A Case Study on Equity－Linked Financial Products with Tax－Saving Effects
Asian Tax Journal Vol. 11 No. 4 (2010), pp. 9-38
Abstract
ELF(Equity Linked Fund) is the financial instrument which, by replicating the pay－off structure of ELS(Equity Linked Security) in the investment trust account, grants performance to the investor. ELS and ELF differ in their tax treatment of profit：all profit from ELS is considered dividend and is taxed accordingly. Profit incurred from ELF, on the other hand, is not always considered dividend and thus is taxed according to the specific income source from which it originates. Such a visible difference in taxation encourages ELF managers to replicate ELS in the way that applies the lowest tax rates possible. Consequently, the after－tax return of ELF can be higher than that of ELS. The financial equivalence can be exercised in order to elicit a desirable income structure, one that provides both the lowest tax payments possible and the equivalent economic consequences. We analyze cases that developed the tax－saving instruments, employing the financial equivalence. Former case studies of this kind have applied static replication methods and the replicated assets have been fixed－return instruments such as synthetic bond and JPY－KRW swap deposit. Our case study, however, employs both static and dynamic replication methods for the sake of analyzing ELF, of which the replicated assets are contingent－return instruments. The purpose of this case study introduces the various tax saving techniques that exploit the concept of financial engineering with a particular emphasis on a wide spectrum of aggressive tax planning and the trade－off between risk factors caused by that tax planning. This study could serve as a useful case material in a strategic tax planning course for MBA and doctoral students. It also casts useful insights on discussions concerning the improvement of taxation on synthetic instruments and the desirability of transaction tax imposed upon derivative instruments.
Keywords
- ELS
- ELF
- financial equivalence
- put－call parity
- aggressive tax planning
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