Tax Shield Formula

Updated on April 4, 2024
Article byWallstreetmojo Team
Edited byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

 Formula to Calculate Tax Shield (Depreciation & Interest)

The term “Tax Shield” refers to the deduction allowed on the taxable income that eventually results in the reduction of taxes owed to the government. The formula for tax shields is very simple, and it is calculated by first adding the different tax-deductible expenses and then multiplying the result by the tax rate.

Mathematically, it is represented as,

Tax Shield formula = Sum of Tax-Deductible Expenses * Tax rate.

Tax Shield Formula

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Tax Shield Formula (

Although tax shieldTax ShieldTax shield is the reduction in the taxable income by way of claiming the deduction allowed for the certain expense such as depreciation on the assets, interest on the debts etc. It is calculated by multiplying the deductible expense for the current year with the rate of taxation as applicable to the concerned more can be claimed for a charitable contribution, medical expenditure, etc., it is primarily used for interest and depreciation expenses in a company. Therefore, the tax shield can be specifically represented as tax-deductible expenses.

The calculation of interest tax shield can be obtained by multiplying average debt, cost of debtCost Of DebtCost of debt is the expected rate of return for the debt holder and is usually calculated as the effective interest rate applicable to a firms liability. It is an integral part of the discounted valuation analysis which calculates the present value of a firm by discounting future cash flows by the expected rate of return to its equity and debt more and and tax rate as shown below,

Interest Tax Shield Formula = Average debt * Cost of debt * Tax rate.

The calculation of depreciation tax shieldDepreciation Tax ShieldThe Depreciation Tax Shield is the amount of tax saved as a result of deducting depreciation expense from taxable income. It is calculated by multiplying the tax rate with the depreciation more can be obtained by depreciation expense and tax rate as shown below,

Depreciation Tax Shield Formula = Depreciation expense * Tax rate

Calculation of Tax Shield (Step by Step)

The tax shield can be calculated by using the following steps:

  1. Firstly, gather all the tax-deductible expenses, such as interest expense, depreciation expense, charitable contribution, medical expenditure, etc., from a company’s income statement. Add all such expenses to derive the sum of all the tax-deductible expenses.

  2. Next, the tax rate that applies to the company is determined, depending on the jurisdiction.

  3. Finally, the tax shield is calculated by multiplying the sum of tax-deductible expenses and the applicable tax rate, as shown above.

Tax Shield Formula Explanation Video



You can download this Tax Shield Formula Excel Template here – Tax Shield Formula Excel Template

Example #1

Let us consider an example of a company XYZ Ltd, which is in the business of manufacturing synthetic rubber. As per the recent income statementIncome StatementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user more of XYZ Ltd for the financial year ended on March 31, 2018, the following information is available. But, first, do the calculation of Tax Shield enjoyed by the company.

Example 1.1

Based on the information, do the calculation of the tax shield enjoyed by the company.

The following is the Sum of Tax-deductible Expenses,

Example 1.2

Therefore, the calculation of Tax Shield is as follows,

Example 1.3
  • Tax Shield Formula= ($10,000 + $18,000 + $2,000) * 40%

The Tax Shield will be –

tax shield formula example 1.4

Tax Shield= $12,000

Therefore, XYZ Ltd enjoyed a Tax shield of $12,000 during FY2018.

Accounting for Financial Analyst (16+ Hours Video Series)

–>> p.s. – Want to take your financial analysis to the next level? Consider our “Accounting for Financial Analyst” course, featuring in-depth case studies of McDonald’s and Colgate, and over 16 hours of video tutorials. Sharpen your skills and gain valuable insights to make smarter investment decisions.

Example #2

Let us take the example of another company, PQR Ltd., which is planning to purchase equipment worth $30,000 payable in 3 equal yearly installments, and the interest is chargeable at 10%. The company can also acquire the equipment on leaseEquipment On LeaseEquipment Lease is where the equipment owner allows another party to use it in exchange of periodic rentals with no transfer of ownership and has the right to cancel the lease right away in case of breach of the lease more rental basis for $15,000 per annum, payable at the end of each year for three years. The original cost of the equipment would be depreciatedEquipment Would Be DepreciatedDepreciation on Equipment refers to the decremented value of an equipment's cost after deducting salvage value over the life of an equipment. It lowers its resale more at 33.3% on the straight-line method. The applicable tax rate is 35%. Determine which option is more viable for the company. Purchase of Equipment on Debt or Purchase of Equipment on Lease.

1st option (Purchase of Equipment on Debt)

Annual repayment=Equipment price * Interest rate * [(1 + Interest rate)No. of years] / [(1 + Interest rate)No. of years -1]

= $30,000 * 10% * [(1 + 10%)3] ÷ [(1 + 10%)3 -1] = $12,063

Cash Outflow in Year 1 = Annual repayment – Depreciation tax shield – Interest tax shield

= $12,063 – $30,000 * 33.3% * 35% – $30,000 * 10% * 35% = $7,513

Cash outflow in year 2 = $12,063 – $30,000 * 33.3% * 35% – ($30,000 – $12,063 + $3,000) * 10% * 35%

= $7,831

Cash outflow in year 3 = $12,063 – $30,000 * 33.3% * 35% – ($20,937 – $12,063 + $2,094) * 10% * 35%

= $8,180

PV of cost of acquisition @10% = $7,513 / (1+10%) + $7,831 / (1+10%)2 + $8,180 / (1+10%)3

= $19,447

2nd option (Purchase of Equipment on Lease)

Yearly cash outflow after tax shield   = $15,000 * (1 – 35%) <<since lease rental is the only tax deductible expense, no depreciation due to lease and no interest as no debt>>

= $9,750

PV of cost of acquisition @10% = $9,750 / (1+10%) + $9,750 / (1+10%)2 + $9,750 / (1+10%)3

 = $24,247

Therefore, the 1st option is better since it offers a lower cost of acquisition.

Tax Shield Calculator

You can use the following tax shield calculator.

Sum of Tax Deductible Expenses
Tax Rate
Tax Shield Formula

Tax Shield Formula = Sum of Tax Deductible Expenses x Tax Rate
0 x 0 = 0

Relevance and Use

The tax shield is a very important aspect of corporate accounting since it is the amount a company can save on income tax payments by using various deductible expenses. These savings eventually add to the Company’s bottom lineBottom LineThe bottom line refers to the net earnings or profit a company generates from its business operations in a particular accounting period that appears at the end of the income statement. A company adopts strategies to reduce costs or raise income to improve its bottom line. read more. The higher the savings from the tax shield, the higher the company’s cash profit. The extent of tax shield varies from nation to nation, and their benefits also vary based on the overall tax rate.

Recommended Articles

This has been a guide to the Tax Shield Formula. Here we discuss calculating depreciation and interest tax shield for the company, along with the practical examples and a downloadable excel sheet. You can learn more about financing from the following articles –

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *