The foundation of Corporate Tax Essay
71168540 CORPORATE TAX
The determination of the national income of a country is dependant upon the nation’s wealth1 As such; this national income is realized from real assets owned by the citizens through taxation or non-taxable activities. Therefore in order to critically understand and appreciate corporate tax, it is imperative for us to examine the foundations of tax, systems of which shall include the definition of taxation; classification of tax and the purpose of taxation
The foundation of Corporate Tax
Definition of tax
Taxation is a mandatory financial contribution imposed by the government to raise revenue2. It is commonly associated with income, consumption or wealth that individuals and corporations are required to make annually to the government. Tax can be classified as either direct or indirect taxation. Direct taxes are those that are withheld/obtained directly from the source. Since corporations are considered as economics entities corporation rates such as taxes on profit, sale proceeds on assets of firms and corporation are considered direct taxes3.
What then is the purpose of taxation? The fundamental purpose of taxation us observed in the introduction is to raise revenue for the government so as to facilitate the provision of goods and services4. The taxes are also imposed
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Tax systems are not only viewed by examining their purpose but also their characteristic feature. S a good tax system constitutes of the foregoing features:
Equity should govern the principles of taxation so as to ensure fairness in all aspect. Equity is divided into two categories: horizontal equity, which promulgates for equality of treatment to persons earning the same salary or participating in a similar kind of activity7. Vertical equity on the other hand, examines the relations of different situations so as to get a fair burden split8. It therefore describes for the treatment of taxpayers who are unequal with the appropriate degree of equality9. Vertical equity is pursuit through the imposition of progressive income tax the issuance of tax reliefs, which vary according to the commitments. Thus the greater a person’s income the greater the proportion collected in tax.
A good tax system should also take into consideration the taxable capacity, which promulgates that people should pay tax to the extent in which they can afford it10. Two assumptions lie behind this approach on incomes proportionately; the use of the progressive rate systems to insure income redistribution. Pratt and Kulsrund11however maintain that though the concept on taxable capacity is intimately connected with the concept of ability to pay, the latter refers to a method of apportioning a given tax burden amongst the tax payers and that such apportioning may or may not exceed the capacity to pay. That ability to pay refers only to the existing circumstances. Taxable capacity on the other hand refers to the maximum tax which might be collected from a particular tax payer or a group of tax payers under consideration which is made in reference to the economy which is made in reference to the economy as a whole, a region, an industry or a group of people. Pratt and Kulsrund12conclude by stating taxable capacity can therefore not constitute of a constant entity.
Another constituent of a good tax system is administrative efficiency, which relates to the percentage of revenue dissipated on collection expenses13. it is imperative to note that it is not only the authorities who bear expenses when one adds the cost to tax payers but also the cost revenue ration also becomes considerable14. Therefore a tax with low administrative cost may be bad bargain compared with a more suitable and economically efficient tax with costs. Administrative efficiency is also administered if collection points are well spread with the encapsulation of clarity and ease of the definition pf tax base. The import of administrative cost being the ease or difficulty of enforcing and evasion of tax15
Allocative neutrality also constitute of another prerequisite of a good tax system. Neutrality defined is the extent to which the tax avoids distortion of working of the market mechanism16. In the market economy, the majority of decisions about what to buy, how much to save and so forth are made by a comparison of the benefits of this action with the costs involved. Therefore any taxation, which is related to any economic activity, will clearly distort this comparison of costs and benefits. This constitutes of distortion of individual choices involved in the process of taxation17. The goal of neutrality is therefore to minimize on excess burdens18.
Lastly, a good tax system should aim at reducing consumption from private hands.
The question to be considered however is how effective does the tax system achieve this goods taking into consideration that the restraining effect highly depends on who is taxed because different people and entities have different marginal propensities to consume19.
It is upon the foregoing backdrop that we shall examine the corporate tax systems. However, it is imperative to note that the above mentioned principle and purposes of tax, though general in nature also relate to corporate tax and in no circumstance can be derogate from them whether dealing with value added tax, income tax or corporate tax.
Income Taxation of Corporations
Every business organized and operating within the United States is classified for Federal income Tax purposes20; corporations not being exceptions. Usually taxpayers choose which tax from his or her business will take depending with the type of business settled for. For example the dominant tax reason for not operating a business in the regular corporate form is the avoidance of double taxation of the same source of income. If a business is operated as a regular corporation, its income is taxed once at the corporate level and again as (dividends) when the income is distributed to the shareholders21. conversely the most significant non tax reason for selecting the corporate form is the limited liability that this form offers to its owners22.
The International Revenue Code provides the possibility of certain closely held corporation to elect to be treated as conducts for federal income tax purposes23. For this reason, certain corporations are referred to as S corporations. If the corporation elects the S states it is taxed in virtually the same fashion as a partnership. With multiplicity of definitions of corporations. It is imperative to define the term corporation
What is a corporation?
A corporation is an artificial person created by state law. This implying that the state imposes restrictions on the issuance of shares and the type of business conducted. It also specifies the requirements for incorporation such as filing of articles of incorporation among others. The Internal Revenue Code Under Sec 7701(a)(3) defines the term corporation as to include associations, Joint stock companies and insurance companies Sec.11 of the code imposes tax on all corporations foreign corporations and their foreign and domestic source income. Through Sec. 11 exceptions to corporate tax include non-profit literary, educational or certain other purposes24. This provision is however not absolute in itself. If non profit organizations conduct business which is not related to the purpose for which its prescribed it would consequently be subject to taxation25.
Exceptions to treatment of entities as corporations may also be allowed when a corporation’s only purpose is to reduce taxes of its owners or to hold title to property. In Higgins V. Smith26 it was established that if the corporations has no real business or economic function or if it conducts no activities it may be cohesive as a Sham or “dummy’ corporation. To reinforce the decision in the above case it was established in Moline Properties Inc,27 that as long as there is a business activity earned on a corporation will be considered a separate taxable entity
1 Wealth according to Hyman D. in his book Micro economics constitutes of the stock of real assets that are owned by people of a country at a given point in time
2 Schiller R. B, (1980) The Micro Economy Today
4 Hyman David (1989) Micro economics (4Ed) Irwin/McGraw-Hill, North Carolina
5 Karayan J.E. (2002) Strategic corporate tax planning
7 Dechman A. J. who paid the taxes, 1966-1985
9 Supra F.N. No.4
10 In Corporate Partnership Estate and Gift Taxation, Dame publications Inc (1988)
12 Supra F.N. No. 7
14 Organization for Economic Cooperation and Development 2001
16 Mancuso (2005) How to Form a Non Profit corporation
17 Pratt and Kulsrund promulgate that for minimization to be effected.
All taxes fall ultimately on someone’s or corporate income
That taxes reduce income directly or reduce the real value of income by raising the prices of things
They therefore conclude that a single tax on income would be the best tax.
18 Supra F.N. No.4
20 Supra F.N. No. 10
22 Sec 1361 through 1379