Around the Markets: Stocks on margin - a new squeeze
Floyd Norris NYT
Friday, January 24, 2003
Investors who buy stock with borrowed money will find that the dividends they get will be taxable even after other dividends are no longer taxed, according to the Bush administration.
"This could have a big impact on people who buy stock on margin," said David Hariton, a tax partner at Sullivan Cromwell, after the United States said it would make dividends taxable if they came from "debt-financed stock."
The Treasury Department said it would extend an existing provision of the law that applies to corporations that buy stock with borrowed money. Under that law, dividends from such shares do not qualify for the existing tax break on dividends paid by one corporation to another.
Robert Gordon, the president of 21st Securities, said that under such a provision, "a margin investor will see his dividend become not tax-free, but proportionate. If you bought a stock on 50 percent margin, 50 percent of the dividend will be taxable."
That would mean that investors would be better off if dividend-paying stocks were bought with cash that was not borrowed to make the purchase.
Keeping such stocks out of margin accounts, which enable investors to borrow up to half the value of the stocks they purchase, would be one way to do that.
Not only margin debt could be affected. An investor who used a home-equity loan to buy stock could find the dividends are taxable.
Greg Jenner, deputy assistant Treasury secretary for tax policy, said he expected that investors would alter their behavior as a result of the rule, perhaps by keeping dividend-paying shares out of margin accounts.
Advocates of ending what they call the double taxation of dividends have predicted that the change would lead to a rise in stock prices, by making equity investments more attractive. But if investors were to sell stock to pay off margin loans, that could cause share prices to fall.
The use of margin loans has slid since hitting a record in March 2000, when margin borrowers owed $278.5 billion. But they still owed $133.1 billion at the end of November.
The dividend-exclusion proposal already threatened to make it harder to borrow stocks around the time dividends are paid. That is because an investor, to get the tax-free dividend, would have to own the shares at the time of the payment, not have lent them out. (An investor who lent such shares would normally receive a payment in lieu of the dividend from the borrower, but that income would be taxable.)
Some investors, such as pension funds and charitable foundations that do not care about the tax status of dividends they receive, would still be willing to lend shares for shorting. They might be in a position to charge higher fees for making the loans.
Increased difficulty in borrowing shares could also lead to new interest in single-stock futures, which economically provide the same investment as buying or shorting a stock, depending on whether an investor buys or sells a futures contract. Such futures now trade on two American exchanges, but have not yet taken off. The single-stock future with the greatest open interest on both exchanges is Microsoft, but the open contracts on the two exchanges together cover only 823,000 shares, a fraction of daily trading volume in the stock.
- Floyd Norris (NYT)
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