CT2 Q and A Bank Q 2.21

[tommo]

I refer to the point iii)

A change in accounting policy that reduces a company's depreciation by £1,000,000, will usually increase post tax profits attributable to normal share holders by £1,000,000.


I agree that this reduction in depreciation will increase the PRE tax profits, W, as you adjust the tax bill to account for any depreciation charged over the accounting year.

I lose the argument from then as surely you apply the tax percentage (X) to the pre tax profits and arrive at a POST tax profit of (100-X%) x W = Y, which is not going to be Y unless X is zero..... So if W increases by T, say, then surely Y will only increase by the residual ratio of X to W, not T??

The answer goes on to say that corporation tax is based on capital allowances etc etc rather than depreciation etc etc.....


Where is the flaw in my hypothetical calculation??

 

[Simon James]

The tax payable is independent of the depreciation charge (depreciation is added back in to taxable profits for the tax calculation).

So if we have:
Depreciation D
Pre tax profits X
Tax T
Post tax profits X-T

Then an increase in post tax profits of 10 due to a reduction in depreciation charge gives:
Depreciation D-10
Pre tax profits X+10
Tax T
Post tax profits X+10-T

ie the T is unchanged as it is based on X+D in the first case and X+10+(D-10)=X+D in the second