Dividend Taxation and Stock Returns: Time-Series Analysis of Canada and Comparison with the United States

This article examines the relationship between differences in the taxation of dividends and capital gains, and annual stock returns of Canadian public companies. Using Standard and Poor's (S&P) Compustat and Thomson Reuters Datastream databases over an 18-year period (1995-2012), we find this relationship to be positive for a sample that includes all firms listed on the Toronto Stock Exchange (TSX) and a sample that is restricted to only the largest companies in Canada listed on the S&P/TSX composite index, supporting the theory that a dividend tax premium is capitalized into stock returns. While our results are consistent with previous US studies, these findings were not obvious at the outset, because in Canada the taxation of dividends and capital gains is different from the approach used in the United States, and because the difference between the dividend and capital gains tax rates is substantially smaller in Canada relative to the differences used in the long time-series US studies. Our findings will be of interest to investors, corporations, and policy makers, since stock returns are affected by the method of payout used by corporations, and they will add to the continuing debate on whether investment income taxes affect equity valuation. Our findings are robust under two different methods of empirical investigation.