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Debt interest reduces the profit liable to tax and is therefore saving tax for the company.
So for example if a company has to pay 6 dollars interest every year and they have to pay tax on it lets say 2 dollars, then does that mean they only pay 4 dollars to the debenture holders?
No it does not.
Suppose the tax rate is 20%. If the company makes a profit before interest of $100 then if there was no interest payable they would pay tax of $20.
If the same company made profit before interest of $100 but had to pay interest of $10, then the taxable profit would be $90 and the tax payable would be $18.
Because of the debt interest they have saved tax of $2 (which is 20% x the interest of $10), and so the net cost to the company of the interest is only $8.
The debenture holders will receive the full interest of $10 (we always ignore personal tax in Paper FM).
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