Friday, May 14, 2010


Tax Effects of Salvage Value in Cash Flows

A company will incur a book loss if an asset is sold for a price less than the asset’s book (depreciated) value. On the other hand, the company will make a profit if the asset’s salvage value is more than its book value. The profit on the sale of an asset may be divided into ordinary income and capital gain. Capital gain on the sale of an asset is equal to salvage value minus original value of the asset, and ordinary income is equal to original value minus book value (depreciable value) of the asset. Capital gains are generally taxed at a rate lower than ordinary rate. Does a company pay tax on profit or get tax credit on loss on the sale of an asset? In a number of countries, the sale of an asset has tax implications. But as per the current tax rules, the depreciable base of the block assets is adjusted for the sale of the block asset and no taxes are computed when the asset is sold.

The net salvage value (i.e., net salvage from the sale of the asset) can be calculated as follows assuming tax implications of the sale of assets:

(1). SV <>

proceeds = salvage value + tax credit on loss

Net proceeds = SV – T (SV – BV)

(2). SV > BV but SV <>

Net proceeds = salvage value – tax on profit

Net proceeds = SV – T (SV – BV)

(3). SV > OV: Ordinary profit and capital gain

Net proceeds = salvage value – tax on ordinary profit – tax on capital gain

Net proceeds = SV – T (OV – BV) – Tc (SV – OV)

SV = Salvage value
BV = Book value
OV = Original value
T = Ordinary corporate income tax rate
Tc = Capital gain tax rate

1 comment:

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