INTRODUCTION TO BUSINESS

FINANCE (FIN201)

Corporate Taxes
Lecture 4:
How Corporate Taxes Influence
Business Decisions???

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EXPENSES ARE TAX DEDUCTABLE

 Tax Deductible
 Cost of goods sold

Corporate Taxes
 Selling expense
 Depreciation expense
 Interest expense
 Non-tax Deductible items
Dividends (not an expense)
Interest and depreciation are tax deductible
expenses where as dividends are non-tax
deductible.
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INCOME CAN BE CLASSIFIED AS…

 Taxable
 Operating income

Corporate Taxes
 Rent income
 Tax Exempted

Interest Income is fully taxable but

dividend income is partially exempted
from corporate tax or taxed at a lower
rate.
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TAXES AFFECTS THE FINANCING DECISION AS
INTEREST PROVIDES TAX SAVING (TAX SHIELD) TO
A FIRM. FINANCING FROM DEBT OR EQUITY??
Firm Z
Firm A (Using preferred
(Using debt, paying stocks(equity), paying

Corporate Taxes
interest of Rs. 100) dividends of Rs. 100)
Difference
Operating Income 400 400
Less: Interest -100 0
Taxable Income 300 400
Less: Taxes (30%) -90 -120 30
Net Income 210 280
Less: Preferred
Dividends 0 -100
Income for Common
stock- holders 210 180 30

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STATED COST OF DEBT (INTEREST) IS THE
BEFORE TAX COST…

Before-tax cost(interest) Rs.100

Corporate Taxes
Tax Saving (35% of 100) (35)
After-tax cost of debt Rs.65
(Interest expense acts as a TAX SHIELD)
After-tax cost of debt=
Before-tax cost X (1-Tax rate)
=100 x (1-0.35) =Rs 65
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TAXES AFFECT THE INVESTMENT DECISION AS
DIVIDEND INCOME IS TAXED AT LOWER RATES…

Firm A
(gets Firm Z

Corporate Taxes
dividend (gets interest
income of Rs. income of Rs.
100) 100)

Taxable Operating Income 400 400

Less: Taxes (34%) -136 -136
After Tax Operating Income 264 264
Add: After-Tax
Dividend/Interest Income 90 66
Net Income 354 330
In 2014-15 Income tax rate was 10% on dividends and 34% 6
on interest income for public limited companies in Pakistan
INCOME TAX RATES FOR
THE YEAR 2019-20

 Tax on Interest Income = 29%

Corporate Taxes
 Tax on Dividend Income = 15%

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TAXES AFFECT THE INVESTMENT DECISION AS
DIVIDEND INCOME IS PARTIALLY TAX EXEMPTED
OR TAXED AT LOWER RATES…

Firm A
(gets Firm Z

Corporate Taxes
dividend (gets interest
income of income of
$100) $100)

Operating Income 400 400

Add: Taxable Dividend/Interest 30 100
Taxable Income 430 500
Less: Tax (30%) -129 150
After-tax Income 301 350
Add: Tax-exempted Dividend 70 0
Net Income 371 350
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Assume 30% of dividend income is taxable and 70% is tax-exempt.
Taxes Affect Investment Decision as Dividend
Income is Taxed at a Lower Rate in Pakistan
Firm A Firm Z
(gets dividend (gets interest
income Rs100) income Rs100)

Corporate Taxes
Corporate Taxes
After Tax Operating Income (a) 400.00 400
Dividend/Interest Income 100.00 100
Tax on Dividend/Interest Income 12.50 32
Net Dividend/Interest Income (b) 87.50 68
TOTAL INCOME AFTER TAX(a+b) 487.50 468

Tax rates for 2015-16

Income tax rate for dividend income 12.5%
Income tax rate for interest income 32.0%

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9
Non-cash expenses provide tax savings
and result in higher operating cash flow
for the firm…
Firm A
(with Firm Z

Corporate Taxes
Depreciation of (with 0
Rs. 100) Depreciation)
Earnings Before
Depreciation and Taxes 500 500
Less: Depreciation -100 0
Earnings Before Taxes 400 500
Less: Taxes (32%) -128 -160
Net Income 272 340
Add Back: Depreciation 100 0
Net Operating Cash flow 372 340 10
OPERATING LOSSES CARRY GOOD NEWS
ABOUT TAXES…

Corporate Taxes
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INCOME TAX RATES etc in Pakistan 2018
Tax on dividends = 15%
Tax on Capital Gains on Shares = zero if purchased before
of listed Companies 1-7-2013 otherwise 15%

Corporate Taxes
Corporate Income Tax Rate = 30% for Tax year 2018
and 29% for 2019

Minimum Tax (Turn over tax) = 1.25% of turnover

Business losses may be set off against taxable income earned

in the same year under any head of income. Excess losses may
be carried forward up to 6 years following the tax year.

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OPERATING LOSSES CAN BE CARRIED BACK OR
FORWARD FOR TAX PURPOSES…

2006 2007 2008 2009

Corporate Taxes
Taxable Income 200 250 200 -900
Less: Taxes(40%) -80 -100 -80 *360

* 360 is the tax refund which could be in the

form of a cash refund or a tax saving in the
future year/s or a combination of both.

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CARRY OVER RULES DIFFER FOR DIFFERENT
COUNTRIES…
Assume the companies are allowed to carry-back the losses to 2
years and carry forward to 20 years. Loss of $900 in 2009 can
be adjusted as follows in USA:

Corporate Taxes
2008 2007
Taxable Income 200 250
Less: Loss Adjustment -200 -250
Adjusted Taxable Income 0 0

Cash Refund 80 100

Remaining loss after adjusting the income for 2008: 900-200 = 700
Remaining loss after adjusting the income for 2007: 700-250 = 450
Remaining loss of 450 will be carried forward.
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CARRYING THE REMAINING LOSS OF $450 TO
THE FUTURE YEAR…

2010 2011
Taxable Income 200 1000

Corporate Taxes
Less: Loss Adjustment -200 -250
Adjusted Taxable Income 0 750
Less: Taxes(40%) 0 -300
Net Income 0 450

Tax Saving 80 100

Tax Saving = Cash Refund + Tax Saving

* 360 = 180 + 180
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