Theoretical bypass of withholding tax with futures

Vanishing withholding tax

Many jurisdictions allow deducting losses from gains if you are a tax resident there. Whilst there might still be withholding taxes, they will be returned in full if there are no net gains. E.g. in Switzerland legal entities generally work like that.

Let’s say we are a company (or some more elaborate legal construct). We want to get the risk free rate and some (potentially heavily arbitraged) extra for our market making. So we sell some future on a gross total return equity index (e.g SIM TR) and buy all the underlying stocks. The price movement and returns will cancel out. No gains there and no tax.

The remaining cost of carry consists only of borrowing rate (approaching risk free rate), storage cost, and convenience yield. Storage cost and convenience yield should be very low for such stocks. That is some cost for buying, selling stocks, and rolling futures on one hand, and some yield from security lending on the other.

Which leaves about the risk free rate. The market will have to pay just this through the futures price. Now, since we are are an elaborate legal construct with a risk free business, we borrow endless money from someone else to make some asymptotically small arbitrage gain. We could also use the borrowing cost to transfer any gains to some tax heaven.

The twist

Ok, but we don’t have enough capital to pull a multi-billion transnational organization from our hats. Also we don’t want the risk free rate, but the gross total return of an equity index. True, but that is not a problem, because global capital will do all of the above for us.

We just buy that futures they sell and get the gross total return of the equity index minus the risk free rate. Capital gains from futures are normally not subject to withholding tax. We then pay our local taxes on the gains. In Switzerland we would do so and pay taxes inside a legal entity. Else the taxman will declare you a professional securities trader before you can blink.

But what do we do with that capital that we don’t have to borrow? Buy Irish bond ETF to offset the risk free rate on the futures. No withholding tax there on any level.

tl;dr: Theoretically you don’t have to pay any withholding tax.

PS: Feel free to compile some empirical data.


Are you describing a synthetic ETF?


They probably benefit from the same mechanic. But I think many use swaps instead of futures. Maybe the swap returns are more reliable, because they are a bilateral contract instead of some market agreed price?

Still, interest spreads in UPRO doesn’t seem to beat IBKR by much. 0.411% vs 0.5%, according to some Redditor at least.

Sure, but show me just one “future on a gross total return equity index”. And a Bond ETF that doesn’t distribute.

It might work if you

  1. Buy USD-quoted futures on a price level stock index such as S&P 500. Future dividends in full (I think) then become a discount to the price vs. spot index.
  2. Buy zerobond for the total amount of futures value with the same maturity date as the futures.

In this case it looks like you do avoid any taxes. Might also work with EUR denominated instruments, but not CHF, bond market is too small and liquid short term treasury bonds don’t exist.

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I just claimed that you can make any withholding tax disappear. You will still pay normal local taxes. The trick is that you buy the futures that global capital sells. They take care of arbitraging withholding tax to zero.

As you state correctly, it doesn’t really matter much if the index is price, net, or gross. With all of them an expectation of the dividends minus taxes is priced in. With gross no expectation is needed if taxes on dividends are 0, because the futures produce losses equal to the dividends.

I found some futures on CME that seem to use SPTR (gross) and not SPX (price) or SPXNTR (net).

And also some more TRFs on EUREX.

This doesn’t matter. Ireland doesn’t tax ETF. The US doesn’t tax interest when Portfolio Debt(/Interest) Exemption applies. Same seems to happen for EU treasuries.

What do you want to achieve? Total return, or tax optimization?

If you are interested in Total Return - I would rather have a look at a strategy where you both:

  • Short Sell a 2X Long ETF,
  • Short Sell a 2X Short ETF with the same underlying Index, AND
  • And Re-Balance once one Position was 10% Larger than another

This strategy allows you to monetize both on ETF TER & Tracking Error, Volatility Decay and (depending how smart your Broker was) you can lever up quite heavily.

Only caviat - add a stop loss to cover against unexpected, massive swings greater +/- 50%.

Considering you mainly re-balance but there were no massive trades as such - and assuming you have a real side-job, I don‘t think that your local tax authority would declare you a professional investor.

Cheaper leverage and better return. For more total return.

Interesting, I have extensively simulated just that a week ago. Security borrowing cost tends to eat any return I could produce from any decay on UPRO vs SPXU and JNUG vs JDUST. Interest on the short sale proceeds made it slightly positive. But all that at high risk and time intensive portfolio tending.

The best strategy I could come up with was a combination of:

  • Taking any small profits (leverage falling ~2%)
  • Avoid realizing losses till they decay on their own, by absorbing book losses with not using excessive leverage.
  • Stop loss at dangerous levels (another bad day could bring you to zero)
  • Additionally reset to target every some time interval (10-30 days perform well)
  • Use different intervals with concurrent sub-portfolios to reduce path dependency
  • Using large amounts of third party capital
  • Using derivatives (and persumably other arcane stuff) to increase return by more risk.

are the big no-no-s in “Kreisschreiben Nr. 36”. You just miss high volumes. You still pay taxes on the the interest and dividends from total collateral. But you can’t deduct any expenses like borrowing cost or losses.

If you manage to reduce the tax through converting the collateral to more tax efficient assets (gold, futures, Swiss funds with direct real estate holdings, etc.), someone in the taxman’s office will start to think up ways to part you from your money.

Do you run this strategy at the moment?

Even people doing lots of short term derivative play tend to not be classified though :slight_smile: (they really don’t want people to be able to claim losses).


Yeah, that’s why I talk about reducing taxes setting them off. Or alternatively making large tax-free gains.

Of course, you pay over night rates plus a risk up-tick for the short sale. At the same time, you may invest the proceeds lets say in a commercial 6 months money market (aka make an up-tick with slightly longer duration and slight credit risk vs. treasuries only). As long as you play the re-balancing right and considering it was a long-term strategy, you could technically even go into the range of 2 years duration or so.

The risk of this going wrong is fairly small - it just needs constant monitoring or maybe even better a google sheets or so that alerts you in case you were in a danger zone or the strategy required re-balancing. Unless there was a very catastrophic out of trading hours event; the risk of losing the hedge (long offsets short) is close to zero.

This strategy became famous about 6, 7 years ago - at least that’s when I started to hear about it left and right. There are different papers that conclude whether it was worthwile or not. The consensus is mixed, some people apply it very effectively - others less. The truly important to make something like this to work is that you need efficient trading fees, efficient short selling (IB is your friend), a disciplined approach and that you sensibly (and profitably) invest the sales proceeds in low volatility assets. Yet nothing wrong with taking on some duration and/or credit risk there.

I wouldn’t worry about the professional investor status. Even though its a creative one, this is clearly a long term strategy that was not set up to avoid taxes. You simply tab on another income stream. The essence of the Professional Trader definition is that you either:
i) turn TIME, INTELLIGENCE or IP into MONEY, or
ii) that you apply a SUCCESSFUL GAMBLING System (aka IP again)
This is not the case here as you neither trade heavily (re-balacing doesn’t count), as you don’t spend much time or intelligence working on super sophisticated models (its a simple re-balance) and as you don’t take heavily leveraged, strategic gambling positions. You actually tab on the fairly passive revenue stream of milking volatility, which has nothing to do with an income stream that depends on active trading. Besides, authorities generally don’t want to give you the tag unless you really burn material time and/or use a super sophisticated (and successful) Intellectual Property.

Ah yes to this one - I don’t think it was wise to do this on a 3X leveraged S&P500. 2x S&P 500 may be better. Re. Gold-Miners, I would probably not even dare to do this on a 2X etf as Gold Miner Indices once in a while demonstrate absolutely extrodinary swings in either directions.

Chances are these swings will happen overnight - but not slowly during trading hours.

Correct me if I’m wrong but… Avoiding taxes or not is not a (very relevant) criterion in determining professional trader status, is it? Unlike…

…and income is, in general, always taxable.

As the ESTV memo states:

*„Gemäss Artikel 16 Absatz 1 des Bundesgesetzes vom 14. Dezember 19901 über die direkte Bundessteuer (DBG) sind „alle wiederkehrenden und einmaligen Einkünfte“ steuerbar. Mit dieser Generalklausel hat der Gesetzgeber den Grundsatz der Gesamtreineinkommenssteuer festgehalten. Ausgenommen von der Einkommensbesteuerung sind Einkünfte nur, wenn dies eine ausdrückliche Gesetzesnorm anordnet. Als eine solche Ausnahme erweist sich die Bestimmung von Artikel 16 Absatz 3 DBG, wonach Kapitalgewinne aus der *Veräusserung von Privatvermögen steuerfrei sind.“

What was the suggested plan again?

Short Selling.
Selling something you do not own.

:point_right:t2: Claiming something you do not own (and the sale of it) as part of your personal wealth would seem a bit of a stretch, wouldn‘t it?

The professional trader status in my view is a bit a catch-all for anything that goes terribly wrong. If you, by means of active trading, tried to avoid a taxable income - I suspect that this would push the assessment of your situation more towards a professional trader setup. So yes, its not explicitly listed but if your motivation was to avoid taxes, and you had large trading volumes, leverage and the like - I think that it might push you further in the danger Zone.

With the one and only exception that Capital Gains are not taxed for Personal investors. They can result from short or long sale - still a capital gain.

You own the sales proceeds of the short sale, and you own an obligation aka debt that offsets it. So yes, a short sale can still trigger additional wealth.

Capital gains in and from sales of personal wealth, as the law says.

There’s neither a question nor a problem with that.

My question is: What is it, that you’re selling?
Something you don’t own, that’s not (yet) part of your personal wealth.

No sale from personal wealth, no tax exception - hence, the sales proceeds are taxable income.

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