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Pipeline Theory Definition
Pipeline theory is the notion that an investment firm passing every return on to clients shouldn’t be taxed like regular companies. Pipeline theory includes dividends, capital gains, and interest as returns which should be considered. Also known as “conduit theory.”
A Little More on What is Pipeline Theory
The majority of mutual funds qualify as a regulated investment company, giving them pipeline status and need them to be tax exempted from taxes at the corporate level.
According to pipeline theory, the investment firm sends income directly to the investors, who are eventually taxed as individuals. This implies that investors are have been taxed once on income. Taxing the investment company would be similar to taxing the same revenue twice.
The theory is dependent on the notion that companies passing every capital gain, dividend, and interest to their shareholders are termed pipelines or conduits. Instead of producing goods and services the conventional way corporations do, these companies function as investment conduits, going through distributions to the shareholders and also holding investments in a managed fund.
When distributions to shareholders are carried out, untaxed income is passed directly by the firm to the investors. Only investors that incur income tax on distributions can pay tax. Conduit theory states that investors in such firms should be taxed just once on the same income, as against regular companies. Regular companies would see double taxation on the company’s income, as well as, income on all distributions paid to shareholders, a debatable issue.
Majority of mutual funds are pipelines which qualify for tax exemption as investment companies that are regulated. Other company types that might be termed conduits include limited liability companies, S-corporations, and limited partnerships. The aforementioned companies are exempt from income taxes.
Real estate investment trusts (REITs) have special provisions permitting them to be taxed as partial pipelines. Most times, real estate investment trusts are permitted to subtract the dividend they pay to shareholders, lessening their taxes paid via the deduction.
Pipeline Mutual Funds
Mutual funds register as regulated investment companies so as to be a beneficiary from tax exemptions. This is a pertinent aspect of consideration for every managed fund which passes through dividends and income to their shareholders. Fund accountants are fund tax expenses’ primary manager.
Regulated investment companies that don’t pay tax enjoy lower yearly operating expenses for their investors. Funds would include information on their status of tax exemption in their mutual fund reporting documents.