What Is a Real and Sustainable Tax Shield?

One of the most important tax features of debt financing is that interest and similar financing expenses can, under specified conditions, be deducted from corporate income. That deduction can reduce the corporate tax the firm will pay and therefore creates a “tax shield.” From a financial-management standpoint, however, the real question is how much of the theoretical tax shield calculated on paper actually turns into a cash tax saving, and whether that saving is sustainable over the life of the financing.

A real and sustainable tax shield is therefore the cash tax saving associated with a method of financing that is legally deductible, actually usable given the firm’s capacity to pay tax, timed correctly, and reasonably expected to continue under current tax rules. In other words, “interest × the tax rate” is only the theoretical starting point; the true economic value may be narrower and firm-specific.

1. Why do the theoretical tax shield and the real tax shield differ?

In classical finance theory the tax advantage of debt is explained by the deduction of interest expense from the tax base. In Modigliani and Miller’s (1963) framework, which includes corporate tax, debt can, other things equal, increase firm value through the tax shield. In a simple annual calculation the tax shield is shown as follows:

Tax shield = Deductible interest expense × Marginal corporate tax rate

If, for example, interest expense of 10 million lira is fully deductible and the marginal tax rate is 25 percent, the theoretical tax saving is 2.5 million lira. That calculation may fail to give the true result for four reasons: part of the expense may be non-deductible; the firm may be loss-making and unable to use the deduction in that year; the tax saving may be deferred to later years; related-party, thin-capitalisation or other tax rules may reduce the value of the deduction.

A more useful measure for the financial decision is therefore to compare the present value of the tax shield with the present value of financing expense:

Effective tax-shield ratio = PV(Expected cash tax savings) / PV(Pre-tax financing expenses)

The ratio shows the extent to which the firm actually obtains a tax advantage from the financing.

2. Factors that should be taken into account when calculating the tax shield in Türkiye

The first factor in Türkiye is the deductibility of financing expense. Under the restriction on financing expenses, in some corporations whose foreign resources exceed equity, 10 percent of the financing expenses attributable to the excess—determined by presidential decision—cannot be deducted from corporate income. The rule is not limited to interest; except where they are added to the cost of an investment, commissions, maturity differentials, profit shares, foreign-exchange differences and similar financing expenses may also fall within its scope. It may therefore be incorrect to take the whole of nominal interest expense into the tax-shield calculation.

The second factor is thin capitalisation. The portion of debt obtained from shareholders or from persons related to shareholders and used in the business that exceeds three times the firm’s equity during the accounting period is, under specified conditions, treated as thin capitalisation. Interest, foreign-exchange differences and similar expenses attributable to thin capitalisation cannot be deducted from the tax base. In addition, interest and similar payments other than foreign-exchange differences may, when the relevant conditions are met, be treated as a distributed dividend.

The third factor is transfer pricing. An interest rate on a loan from a group company or a shareholder does not become acceptable merely because it is set by contract. The rate must be at arm’s length having regard to the borrower’s credit risk, maturity, currency, collateral, market conditions and comparable independent transactions. An assessment of a “low-interest loan” or a “large tax shield” on related-party borrowing therefore cannot be made independently of an arm’s-length analysis.

The fourth factor is the firm’s capacity to pay cash tax. If the firm is loss-making, or is not paying tax in any event because of loss carry-forwards and other items, additional interest expense may produce no cash saving in that year. If the saving will be used in the future, its economic value falls below the theoretical amount because of time value and realisation risk. The domestic minimum corporate tax should also be taken into account in this analysis together with the firm’s overall tax position. Minimum tax does not of itself render an ordinary interest expense non-deductible; it may, however, change the firm’s marginal cash tax rate by limiting the effect of certain exemptions and deductions.

3. Applied examples

Example 1 – A bank loan and the restriction on financing expenses

Suppose a manufacturing firm has annual financing expense of 40 million lira and is subject to a 25 percent corporate tax rate for 2026. If the whole of the expense were deductible, the theoretical tax shield would be 10 million lira. If, however, 50 percent of financing expenses is attributable to the excess of foreign resources over equity, 20 million lira of expense enters the restriction calculation. Ten percent of that amount, 2 million lira, becomes non-deductible. Deductible expense falls to 38 million lira and the tax shield to 9.5 million lira. The nominal tax shield is 10 million lira; the real shield is 9.5 million lira.

Item	Amount
Total financing expense	40.00 million lira
Amount entering the restriction calculation	40 × 50% = 20.00 million lira
Non-deductible portion	20 × 10% = 2.00 million lira
Tax-deductible expense	38.00 million lira
Theoretical tax shield (25%)	10.00 million lira
Real tax shield (25%)	9.50 million lira

Example 2 – A loss-making firm

Suppose a firm has interest expense of 10 million lira and a 25 percent tax rate. The simple calculation shows a tax shield of 2.5 million lira. If, however, the firm is in a tax loss in the current year, that interest deduction may not produce a cash saving of 2.5 million lira today. If the tax advantage can be used only when a sufficient tax base arises in later years, the present value of the future 2.5 million lira should be calculated. A saving to be used two years later is worth less than the same amount saved today.

Example 3 – Borrowing from a group company

Borrowing from a shareholder or group company at a rate that appears below the market rate may look advantageous at first sight. If, however, total related-party debt exceeds the thin-capitalisation limit, the tax deduction for interest attributable to the excess may be lost. If the rate applied is not at arm’s length, a transfer-pricing adjustment may also arise. In that case intra-group financing that looks cheaper than a bank loan may become more expensive in after-tax true cost.

4. How should the CFO measure the tax shield?

The finance manager should measure the tax shield not by a single statutory tax rate but by the cash tax differences that will arise over the life of the financing. The practical approach is to construct two tax scenarios: “no financing” and “with financing.” Cash tax payable is calculated for each year; the difference between the two scenarios is that year’s expected tax shield. Those amounts are then brought to present value at an appropriate discount rate.

The analysis should test at least the following: the legal deductibility of the expense, the restriction on financing expenses, thin capitalisation, transfer pricing, the firm’s future tax base, loss carry-forwards, minimum-tax effects and possible changes in the tax rate. It then becomes possible to see whether, and when, borrowing in fact produces a cash tax saving.

A real and sustainable tax shield is a narrower and more economic concept than the theoretical tax advantage of debt. Reality refers to the tax saving actually being usable; sustainability refers to that advantage being able to continue over the life of the financing under regulatory and financial conditions. The highest interest expense therefore does not always produce the largest tax advantage, and the lowest nominal interest rate does not always produce the lowest after-tax cost of financing. A sound financing decision in Türkiye requires that the tax character of financing expense and the firm’s capacity to pay cash tax be assessed together with the interest rate, commissions and exchange-rate risk.

References and current legislation links

1. Revenue Administration of Türkiye (2026). Corporate Tax Return — corporate tax rates for the 2026 accounting period. Source
2. Revenue Administration of Türkiye. Corporate Tax General Communiqué (Serial No. 1), restriction on financing expenses. Source
3. Revenue Administration of Türkiye. Explanation of the thin-capitalisation rules (Law No. 5520, Art. 12). Source
4. Revenue Administration of Türkiye. Arm’s-length standard and transfer pricing on loans from related parties. Source
5. Revenue Administration of Türkiye (2026). Guide to the Domestic Minimum Corporate Tax. Source
6. Modigliani, F. & Miller, M. H. (1963). “Corporate Income Taxes and the Cost of Capital: A Correction.” American Economic Review, 53(3), 433–443. Source
7. Graham, J. R. (2000). “How Big Are the Tax Benefits of Debt?” Journal of Finance, 55(5), 1901–1941. Source

Note: This article is for general information. Because the date of the transaction, the status of the firm and particular circumstances matter in tax practice, current legislation and professional tax advice should be obtained for concrete transactions.