When we talk about the tax shield, we refer to the expense that is reduced from the income statement of a company in order to obtain the value of the profit before taxes (BAT). It is a value that is inversely proportional to the BAT: the higher the tax shield (expenses), the lower the result obtained for the BAT, so you will have to pay less Corporation tax.
To specify, the expenses that are classified as a tax shield are operating, financial and extraordinary expenses, being able to reduce the BAT of the income statement of the company that we are taking into consideration.
Depreciation
It is important that we mention the case of a series of assets in relation to the tax shield. When we talk about depreciación refers to the wear and tear that occurs on an asset or asset. Said wear is caused by the passage of time and by the use of said good.
Well, depreciation also serves as a tax shield, since the value of the asset designated as "depreciative" is corrected, discounting it from the financial statements (including the income statement).
Financial expenses
Another type of tax shield is that caused by financial assets, which generate expenses that must be reduced from the income statement. Specifically, the expenses incurred come from interest or payment of fees or commissions of said assets.
Characteristics of the tax shield
Among the most important fundamental aspects, we find:
- The tax shield is effective when business profits are generated and not losses. Obviously, if there were losses, you would not have to pay corporation tax.
- In some cases, the tax shield does not produce a real outflow of money in the company. It occurs, for example, with the depreciation of a certain asset (explained above) in which taxes are paid periodically, and not in a cash outlay.
- To calculate the value of the tax shield, the tax rate must be multiplied by the expense or amount to be reduced from the company's income statement.