Description
The PPT highlighting own funds vs borrowed funds, lease vs purchase, purchase by installment vs hire
Decisions using taxation
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Case study (own v. borrowed funds) acquires a plant and An assessee, who carries on a business,
machinery costing Rs. 1,00,000 in year one. This plant and machinery is utilised for the business of the company till year ten when it is discarded and sold at the depreciated price. In this case, the taxpayer can claim depreciation from year one to year ten under section 32. Effective tax benefits depend upon maximum marginal rate of tax. For this purpose, it is assumed that the maximum marginal rate of tax is 30.9 per cent. Tax savings are discounted at the rate of 10 per cent to find out present worth in year one. This case study is based on two plans, namely, (i) when owned funds are invested, and (ii) when 75 per cent cost of plant is financed by deposit taken from public. Avg. rate of depreciation is 15% and rate of interest on borrowed funds is 9%. Entire loan is repaid at the end of year 10.
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Depreciation per annum Tax savings @30.9% of depreciation PV of the savings Total the outflows in each year (capital + interest) • Net the outflows for tax (1-T) and find out PV • Net outflow= PV of investment/outflows LESS PV of tax savings
Lease v. purchase
• One must resolve this issue on economic consideration taking into account the different tax shield effects. • If asset is purchased, the assessee can claim depreciation. Besides, interest on capital borrowed to finance investment in plant and machinery can also be claimed as deduction. • If, however, asset is obtained on lease, deduction can be claimed in respect of lease rentals and lease management fees.
Case study
• A plant is to be purchased for Rs. 1,00,000. The depreciation rate is 15 per cent and the corporate tax rate 30.9 per cent. The weighted average cost of capital is 10 per cent. The life of the machine is 10 years. A loan of Rs. 75,000 can be had by accepting public deposits at the interest rate of 9 per cent for financing the investment in plant. It is assumed that the public deposits are repaid after 10 years. • On the other hand, the asset can be obtained on lease. The lease rentals are at the rate of Rs. 34,000 per annum for the primary lease period of 5 years. Beyond this peppercorn rentals of Rs. 600 per annum are to be paid. A lease management fee of Rs. 1,000 is payable on inception of the lease.
• Net outflow for purchase is known (previous slides) • For lease, take total outflows in each year for lease management fees+ lease rentals • Net the outflows for tax benefits (1-T) • Find out PV of net outflows.
Purchase by instalment v. Hire
• If an asset is purchased by instalments, then the taxpayer can claim depreciation under section 32. Besides interest payable on unpaid purchase price can also be claimed as deduction. • In the case of obtaining an asset on hire, deduction can be claimed in respect of hire charges.
Case study
• X Ltd., an Indian company, engaged in the business of manufacture of transformers and switchgears, negotiates for the purchase or taking on hire a machine from a concern in U.K. • If it acquires the machine, then the total cost will be Rs. 60,00,000 payable in 5 annual (interest-free) instalments of Rs. 12,00,000 each, the payments to be made on July 1 each year beginning with the year 2007. • If it takes the machine on hire, it has to pay an annual rent of Rs. 8,00,000 also payable on July 1 each year starting from the same year 2007. The company proposes to use the machine for 10 years from 2007.
The following assumptions have been made : The company’s tax rate is 30.9 per cent, Rate of depreciation on machinery is 15 per cent and Cost of capital is assumed as 10 per cent.
doc_454816921.ppt
The PPT highlighting own funds vs borrowed funds, lease vs purchase, purchase by installment vs hire
Decisions using taxation
•
Case study (own v. borrowed funds) acquires a plant and An assessee, who carries on a business,
machinery costing Rs. 1,00,000 in year one. This plant and machinery is utilised for the business of the company till year ten when it is discarded and sold at the depreciated price. In this case, the taxpayer can claim depreciation from year one to year ten under section 32. Effective tax benefits depend upon maximum marginal rate of tax. For this purpose, it is assumed that the maximum marginal rate of tax is 30.9 per cent. Tax savings are discounted at the rate of 10 per cent to find out present worth in year one. This case study is based on two plans, namely, (i) when owned funds are invested, and (ii) when 75 per cent cost of plant is financed by deposit taken from public. Avg. rate of depreciation is 15% and rate of interest on borrowed funds is 9%. Entire loan is repaid at the end of year 10.
•
•
•
•
• • • •
Depreciation per annum Tax savings @30.9% of depreciation PV of the savings Total the outflows in each year (capital + interest) • Net the outflows for tax (1-T) and find out PV • Net outflow= PV of investment/outflows LESS PV of tax savings
Lease v. purchase
• One must resolve this issue on economic consideration taking into account the different tax shield effects. • If asset is purchased, the assessee can claim depreciation. Besides, interest on capital borrowed to finance investment in plant and machinery can also be claimed as deduction. • If, however, asset is obtained on lease, deduction can be claimed in respect of lease rentals and lease management fees.
Case study
• A plant is to be purchased for Rs. 1,00,000. The depreciation rate is 15 per cent and the corporate tax rate 30.9 per cent. The weighted average cost of capital is 10 per cent. The life of the machine is 10 years. A loan of Rs. 75,000 can be had by accepting public deposits at the interest rate of 9 per cent for financing the investment in plant. It is assumed that the public deposits are repaid after 10 years. • On the other hand, the asset can be obtained on lease. The lease rentals are at the rate of Rs. 34,000 per annum for the primary lease period of 5 years. Beyond this peppercorn rentals of Rs. 600 per annum are to be paid. A lease management fee of Rs. 1,000 is payable on inception of the lease.
• Net outflow for purchase is known (previous slides) • For lease, take total outflows in each year for lease management fees+ lease rentals • Net the outflows for tax benefits (1-T) • Find out PV of net outflows.
Purchase by instalment v. Hire
• If an asset is purchased by instalments, then the taxpayer can claim depreciation under section 32. Besides interest payable on unpaid purchase price can also be claimed as deduction. • In the case of obtaining an asset on hire, deduction can be claimed in respect of hire charges.
Case study
• X Ltd., an Indian company, engaged in the business of manufacture of transformers and switchgears, negotiates for the purchase or taking on hire a machine from a concern in U.K. • If it acquires the machine, then the total cost will be Rs. 60,00,000 payable in 5 annual (interest-free) instalments of Rs. 12,00,000 each, the payments to be made on July 1 each year beginning with the year 2007. • If it takes the machine on hire, it has to pay an annual rent of Rs. 8,00,000 also payable on July 1 each year starting from the same year 2007. The company proposes to use the machine for 10 years from 2007.
The following assumptions have been made : The company’s tax rate is 30.9 per cent, Rate of depreciation on machinery is 15 per cent and Cost of capital is assumed as 10 per cent.
doc_454816921.ppt