What is Tax Arbitrage?

Tax arbitrage involves exploiting discrepancies in the taxation of different types of income, capital gains, and transactions to generate profit. The intricacies of various countries’ tax codes enable individuals and businesses to identify legal loopholes or restructure transactions to minimize tax liabilities. This in essence is tax planning to minimise the amount of tax an individual or business has to pay.

Both individuals and corporations engage in tax arbitrage to benefit from differences in tax systems, treatments, or rates. A common strategy includes recognizing revenues in low-tax regions while recording expenses in high-tax regions, thereby reducing the overall tax burden by maximizing deductions and minimizing taxable earnings. Additionally, entities may profit from price differences in securities resulting from varying tax systems across jurisdictions. For example, capital gains on investments are taxable in many jurisdictions but not in places like Singapore. Therefore, it would be advantageous for an individual or business to realise capital gains in Singapore rather than in those other jurisdictions.

Tax arbitrage can also occur when investors purchase stocks before the ex-dividend date and sell them afterwards. Stock prices typically drop by the dividend amount on the ex-dividend date. This strategy results in a short-term capital loss, which can offset any short-term capital gains. Since short-term gains are taxed as ordinary income, reducing these gains is advantageous for investors.

While some forms of tax arbitrage are legal, others may cross the line into tax evasion. Individuals and businesses must consult a qualified tax advisor before engaging in tax arbitrage transactions. Although tax arbitrage is believed to be widespread, its nature makes it challenging to quantify accurately.

If you need qualified advice on how you can reduce your personal or business tax burden, you can contact the Raffles Corporate Services tax advisory team at [email protected].