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Sir, I read your answers on Timing of Tax in Lease n Buy in another thread but I’m more confused now and it was about question ASOP Co. I have watched your lecture after tgat again n again but still stuck. I hope you’ll not mind asking me again.
In the last part of lecture you have mentioned a specific rule that you said that is only used for Tax timing in Lease n Buy questions (I understand that)
One year delay in tax (meaning tax payable is in arrears)
1) If first cash flow is on first day of the year then tax effect would be on T2 (like lease payments in your example)
2) If first cash flow is on last day of the year then tax effect would be on time T1 (like Tax saving on Capital Allowances)My two questions:-
1) The second rule that you have given that if the cash flow is on last day then it should be on T1 but Asop co clearly mentioned that first cash flow of license fee is on last day so it should be immediately calculated at T0 but since tax is one year delayed it should be T1 but in the examiner’s answer it was calculated at T2 (don’t you think it is against the rule that we learned?)2) You said that machine was bought on the last day and Asop states that license fee is also on last day (they are alike) and you said that since the first cash flow of machine is on the last day of accounting period at T0 (and tax is in arrears in both) but why do we not put license fee in T1 rather it is on T2 (which is totally against about what you said that if first cashflow on last day it should be at T1)
Sorry for a lengthy question. 🙁
(1) is correct.
As far as (2) is concerned then if a flow is on the last day then the tax is calculated on that day and so the tax cash flow is one year later.
So if there is a cash flow at the end of the first year (time 1) the tax affect will be one year later (i.e. at time 2).
In the lease buy example the machine is purchased on the last day of the current accounting period (time 0) and therefore the tax cash flow is one year later (time 1).
In most questions we assume that machines are purchased on the first day of an accounting period (time 0) and therefore the first tax flow is at time 2, but it is obviously important to check just in case the purchase is on the last day of the current period.
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You said in one of your earlier posts that there is no different rule for usual NPV question tax situation and Lease & Buy tax situation.
I know that if tax is not in arrears then it is paid at Time 1; But if tax is in arrears then it is paid at Time 2
BUT in lease & buy you mentioned a rule for lease & buy questions specifically at the end of your lecture which you state as such:
When Tax is in arrears (i.e. Tax is paid one years later) then:
1) If first cashflow is on the 1st day of an accounting period then the first tax effect would be at Time 2
2) If first cashflow is on the last day of an accounting period then the first tax effect would be at Time 1Are you saying that both of these are the same rule for usual NPV questions and Lease & Buy questions?
BUT for me, it is only different in case [2] where you put the tax saving on CA at time 1 because the first cashflow was on the last day; So, I wanna know if we suppose that the first cashflow of the lease payment is at the last day of accounting period then the first tax effect will at time 1 (just like what u did for CA)
Thanks for your previous reply it was actually good 🙂
1 is correct – if a flow is on the first day of an accounting period then the tax flow is 2 years later.
2 is not correct. If a flow is on the last day of an accounting period then the tax flow is 1 year later.
So for 2, operating cash flows are assumed to be at the ends of years (unless told otherwise) so the first operating flow is at time 1 and the tax flow is therefore at time 2.
What is confusing you is that in my lease buy example, the machine is purchased on the last day of the current accounting period, which is time 0. Therefore the first tax flow relating to the tax allowable depreciation is one year later and so at time 1.
In most questions we assume that the machine is purchased on the first day of an accounting period, and is time 0, and so the first tax flow relating to the tax allowable depreciation is two years later and so at time 2.
It has only been in lease buy questions where this trick in the wording of the question has made the difference. Unless told otherwise we always assume that the machine is purchased on the first day of the first accounting period.
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