Abstract

This paper studies the after-tax valuation of convertible bonds in the light of Europe's participation exemption (PEX) rules and International Financial Reporting Standards (IFRS). The focus is on Italy's representative case. PEX rules exempt from company taxation capital gains realized by companies selling stocks. PEX rules raise the value of convertibles as investor companies can strategically convert the bond into stock to enjoy PEX. Historical cost-based national accounting standards imply taxation upon realization and valuable tax timing options (TTOs). ‘Fair value’ based IFRS entail mark-to-market taxation, which ‘kills’ TTOs, but investor companies can convert the bond early in order to enjoy PEX. Early conversion can be valuable.

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