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

This article examines the relationship between dividends and capital gains taxation differences and annual stock returns of Canadian public companies. Using the Compustat and Datastream databases over an 18-year period (1995-2012), we find this relationship to be positive for all stocks on the Toronto Stock Exchange and when using only the largest companies in Canada (S&P/TSX composite index firms), supporting a dividend tax premium being 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 US and because the difference between the dividend and capital gains tax rates is substantially smaller relative to the differences used in the long time series US studies. Our findings will be useful for investors and corporations because stock returns are affected by the method of payout used by corporations. In addition, Canadian policy makers will note that tax rules can affect capital markets. Our findings are robust to using two different methods of empirical investigation.