Jill is the CFO of Portech, Inc. Portech\'s tax advisers have recommended two ta

Question

Jill is the CFO of Portech, Inc. Portech's tax advisers have recommended two tax planning ideas that will each provide $5 million of current-year cash tax savings. One idea is based on a timing difference and is expected to reverse in full 10 years in the future. The other idea creates a permanent difference that never will reverse.

Determine whether these ideas will allow Portech to reduce its reported book income tax expense for the current year. Illustrate in a table or timeline your preference for one planning strategy over the other. Which idea will you recommend to Jill?

Explanation / Answer

For the timing difference idea the net present value of the $5 million temporary tax savings is less than $5 million and as a result creates a deferred tax liability.

On the other hand the $5 million in permanent savings has a net present value that is equal to $5 million and hence will reduce Portech’s book effective tax rate for the current year.

Hence the idea that I will recommend to Jill is the idea based on permanent difference.

NPV = cash flow/(1+r)^n. In the idea of temporary difference the table is provided below (assuming a rate of return of 10%):

As we can see that NPV in case of temporary difference is $3,072,283.55 or $3.07 million. On the other hand idea of permanent difference has a NPV of $5 million/(1.1)^0 = $5 million.

As $5 milion>$3.07 million the idea that I will recommend to Jill is the idea based on permanent difference.

Year Cash flow Particulars 1+r PVIF PV 0 5,000,000.00 Temporary tax difference 1.10 1.00 5,000,000.00 10 -5,000,000.00 Reversal 0.38554 -1,927,716.45 NPV 3,072,283.55

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