Corporate taxation refers to the amount of tax that companies are supposed to pay to the government or tax authorities from annual profits. This tax has various effects on the company’s investment decisions as well as government revenues.
It affects the capital structure of companies. It makes companies to use more debt capital than share capital in investments. The companies have to deduct interest expense before the profits are subjected for taxation. This reduces the amount of tax payable by the company thereby increasing profit. Hoever, excessive use of debt capital may lead to financial distress which affects the liquidity of the firms.
It also leads to double taxation given that the companies pay taxes separately and also the shareholders pay taxes from the dividends received. This discourages many businesses from registering as corporate. Instead, they prefer other forms of businesses like partnerships and sole proprietorship where tax is only imposed on the persons or business owners and not on the businesses.
All decisions made by companies about mergers and acquisitions are usually affected by the corporate tax rates. Before a company decides on where to acquire or merge with another company, it has to consider the rate of tax charged for companies in that country where it is targeting to merger. If the taxes are high in the target country, the chances of forming a merger or acquisition are very low. However, when the tax rate is low in the target country, then more companies are likely to have mergers with foreign companies to take advantage of low taxes.
For the government, corporate tax enables it to monitor the operations of the companies as well as increase its revenue collection. Public companies have to provide their financial statements for statutory audits which are a legal requirement. In this way, the government can monitor the companies’ operations and also check the reliability of the reported profits. All companies do pay taxes from the profits and also on the distributed dividends. The government is therefore able to get more revenues unlike from other forms of businesses where tax is only imposed on the owners of the businesses.
In conclusion, it has been noted that corporate taxation has significant effects on companies’ financial decisions on capital structure, double taxation, mergers and acquisition decisions and government revenue.
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