{"id":1854,"date":"2008-02-28T14:22:04","date_gmt":"2008-02-28T18:22:04","guid":{"rendered":"http:\/\/www.prefblog.com\/?p=1854"},"modified":"2008-02-28T14:22:04","modified_gmt":"2008-02-28T18:22:04","slug":"dividend-taxation-changes","status":"publish","type":"post","link":"https:\/\/prefblog.com\/?p=1854","title":{"rendered":"Dividend Taxation Changes"},"content":{"rendered":"

Rob Carrick had a column in the Globe today<\/a> that examines the effect of the recently announced changes in dividend taxation:<\/p>\n

Still, there are going to be cases where investors pay more tax without the offsetting benefit of a higher dividend. Preferred shares are one example, while another is the shares of companies that maintain a steady dividend.<\/p>\n

Since the dividend tax credit was enhanced a couple of years ago, dividends have in many cases been the most tax-efficient form of investment income (we’re talking here about so-called eligible dividends, or those typically paid by large corporations). Mr. Mida said dividend income may lose this distinction to capital gains, but not by a big margin.<\/p>\n

The status quo will hold in dividend taxation until 2010, when a three-year phased adjustment begins.<\/p><\/blockquote>\n

Mr. Carrick’s source for the figures used in his report appear to be those of Price Waterhouse<\/a>:<\/p>\n

<\/div>\n

These are different from the Ernst & Young figures<\/a> that I normally use<\/a>. Presumably, the two accounting houses have used different assumptions regarding what constitutes a ‘base-case average taxpayer’. Not a big deal … it would be nice to know just precisely what the differences are, but we can’t have everything for free.<\/p>\n

Enough! Let’s do some work here! Using Mr. Carrick’s published figures and assuming no change in the marginal rate charged on income:<\/p>\n

\n\n\n\n\n\n\n\n\n
Projected Taxation Factors<\/td>\n<\/tr>\n
Year<\/td>\nIncome<\/td>\nDividend<\/td>\nEquivalency Factor<\/td>\n<\/tr>\n
2008<\/td>\n46.41%<\/td>\n23.96%<\/td>\n1.419<\/td>\n<\/tr>\n
2009<\/td>\n46.41%<\/td>\n23.06%<\/td>\n1.436<\/td>\n<\/tr>\n
2010<\/td>\n46.41%<\/td>\n24.56%<\/td>\n1.408<\/td>\n<\/tr>\n
2011<\/td>\n46.41%<\/td>\n27.59%<\/td>\n1.351<\/td>\n<\/tr>\n
2012<\/td>\n46.41%<\/td>\n30.19%<\/td>\n1.303<\/td>\n<\/tr>\n<\/table>\n<\/div>\n

So … the estimate is that the equivalency factor is going to revert to approximately what it was in the nineties<\/a>.<\/p>\n

Before we take the next step, let’s emphasize to ourselves that these are estimates, approximations and forecasts! In the first place, accountancy firms can’t even agree with each other on what the top marginal rates are, such is the idiotic and increasing complexity of the Income Tax Act. In the second place, a five year\u00a0forecast of something political like tax rates is going to be even more subject to error than a five-year\u00a0forecast of investment returns … at least when you perform the latter operation, you can assume that at least a tiny minority of the players have functioning brain cells!<\/p>\n

So. This is an estimate. Do with it what you will.<\/p>\n

\n\n\n\n\n\n\n\n\n
Estimated Effect of Tax Changes
\nOn Perpetual Discounts<\/td>\n<\/tr>\n
Year<\/td>\nEquivalency Factor<\/td>\nChange in
\nSpread if
\nPrices Constant<\/td>\n		Change in
\nPrice if
\nSpread Constant<\/td>\n<\/tr>\n
2008<\/td>\n1.419<\/td>\n0<\/td>\n0<\/td>\n<\/tr>\n
2009<\/td>\n1.436<\/td>\n+9bp<\/td>\n+1.33%<\/td>\n<\/tr>\n
2010<\/td>\n1.408<\/td>\n-6bp<\/td>\n-0.89%<\/td>\n<\/tr>\n
2011<\/td>\n1.351<\/td>\n-37bp<\/td>\n-5.48%<\/td>\n<\/tr>\n
2012<\/td>\n1.303<\/td>\n-63bp<\/td>\n-9.34%<\/td>\n<\/tr>\n<\/table>\n<\/div>\n

Note on calculation: I use base case figures for 2008 of a PerpetualDiscount yield of 5.39% and a long corporate yield of 5.90%. At the 2008 equivalency factor of 1.419, the current interest-equivalent on PerpetualDiscounts (IE Spread)\u00a0is 7.65%; the current spread to long corporates is therefore 175bp.<\/p>\n

Figuring out the change in IE Spreads is easy – multiply today’s yield by tomorrow’s equivalency factor to get tomorrow’s estimated IE Yield; subtract the (constant) corporate yield to get tomorrow’s IE Spread; subtract today’s IE Spread to get the change.<\/p>\n

To estimate the effect on price if the IE Spread is constant, I multiply the change in IE spreads by 14.82, which is the modified duration of the PerpetualDsicount index. Thus, for year 2012, the change in price (from now) is 0.63 x 14.82 = 9.34. To check this … let us assume we have a $100 pref yielding 5.39% at the moment … therefore, it pays $5.39 p.a. If the price drops by 9.34%, the new price will be $90.66; and the yield will change to (5.39 \/ 90.66) = 5.95%. The Interest Equivalency Factor is 1.303, so this yield will be equivalent to 7.75% interest. We were hoping to get 7.65%, but 10bp difference is due to convexity effects (the modified duration will decrease as the price decreases; modified duration is, strictly speaking, applicable only to infinitesimally small changes in price … and a 9.34% drop is not “infinitesimal”). Additionally,\u00a0the extremely precise modified duration of 14.82 is calculated using HIMIPref\u2122’s limitMaturity<\/a>, which assumes a maturity at the current price in thirty years. This is not strictly accurate in itself and is not consistent with the use of Current Yield as an approximation of YieldToWorst. So a 10bp error isn’t bad!<\/p>\n

Update, 2008-2-29<\/b>: This post updates Federal Budget – Effect on Prefs<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"

Rob Carrick had a column in the Globe today that examines the effect of the recently announced changes in dividend taxation: Still, there are going to be cases where investors pay more tax without the …<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[30],"tags":[],"class_list":["post-1854","post","type-post","status-publish","format-standard","hentry","category-taxation"],"_links":{"self":[{"href":"https:\/\/prefblog.com\/index.php?rest_route=\/wp\/v2\/posts\/1854","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/prefblog.com\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/prefblog.com\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/prefblog.com\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/prefblog.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=1854"}],"version-history":[{"count":0,"href":"https:\/\/prefblog.com\/index.php?rest_route=\/wp\/v2\/posts\/1854\/revisions"}],"wp:attachment":[{"href":"https:\/\/prefblog.com\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=1854"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/prefblog.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=1854"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/prefblog.com\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=1854"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}