Question

when a person contributes cash or property to a corporation and receives stock in exchange this is classified as a section 351 transaction and generally is not taxable as long as the property or cash contributed is equal to the value of the stock. Personal services contributed are considered wages and, if exchanged for stock, become a taxable event.

A corporate can also reduce its investment income when purchasing certain types of stock of other companies. This credit is know as the 'dividend received deduction'.

1. Relative to corporate formation, how can one contribute appreciated property without gaining recognition for the transferor?
2. Describe, in detail, the dividend-received deduction.
3. What are some items that increase book income? What are some items that reduce book income when reconciling book to taxable income

Answer 1

Dividend Received deduction (DRD) in general applies to group companies or related party companies or associate companies. ie in other words where there are inter company investments or in other words to reduce the impact of taxability for the ultimate beneficial holder. For eg If Company A is taxed for its income and then declares a dividend of Rs. 10, and Company B which is a holder of Company A is liable to be taxed for this dividend income. However since this income is already taxed in company A, this leads to repetitive taxation. Therefore this is given.

There are few rules in this regard to claim the deduction like the holding period and % of deduction allowed based on the holding of the company in the company that declares the dividend. In the above example, The holding of number of shares of B company in Company A decides the % applicability of the dividend.

The next question which deals with under what situation it can be beneficial or not to the company. To analyse this we have to see the % deduction allowed for company B. In situations where the taxable limit becomes less than the dividend received deduction amount calculated under the appropriate provision of law, then we have to use the proportion to the taxable limit and not the dividend amount .

or in other words when the taxable value of the company is less than the DRD then full DRD can be deducted, If more than DRD the proportionate to the taxable value only the amount can be deducted.

For eg, If the amount of taxable value is 500 and the DRD (calculated as per the appropriate provision) is 600 then the entire amount can be deducted, else if it DRD is 400, then an amount proportionate to 500 (in the same proportion as was applied to compute 400) has to be deuducted from the taxable income.

.