Robin Morgan (Toronto) presents Financial Innovation and Fixed-Income Tax Arbitrage: A Return to Capital Invariance? at Toronto today as part of its James Hausman Tax Law and Policy Workshop Series hosted by Ben Alarie:

The development of new financial products allows investors to approximately or fully recreate underlying cash flows while achieving different tax consequences. This article presents a tax arbitrage strategy for fixed-income assets, using short-term Treasuries as an example, which converts debt streams into equity streams at the investor level. Because of the development of exchange traded funds (ETFs) since the 1990s, a taxpayer can either invest in U.S. Treasuries directly or can purchase an ultra-short term Treasury ETF which regularly pays out interest as dividends. By engaging in ex-dividend day trading, the taxpayer can convert all of what would otherwise be interest into capital gains. We present analysis of the 2007-2025 period to show that, except for ultra-low interest rate environments, an ex-dividend day trading strategy would have resulted in increases in after-tax returns by up to 102.62% (i.e. double) for certain classes of taxpayers compared to a standard buy-and-hold strategy for U.S. Treasuries. This strategy is particularly appealing to certain foreign investors due to formal recognition under non-U.S. law of the ETF as a corporation. The findings presented here have direct applications to tax policy, portfolio theory, and capital structure, since it shows that corporations can issue debt and deduct interest expenses at the corporate level, while investors can obtain capital gains treatment through the use of a publicly traded financial intermediary like an ETF.

For further workshop information contact events.law@utoronto.ca