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Sir in the qs i have doubt in the calculation of tax payable ie is tax relief available on losses or not ie losses carried forward
0 1 2 3 4
Taxable
Profits(35000)(3732) 6577 26249 19723
Tax 20% – (6577-
3732×20%)
Tax payable ( 569) (5250) 3945
WCI -1032 -1972 -2496 1144
Recovery 4356
Tax savings 1050 1050 1050 2450
Scrap 7000I have done this way but my net cash flows are not correct please tell me about the issue of taxes and where i am wrong thanks
Tax is calculated on the taxable profits, which are the cash flows less the tax allowable depreciation. The workings are shown in workings 3 of the examiners answer and as a result there is a tax ‘loss’ of 8,982 at time 1. The question says they are making sufficient profits elsewhere, and so this ‘loss’ reduces their overall taxable profits and therefore results in a tax saving of 20% x 8,982.
It may help you to watch my Paper FM (was F9) free lectures on investment appraisal with tax where I explain the tax rules.
Sir One quick question!
Is it right if I C/F the Year 1 loss and set it off against Y2 and Y3 profits?
Will the examiner reward me the full marks even if I do state the assumption? Pls advise.
Thanking you in advance for your kind explanation.
It is not quite as quick an answer!!
If the new project is in the same country as the company, then we assume always that the company is already making a profit. Therefore a ‘loss’ on the new project simply reduces the existing taxable profit and therefore results in a tax saving in year 1. There is no ‘loss’ to carry forward.
If the new project is in another country (which is often the case in Paper AFM), then the question always states what happens to losses, but it has always been that losses are carried forward and therefore there is not tax in year 1, but taxable profits are reduced in the following year(s).
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