For debt instruments,
the issuing corporation recognizes no income upon the receipt of capital and
the investor recognizes no deduction for the investment made.
Thus, as the debt is repaid,
the corporation does not deduct the principal repayment and
the investor does not recognize income on the return of their capital investment.
However, the interest paid to the investor for
use of their investment is deductible from corporate taxable income.
While the interest received is generally taxed as ordinary income by the investor.
For equity instruments, the tax treatment of the initial investment and
return of capital are the same as debt instruments.
That is, the corporation recognizes no income upon the receipt of capital, and
the investor recognizes no deduction for the investment.
If the capital investment is returned to the investor,
the corporation receives no deduction and the investor does not recognize income.
However, when returns on equity are paid to investors,
the tax treatment differs from that of debt.
Specifically, unlike deductible interest expenditures on corporate debt,
dividends paid to the investor by the issuing corporation
are not deductible from corporate taxable income.
The dividends are also taxable to individuals, often
receiving capital character treatment, as well as corporate shareholders.
But the latter could potentially obtain the dividends received deduction you
learned about in a previous lesson.