{"id":1255,"date":"2007-09-29T13:00:49","date_gmt":"2007-09-29T17:00:49","guid":{"rendered":"http:\/\/www.prefblog.com\/?p=1255"},"modified":"2007-09-29T13:00:49","modified_gmt":"2007-09-29T17:00:49","slug":"after-tax-yield-equivalency","status":"publish","type":"post","link":"https:\/\/prefblog.com\/?p=1255","title":{"rendered":"After-Tax Yield Equivalency"},"content":{"rendered":"

It must be fall! The time when an old man’s fancy lightly turns to thoughts of tax planning! I received my first indication of the change in season today …<\/p>\n

My correspondent sent me the following calculation and wondered why the after-tax yield on a dividend that he was investigating was lower than the pre-tax yield … he attached a calculation:<\/p>\n

\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n
Tax Effect on Dividends<\/td>\n<\/tr>\n
A<\/td>\nPreferred Shares Purchase Price<\/td>\n$100.00<\/td>\n<\/tr>\n
B<\/td>\nDividend Rate of Return<\/td>\n4.25%<\/td>\n<\/tr>\n
C<\/td>\nYearly Amount of Dividends (A*B)<\/td>\n$4.25<\/td>\n<\/tr>\n
D<\/td>\nGross-Up Percentage<\/td>\n45%<\/td>\n<\/tr>\n
E<\/td>\nTaxable (i.e. Grossed-Up) Amount of Dividends = (1+D)*C<\/td>\n$6.16<\/td>\n<\/tr>\n
F<\/td>\nTax Rate<\/td>\n30%<\/td>\n<\/tr>\n
G<\/td>\nTax on Grossed-up Amount of Dividends (F*E)<\/td>\n$1.85<\/td>\n<\/tr>\n
H<\/td>\nTax Credit Percentage<\/td>\n19%<\/td>\n<\/tr>\n
I<\/td>\nTax Credit (H * G)<\/td>\n$0.35<\/td>\n<\/tr>\n
J<\/td>\nNet Tax (G-I)<\/td>\n$1.50<\/td>\n<\/tr>\n
K<\/td>\nAfter Tax Return (C-J)<\/td>\n$2.75<\/td>\n<\/tr>\n
L<\/td>\nAfter Tax Rate of Return (K\/A)<\/td>\n2.75%<\/td>\n<\/tr>\n<\/table>\n<\/div>\n

My correspondent’s problem was that he had been told that “L” should be more than “B”.<\/p>\n

Well, he was quite right to be suspicious! An after tax rate of return higher than the pre-tax rate implies a negative taxation rate; and while such things may sometimes happen to a very small extent in some corners of the tax world, given very particular (and relatively small!) numbers, it’s just not there for most of us! It will doubtless be a promise in the next Federal election campaign, however.<\/p>\n

I suspect that my correspondent was told a garbled version of something that really\u00a0is a general rule: that dividend income is better than interest income and that a dividend of $1 will always leave more in your pocket than an interest receipt of $1. Always? Well, there might be some exceptions! I will stress that I am not a tax expert and that anything I say about taxes should be checked!<\/p>\n

What we need to illustrate this is a few more lines in the calculation:<\/p>\n

\n\n\n\n\n\n\n
Additional Lines for Interest Equivalency Factor<\/td>\n<\/tr>\n
M<\/td>\nRate of tax on interest income (from tables)<\/td>\n43.4%<\/td>\n<\/tr>\n
N<\/td>\nPercentage of Interest Income kept (1-M)<\/td>\n56.6%<\/td>\n<\/tr>\n
O<\/td>\nInterest Required to produce after-tax amount (= K \/ N)<\/td>\n$4.86<\/td>\n<\/tr>\n
P<\/td>\nEquivalency Factor (= O \/ C)<\/td>\n1.14<\/td>\n<\/tr>\n<\/table>\n<\/div>\n

So what we conclude from this particular equivalency factor is that:<\/p>\n