A bit confused here, please shed some light please if possible.
I originally thought Tax Burden was different than Tax Effect and did not equal one another - (ie. Tax Burden = NI / EBT while Tax Effect = 1 - Tax Rate or 1 - (Taxes Paid / EBT).
Maybe I just figured this out in writing out my question…
Am I correct that they are two different terms and calculations however, their products are the same?
I’m working on the Dupont Model and in one place I have read:
ROE = ( Tax Burden ) x (Interest Burden) x (Operating Margin) x (TA Turnover) x (Financial Leverage)
and in another place I read:
ROE = (Operating Margin) x (Interest Burden) x ( Tax Effect ) x (TA Turnover) x (Financial Leverage)
I would deduct that they reflect different calculations but the result is the same!.. Please confirm and/or clarify.
Tax effect is the effective tax rate on income before taxes, which is taxes paid/EBT.
They are the same.
In calculating ROE, you need to net out taxes from operating income, so use 1-ETR. The term 1-ETR might be called the tax effect on ROE, or the tax burden. The most important thing to remember is what it implies, not get caught up with the term itself as anyone can give it names.
From this example, obviously the lower taxes you pay, the higher your return on invested equity.
They also call it the “pre-tax margin” so watch for that terminology as well. If you can just memorize the 5 part Dupont equation then you should be fine to plug and chug on the test.
Tax burden is one of a number of terms that mean the opposite of what they sound like, since you wouldn’t expect a higher tax burden to be better, but it is.
Effective tax rate The net rate a taxpayer pays on income that includes all forms of taxes. It is calculated by dividing the total tax paid by taxable income.
