Dividend Tax Credits, the Ex-Day, and Cross-Border Tax Arbitrage: The Case of Germany
Robert L. McDonald, Northwestern University

German dividends typically carry a tax credit which makes the dividend worth 42.86% more to a taxable German shareholder than to a tax-exempt or foreign shareholder. Bob shows that, as a result of the credit, the ex-day drop exceeds the dividend by more than one-half of the tax credit, and that futures and option prices embed more than one-half of the tax credit. These findings are consistent with costly tax arbitrage activity by German investors, who face tax risk due to anti-arbitrage rules. The existence of the credit creates opportunities for cross-border tax arbitrage and implies it is tax-efficient for foreign investors to hold derivatives rather than investing directly in German stocks. (Accepted Late Spring 1999.)