The tax payments represent a cash outflow from the business and therefore, these tax cash flows are critical part of the financial decision making in a business firm. In deed in some practical situations, the taxation implications are dominant influences on the final investment decision also. Taxation effects a firm in numerous ways, the most significant effects is given below:
- Corporate taxes on firm’s profits.
- Reduction in weighted average cost of capital because interest payments are allowable against tax.
- Dividend will not reduce the tax burden of the firm since it is not a charge on profits.
- Where the firm incurs overall loss, it can be carried forward to a future profit making year.
- Where a unit of the firm incurs loss but the firm gets overall profits from all other units, loss of the loss making unit will reduce the overall tax liability of the firm by set off of losses.
- Impact of depreciation provision on the reduction of taxable income.
- Taxation of capital gains and its impact on profits of the firm.
- Double taxation of firm’s earnings like dividends receives from other companies and its impact on profits etc.
Financing with debt and making interest payments rather than dividend payments will generate after-tax income for the company’s suppliers of equity capital, but simultaneously there is greater risk associated with financing with debt.
A business organization must consider the tax consequences for the investors in company’s shares, debentures and bonds in order to attract investors to the firm’s securities. The investments in company attract two types of taxes to the investors:
- Earnings in the form of dividends and interest.
- Capital gains from disposal of the investments.
When the investments made in tax free securities like Tax free municipal bonds, will not attract any taxation on the individual investors.
Type of Tex Rate
- A progressive tax rate is a rate that escalates as the amount of income increases.
- A marginal tax rate is to be applied to the next rupee of income.
- The average tax rate equals the amount of tax divided by the taxable income.
Corporate Income Tax
A corporation’s taxable income is found by deducting all allowable expenses, including depreciation and interest, from revenues. This taxable income is then subjected to a graduated tax structure.
The taxability of a company’s income depends on its domicile.
- Indian companies are taxable in India on their worldwide income.
- Foreign companies are taxable on income that arises out of their Indian operations, or, in certain cases, income that is deemed to arise in India. Royalty, interest, gains from sale of capital assets located in India (including gains from sale of shares in an Indian company), dividends from Indian companies and fees for technical services are all treated as income arising in India.
- The tax rate of the shares in an Indian company, dividends from Indian companies and fees for technical services are all treated as income arising in India.
A percent of taxable income that must be paid in taxes that is applied to each income bracket is referred to as a marginal rate. For example, each additional dollar of taxable income above Rs.50 Foreign companies are taxable on income that arises out of their Indian operations, or, in certain cases, income that is deemed to arise in India. Royalty, interest, gains from sale of capital assets located in India (including gains from sale of shares in an Indian company), dividends from Indian companies and fees for technical services are all treated as income arising in India.,000 is taxed at the marginal rate of 25 percent until taxable income reaches Rs.75,000. At that point, the new marginal rate becomes 34 percent.
The average tax rate for a firm is measured by dividing taxes actually paid by taxable income. For example, a firm with Rs. 100,000 of taxable income pays Rs. 22,250 in taxes and, therefore, has an, average tax rate of Rs. 22,250 / Rs. 100,000 or 22.25 percent. For small firms (i.e., firms with less than Rs.335, 000 of taxable income), the distinction between the average and marginal tax rates may prove important. However, the average and marginal rates converge at 34 percent for firms with tax-able income between Rs.335, 000 and Rs. 10 million and, finally, converge again, this time to the 35 percent rate, for firms with taxable income above Rs. 18,33,333.
Income of companies is taxed at the following rates
| Type of company Old Rate (%) New Rate (%) |
| Domestic company Widely held company 45 40 Closely held company 50 40 Foreign company 65 55 |
A surcharge of 15% of the amount of tax payable is levied on domestic companies, if taxable income exceeds Rs.75, 000.
Taxable Income
The main source of income of a company is generally from “business”. A company would also earn income from under the following heads:
- Income from house property
- Income from capital gains
- Income from other sources
Taxable income is calculated according to the rules for each class of income and then aggregated to determine total taxable Income.
