Chartered Financial Analyst Level 2

Explanation

In a dividend imputation tax system, shareholders receive credit for corporate taxes already paid. The calculation is:

Key points:

• Corporate tax rate: 25%
• Shareholder marginal tax rate: 40%
• Under imputation, the shareholder's tax liability is calculated on the grossed-up dividend (pre-tax corporate income)
• The shareholder receives credit for the corporate tax already paid

Effective tax rate calculation:

• The shareholder effectively pays their marginal tax rate on the distributed income
• Since the corporation distributed all after-tax income, the shareholder's effective tax rate equals their marginal tax rate of 40%

This eliminates the double taxation that occurs in classical tax systems.