Financing Decisions
Strategic Tax Management
Sources of Financing
Internal Financing- comes from the business itself. It is a type of self-sufficient
funding that is generated by the operations of the business itself
Day-to-day profit boosting operations, such as the sale of stock or services
or proceeds from the sale of business assets, undisbursed retained earnings
External Financing- comes from outsider investors which will include
shareholders and lenders
Money that comes from investors or loans through stocks and shares as well
as lines of credits that can be opened with banks or financial institutions
Non Tax Considerations
Internal Financing External Financing
Easier to avail and timing can be easily Subject to voluminous documentation
controlled. Less transaction costs. Not and timing is unpredictable. More
subject to pay out and control transaction costs. Subject to pay out and
restrictions control restrictions
Tax Consideration
Internal Financing- control the timing
Understanding the concept of tax benefit
Gross Income - Allowable Deductions = Taxable Net Income
Gross Income = proportional with taxable net income and tax sue
There are benefits in the deduction in gross income = less tax due
Allowable deduction inversely proportionate with taxable net income and
less tax due
Net Operating Loss
If the allowable deductions are greater than the gross income
MCIT shall be applied on the gross income if there is net loss = 1%
Example:
An entity intends to purchase a property with a cost of 1,000,000 and an estimated
useful life of five years. Tax rate for Years 1 and 2 is 30%, Years 3 and 4 is 25%, and
Year 5 onwards is 20%. What is the net benefit/cost of delaying the purchase to (a)
Year 3? (b) Year 5?
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Buy Now (1,000,000 200,000 200,000 200,000 200,000 200,000
)
Tax 0 60,000 60,000 50,000 50,000 40,000 =
Benefit 220,000
54,545.45 =
60,000*1/1.1
External Financial
Debt- short-term or long-term borrowings, depending on when the obligation
will be settled
Cost of debt- interest payment, which is deductible from gross income,
resulting in the recognition of tax benefits
Equity- ordinary or preference share or interests in partnerships, in exchange for
cash or non-cash contributions from shareholders or partners.
Cost of equity- dividend payment, which is NOT deductible from gross
income, hence, no tax benefit can be derived.
NON-DEDUCTIBLE INTEREST EXPENSE
Interest paid in advance
Interest on amortization
Interest payments made between related taxpayers
Interest on indebtedness incurred to finance petroleum exploration
Interest treated as capital expenditures
PART 2
Which is better? Debt or Equity?
Company A- Debt 3,000,000 and equity- 7,000,000
Taxation on the Part of the Creditor in Debt Financing
Taxation of Interest Income
1. On bank deposits
2. On notes receivable
3. On long-term deposits
4. On sale of long-term investments
Taxation Part of Investor in Equity Financing
1. Share price appreciation- tax exempt
2. Sale of shares of stocks not listed or traded in the local stocks exchange- 15%
capital gains tax on net capital gains
3. Sale of shares of stocks listed or traded in the local stocks exchange- 6/10 of 1%
selling price
4. Dividends- subject to final income tax (lump sum vs installment, negotiation)
5. Liquidating dividends- taxed as capital gain or capital loss, subject to holding
period
Loss on Worthless Debt and/or Equity
Ordinary Vs. Capital Loss
An ordinary loss is fully deductible to offset income thereby reducing the tax
owed by a taxpayer. Capital losses occur when capital assets are sold for less
than their cost
Net operating loss of the business or enterprise for any taxable year
immediately preceding the current taxable year, which had not been previously
offset as deduction from gross income shall be carried over as a deduction from
gross income for the next three consecutive taxable years immediately following
the year of such loss.
