a company to distribute profits to its owners as a capital sum, instead of a dividend, which offers tax benefits if the effective tax rate on capital gains is lower than for dividends. For example, consider a company called ProfCo wishing to distribute D, with the help of a stripper company called StripperCo.
The net effect for the owners is a capital gain of +D and a dividend distribution of -D. The net effect for StripperCo is nothing; the dividend it receives is income, and its loss on the share trading is a deduction. StripperCo might need to be in the business of share trading to get such a deduction (i.e. treating shares as merchandise instead of capital assets).
Many variations are possible:
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Dividend stripping
Dividend stripping (also known as dividend arbitrage) is the practice of buying shares a short period before a dividend is declared, called cum-dividend, and then selling them when they go ex-dividend, when the previous owner is entitled to the dividend. On the day the company trades ex-dividend, theoretically the share price drops by the amount of the dividend.
This transaction may be done by an ordinary investor as an investment strategy, or used as a foundation for complex tax avoidance (such as cum-cum trading) or tax fraud (such as cum-ex trading) schemes by a company's owners or associates.
For an investor, dividend stripping provides dividend income, and a capital loss when the shares fall in value (in normal circumstances) on going ex-dividend. This may be profitable if income is greater than the loss, or if the tax treatment of the two gives an advantage.
Different tax circumstances of different investors is a factor. A tax advantage available to everyone would be expected to show up in the ex-dividend price fall. But an advantage available only to a limited set of investors might not.
In any case, the amount of profit on such a transaction is usually small, meaning that it may not be worthwhile after brokerage fees, the risk of holding shares overnight, the market spread, or possible slippage if the market lacks liquidity.
Dividend stripping can be used as a tax avoidance strategy, enabling a company to distribute profits to its owners as a capital sum, instead of a dividend, which offers tax benefits if the effective tax rate on capital gains is lower than for dividends. For example, consider a company called ProfCo wishing to distribute D, with the help of a stripper company called StripperCo.
The net effect for the owners is a capital gain of +D and a dividend distribution of -D. The net effect for StripperCo is nothing; the dividend it receives is income, and its loss on the share trading is a deduction. StripperCo might need to be in the business of share trading to get such a deduction (i.e. treating shares as merchandise instead of capital assets).
Many variations are possible: