Publically listed companies have to disclose specified information on their taxes in their annual reports/form 10-Ks. This includes:
- Effective tax rate for years covered.
- The income tax benefit or expense.
- The components of deferred tax assets and deferred tax liabilities.
- Reconcillation of the differences between the US statutory rates and income tax expense reported in the income statement.
- Actual taxes paid.
- Expected changes/risks involved in any tax positions taken.
- Allowances that may impact tax liabilities; and more.
These disclosures are found throughout the 10-k, starting with the MD&A all the way up to the notes to the financial statements.
But when valuing an asset, we are interested not in the past but the future. We are trying to estimate the free cash flows of the business. Taxes will impact our free cash flows. In this context, what can actual taxes paid tell you about future cash flows and valuation?
We would obviously be looking for clues on future tax rates to add to our model. Unfortunately, the actual tax paid cannot be used to estimate future tax expense because the actual tax paid will be materially different due to one or more of the following reasons.
- The taxes paid accounts for the deductions and deferred tax provisions that apply to a company’s net income. The deferred tax benefits and costs reverse over time.
- The taxes paid is lower than effective operating tax liability when a company has debt due to the debt tax shields. This will double count the benefit of tax shields if we also incorporate the tax shield benefits in our discount rate.