Corporate Taxes and their Impact on Investment & Financing Decisions

The Federal Tax Code is generally divided into two sections: (1) tax laws that are applicable
to individuals, including proprietorships and partnerships and (2) tax laws that are
applicable to corporations.

Taxable income is defined as gross income less deductions and exemptions that are allowed
by the tax code. Most expenses incurred by businesses are tax deductible, whereas few
expenses incurred by individuals are tax deductible.

Generally speaking, an allowable business expense is a cost incurred to generate business

revenues. On the other hand, if an expense is incurred for personal benefit (use), it is
considered a personal expense, which is not tax deductible.

Tax deductible exp & taxable earnings

Interest Income: Most interest income received by corporations and individuals is taxable.
Interest Expense: Interest payments made by businesses on loans are tax deductible when
computing taxable income.
Dividend Income: Dividends received by both individuals and corporations are considered
income for tax purposes and thus taxed.
Capital Gains: When an individual or corporation buys a capital asset and later sells it for
more than its depreciated value, the profit is called a capital gain, which is taxable.
Depreciation: Depreciation plays an important role in income tax calculations. The tax code
specifies the life over which assets can be depreciated for tax purposes and the methods of
depreciation that can be used. Amount of depreciation a firm can take in a given year
affects firm’s taxable income and an important effect on taxes paid and cash flows from
operations.

GST- Goods and Services Tax: The Goods and Services Tax (GST) is a value-added tax levied
on most goods and services sold for domestic consumption.
WHT-Withholding Tax: Employee income tax (such as PAYE) and other government
imposed deductions from dividends, salaries, wages & other incomes.

Your average tax rate is your tax bill divided by your taxable income—in other words, the
percentage of your income that goes to pay taxes.
Your marginal tax rate is the rate of the extra tax you would pay if you earned one more
dollar.

If a company is financed by debt capital, there will be tax relief available on interest
payments. On the contrary, if the company is financed with shareholders’ fund (equity
capital), then dividend will be paid, which will in turn give rise to a liability for income tax.

In short, good estimates of how the tax treatment of dividends and debt affects the cost of
capital and firm value are a high priority in corporate finance.
Aiming at maximizing firm value, financial managers both of small and medium
enterprises as of multinational enterprises try to optimize their company’s tax liabilities.

Tax considerations regarding location, organizational form, type and timing of

transactions enhance the risk that financial decisions are guided by tax purposes rather
than management objectives. This is especially true for multinational companies. Since
value maximization is the leading principle of financial management, the use of tax
planning strategies has a substantial impact on a company’s financing and investment
decisions.