[Essay] The Impact of Tax on Capital Structure Choices

Tax is one of the factors that affect all of us and not only in business society. The author believes that this tax lessen our disposable income, thus, our spending and saving. In most of us, tax is considered as a burden but for the government, tax is a help to materialize its plans. Basically, the implementation of tax as a way of redistributing income hurt and benefited different group of people. Apparently, people benefiting from it find tax as a help and people who end up paying higher find it a burden. As the government imposes tax, it affects different classes of people and depending on the tax system that it chooses to adopt.

Business enterprise has received a very diverse review from the ethicists of this generation (Cotton, 2008). In the 80s, there was very little concern for ethics in the world of business. The 90s saw an awakening to the need for ethics because of the many scandals that were beginning to erupt within the world of business and finance. The problem is that in the 90s, the concern for ethics has not returned us to any absolute standard of ethics, but rather to a search for relative balance between ethics and the bottom line or personal values (Cotton, 2008).

The most direct and visible method for governments to influence businesses is through taxation. It is the system used by national administrations to acquire money from both people and organizations. Collected taxes are then used in to support the government itself as well as to finance public services. Taxation is not only relatively permanent but compulsory as well. In addition, the amount contributed by an individual is not directly related to the extent of government services he or she receives (Taxation, n.d.).

Before we proceed to the main course of this paper i.e. the impact of tax on capital structure choices, let’s try to consider first the role of business taxes. The role of business tax among the citizens has been gaining momentum over the past two centuries. Although initially established and founded as a legal requirement among sales transactions, business tax has become a critical link between firms and those citizens who have vested interests in the firm. Business tax is needed not only to protect the interests of the stockholders but also other stakeholders. Business tax is mandated to ensure the interests of the public-sector and private-sector organisations are represented. In addition, business tax aids in securing confidence not only for stockholders but also for other stakeholders such as customers, suppliers, employees and the government in ensuring that firms are accountable for their business actions.

Business tax gives benefits and advantages to citizens. These include increased profits for businesses and organisations, increase in trading, improvements to transportation, communication and information technologies, job opportunities for people, and solutions to problems of society. Business tax helps citizens increased profits for businesses within it. Through opening to the world business the business within it can transact with other business or countries. This increases not only the clients this business have but increase the income of business. Business tax helps in the increase in trading. Through business tax the people become more interested and engaged in trading stocks, bonds, currencies, and other investments.

From this tax issues and roles, the continued existence of the organization is secluded by capital structure (CS) choices as organization’s internal consequences strategies are noticed. Tax actually play significant impact to organizations capital structure choices because taxes may decrease and increase burdens to the financial capabilities of an organization. Queries like “Do we have sufficient money for the venture?”, “Do we need to issue or borrow shares?” and “What is the gearing ratio to be assumed to make the most of the capabilities of the endeavor?” This provision has also its impacts on organizations capability to predict, use and tone down changes and even give pressure over its continuing development. As Hitt, Hoskisson & Ireland (2003 p. 22) stated, this can attain worth by considering the resource-based model of over average returns in which core competencies are coordinated in opposition to the varying situation.

Actually, the firm can enjoy the calculated future earnings without intervention from awaiting commitments to shareholders or creditors of government taxes by considering CS as the base for project arrangement and execution. This is significant for project cash flows to be acquired right the way through its span of life for the reason that creditors can take legal action to an organisation when debt agreement or shareholders’ expected output are not achieved. For instance, the US operations of News Corporation early years, its financial officers and CEO faced trouble to calm its creditors and suspend lawsuit that can significantly upset its corporate life in the US (Hill, Jones & Galvin 2004 C101).

Thus, tax evaluation is necessary since lacking of it can give a big headache for business organizations. Though, with CS, businesses may have relinquished some of its control in goodwill of equity financing. Therefore, it may have disallowed the last minute appeal and risky conflicts to its creditors.

In essence, debt financing in consideration to tax and capital structure is inexpensive than equity financing since it is a tax acceptable expense (Mcmenamin 1999 p. 16). But, it is also more dedicated (hence, risky) due to repaying that includes the interest and principal and it is compulsory even if the business organization ends to a loss. Moreover, excessively debt can dampen shareholder and their funds from inflowing the organisation’s capital for the reason that ordinary shareholder is just honored with the profit left over after the creditors are compensated

With respect to tax consideration, the basic advantages of CS are obtained in its capability to show numerical evidence as a basis of decision-making. Aside from this, there are numerous methods for common stock assessment (e.g. freezing the multifaceted content of favoured shares and the vibrant interest-bearing in debts). This variety of valuation methods are connected to the uniformity of the business to offer dividends. What if the business does not give dividends for the present year? Well, it has to use an additional challenging policy for arriving at a precise gauge of stock pricing. These overlapping methods can produce decision blockages to the organization which eventually propose the very essential role of the basic CS facts.

References:

Case 10 “News Corporation: entering the US pay TV industry.” (C101) in the textbook: Hill, CWL, Jones, GR & Galvin, P 2004, Strategic management an integrated approach, John Wiley & Sons, Milton, Qld.

Cotton, R 2008, “Business” and “Ethics”: Can these terms be used in the same title? Probe Ministries International. Available at [www.leaderu.com/orgs].

Hitt, M, Hoskisson, R & Ireland 2003, Strategic Management: Competitiveness and Globalization, 5th Edition, South Western; Thomson Learning, Singapore.

Mcmenamin, J 1999, Financial management: an introduction, Routledge, London.

Taxation n.d., Encyclopedia Title: The Columbia Encyclopedia, Sixth Edition. Publisher: Columbia University Press.

UAEP 2006; Fitzgerald Institute for Entrepreneurial Studies; viewed on 25 August 2010, <www.uakron.edu>