Optimal Payment Strategy for Corporate Income Tax Instalments

Abstract:     
This paper formulates a theory of the optimal payment of Canadian corporate income tax instalments (the Canadian counterpart of US monthly payments of "estimated tax"). The theory incorporates uncertainty because the required amount of instalment payments depends in part upon the amount of the corporation's tax liability for the year, which is unknown at the time most or all of the instalment payments must be made. Taxpayers must balance the risks of overpayments and underpayments. Overpayments are undesirable since they constitute interest-free loans to the government; underpayments, on the other hand, result in nondeductible interest charges and possible penalties. The paper shows that the major factors affecting optimal payment amounts and their timing throughout the year are the probabilities of different amounts of tax liability, the taxpayer's cost of capital and the interest rate the government charges on underpayments. A key result is that it is often optimal for a taxpayer to delay making substantial amounts of instalment payments until late in the fiscal year (resulting in unstable government revenue streams and confusing government revenue projections). Linear programming can be used to provide numerical solutions for particular taxpayer situations.

JEL Classification: G38, H25

Accepted Paper Series