Part IV Taxation and Corporate Decision Making

• Chapter IV Taxation and corporate decision
making
Taxes have important impacts on investment and
other economic activities;
• For example, the use of tax policy to attract
companies through low tax rates highlight the role
of taxation in investment, which in turn contributes
to economic growth.
• Governments often consider the use of tax
incentives;
• Theoretically, these incentive schemes are believed
to have effect on corporate decision making;
• Taxation affects the financial policy of firms;
• how much of the capital structure to support by

debt, rather than equity; and
• how much of the earnings to retain for use as

internal equity finance, rather than distributing
dividends and raising new equity in the market.
• Taxation and choice of finance
• firms can finance their investments using equity

or debt.
• Equity – internally available to the firm or funds
raised by issuing stock;
• Debt – a firm can raise debt by borrowing from its

shareholders, from financial institutions, or from
the public;
• All interest paid by a corporation to its lenders is
tax-deductible, generating a tax shield;
– Subject to limit in Ethiopia
• Dividends are not tax- deductible;

– Distribution of after tax net income
• there is an incentive for firms to use debt instead
of equity;
• likely to lead to excessive corporate leverage;
– Higher level of risk
• Empirically, the evidence is mixed:
• Some indicate that higher corporate tax rates are

associated with increased use of debt.
• Others show that corporations use significant
amount of equity capital;
• There can be significant nontax costs involved
with debt financing.
– standard costs of borrowing and risks of financial
distress that liabilities imply.
• Firms fall into financial distress when they have
difficulty making their debt payments.
• Extended periods of financial distress can lead
to bankruptcy.
• Taxation and dividend policy
• Double taxation is criticized for it leads to high
overall tax rates on corporate income;
• Systems to dividends taxation;
• classical,
• imputation and exemption (shareholders’ level),
• split rate and dividend deduction (corporation
level) .
• Classical system:
• no relief is given for double taxation;
• Imputation or dividend credit (Australia, New
Zealand);
• tries to tax corporate income – dividend- at
personal income tax rates;
• personal income is "grossed up" by the amount
of corporation tax paid and credit is allowed for
corporation tax from gross personal tax due; Tax
on corporation=0.3 Dividend Income=700
PIT=0.35
• PI=700/(1-0.3)=1000
• Tax liability=(1000*0.35)-300=50
• exemption –exempting dividend income from the
personal income tax;
• dividend deduction – deducting the dividend

from corporate taxable income;
• split rate system- under which dividends are

taxed at a lower rate;
• Double taxation - likely to cause economic
distortions:
• double taxation of dividends encourages

corporations to favour debt financing;
• taking on more debt, so that the firm’s cash

payments to its investors take the form of
interest payments;
Impact on Form of Organization
• Double taxation of dividends discourages
businesses from holding corporation
status; Td=10% in Ethiopia
• Hence, organization as sole trader,
partnership or limited liability companies
• In Ethiopia, all are subject to business IT
• Is it double taxation?
• Decisions to retain earnings or distribute
dividends;
• double taxation encourages corporations to
repurchase shares rather than pay out dividends;
Tg=30% & Td=10% in Ethiopia
• repurchasing shares would result in a reduced
capital gains tax rate;
• So, as an investor, sale your shares if you need
the money
• Firms make cash payments to shareholders by
repurchasing their own shares;
• Taxation and choice of company location
• Low-tax jurisdictions also exist within

countries;
• Examples include:
– special economic zones in China,
– low-tax states and enterprise zones in the
United States;
– Subsidies of land and other facilities in
Ethiopia
• Companies try to use tax havens in their
choice of investment location;
• For example, U.S. companies make extensive

use of foreign tax havens in their decision of
where to locate their investment;
• As of 1999, nearly 60 percent of U.S. firms

with significant foreign operations had an
affiliate presence in tax-haven countries;
Involvement in Charities
• Taxation influences firms involvement in
charities
– Tax deductible donation policies
• In Ethiopia, no more than 10% of taxable
income, including:
– Donations in response to state of emergency
declared by government
Employee Benefit Decisions
• Limiting tax free and other benefits:

– Transportation allowances
– Pension contributions
– Representation allowances
– Interest for loans from owners
The End

Part IV Taxation and Corporate Decision Making

Uploaded by

Copyright:

Available Formats

Part IV Taxation and Corporate Decision Making

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Part IV Taxation and Corporate Decision Making

Uploaded by

Copyright:

Available Formats

• Chapter IV Taxation and corporate decision

• how much of the capital structure to support by

• how much of the earnings to retain for use as

• firms can finance their investments using equity

• Debt – a firm can raise debt by borrowing from its

• Dividends are not tax- deductible;

• Empirically, the evidence is mixed:

• Some indicate that higher corporate tax rates are

• dividend deduction – deducting the dividend

• split rate system- under which dividends are

• double taxation of dividends encourages

• taking on more debt, so that the firm’s cash

• Low-tax jurisdictions also exist within

• For example, U.S. companies make extensive

• As of 1999, nearly 60 percent of U.S. firms

• Limiting tax free and other benefits:

You might also like