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- This topic has 7 replies, 2 voices, and was last updated 2 years ago by John Moffat.
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- August 4, 2021 at 7:51 pm #630412
Sir, I am having a problem with the number of Tax-Savings on Capital Allowance in the Lease n Buy question in the notes. Why do we have Tax Saving on Capital Allowance in Year 5 when considering buying option?
You said in your lecture that since the machine is bought on the last day therefore first Tax-Saving would be at [Year 1] and then we use the machine for 4 years therefore it would be 5 years allowances until [Year 5]?
I still don’t understand this? How can we receive the Tax benefit of 5 years time when the machine has a life of four years in total and it will be sold at Year 4?
I do understand that if the machine is bought on the last day of the accounting period then TAD is calculated immediately at [Year 0] and the first Tax-Saving would be at [Year 1] BUT the total number of Tax-savings should be based on the number of life the asset has? Isn’t it?
Please explain!
August 5, 2021 at 7:34 am #630441No. They get the TAD in every accounting period during which it was owned.
So even though it was bought on the last day of an accounting period they still get the TAD for that year and then also get it for each of the four years that they used it.
August 5, 2021 at 10:01 am #630459Please correct me with these two issues relating to the previous query!
1) If the machine is bought on the first day of an accounting period at [Time 0] then the first TAD is calculated at the year-end at [Time 1] and the Tax-saving occurs at [Time 2]
2) If the machine is bought on the last day of an accounting period at [Time 0] then the first TAD is calculated immediately at [Time 0] and the Tax-saving occurs at [Time 1].
Here we will get one year more Tax-saving because since the machine is bought on the last day therefore first Tax-Saving would be at [Year 1] and then we use the machine for 4 years, therefore, it would be 5 years allowances until [Year 5]
3) Is it a rule with lease & buy questions only or it is also a rule for usual NPV appraisal questions?
August 5, 2021 at 4:02 pm #6304961. Correct (assuming tax is payable one year in arrears)
2. Correct (assuming again that tax is payable one year in arrears).
Because of the balancing charge or allowance in the final year, then although there will be 5 years of allowances the total of the allowances will be the same. The total is always the difference between the initial cost and the sale proceeds.
3. It is the same rule for all NPV questions. Usually the initial investment is on the first day of an accounting period (and we assume this to be the case unless told otherwise).
August 5, 2021 at 7:12 pm #630514The rule that I asked you in my previous question about when the machine was bought is only for the timing of tax-saving on Capital Allowance?
When the machine was bought (whether first day or last day of an accounting period) has nothing to do with the timing of Tax cashflows but with the timing of the Tax-saving on Capital Allowance? (correct?)
But you said at the end of your lecture that only “if tax is in arrears” which was confusing to me just like the way you said in your previous response line 1 & 2 that assuming tax is payable in arrears.
it rather seems to me that you are saying that when the machine was bought is a rule to see only when tax is payable in arrears!
August 6, 2021 at 9:37 am #630553Tax is always calculated at the end of the accounting period. In exams, the tax is then either payable immediately (so at the end of the same accounting period) or is payable one year in arrears (which is one year after the end of the accounting period).
Most common is for it to be payable one year in arrears in the exam, but you always need to check because sometimes questions do say that it is payable immediately.
Have you watched the free lectures on ‘investment appraisal with tax’?
August 6, 2021 at 9:38 am #630555I did watch all your lectures 🙂
Pardon but I don’t understand your line when you say “if the tax is in arrears” at end of your lecture which was confusing to me because the timing of Taxation and Capital Allowance are two different things?The way I understand is that Taxation if not in arrear occur at [Time 1] & if in arrear occur at [Time 2].
But for the Capital Allowances we have to see whether the machine was bought on the first day or last day then this rule that I asked you was going to apply:
1) If the machine is bought on the first day of an accounting period at [Time 0] then the first TAD is calculated at the year-end at [Time 1] and the Tax-saving occurs at [Time 2]
2) If the machine is bought on the last day of an accounting period at [Time 0] then the first TAD is calculated immediately at [Time 0] and the Tax-saving occurs at [Time 1].
If you can tell me whether what I mentioned above the way I understand is correct or not; I would be grateful to you!
August 6, 2021 at 10:23 am #630565Tax on profits and tax saving on TAD is always calculated at the end of the accounting period.
When the tax is paid (or the tax saving is got) depends on the rule given in the question. Usually tax is payable one year in arrears which means it is paid one year after the end of accounting period, because this is what happens in real life – they prepare accounts at the end of the year, the tax owing is then calculated, but the tax is actually paid later.
Your two statements are correct if the tax effect is one year in arrears. If the tax is payable immediately then the tax saving due to the TAD occurs immediately i.e. at the end of the relevant accounting period.
The timing of the tax on the operating cash flow and the tax on the TAD’s are exactly the same, because the TAD reduces the taxable profit and therefore reduces the tax payable (for ease in Paper FM we show the tax on the operating cash flow and the tax saved on the TAD separately).
Do watch the lectures on investment appraisal with tax again, because I do show what happens in practice (as in Paper TX) and what we do in Paper FM (which ends up giving the same result) and why we do it the way we do in Paper FM.
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