{"id":9558,"date":"2010-01-29T11:49:19","date_gmt":"2010-01-29T15:49:19","guid":{"rendered":"http:\/\/www.prefblog.com\/?p=9558"},"modified":"2010-01-29T11:49:19","modified_gmt":"2010-01-29T15:49:19","slug":"tax-impact-on-fixedresetpremium-yields","status":"publish","type":"post","link":"https:\/\/prefblog.com\/?p=9558","title":{"rendered":"Tax Impact on FixedResetPremium Yields"},"content":{"rendered":"<p>Assiduous Reader <i>pugwash<\/i> <a href=\"http:\/\/www.prefblog.com\/?p=9538#comment-67258\">asked on another thread<\/a>:<\/p>\n<blockquote><p>The discussion ten days ago on this excellent blog about the impact of tax on premium bonds led me to consider if there is there a tax downside to owning premium resets.<\/p>\n<p>How is the capital loss between the purchase price of say $28 in todays market and the call price of $25 dealt with?<\/p>\n<p>Not many of us have capital gains to use as an offset!<\/p><\/blockquote>\n<p>He was referring to a <a href=\"http:\/\/www.prefblog.com\/?p=9469#comment-66565\">comment by <i>prefhound<\/i><\/a> on my essay <a href=\"http:\/\/www.himivest.com\/media\/moneysaver_0911.pdf\">The Bond Portfolio Jigsaw Puzzle<\/a>. And, naturally enough, his use of the phrase &#8220;excellent blog&#8221; virtually guaranteed a response!<\/p>\n<p>In order to investigate the problem of tax effects, we need:<\/p>\n<ul>\n<li><a href=\"http:\/\/www.prefinfo.com\">Issue Characteristics<\/a>\n<li><a href=\"http:\/\/www.ey.com\/CA\/en\/Services\/Tax\/Tax-Calculators-2009-Personal-Tax\">Tax Rates<\/a>\n<li><a href=\"http:\/\/www.prefblog.com\/?p=6693\">Yield Calculator<\/a><\/ul>\n<p>The last two requirements are permanently linked on the right-hand panel of this blog under the heading &#8220;On-Line Resources&#8221;. Note that we don&#8217;t really need the &#8220;FixedResets&#8221; version of the calculator; since we&#8217;re only going to be calculating yield to the first call, the <a href=\"http:\/\/www.telusplanet.net\/public\/kbetty\/ytc.xls\">regular version<\/a> will do the same job; but we&#8217;ll use the souped-up version anyway. Why not?<\/p>\n<p>Calculations will be performed for an Ontario resident with taxable income of $150,000. Ernst &#038; Young claims the marginal rate on capital gains is 23.21% and the marginal rate on dividends is 23.06% (compare to the marginal rate on income of 46.41%, which is not used in this calculation).<\/p>\n<p> <i>pugwash<\/i> specified a price of $28 for discussion, so for discussion purposes we&#8217;ll examine HSB.PR.E, which closed last night at 28.01-15. It pays 1.65 p.a. unitl the first Exchange Date 2014-6-30, when it resets to GOC5+485, or is called at 25.00.<\/p>\n<p>The dividend rate of 1.65 implies quarterly payments of 0.4125. For taxable accounts, we will assume that this is reduced by 23.06% to 0.3173775. Dividends are paid at the end of June\/Sept\/Dec\/Mar and the next ex-date is March 11 (estimated) so we&#8217;ll get the next dividend.<\/p>\n<p>It should be noted that a horrifyingly precise calculation will not pay the tax on day of receipt, as assumed in the above paragraph, but pay annual taxes in the following calendar year. HIMIPref&trade; does this calculation, but the current calculation using the spreadsheet software doesn&#8217;t.<\/p>\n<p>The maturity price is 25.00, which is all we need for the non-taxable calculation, but taxable accounts with capital gains will be able to claim the 3.01 capital loss until maturity. The tax rate of 23.21% on capital gains implies that this deduction will be worth 0.698621, so a taxable account with capital gains to offset the loss may use a maturity price of 25.698621.<\/p>\n<p>Having accumulated the data, we can fill in the calculation spreadsheet:<\/p>\n<div align=\"center\">\n<table border=\"1\">\n<tr>\n<td colspan=\"4\">HSB.PR.E Yield-to-Call Calculations<\/td>\n<\/tr>\n<tr>\n<td>Data<\/td>\n<td>Non-Taxable<\/td>\n<td>Taxable with Capital Gains to offset loss<\/td>\n<td>Taxable without Capital Gains to offset loss<\/td>\n<\/tr\n\n\n<tr>\n<td>Current Price<\/td>\n<td colspan=\"3\">28.01<\/td>\n<\/tr>\n<tr>\n<td>Call Price<\/td>\n<td>25.00<\/td>\n<td>25.698621<\/td>\n<td>25.00<\/td>\n<\/tr>\n<tr>\n<td>Settlement Date<\/td>\n<td colspan=\"3\">2010-1-28<\/td>\n<\/tr>\n<tr>\n<td>Call Date<\/td>\n<td colspan=\"3\">2014-6-30<\/td>\n<\/tr>\n<tr>\n<td>Quarterly Dividend<\/td>\n<td>0.4125<\/td>\n<td>0.3173775<\/td>\n<td>0.3173775<\/td>\n<\/tr>\n<tr>\n<td>Cycle<\/td>\n<td colspan=\"3\">3<\/td>\n<\/tr>\n<tr>\n<td>Pay Date<\/td>\n<td colspan=\"3\">31<\/td>\n<\/tr>\n<tr>\n<td>Include First Dividend<\/td>\n<td colspan=\"3\">1<\/td>\n<\/tr>\n<tr>\n<td>First Dividend Value (if different)<\/td>\n<td colspan=\"3\">[blank]<\/td>\n<\/tr>\n<tr>\n<td>Reset Date<\/td>\n<td colspan=\"3\">2014-6-30 (irrelevant)<\/td>\n<\/tr>\n<tr>\n<td rowspan=\"2\">Quarterly Dividend After Reset<\/td>\n<td>0.4125<\/td>\n<td>0.3173775<\/td>\n<td>0.3173775<\/td>\n<\/tr>\n<tr>\n<td colspan=\"3\">(irrelevant)<\/td>\n<\/tr>\n<tr>\n<td colspan=\"4\">&nbsp;<\/td>\n<\/tr>\n<tr>\n<td><b>Annualized Quarterly Yield to Call<\/b><\/td>\n<td><b>3.43%<\/b><\/td>\n<td><b>2.61%<\/b><\/td>\n<td><b>2.04%<\/b><\/td>\n<\/tr>\n<tr>\n<td>Effective Tax Rate<\/td>\n<td>0%<\/td>\n<td>23.91%<\/td>\n<td>40.52%<\/td>\n<\/tr>\n<\/table>\n<\/div>\n<p>Note that the calculated yield on the taxable account with no capital gains (2.04%) is a little harsh, because it does not reflect the fact that the investor will have a capital loss of 3.01 that may be used at some time to offset future capital gains. However, if he never makes any capital gains, this asset will be worth zero.<\/p>\n<p>Note also that the effective tax rate for a taxable account with capital gains (yield of 2.61%, effective tax rate of 23.91%) is in excess of both the capital gains rate and the dividend rate. This is because the investor is paying tax up-front (when the dividends are received) and receiving the benefit of the capital loss later.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>Assiduous Reader pugwash asked on another thread: The discussion ten days ago on this excellent blog about the impact of tax on premium bonds led me to consider if there is there a tax downside &hellip;<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[23,30],"tags":[],"class_list":["post-9558","post","type-post","status-publish","format-standard","hentry","category-reader-initiated-comments","category-taxation"],"_links":{"self":[{"href":"https:\/\/prefblog.com\/index.php?rest_route=\/wp\/v2\/posts\/9558","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=9558"}],"version-history":[{"count":0,"href":"https:\/\/prefblog.com\/index.php?rest_route=\/wp\/v2\/posts\/9558\/revisions"}],"wp:attachment":[{"href":"https:\/\/prefblog.com\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=9558"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/prefblog.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=9558"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/prefblog.com\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=9558"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}