Taxation in Finance

Taxes have a strong impact on the three main decisions (Investment, Financing, and Dividends) of Corporate Finance and, therefore, on creating shareholder value. Taxes should be a vital concern for managers, particularly in the Finance Department. Taxes impact decisions regarding investment, as tax payments reduce the NPV and a project’s return. However, the way firms calculate tax costs, tax benefits, and tax deductions can all reduce tax costs and mitigate such effects from taxes. In turn, taxes impact financing decisions. The relative tax debt advantage influences the capital structure of a firm. The use of debt (with limits) may provide a reduction in the cost of capital twice over: the interest rate being lower than the cost of equity and the tax benefit of deducting interest costs (when dividends are usually not deducted, however, such a marginal benefit, which only occurs if the tax benefits exceed the marginal financial distress costs). This increases shareholders’ returns and the value of the firm. The dividend decision (whether to pay to shareholders through dividends or shares buybacks) is also affected at the income tax level if there is any difference in taxation of dividends or of capital gains as income.