Reading 31: Dividends and Share Repurchases: Analysis-LOS e 习 stock

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Session 8: Corporate Finance
Reading 31: Dividends and Share Repurchases: Analysis

LOS e: Calculate and interpret the effective tax rate on a given currency unit of corporate earnings under double-taxation, split rate, and tax imputation dividend tax regimes.

 

 

David Drakar and Leslie O’Rourke both own 100 shares of stock in a German corporation that makes

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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%.

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This is an example of a split-rate corporate tax system. The calculation of the effective tax rate on a Swiss franc of corporate income distributed as dividends is based on the corporate tax rate for distributed income.

The effective tax rate on income distributed as dividends = 30% + [(1 ? 30%) × 40%] = 58%.

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Laura’s Chocolates Inc. (LC) is a maker of nut-based toffees. LC is considering a cash dividend, but is concerned about the “double taxation” effect on their shareholders. If the corporate tax rate is 35%, and the tax on dividends is 20%, what is the effective tax rate on a dollar of corporate earnings?

A) 55%.

B) 42%.

C) 48%.

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0.35 + (1 ? 0.35)(0.20) = 48%