Dividend Stripping - Tax Avoidance

Tax Avoidance

Dividend stripping as a tax avoidance scheme works to distribute a company's profits to its owners as a capital sum, instead of a dividend. The purpose is generally that capital gains may be subject to less tax.

As a basic example, consider a company called ProfCo wishing to distribute $X, with the help of a stripper called StripperCo.

1. StripperCo buys ProfCo shares from their present owners for $X+Y.

2. ProfCo pays a dividend of $X to StripperCo.

3. StripperCo sells its shares back to the owners for $Y.

The net effect for the owners is an $X capital gain. The net effect for StripperCo is nothing, the dividend it receives is income, and its loss on the share trading is a deduction. StripperCo might need to be in the business of share trading to get such a deduction (i.e. treating shares as merchandise instead of capital assets).

Many variations are possible:

• StripperCo might buy different "class B" shares in ProfCo for just the $X amount, not the whole of ProfCo.
• Such class B shares could have their rights changed by ProfCo, rendering them worthless, instead of StripperCo selling them back.
• ProfCo might lend money to StripperCo for the transaction, instead of the latter needing bridging finance.

The tax treatment for each party in an exercise like this will vary from country to country. The operation may well be caught at some point by tax laws, and/or provide no benefit.