The accounting procedure for capital expenditures under the SBT is the reverse of traditional profits taxation. Traditional profits taxes using depreciation schedules allow no deduction for a capital expenditure, but subtract depreciation from the tax base. The SBT adds back in the depreciation, then subtracts capital expenditure. Because the sum over time of depreciation equals the (historical) cost of the capital expenditure, the two systems both deduct the full historical cost of a capital investment.

The difference lies in the timing of the deductions; a consumption-type VAT deducts the full cost in the year the capital investment is made, while a profits tax spreads the deductions across the depreciable life of the investment.

Recognizing the essential principle behind the taxation of capital expenditures – that the historical costs of investments are deducted from the tax base, while the profits or value-added are included – is crucial to the selection of an appropriate tax base for the SBT, and will be used later in this report.

To see this more clearly, examine the hypothetical firm in Table Two. The firm makes a 55,000 capital expenditure in year one, depreciating it over three years under a profits tax, and deducting it entirely in year one under a consumption-type VAT. Under both systems, the firm reduces its tax base by exactly $6,000. Under a profits tax the deduction is spread over three years, while under a VAT it is taken entirely in year one.

The actual calculation of the SBT starts with Federal Taxable Income. which is Gross Business Income (before taxes or capital costs) less depreciation. To arrive at the SBT taxable income, add back in depreciation (to zero out the prior deduction under the federal system), and then subtract capital expenditures. Finally, add in labor and interest expenses to equal Value-Added, which is the proper base for theSBT. [16]

TABLE 2

Example: Comparison Between Consumption-based VAT and Profits Tax Systems In the Taxation of Capital Expenditures

Assumptions

Year 1

Year 2

Year 3

Gross Business income (Pre-tax, before capital costs)

$10,000

$10,000

$10,000

Capital Investment

$6,000

0

0

Depreciation

$3,000

$2,000

$1,000

Labor + Interest

$2,000

$2,000

$2,000

 

 

 

 

Profits Tax System

Gross Business Income

$10,000

$10,000

$10,000

less: Depreciation

($3,000)

($2,000)

($1,000)

equals: Taxable Income

$7,000

$8,000

$9,000

 

Tax Liability = tax rate * Taxable Income

Total reduction in Tax Liability because of capital investment:

tax rate * SUM(depreciation) = tax rate * 6,000.

 

Value-Added Tax System

Gross Business Income

$10,000

$10,000

$10,000

less: Depreciation

($3,000)

($2,000)

($1,000)

equals: Taxable Income

$7,000

$8,000

$9,000

plus: Depreciation

$3,000

$2,000

$1,000

less: Capital Expenditure

($6,000)

0

0

plus: Labor + Interest

$2,000

$2,000

$2,000

equals: Value-Added

$6,000

$12,000

$12,000

 

Tax Liability = tax rate * Value-Added.

Total reduction in Tax Liability because of capital investment:
tax rate * capital expenditure = tax rate * 6,000.

Example: This hypothetical firm made a $6,000 capital expenditure in year one, reducing its tax base by $6,000 over three years under both systems. The systems differed in the timing of the deductions.