# How the heck did I get this wrong?

Simon Rosen, CFA, a portfolio manager for the Asian Spec Fund, recently purchased 1,000 shares of China Petroleum at a price of 271.11 Chinese yuan (CY) on the Shanghai Stock Exchange. The current exchange rate at the time was 8.2781 CY to one U.S. dollar (USD). China Petroleum paid an annual dividend of 9.02 CY per share and dividends are subject to 10% withholding tax. Capital gains taxes and dividends are 20% for the U.S. Simon sold all of his holdings in China Petroleum one year later at a price of 325.33 CY. Assume that the U.S. tax laws allow a full tax credit for taxes paid on international investments. Further assume that over the course of the year, exchange rates remained constant. The total after tax return on this investment is: A) 20.00%. B) 18.99%. C) 18.66%. Your answer: B was incorrect. The correct answer was C) 18.66%. Gross proceeds on the sale (USD) = (325.33 CY × 1,000 shares) / 8.2781 CY/USD = USD39,300.08 Cost of investment (USD) = (271.11 CY × 1,000 shares) / 8.2781 CY/USD = USD32,750.27 Gross capital gain (USD) = USD39,300.08 − USD32,750.26 = USD6,549.81 Net capital gain after tax = USD6,549.81 × (1 − 0.20) = USD5,239.85 CY dividend paid = 9.02 CY × 1000 = 9,020 CY Dividend Paid (USD) = 9020 CY / 8.2781 CY/USD = USD1,089.62 Dividend received after withholding tax = USD1,089.62 × (1 − 0.10) = USD980.66 U.S. Taxes on dividends = USD1,089.62 × 20% = USD217.92 Tax withheld available for tax credit = 9,020 × 10% = 902 CY Tax credit in US dollars = 902 CY / 8.2781 CY/USD = USD 108.96 Total after-tax return = [(5,239.85 + 980.66) − 217.92 + 108.96] / 32,750.26 = 18.66% ----------------------------------------- My calculation was as follows: Purchase = 271.11 * 1,000 / 8.27811 CY/USD = \$32,750.2688 Dividend = 9.02 * 1,000 / 8.2781 CY/USD = \$1,089.6220 Sale = 325.33 * 1,000 / 8.2781 CY/USD = \$39,300.0809 CY Div Tax of 902CY in USD = \$108.9622 USD Div Tax = \$217.9244 USD Cap Gain Tax = \$1,309.9624 Total after tax return = \$39,300.0809 - \$32,750.2688 + \$1,089.622 + \$108.9622 - \$217.9244 - \$1,309.9624 / \$32,750.2688 = 18.99% Why did I get this question wrong? I’m pissed cuz I know this crap is easy! WTF?

Correct me if I’m wrong here, but you do not need to include the 10% CY dividend tax. To look at it simply, if you do the calc again and leave out the \$108.9622, you get 18.66%. Really, the CY portion of the dividend tax doesn’t factor into the return percentage because you pay it out, then get it back later… cancelling it out. In your formula, the tax is only listed as a positive. I don’t think the Chinese governemnt will give you \$108.96 just to be nice. Hope that helps!

2 things here. 1. exchange rate remained the same. so take that conversion out of the picture. buy 271.11, sell 325.33, div 9.02 tax = 20% -> ignore the withholding and give back, since it is not relevant. so your hpr = [325.33-271.11+9.02]*(1-0.2)/271.11 = 18.66%

CP ^^ schweser can’t come up with a shorter solution! For simplicity though: Rate of return(net of taxes) = (Cap gains + Gross div - Cap Gains tax - Incm tax)/initial inv cap gains per share = 325.33 - 271.11 gross div per share = 9.02 inc tax per share = .2 * 9.02 cap gains tax per share = .2 * (325.33 - 271.11) = 10.846 initia inv per share = 271.11 return =( (325.33 - 271.11) + 9.02 - 10.846 - 1.8040)/271.11 = 18.66% NB: I solved every EOC in the cfai on this reading and didn’t see any question related to constant exchange rates. This Qbank question serves up another reason to surely not relegate the Qbank for the L2.

team_alex Wrote: ------------------------------------------------------- > Correct me if I’m wrong here, but you do not need > to include the 10% CY dividend tax. > > To look at it simply, if you do the calc again and > leave out the \$108.9622, you get 18.66%. > > Really, the CY portion of the dividend tax doesn’t > factor into the return percentage because you pay > it out, then get it back later… cancelling it > out. > > In your formula, the tax is only listed as a > positive. I don’t think the Chinese governemnt > will give you \$108.96 just to be nice. > > Hope that helps! Okay simply removing the \$108.96 converted CY tax amount of \$902 gives me the correct answer. Total after tax return = \$39,300.0809 - \$32,750.2688 + \$1,089.622 - \$217.9244 - \$1,309.9624 / \$32,750.2688 = 18.66% I thought the amount of withholding by the Chinese government in this example will be refunded by the US government. No? That was why I added it back. Now, it’s like you’re being charged twice. You got paid a dividend amount of 9,020 CY and got charged a 10% withholding of 902 CY by the Chinese government. This same 9,020 CY dividend converted to USD 1,089.622 now gets deducted again by \$217.9244 (20% US withholding). This is why I added the converted 902 CY (USD 108,9622) cuz of the fact that it has to be refunded by the US government. No?

Damil, way I look at it is: you pay 108.96 as tax in China Pay 217.92 in US get back 108.96 back… on your US return. [for the tax paid in China]. Essentially the 108.96 is being added and subtracted… (ignore it), since you have the tax treaty anyways.

Let say you paid \$100 tax in China instead of \$108.96 and paid \$217.92 in US, will you ignore the \$100 as well in the calculation?

you would get the 100\$ back on your US tax… so yes, it is ignored