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  2.  
  3. London School Of Economics (LSE)
  4.  
  5. MSc Finance
  6.  
  7. Corporate Finance (FM422)

Class notes

Tax Loss Carry Forward and Personal Taxes

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  • Course
  • Corporate Finance (FM422)
  • Institution
  • London School Of Economics (LSE)
  • Book
  • Corporate Finance

These are the lecture notes for TLCF and Personal Taxes part of Corporate Finance. I have other notes for other modules and I graduated from LSE with a Distinction. So if you need help or tutor, just contact me. Thank you.

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Document information

  • October 19, 2018
  • 1
  • 2018/2019
  • Class notes
  • Dirk jenter
  • Tlcf and personal taxes

Subjects

  • corporate finance
  • tlcf
  • personal taxes
  • tax loss carry forward
  • lse

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Handout - LSE

So:
 Raising debt does not create value (i.e., you cannot create value by borrowing and sitting on
the excess cash).
 It creates value relative to raising the same amount in equity.
 Hence, value is created by the tax shield when you:
o Finance an investment with debt rather than equity
o Undertake a recapitalization (i.e. fnancial transaction in which some equity is retired
and replaced with debt).
 If we issue debt and invest in fnancial asset then we are taxed and so, there is a problem that
this offset each other  loss the beneft of debt

THE TAX COST OF EXCESS CASH
 Excess cash:
o Not useful to run operations (hard to pin down)
o Invested in fnancial assets
o It is like a negative debt for the company
o Net debt = Debt – Cash
 So, it comes with a negative tax shield.
 In conclusion:
o Tax shield of debt matters a lot
o And how this fnancing choice affects the government’s bite of the corporate pie?
 It is standard to use t*D for the MV of debt’s tax break
o Caveats (warning):
 Not all frms face full marginal tax rate and it is defnitely not ok for non
taxpaying companies  TLCF
 Personal taxes

TAX-LOSS CARRY FORWARDS (TLCF)
 This answer how company not paying tax.
 In this case, debt is not attractive.
 Typically, losses in a given year can be carried forward (TLCF) against taxable income for
several tax years.
 Firms with large TLCFs may not exhaust them for a number of years while they return to
proftability: in the meanwhile, they pay no taxes.
 These frms cannot utilize tax shields from existing or new debt: marginal tax rate is zero.
 More TLCF  debt fnancing less attractive
 So, the loss is carried forward so you do not need to pay taxes for few years in the future.

PERSONAL TAXES
 Investors’ return from debt and equity are taxed differently.
 Classical Tax Systems (e.g., US)
o Interest and dividends are taxed as ordinary income
o Capital gains are taxed at a lower rate
o Capital gains can be deferred (contrary to dividends and interest)
 So, from the perspective of individual investors’ personal taxes, equity may be preferred to
debt.
 However, in most cases, the personal tax advantages of equity do not outweigh the corporate
tax advantages of debt.
 Moreover,
o Corporations have a 70% exclusions on dividend taxation in the US
o Equity ownership is increasingly dominated by tax-exempt institutions such as pension
funds.
 Thus, it is OK to ignore personal taxes from a capital structure perspective most of the time
and we’ll ignore personal taxes.
 Overall, from a tax perspective, debt is preferred to equity.

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