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Homework answers / question archive / Debt has a tax advantage over equity in most markets, in that the interest payable is deductible before taxes are calculated
Debt has a tax advantage over equity in most markets, in that the interest payable is deductible before taxes are calculated. Discuss what you think would happen if this advantage to debt were removed and neither debt nor equity had any tax deductibility. Should companies still have debt in their capital structure?
The interest paind to the bondholders can be deducted from EBIT thereby reducing the taxable income. Tax deductibility is the element that makes the bonds economical as the cost of borrowing is reduced and also it provides leverage thereby leaving more earnings for the shareholders. If the tax deductibility is removed then the cost of borrowing will increase and then the interest amount will have to be deducted from the PAT (profit after tax) which will not provide any kind of leverage hence no extra earnings for the equity holders thereby making Debt less attractive. Hence if the tax deductibility is removed then there will not be any point in companies having debt in their capital structure.
