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Tax shield on depreciation

Sanmitra Sanjeev Ratnaparkhi (-) (223 Points)

08 May 2014

Why do we calculate tax shield on depreciation?

& why we calculate it on interest like Interest(1-Tax rate) & on depreciation like Depreciation x Tax rate ?

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Because in decision making about any proposal, you'll have to calculate it's all inflows and outflows.

For outflow of interest, you save tax on it, because it is tax deductible. Suppose, there is no debt in your business and you are earning Rs. 100,000, tax rate is 30%. So, your net profit left to you for your disposal is 100,000(1-30%)=70,000. But, if you had some debt of Rs. 300,000 @ 10%(interest). Then your net profit at your disposal would be:

Profit before interest: 100,000

Less: interest: 300,000 X 10% = 30,000

Less: tax: (100,000-30,000)(1-30%) = 49,000

It means, if you had debt, your net profit would be 49,000 which is 21,000 less, in case if you had no debt (profit would be 70,000). So, net cost you incurred because of debt, becomes 21,000 (300,000 X 10%(1-30%)) [difference between profits of both cases]

Same, as in case of depreciation, what you incur today to show that in fixed assets, is allocated as expense to different periods. Because of that pre-incurred expenditure, which is allocated now, as expense, result in tax savings.

Hope it's clear!

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