Why The Pursuit of Tax-Motivated Transactions Rarely Makes Sense

canstockphoto20424571An important part of our business is to advise our clients on how they can legally minimize their tax liability. We have specific expertise in this area and we know we do a good job without exposing our clients to the risk of non-compliance.

It concerns us, however, to see many business clients recklessly seek to minimize their taxes often at a cost to profitability and therefore at far greater cost in terms of the value of their business.

Let me illustrate what we mean. Suppose your profit was $1,000 and the applicable valuation earnings multiple was 3. If your average tax rate is 40% your tax bill will be $400. That hurts!

So what some people do is find a business-related expense they can incur in order to reduce this. Let’s suppose they can find $200 worth of deductible expenditures. Their profit drops to $800 and they save $80 in tax. The problem with this (often ill-considered) action is that unless that $200 was invested in something that would bring at least that amount back into the business at some time in the future, all that’s been achieved is to swap $200 for $80.

Not only that, the value of your business may also have dropped by 3 times the reduction in profit — (assuming a P/E ratio of 3).

The position that we take is that it makes much more sense to worry about the issue of tax liability after the profit has been made, not before. We believe that business managers should first concentrate on building profitability and value and only then on the issue of minimizing taxes.

As your tax advisers we can, and do, help you legally minimize your taxes. But as business advisers who are systematically helping you build the profitability and value of your business, we are able to contribute far more value to the relationship you have with us.