Equating U.S. Tax Treatment of Dividends and Capital Gains for Foreign Portfolio Investors

The U.S. tax law equates the tax rate on dividends and long-term capital gains on stock owned by U.S. citizens and residents. However, the taxation of these two types of rewards in the hands of foreign portfolio investors remains dramatically different from each other, with the capital gain being fully exempt. Several reasons support this article's proposal to no longer exempt these gains. Extending finance theory and prior normative tax research, this article argues that foreigners’ portfolio dividends and capital gains should be taxed in the same manner because they are economically equivalent and emanate from the same source. Three recent empirical developments also support repeal of the foreigner's exemption. First, there is now extensive use by U.S. corporations of stock repurchases—which are taxed to selling shareholders as capital gain—as a form of corporate payout that was in the past primarily accomplished through dividends. Second, foreign ownership of U.S. stocks has continued to increase, with an estimated one-third of these stocks owned by foreigners. Third, the modern tax compliance environment—including aspects of the Foreign Account Tax Compliance Act that apply to foreigners—reduces past congressional and academic concerns about enforcing the taxation of foreigners’ portfolio gains.