ACCA Advanced Taxation (ATX) Practice Exam

What formula is used to determine the corporation tax needed to pay a dividend?

1. Dividend amount multiplied by the tax rate

2. Dividend amount divided by (100 - tax rate)

3. Dividend amount multiplied by the tax rate divided by (100 - tax rate)

4. Dividend amount plus the tax rate

The correct answer is: Dividend amount multiplied by the tax rate divided by (100 - tax rate)

To determine the corporation tax needed to pay a dividend, it is essential to account for the impact of the corporation tax rate on the net profits available for distribution. The correct formula used is the dividend amount multiplied by the tax rate divided by (100 - tax rate). When a company pays dividends, it distributes profits that have already been subject to corporation tax. Therefore, to find out how much before-tax profit is required to sustain a certain dividend amount, one needs to consider the inverse of the corporation tax rate. Specifically, the net amount that shareholders receive as dividends is a proportion of the taxable profit after corporation tax has been deducted. Using the formula, if you have the dividend payment amount and the applicable corporation tax rate, multiplying the dividend amount by the tax rate indicates the portion of the profit that has gone towards tax. Dividing by (100 - tax rate) allows you to backtrack to find the total profit needed before tax is applied to ensure that the dividend amount can be paid out in full. In contexts where the dividend is distributed as a net figure, using this formula captures the essence of how tax impacts the amount distributable as dividends, ensuring that the full dividend is covered after tax obligations are considered.