Business Organizations and the Tax Environment Chapter 6.

Business Organizations and Business Organizations and the Tax Environmentthe Tax Environment

Chapter 6

Alternative Forms of Alternative Forms of Business OrganizationBusiness Organization

Sole Proprietorship - unincorporated business owned by one individual

Alternative Forms of Alternative Forms of Business OrganizationBusiness Organization

Sole Proprietorship Partnership - unincorporated business

owned by two or more persons

Alternative Forms of Alternative Forms of Business OrganizationBusiness Organization

Sole Proprietorship Partnership Corporation - legal entity created by a

state, separate and distinct from its owners and managers, having unlimited life, easy transferability of ownership, and limited liability

Alternative Forms of Alternative Forms of Business OrganizationBusiness Organization

Sole Proprietorship Partnership Corporation

corporate charter is filed with the state providing information about the company and directors

Alternative Forms of Alternative Forms of Business OrganizationBusiness Organization

Sole Proprietorship Partnership Corporation

corporate charter is filed with the state providing information about the company and directors

bylaws are for internal management and procedures

Finance in the Organizational Finance in the Organizational Structure of the FirmStructure of the Firm

Board of Directors

VP ManufacturingVP Finance

(CFO)VP Marketing

ControllerTreasurer

TaxDepartment

FinancialAccounting

Cost Accounting

Credit Manager

InventoryManager

Director ofCapital

Budgeting

President

The Goals of the The Goals of the CorporationCorporation

Stockholder wealth maximization considers the risk and timing associated

with expected earnings per share in order to maximize the price of the firm’s common stock

The Goals of the The Goals of the CorporationCorporation

Stockholder wealth maximization Managerial incentives to maximize

shareholder wealth

The Goals of the The Goals of the CorporationCorporation

Stockholder wealth maximization Managerial incentives to maximize

shareholder wealth Social responsibility

The Goals of the The Goals of the CorporationCorporation

Stockholder wealth maximization Managerial incentives to maximize

shareholder wealth Social responsibility Stock price maximization and social

welfare

Profit Maximization Will profit maximization also result in

stock price maximization?

Managerial Actions to Managerial Actions to Maximize Shareholder WealthMaximize Shareholder Wealth

Managerial Actions to Managerial Actions to Maximize Shareholder WealthMaximize Shareholder Wealth

Profit Maximization Consider:

total corporate profit versus earnings per share (EPS)

timing of earnings risk of project risk of financing dividend payout versus reinvestment

Agency RelationshipsAgency Relationships

Owner/principal hires an agent and delegates decision-making authority to that agent to act on behalf of the principal

Agency problem exists when conflict of interest between principal and agent between stockholders and managers between stockholders and creditors

Stockholders versus Stockholders versus ManagersManagers

The threat of firing The threat of hostile takeover

due to underpriced stock may be warded off with poison pill or

greenmail

Structuring management incentives executive stock options performance shares

Stockholders versus Stockholders versus CreditorsCreditors

Creditors lend based on expectations riskiness of the firms existing assets expectations concerning the riskiness of

future asset additions the firm’s existing capital structure expectations concerning future capital

structure changes (amount of debt)

Stakeholders must be treated fairly

Factors Affecting Stock PricesFactors Affecting Stock PricesThe External EnvironmentThe External Environment Legal constraints General level of economic activity Tax laws Conditions in the stock market

Factors Affecting Stock PricesFactors Affecting Stock Prices External ConstraintsExternal Constraints

Antitrust laws Environmental regulations Product and workplace safety

regulations Employment practice rules Federal reserve policy International developments

Factors Affecting Stock PricesFactors Affecting Stock Prices Strategic Policy Decisions Strategic Policy Decisions Controlled by ManagementControlled by Management

Types of product or services produced

Production methods used Relative use of debt financing Dividend policy

Factors Affecting Stock Prices Factors Affecting Stock Prices Level of Economic Activity and Level of Economic Activity and

Corporate TaxesCorporate Taxes

Expected profitability Timing of cash flows Degree of risk

Factors Affecting Stock Prices Factors Affecting Stock Prices Stock Market ConditionsStock Market Conditions

Stock price

Business EthicsBusiness Ethics

Company’s attitude and conduct toward its stakeholders (employees, customers, stockholders…)

Ethical behavior requires fair and honest treatment toward all parties

Business EthicsBusiness Ethics Avoids fines and legal expenses Builds public trust Attracts business from customers who

appreciate and support the firm’s policies

Attracts and keeps employees of the highest caliber

Supports the economic viability of the communities in which it operates

Forms of Businesses in Forms of Businesses in Other CountriesOther Countries

Public limited company (PLC) Aktiengesellshaft (AG) Sociedad Anónima (SA) Industrial groups

keiretsu chaebol

Multinational CorporationsMultinational Corporations

Operate in more than one country To seek new markets To seek raw materials To seek new technology To seek production efficiency To avoid political and regulatory hurdles

Multinational versus Domestic Multinational versus Domestic Managerial FinanceManagerial Finance

Different currency denominations

Different currency denominations Economic and legal ramifications Language differences Cultural differences

Multinational versus Domestic Multinational versus Domestic Managerial FinanceManagerial Finance

Different currency denominations Economic and legal ramifications Language differences Cultural differences Role of governments

Multinational versus Domestic Multinational versus Domestic Managerial FinanceManagerial Finance

Multinational versus Domestic Multinational versus Domestic Managerial FinanceManagerial Finance

Different currency denominations Economic and legal ramifications Language differences Cultural differences Role of governments Political risk

The Federal Income Tax The Federal Income Tax SystemSystem

Count on changes indexed items new tax laws

Individual Income TaxesIndividual Income Taxes

Progressive tax: higher tax on higher incomes

Taxable income is gross income minus exemptions and allowable deductions

Marginal tax rate is the tax on the last unit of income

Average tax rate is taxes paid divided by taxable income

Taxes On Dividend and Taxes On Dividend and Interest IncomeInterest Income

Dividends are paid out of earnings that have already been taxed

Interest on most state and local government bonds (municipals) is not subject to federal income taxes

Comparing Yields Tax-free Comparing Yields Tax-free and Taxableand Taxable

Equivalent pre-tax yield on a taxable investment

Yield on tax-free investment

1 - Marginal tax rate=

A taxpayer in the 30% marginal tax bracket who could buy a municipal bond that yields 10 % would have to receive a before-tax yield of 14.3% on a corporate or US Treasury bond to have the same after-tax yield.

10%

1 0.3014.3%

Individual Income TaxesIndividual Income Taxes

Interest paid by individuals is generally not deductible, with the exception of mortgage interest

Capital gains versus ordinary income profit from sale of capital asset benefits of long-term capital gains

Business versus personal expenses

Corporate Income TaxesCorporate Income Taxes

Interest and dividend income received by a corporation 70% of dividends received by another

corporation is excluded from taxable income

Interest and dividends paid by a corporation interest is deducted from income

Corporate Income TaxesCorporate Income Taxes

Corporate capital gains currently taxed at same rate

Corporate loss carryback and carryover losses can be carried back 2 years and

carried over to the next 20 years

Accumulated earnings tax

Corporate Income TaxesCorporate Income Taxes

Consolidated corporate tax returns if own 80% or more

S Corporations small corporation that elects to be taxed as

a proprietorship or partnership yet retains limited liability and other benefits of incorporating

I. DevelopedMarkets

Tax Rate

Australia 36.0%

Canada 44.6

France 36.7

Germany 57.4/44.1

Italy 53.2

Japan 51.6

Netherlands 35.0

Switzerland 28.5

United Kingdom 31.0

United States 40.0

Corporate Tax Rates Corporate Tax Rates in Other Countriesin Other Countries

Corporate Tax Rates Corporate Tax Rates in Other Countriesin Other Countries

II. Emerging Markets Tax Rate

Brazil 25.0

Chile 15.0

China, PR 33.0

India 35.0

Indonesia 30.0

Korea 30.8

Malaysia 30.0

Mexico 34.0

Philippines 35.0

Thailand 30.0

DepreciationDepreciation

Expensing the price of a long-term asset over time

End of Chapter 6End of Chapter 6

Business Organizations and the Tax Environment