Conduit theory, also known as pipeline theory, is related to avoiding double taxation; taxation at both corporate and individual levels. The theory states that investment firms that pass all capital gains, dividend yields and interests on to its shareholders must not be taxed at corporate level. The shareholders are taxed only at individual levels for capital gains and income.
The idea behind conduit theory of investment is that the firms that are merely acting as conduit for passing capital gains to their shareholders should not be treated as regular companies and should not be taxed like them. A regular company is taxed for its earnings and profits at corporate level and the stock holders are also taxed for their dividend yields. The main beneficiaries of conduit theory are Real Estate Investment Trusts, mutual funds and similar regulated investment companies.
The tax benefit associated with conduit theory has its existence on IRS regulation M. The firms are exempted from tax as long as they satisfy certain federal rules. Conduit theory of investment has both proponents and opponents. Supporters of the theory believe that the theory has a good business sense and common sense; and the opposition believes that it gives investment firms an added advantage over other companies, especially other financial institutions.
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