Interest tax shield

(redirected from Interest Tax Shields)

Interest tax shield

The reduction in income taxes that results from the tax-deductibility of interest payments.

Interest Tax Shield

A reduction in tax liability coming from the ability to deduct interest payments from one's taxable income. For example, a mortgage provides an interest tax shield for a property buyer because interest on mortgages is generally deductible. An interest tax shield may encourage a company to finance a project through debt because dividends paid on stock issues are never deductible.
References in periodicals archive ?
Wu, 2012, "Interest Tax Shields: A Barrier Options Approach." Journal of Quantitative Finance and Accounting, 39, 123-146.
Thus interest tax shields are more beneficial to firms with relatively high and stable taxable income compared to firms with large accumulated tax loss from previous years and uncertain future prospects.
However this assumption might not hold, and applying standard ReOI expression (1) or (8) can lead to aberrations in financial performance measurement due to divergence in actual and implicit interest tax shields. These aberrations could be significant if the firm has issued long term public debt.
That is, many highly profitable and big firms with investment grade credit ratings use conservative levels of debt even though the trade-off theory predicts that such firms should use higher levels of interest tax shields (e.g., Graham (2000, 2008), Kemsley and Nissim (2002), and others).
Other factors possibly altering the usability of depreciation tax shields are the alternative minimum tax and the amount of other corporate tax shields, such as interest tax shields. Another component of the tax shield which contributes to its uncertainty is the marginal tax rate and its volatility (hereafter also referred to as the tax rate risk).
We identify, the assumption that justifies the textbook approach of discounting interest tax shields at the cost of debt.
Because the interest tax shields are included in the cash flows, the CCF approach is easier to apply whenever debt is forecasted in levels instead of as a percent of total enterprise value.
Therefore, the before-interest rate should be more closely related to ability to use interest tax shields in the future.
The essential message is that if the level of debt is held constant across long- and short-term debt maturity strategies and there is no refinancing risk associated with the short-term strategy, then the expected present values of interest tax shields for the two strategies are equal.(11) We next show that bondholder tax-trading opportunities create a preference for a long-term debt maturity strategy.
Under this tax structure, there is an increase in the depreciation and interest tax shields, but it assumes the acquisition can be structured in such a way as to avoid the capital gains tax levied on the target firm.
These relationships can take on three different forms, as shown in the three panels of Exhibit 2, depending on what is assumed about the time pattern and risk of the firm's interest tax shields. Exhibit 1.
Their argument is that since the interest schedule on a callable bond and its future refunding bond can never increase, but may decrease, the present value of the stream is higher for investors facing lower tax rates (higher after-tax discount rates) and lower for corporations (higher present value of interest tax shields).
Full browser ?