Tax Capacity
Short definition
Tax capacity is the taxable-income and cash-tax ceiling against which interest and similar deductions can actually cut cash tax. Above that ceiling the shield is zero.
Detailed explanation
Capacity ≈ expected taxable profit × T, after thin-cap, losses and exemptions. Adding debt without capacity only adds cash interest.
APV values the shield only up to capacity. High rates plus a thin tax base close the tax face of debt capacity.
Why it matters for the CFO
Net debt/EBITDA can say “there is room” while tax capacity is zero, so extra debt does not cut WACC.
How to read it
Capacity is sustainable taxable income and audit risk, not one year’s profit. Incentives also cut capacity.
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What to learn next
Definitions are educational. They are not investment, credit or tax advice.