Tax Shield by Debt Level in Indian Industries - A Descriptive Analysis

Abstract

A tax shield is the reduction in tax that results from taking an allowable deductions such as debt interest, charitable donations, amortization and depreciation etc., from taxable income. Interest on debt is a tax-deductible expense taking on debt creates a tax shield. Since a tax shield is a way to save cash flows, it increases the value of the business, and it is an important aspect of business valuation. Tax shields vary from country to country, and their benefits will depend on the taxpayer's overall tax rate and cash flows for the given tax year. The growth of Indian industries depends in the traditional view depends upon their scale of operation, productivity, trade performance etc. However, in the modern approach, the same can be viewed as the industry’s ability to raise its fund, minimizing the tax liability and maximizing the profitability. The fund required to raise the capital structure of the firm can be done through own capital (equity) and/or borrowed capital (debt). Though these two sources of funds are available to the firm form the capital structure, majority of the companies prefer debt financing in order to enjoy the maximum benefit as in the form of tax shield. Hence, this paper deals with the tax shield at different debt levels across various industries like cement, steel, textiles, food and pharmaceutical industries.