8-Taxes

8)- Taxes

Taxes are found in different places in the income statement. When comparing companies in different countries, taxes are the least comparable items of the income statement. For most countries the largest tax on businesses is the income tax calculated on net profit before tax. The corporate income tax rate varies from as little as 10% (in Switzerland) to well over 50% (for Scandinavian countries). In the United States the corporate income tax rate is a moderate 34% at the Federal level, but with State corporate income taxes, the overall effective rate can almost reach 50%. For European companies (as well as companies in several other countries), the value added tax (VAT) is the most important tax, and it is generally calculated at a rate of around 20% on total sales net of VAT paid on purchases. There are also real estate taxes, sales taxes, customs and excises, which are usually lumped as a small amount in general and administrative expenses. Some countries also assess a gross receipt tax calculated (as the wording implies) on gross sales; the tax is in addition or instead of the corporate income tax.

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The corporate income tax reported in the income statement is not the actual tax paid. The actual tax liability is calculated on the income tax return with all tax rules on income recognition and allowable deductions that are permitted and most advantageous to the firm. The reason why the actual tax is not the one shown on the income statement, is attributable to the accounting requirement of matching expenses with revenues: the tax on the income statement is calculated using the official tax rate for the income and expenses as they are shown in the income statement, rather than as they appear in the tax return. For instance, an accelerate depreciation is allowed on the tax return, but straight line is used on the income statement: this reduces tax liability today, and the resulting reduction in tax is the deferred income tax liability which has been mentioned on several occasions. Another example is that of employee post-retirement benefits which are expensed, recorded as liability, but not actually paid out (until the employee retires), and therefore, not deductible for tax purposes: this creates a deferred income tax asset for the amount of tax that will not have to be paid when the post-retirement payments are deductible for tax purposes. Other examples of deferred income tax assets are loss carryforward and unused investment tax credit. American companies must explain in notes to financial statements and/or statements, a) the current, deferred and expensed income tax (i.e. income statement amount), b) a reconciliation of the effective tax rate with the statutory federal income tax rate, and c) a list of sources of temporary and permanent deferred tax liabilities and assets. Studying this information can be useful for the analyst to uncover unusual items.

Here is an example of information discovered by reading the note to financial statement on income taxes. In Mylan Laboratories Inc. 1999 Annual Report, the schedule of deferred tax liabilities and assets in Note K to financial statements, included amounts of tax loss carryforwards of $ 18,198 millions and tax credit carryforwards of $ 3,683 millions for the year 1999, but not for prior years. This was a surprise. Mylan had a large profit in 1999, and had been, by all measures, a highly profitable company for the past ten years (as mentioned in previous examples). These carryforwards must not have been Mylan's own but that of an acquired company. Indeed further reading of the annual report confirmed that Mylan had acquired Penederm Inc. which had two products in an advanced stage of development but no sales, and consequently, most likely large losses.

The tax information in the note to financial statements also ought to be a tool for analyzing if the company follows a tax saving policy, but in reality, such analysis is extremely difficult to do because details of the corporate income tax return are only for the eyes of top management and auditors.

See review questions .Q-13C8.1 through Q-13C8.8

See research assignments R-13C8.1 through R-13C8.3.

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Last modified: Jun/01/01 Next: 9-Other