Equity Income on I.S. (from invest. in Assoc.) - Taxable?

CFA Level II
#1

A lot of the questions ask what contribution on Income Statement does an investment in associate make. Easy right. But what if they ask “what is its contribution to Investor’s net income”?

I assume we take the total income from equity investment (on I.S) and multiply by (1 - tax rate). But this is not clear in any of the readings.

Basically my question is: are the earnings from equity investment taxable? And what about the contribution due to the amortization of net assets - would this also be taxed?

#2

If you (personally) own stock in Google, do you have to pay taxes on Google’s income?

Neither does a company when it owns stock in another company.

You pay taxes on dividends on your Google stock.

A company pays taxes on dividends it receives from its equity investments.

#3

If you are talking about contribution of investment in ASSOCIATES to Investor’s net income” you are spot on. Yes you take your share of income from associates and multiple by 1- tax rate. However in most cases the questions are worded as follows “what is the income from associates in XX income statement for year ended …” in which case we should just work out the contribution to income (ignoring taxes) but its pretty clear you need to include taxes if they ask for contribution from associates to equity. The same should be applied for any questions on contribution to net income or equity whether its amortisation of assets, inventory, pensions etc…ALWAYS NET OF TAXES!. To illustrate my answer see example here.

Lets say our share of Associate net assets at begging of the year is $100. And our share of income this year is $20 and tax rate is 30%. We also assume no other assets of liabilities, the balance sheets last year and this year is as follows:

Last year:

Assets: Investment in associates $100

Equity $100

This year :

Assets: investment in associates $120

Liability: Tax due $(6)

Net assets: $114

Equity $114

This year income statement:

Income from assocaites: $20

Total net income before tax $20

Tax ($6)

Net income $14

Hope this helps!!

#4

Why would our company be taxed on income we didn’t receive?

I believe that you’re mistaken. Most taxation systems are cash-based.

#5

No, the Associate’s net income is already net of tax. You’re taxing the associate’s net income at the corporate level twice if you do that, on net income that the investor didn’t even actually receive in the form of cash.

#6

Gents & ladies, most corporation tax, certainly here in UK is not cash based. A company is taxed on total income from its worldwide operations including associates income. However in most jurisdictions tax suffered at subsidiary level or overseas operations, associates etc can be netted off as a tax credit under double taxation only if there is a double tax agreement or allowed the law.

Anyway this is certainly beyond the scope of this discussion.