The following article provides brief and concise information on the relationship between investments and depreciation in perpetual retirement.
No cash flow, i.e. no consideration of deferred taxes?
Deferred taxes are hidden tax burdens or tax benefits that arise as a result of differences in the recognition or valuation of assets or liabilities between the tax balance sheet and the commercial or IFRS balance sheet and which balance out again in future financial years.
Income and expenses from the formation and liquidation of deferred taxes are therefore of an accounting nature, which are calculated relative to the tax balance sheet by the applied external accounting system.
At least in all cash-flow-based processes, it appears as though the valuer can therefore neglect these bookings. The following article shows that this is by no means the case and that dealing with the topic is certainly indicated.
Causes of deferred taxes: loss carryforwards vs. “temporary differences”
The classic case of “temporary differences” results from time-limited, different approach and valuation requirements in the tax and trade balance, e.g. through the use of voting rights. Even in the event of temporary differences, two scenarios can be differentiated in principle; in addition, there are latencies due to loss carryforwards.
- The company generates temporary differences irregularly and unsystematically.
The term is intended here to describe a case in which latencies arise from time to time in the company in question, but both on the asset and liabilities side and the company can control their development, nor that there is a relationship with the type of business model. - The company systematically creates temporary differences on one side of the balance sheet.
An active deferred tax due to tax loss carryforwards is of a different nature. This becomes clear in the simple case of a company that accounts equally for tax and commercial law and makes losses. The active deferred tax is created here — insofar as it can be accounted for — from the expected tax savings, which do not arise from accounting voting rights, but from a return to profitability. - The company has made losses in the past
and there are prospects of offsetting future gains (in part) against accumulated loss carryforwards.
All of these three cases are explained below, but first a distinction should be made from original tax claims and liabilities.
Distinction from original tax claims and liabilities
The original receivables and liabilities vis-à-vis the tax authorities should not be confused with deferred taxes. In the annual financial statements, these arise, for example, due to differences in advance corporate income tax payments and the actual, expected tax burden from corporation tax.
This type of tax claim and liability is not latent in nature in the above sense. From a valuation point of view, these receivables and liabilities have the character of working capital in relation to the original (non-deferred) tax burden. This complex of topics will not be discussed further here, but will be addressed in a separate blog.
Taxes using the example of the DCF procedure for a corporation
The DCF's standard procedure generally provides for the following procedure with regard to the treatment of taxation:
- Personal taxes of shareholders: usually not taken into account with reference to indirect classification; this is not appropriate in all valuation cases, but should be assumed here for the sake of simplicity.
- Corporate taxes: Application of statutory tax rates, i.e. corporation tax plus solidarity surcharge and business tax
- Tax Shield: Inclusion in the discount interest rate
- Loss carryforwards: Separate assessment taking into account the limited transferability of losses
- Original tax receivables and liabilities: often neglected, but may be included in working capital
- Deferred tax claims and liabilities ex loss carryforwards: often neglected, but may be taken into account via the effective tax burden
There is no blanket solution to the problem of “deferred taxes in company valuation”. Both the way in which deferred taxes are taken into account and the value contribution depend heavily on the causes behind existing deferred taxes.