Chartered Financial Analyst Level 2
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- A corporation operates in a jurisdiction that has a corporate tax rate of 25% and uses a dividend imputation tax system. If the corporation distributes all its after-tax income to shareholders, the effective tax rate on dividends of a shareholder whose marginal tax rate is 40% is:
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A
25%.
B
40%.
C
55%.
Explanation:
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.
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