(Corp Finance) Effective Tax Rate, Split-rate corporate tax individual, corporate, effective, question, applies

mfleming1983

Hi all,
Please kindly show me how to approach this question. I am very confused…
Thanks!
International Pulp, a Swiss-based paper company, has annual pretax earnings (in Swiss francs) of SF 600. The corporate tax rate on retained earnings is 55%, and the corporate tax rate that applies to earnings paid out as dividends is 30%. Furthermore, International Pulp pays out 30% of its earnings as dividends, and the individual tax rate that applies to dividends is 40%.
What is the effective tax rate on corporate earnings paid out as dividends?
A)
70%.
B)
48%.
C)
58%.
Ans: C

Zestt

The corporation is taxed 30% on earnings paid as dividends, leaving 70% to be paid to the shareholders.  The shareholders pay 40% taxes on the dividends, leaving them with 60% of the dividends paid.  Thus, the shareholders end up with 42% (= 60% of 70%) of the earnings paid as dividends.  If they end up with 42% of the earnings paid as dividends, the taxes paid amount to 58% of the earnings paid as dividends.
If you want a simple formula (I wouldn’t bother, personally), it’s:
1 – (1 – tc)(1 – ti) = 1 – (1 – tc – ti + tc

AnalystForum

It’s pretty simple. If they spend $1 on dividends, only $0.70 gets to the stockholder because IP pays $0.30 as tax. The stockholder pays 40% of $0.70 = $0.28 in taxes, so IP and stockholder together pay $0.30 + $0.28 = $0.58 in taxes, or 58%.