A parent holding company sells shares in its subsidiary such that the parent now

Question

A parent holding company sells shares in its subsidiary such that the parent now owns only 65% of the subsidiary and, thus, the tax returns of the parent and its subsidiary can't be consolidated. The parent receives annual dividends from the subsidiary of $2,500,000. If the parent's marginal tax rate is 34% and if the exclusion on intercompany dividends is 70%, what is the effective tax rate on the intercompany dividends, and how much net dividends are received?

a)10.2%; $2,245,000

b)10.2%; $2,135,000

c)23.8%; $1,905,000

d)10.2%; $1,750,000

e)34.0%; $1,650,000

Explanation / Answer

Effective tax rate             = (1 – Exclusion)(Tax rate)

                = (1 – 0.70)(0.34) = 10.2%.

Net dividends    = Gross dividends – Tax

                = $2,500,000 – $2,500,000(1 – 0.70)(0.34)

                = $2,500,000 – $255,000 = $2,245,000.

Hence Option a is correct

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