Page 212 - DCOM508_CORPORATE_TAX_PLANNING

Unit 9: Financial Management Decisions

(a) Pay dividends Notes

Shareholders receive in 5 years:
` 1000 (1 - .28) (1 + .072)5 = ` 1019.30 (.072 is individual’s after tax return)
(b) Retain the cash for investment in the fi rm
The company retains the cash and invests in T-bills and pays out the proceeds 5 years from now.
(Individuals pay the taxes at the end)
Shareholders receive in 5 years:
` 1000 (1 + .066)5 (1 - .28) = ` 991.188 (.066 is corporations after tax return)
(a) Pay low (no) dividends if corporate rate is less than the individual rate.

(b) Pay high dividends (higher tax benefit) when the individual rate is less than the corporate
rate.
(c) In addition, corporations (as holders of stock) are able to exclude 80% of the dividend
income they receive from holding stock.

Notes In this case the holder and payee are both corporations. Treat the holder like an
“individual”.

Self Assessment

State whether the following statements are true or false:
7. Dividend refers to the corporate net profits distributed among shareholders.

8. Cash dividend is the issuance by a company of its common stock to its common shareholders
without any consideration.
9. A dividend policy shows how a company determines the amount of earnings to be paid
out as dividends to its shareholders on a regular basis.
10. The retention ratio is the amount of dividends paid to stockholders relative to the amount
of total net income of a company.

11. Legal stipulations require not only a dividend declaration but they specify the conditions
under which dividends must be paid.
12. The decision to pay dividends to investors does not have an impact on a company’s
corporate tax.

9.3 Dividend Distribution Tax (DDT)

Dividend distribution tax is the tax levied by the Government on companies according to the
dividend paid to a company’s investors. Every domestic company is liable to pay Dividend
Distribution Tax @ 15% on the amount declared, distributed or paid by such company by way of
dividends. The effective rate of tax works out to 16.995%.

LOVELY PROFESSIONAL UNIVERSITY 207