Question

1. Joe sells his shares in BHP and buys shares in a tech stock company. Are these primary or secondary market transactions? Explain why.
2. In what way is the existence of well-developed secondary markets important to the functioning of the primary markets within the financial system?                                                                                                                                                        (Marks 2 + 2 =4)

2. Distinguish between a coupon security and a discount security. Give an example of each.                                                                                                        (Marks 2)

3. Riley and Bailey are planning to start a new business together. They are expecting annual taxable income of $250,000 from their business, but they are concerned about the expected tax burden. They know that the corporate tax rate is 30% and individual tax is payable as per the following table:

Taxable income	Tax on this income
0 - $18,200	Nil
$18,201 - $37,000	19c for each $1 over $18,200
$37,001 - $80,000	$3,572 plus 32.5c for each $1 over $37,000
$80,001 - $180,000	$17,547 plus 37c for each $1 over $80,000
$180,001 and over	$54,547 plus 45c for each $1 over $180,000

They are seeking your advice on the tax implications of the two following forms of business structures and have requested you to calculate the tax payable under each of them:  

1. Partnership - Riley 30% and Bailey 70%.
2. Corporation.
3. Which form of business would you recommend to Riley and Bailey and why?

Answer 1

i) Primary market transactions are those transactions where the investor can purchase the security directly from the issuer. Secondary market transactions are those transactions where the investors can purchase the security indirectly from another investors. Hence, when Joe sells his shares in BHP, it is a secondary market transaction since he is selling these shares to another investor. However, when Jose buys shares of a tech stock company, is he is buying them from another investor through stock market it will be a secondary market transaction since the issuer is not involved in this transaction.

ii) Secondary markets are where the investors can buy and sell securities from other investors without the involvement of the original issuer of these securities. These markets ensure that the securities are valued in a better manner and also ensure liquidity in the markets for them. It ensures economic efficiency as well. Exchanges have tha advantage of gaining from these transactions and also provides a safe and secure platform to the investors to invest in securities in an efficient way. It is a win win situation for all.

a) - Coupon Security: Coupon Security is a security which pays fixed annual/semiannual interest to its subscribers.The rate of interest provided by the original issuer of the security on the face value of the security. For Example, X Ltd issues 1000 bonds of $100 each at 5%p.a. Here, 5% is the coupon rate that will be paid by X Ltd to the subscriber of the bond.

- Discount Security: Any security that is sold at a value which is lower than the face value of the security is called a discount security. This security will mature at the face value at the maturity date. This leads to a gain to the investor since the maturity value is higher than the investment value. For Example, Mr. A purchase 200 bonds of $100 each at $90. Here there is a discount value of $10.

a) i) Partnership:

+ Rileys share of taxable income(30%)= $250,000* 0.3= $75,000

Tax Liability [Tax Bracket- $37,001-$80,000] = $3,572 + 0.325*(75000-37000)

= $15,922

+ Baileys share of taxable income(70%)= $250,000* 0.7= $175,000

Tax Liability [Tax Bracket- $80,001-$180,000] = $17,547 + 0.37*(175000-80000)

= $52,697

Total tax liabilty(Partnership)= $15,922+ $52,697

= $68,619

ii) Corporation-

Annual Taxable income= $250,000

Corporate tax rate = 30%

Total tax liability(Corporation)= $ 250,000*0.3

= $75,000

iii) In conclusion, as per tax perspective, since the tax liability is lower in corporation as compared to partnership firm, it is better to form a corporation.