Question

A corporation buys shares of another domestic corporation. They receive $100,000 of dividend income. They hold the shares for 75 days and then sell the stock. What tax consequences accrue to the corporation from the receipt of the dividend? What is the rationale for the rule? Would the result change if the corporation only held the stock for 5 days? If so, why? Does it really violate the rationale for the general rule?

Answer 1

As per the applicable rules, a corporation is eligible for dividend received deduction in the following amounts:

1) 50% of the dividend received from the other corporation

2) 65% of the dividend received if the corporation that received the dividend owns 20% or more of the stock of the dividend distributing corporation

3) 100% of the dividend received if the corporation that received the dividend owns 80% of the stock of the dividend distributing corporation

However, there is a holding period limitation that applies to dividend received deduction. In order to claim this deduction, it is necessary that the corporation holds the stock of the dividend distributing corporation for a period of more than 45 days from the date of acquisition.

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Assuming that the corporation owns less than 20% stock of the dividend distributing corporation in the given case, it will be entitled to claim a maximum dividend received deduction of $50,000 (100,000*50%) subject to its maximum taxable income. The remaining 50% will be taxable. The basic rationale behind this rule is to avoid multiple taxation on profits (tax on profits of dividend distributing corporation and tax on the dividends that the dividend distributing corporation pays to its shareholders) resulting from holding of stocks of other corporation (s).

However, if the corporation has held the stock for only 5 days from acquisition, it will not be entitled to dividend received deduction. No, this doesn't violate the rationale for general rule as the dividend received deduction with respect to stock purchased immediately before dividend record date and sold ex-dividend would result in a capital loss (as stock was purchased at a higher price and sold at a lower price) that would exceed the value of dividend income so received.