Effective tax rate

CFA Level II
#1

Can someone please explain this formula:

effective tax rate = 1-(1-t)(1-td)

is it the same as corporate tax rate + (1-corporate tax rate)(individual tax rate)

Thanks.

#2

(1-T) is corporate tax rate and this formula shows double taxation of same tax payer. First corporate earnings are taxed on corporate level then by dividend payoff once again is taxed by tax on dividend on personal level.

#3

Yes. If we denote

T=corporation tax

t=personal tax (td=tax on dividends which is taxed on individuals who receive them)

then

1-(1-T)(1-t)

1-(1-t-T+Tt)=1-1+t+T-Tt T+t-Tt T+t(1-T) or Corp +personal(1-corp)

Don’t forget to cross the ts…

#4

So which one should I memorise for the exam?

#5

Ok, i am just seeing this formula, but i think i will stick with the normal one in the corriculum which is {Corp Tax + (1-corp tax)*(ind tax)}

#6

Neither.

You should understand one of them.

I prefer using

1 – (1 – Tc)(1 – Td)

as I can visualize it easily:

  • The corporation pays taxes and is left with (1 – Tc) of the original
  • The shareholder pays taxes on the dividend and is left with (1 – Td) of the dividend, or (1 – Tc)(1 – Td) of the original
  • The taxes are the difference between the original and what’s left: 1 – (1 – Tc)(1 – Td)

Easy-peasey.

2 Likes
#7

Easy! Thank you magician.

#8

You’re welcome.