Abstract
This paper explores withholding-tax non-compliance in the context of dividend taxation. It focuses on a specific type of stock-market transactions around ex-dividend dates, so-called “cum-ex” trades, which caused considerable revenue losses due to illegitimate tax refunds in Germany and other countries. We use a stylized model of the stock-market equilibrium to analyze the incentives of traders on the German stock market and find that cum-ex trades are only profitable for both buyer and seller in the presence of collusive tax fraud. Our empirical analysis of market data for publicly traded German stocks from 2009 to 2015 confirms that transaction numbers of stocks suitable for cum-ex trades show the expected increase shortly before ex-dividend dates in the period before the tax refunding was reformed. In line with the collusion hypothesis, effects on stock-market prices are not found.
Highlights
Withholding taxes are a key instrument to ensure tax enforcement
As we show in this paper, in a stock-market equilibrium characterized by elimination of arbitrage opportunities for German institutional investors, cum-ex trades are only profitable for both buyer and seller if they collude in tax non-compliance
Responsible for these losses are so-called cum-ex trades of stocks around ex-dividend dates, which under certain conditions lead to refundable tax credits for dividend taxes that have not been remitted
Summary
Withholding taxes are a key instrument to ensure tax enforcement. taxation of dividends strongly relies on withholding taxes. If the second explanation holds, despite already tight regulation and supervision of financial markets, tax authorities would need to take further action to make collusion of non-compliant traders more difficult Against this background, this paper explores withholding-tax non-compliance involving illegitimate tax refunds in the context of dividend taxation. In accordance with the collusion hypothesis, the empirical results indicate that market-price effects are absent They confirm higher trading volumes shortly before the ex-dividend date in publicly available transaction data. Whereas the literature has discussed various reasons for abnormal trading volumes around ex-dividend dates (e.g., Lakonishok and Vermaelen 1986; Karpoff and Walkling 1990; Michaely and Vila 1995; Dhaliwal and Li 2006; Akhmedov and Jakob 2010; Haesner and Schanz 2013; Hartzmark and Solomon 2013; Henry and Koski 2017), our paper shows that withholding-tax non-compliance offers a further explanation.
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