Effective Tax Rate

Posted in Finance, Accounting and Economics Terms, Total Reads: 455
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Definition: Effective Tax Rate

Effective tax rate connotes average tax paid by an individual or by a corporation. An individual is taxed on his personal income from all sources and an organization is taxed on its EBT (earning before tax) .The most widely used method of taxation is marginal tax system. Here the taxable income is divided into tax slabs and we follow a progressive taxation system, which is the higher the income the higher the tax rate.


For example:

 

Income

Tax rate

0-100000

nil

100000-500000

10%

500000-1000000

15%

>1000000

20%

 

Now let us take two organization A and B. The earning for the organization before tax (EBT) are 600000 and 900000 respectively. Computing taxes for both the organization:

A: (10%*4000000 + 15%* (600000-500000)) =55000

B: (10%*4000000 + 15%* (900000-500000)) =100000

Thus effective tax rate for organization A = 55000/600000 = 9.16%

Similarly for organization B = 100000/900000 = 11.11 %

This provides an easy way to compare the tax exposure of company A and B.

 

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