Question

One of the assumptions underlying the M&M Propositions relating to capital structure is that there is no tax. Briefly discuss the impact of tax on shareholder’s equity..

Please also how it would decrease or increase shareholder equity

Answer 1

Taxation is having a negative impact on the shareholders equity because all such payments which are made to the shareholders in form of dividend and other type of capital gains are taxable and they will be decreasing the distributions value.

Dividend which are payable to the shareholders are taxable twice and it is taxable once in the hands of the company at the corporate rate and it is also taxed once in the hands of the shareholders at the personal rate so it will be relating to a very low amount of saving for the shareholder.

Buyback of shares is also subject to taxation and capital gains are also subject to taxation so shareholders equity will be lowered due to impact of taxation whereas debt holders are having a benefit in relation to taxation because interest will have tax deduction.

Overall, shareholder will have to face negative impact of taxation to dividend double taxation and taxation on the share repurchase along with capital gains distributions.

It will decrease the overall shareholders equity.