Methods of depreciation and Income Taxes

Methods of Depreciation (Continued)...

5. Modified Accelerated Cost Recovery System (MACRS):

Historically for both tax and accounting purposes, an asset’s depreciable life was determined by its projected useful life; it was intended that the asset is fully depreciated at approximately the end of its useful life. The MACRS system however totally abandoned this practice and simpler guidelines were established that created several groups of assets each with a more or less arbitrary life called a recovery period. The MACRS scheme includes eight categories of assets with lives of 3, 5, 7, 10, 15, 20, 27.5 and 39 years. Under the MACRS, the salvage value of the property is always taken zero.

Table: MACRS property classification

MACRS Depreciation Rules

MACRS method established prescribed depreciation rates called recovery allowance percentages for all assets within each class. The yearly recovery or depreciation expense is determined by multiplying the asset’s depreciation base by the relevant recovery allowance percentage.

1. Half-year convention

Here it is supposed that all assets are employed in service at midyear and that they will have zero salvage value. As a result, only half year of depreciation is endorsed for the first year that property is placed in service. With half of one year’s depreciation being engaged in the first year, a full year’s depreciation is allowed in each of the remaining years of the asset’s recovery time period and the remaining half year’s depreciation is taken in the year following the end of the recovery period. A half-year depreciation is also allowed for the year in which property is disposed of or is otherwise discharged from service at any time before the end of the recovery period.

Table: MACRS Depreciation Schedules for personal assets with half-year convention, Declining Balance Method

‘*’ Refers to Year to switch from declining balance to straight line

2. Switching from DB to the Straight Line Method

The MACRS asset is depreciated firstly by the DB method and then by SL depreciation. Consequently, the MACRS adopts the switching convention as discussed in the previous section.

Corporate Tax:

Corporate tax or company tax refers to a tax imposed on entities that are taxed at the entity level in a particular authority. Such taxes may include income or other taxes. The tax systems of most countries impose an income tax on certain entities (company or corporation). Many systems additionally tax owners of members of those entities on dividends or other supplies by the entity to the members. The tax generally is imposed on net taxable income. This net taxable income for corporate tax is generally financial statement income with alterations and may be defined in detail within the system. The tax rate varies by authority. The tax may have a substitute base such as assets, payroll or income calculated in an alternative manner.

As the income tax is imposed on the taxable income as its certain percentage, firstly we should make the Income Statement as discussed earlier.

In the context of Nepal, the personal income tax rates allocated for the fiscal year 2015/ 016 and the two earlier fiscal years 2014/ 015 and 2013/ 014 are tabulated below:

The corporate tax structure is relatively simple. The tax rate of Nepal is progressive that is the business with lower taxable incomes are taxed at relatively lower rates than those with higher taxable incomes. The tax rate is classified in two ways; marginal tax rate and Effective tax rate.

Marginal tax rate:

It is the amount of tax paid on an additional dollar of income. It is also defined as the rate applied to the next marginal or incremental amount of income (or deductions).

For example, income up to Rs.250,000 is taxed at a 1% rate; income between Rs.250,000 and Rs.350,000 is taxed at 15% and so on. This shows that the corporate tax is progressive in nature.

Effective tax rate:

It is the rate a taxpayer would be taxed at if taxing was done at a constant rate instead of progressively.

Suppose a corporation has taxable income of Rs.800,000 in a year 2016, the income tax owed by the corporation would be as follows:

Tax for first Rs. 250,000 = 0.01 × 250,000 = Rs.2,500

Tax for next Rs. 100,000 = 0.15 × 100,000 = Rs.15,000

Tax for next remaining Rs. 450,000 = 0.25 × 450,000 = Rs.112,500

Total income tax = Rs.2,500 + Rs.15,000 + Rs.112,500 =Rs.130,000

Then, Effective (Average) tax rate would be

130,000/ 800000 = 0.1625 or 16.25%

This shows that on the average, the company paid 16.25 paisa for each taxable Nepalese rupee it generated during the accounting period.

After tax cash flow estimate:

The after-tax cash flow is the net amount proceeding from an income generating property after all the costs (taxes, mortgage interest, maintenance expenses etc.) of owning and operating the property has been deducted from the gross income.

After tax Economic Analysis:

Cash flow before Taxes (CFBT) = Net operating Income – Debt Service – Capital Additions + Loan Proceeds + Interest Earned

Cash flow after Taxes (CFAT) = CFBT – Income Tax Liability

The format for after-tax economic analysis made with the formation of cash flow statement is shown in the following diagram.

BIBLIOGRAPHY:

Chan S.Park, Contemporary Engineering Economics, Prentice Hall, Inc.
E. Paul De Garmo, William G.Sullivan and James A. Bonta delli, Engineering
Economy, MC Milan Publishing Company.
James L. Riggs, David D. Bedworth and Sabah U. Randhawa,Engineering
Economics, Tata MCGraw Hill Education Private Limited.