The Distributed Profit Based Corporate Taxation, and the Valuation of Cash Holdings

Business: Theory and Practice

2018

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Corporate value creation and management are one of the key issues for any business enterprise. A gap exists in research into the implications of the distributed profit taxation (DPT) system in Estonia for corporate value creation. Under the Estonian system of corporate taxation, companies need not pay income tax on undistributed earnings, allowing them to postpone income tax liability indeterminately. This theoretical paper compares the relationship between a company’s equity value and taxation of profits under traditional (or classical) (TPT) and DPT systems. A TPT system is a system where the amount of corporate income tax is determined by the profit the company earned during the taxation period. We show that fundamental equity value under a DPT system should be higher vis-à-vis equity value under a TPT system (ceteris paribus). To illustrate this, we use a dividend discount model and values from a hypothetical company. The equity value under DPT is also higher when financial leverage is considered. The results suggest that conventional valuation models and their inputs should be adjusted when valuing Estonian companies. Ignoring these adjustments runs the risk of undervaluing the equity of Estonian companies, as well as the equity of companies operating under similar tax regimes.

Section: Introductionmentioning

confidence: 94%

A Lesson in Valuation From Estonia: The Difference Between the Fundamental Value of Equity Under Distributed and Traditional Profit Taxation Systems

Business: Theory and Practice

2018

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“…Though some aspects of valuation are considered in papers by Hazak (2007) and Hazak (2008), their focus was different. Relevant theoretical research includes papers by Sander and Kantšukov (2009), Sander et al (2014), and Kantšukov and Sander (2018). Sander and Kantšukov (2009) demonstrated that ROE and P/B ratios provide different values depending on profit taxation schemes -TPT versus DPT.…”

Section: Valuation and Distributed Profit-based Taxationmentioning

confidence: 99%

“…Sander and Kantšukov (2009) demonstrated that ROE and P/B ratios provide different values depending on profit taxation schemes -TPT versus DPT. Sander et al (2014) showed that, when valuing the cash holding of companies operating under DPT, one has to apply a discount to cash holdings equivalent to the tax burden of a company associated with profit distribution. In Kantšukov and Sander (2018), it was demonstrated that the fundamental value of equity under distributed profit taxation is higher than that under traditional profit taxation.…”

Section: Valuation and Distributed Profit-based Taxationmentioning

confidence: 99%

Optimal Holding Period of an Investment Property Under Different Systems of Income Taxation – An Individual Investor’s Perspective

Real Estate Management and Valuation

2022

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Taxes, particularly income tax, may affect how long investors decide to hold on to an investment property. There exists a research gap regarding the implications of a distributed profit-based taxation system for the holding period of an investment asset. As a distributed profit-based taxation system allows investors to postpone income tax liability, it creates an advantage for investors operating under such a system compared to investors operating under other systems of income taxation. In this paper we model optimal holding periods under different systems of income taxation using a specific type of discounted cash flow model. We show that, theoretically, under the distributed profit taxation system, an optimal holding period for an investment property for an individual investor is the longest (ceteris paribus). This is in concordance with the circumstance that the after-tax value of the property for the investor is highest under the distributed profit taxation system. The results suggest that investment and property development projects under distributed profit taxation are not to be treated in the same way as projects under other tax systems with respect to time. Limitations of the study are related to the deterministic setting of the model as well as some restrictive assumptions.

“…In literature it is also referred to as a distributed profit (based) taxation (or -DPT) system (see e.g. Hazak, 2007;Hazak, 2008;Hazak, 2009; Masso et al, 2013;Staehr, 2014;Sander et al, 2014). The Estonian system of corporate income taxation is unique as no other country in the world currently employs such an approach to profit taxation.…”

Section: Author Unknownmentioning

confidence: 99%

“…Citing largely acclaimed valuation models from widely acknowledged textbooks in the case of DPT may lead to serious valuation distortions. Theoretical linkage between distributed profit taxation and company valuation has been discussed in Sander and Kantšukov (2009) and Sander et al (2014); in those papers it was shown that under a DPT regime corporate financial indicators yield different values compared with those in the environment of traditional profit taxation. The present paper is the first empirical study dealing with valuation under a DPT system from a practical perspective.…”

Section: Author Unknownmentioning

confidence: 99%

Value in the eye of the beholder: a survey of valuation practices of Estonian financial professionals

Investment Management and Financial Innovations

2016

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This is the first empirical study related to the linkage between distributed profit taxation and company valuation. In this paper we present the results of a survey of Estonian valuation practitioners. The main purpose of this study is to clarify the valuation practices of Estonian analysts with emphasis on fundamental analysis-based valuation methods. We elucidate whether and how practitioners treat certain aspects of corporate income taxation when valuing Estonian companies, and how they adjust conventional models taking into account the peculiarities of the Estonian distributed profit taxation system. As distributed profit taxation allows Estonian companies to postpone their income tax liability, it should lead to a positive impact on the value of Estonian companies compared to non-Estonian ones. The survey also included hypothetical valuation cases seeking to determine the difference in analysts’ views on equity value in a simplified framework. Results show that free cash flow to the firm and EV/EBITDA multiples are the most popular valuation models among analysts, with the majority of analysts using these models together. Analysts adjust models primarily when calculating the cost of capital and forecasting corporate income tax liability. However, many respondents did not make any adjustments when valuing Estonian companies, but proceeded from the same grounds when valuing Estonian and non-Estonian businesses. The equity valuation of hypothetical companies revealed highly diverse estimates and an unawareness of the positive aspects of distributed profit taxation vis-à-vis traditional profit taxation on a company’s value