Tax Shield: What is It, Example & Formula

A tax shield is a legal method that helps reduce taxable income, thereby lowering the amount of tax an individual or a business needs to pay. It involves using deductions, expenses, or exemptions that are allowed under tax laws to minimize tax liability. In India, tax shields are commonly used in the form of interest deductions on home loans, business expenses, depreciation, and investments in tax-saving instruments. Understanding tax shields is essential as they play a crucial role in tax planning, allowing individuals and businesses to optimise their financial resources while staying compliant with the law.

Tax shields are used by individuals and businesses to reduce taxable income and ultimately lower the amount of tax paid. Some common ways tax shields are applied in India include:

1. Home loan interest deduction

Individuals who have taken a home loan can claim a deduction on interest paid under Section 24(b) of the Income Tax Act. This reduces taxable income and provides significant tax savings.

2. Depreciation on assets

Businesses use depreciation tax shields by deducting depreciation expenses on assets such as machinery, buildings, and equipment. This lowers taxable income and encourages investment in capital assets.

3. Interest paid on business loans

Businesses can deduct interest paid on loans such as working capital loans, term loans, or overdraft facilities. This tax shield helps reduce the overall cost of borrowing and enhances profitability.

4. Medical expenses and insurance premiums

Individuals can claim tax benefits on medical insurance premiums under Section 80D and medical expenses under Section 80DDB. These deductions act as a tax shield and promote financial security.

5. Investment in tax-saving instruments

Investments in schemes such as Public Provident Fund (PPF), National Pension System (NPS), and Employee Provident Fund (EPF) qualify for tax deductions under Section 80C and 80CCD. These help in wealth accumulation while reducing tax liability.

6. Charitable donations

Donations made to registered charities or relief funds under Section 80G qualify for tax deductions. This provides an effective tax shield while supporting social causes.

7. Business expenses

Companies can deduct salaries, rent, advertising, and operational costs as business expenses. These deductions act as tax shields and help in managing cash flow efficiently.

The tax shield formula helps calculate the tax savings from deductions and expenses. The formula is:

Tax Shield = Deductible Expense×Tax Rate

Where:

Deductible Expense is the amount that qualifies for a tax deduction (such as depreciation, interest, or medical expenses).

Tax Rate is the applicable income tax rate for an individual or business.

Example: Calculating a tax shield on home loan interest

Suppose you pay Rs. 2,00,000 as interest on a home loan, and your income tax rate is 30%.

Using the formula:

Tax Shield = 2,00,000×30%

= 2,00,000×0.30

= Rs.60,000

This means that Rs. 60,000 is the amount saved in taxes due to the tax shield provided by the home loan interest deduction.

The interest tax shield is one of the most widely used tax shields, particularly in businesses and personal finance. It refers to the tax savings that result from deducting interest payments on loans from taxable income.

Example: Interest tax shield for a business loan

Consider a company that has taken a business loan of Rs. 50,00,000 at an interest rate of 10% per annum. The annual interest expense on this loan will be:

Interest Expense = 50,00,000×10% = Rs.5,00,000

If the company falls under the 30% corporate tax bracket, the tax shield can be calculated as:

Tax Shield= 5,00,000×30%

= 5,00,000×0.30

= Rs.1,50,000

This means that due to the interest tax shield, the company saves Rs. 1,50,000 in taxes for that financial year. This reduces the overall borrowing cost and improves cash flow for the business.

Interest tax shields encourage companies to use debt financing as an effective tax-saving tool while optimising their financial strategy.

A tax shield is a crucial financial tool that helps reduce taxable income through various deductions, exemptions, and expenses. Whether it is through home loan interest, depreciation, business expenses, or medical insurance premiums, utilizing tax shields effectively ensures better financial planning and higher tax savings.

For businesses, tax shields play a significant role in reducing overall costs and increasing profitability. The interest tax shield, in particular, encourages borrowing by making debt financing more affordable. If you are looking for safe investment option, then you can consider investing Bajaj Finance Fixed Deposit. With a top-tier AAA rating from financial agencies like CRISIL and ICRA, they offer one of the highest returns, up to 8.60% p.a.

Trusted by 50 million+ customers in India, Bajaj Finserv App is a one-stop solution for all your financial needs and goals.

You can use the Bajaj Finserv App to:

• Apply for loans online, such as Instant Personal Loan, Home Loan, Business Loan, Gold Loan, and more.
• Explore and apply for co-branded credit cards online.
• Invest in fixed deposits and mutual funds on the app.
• Choose from multiple insurance for your health, motor and even pocket insurance, from various insurance providers.
• Pay and manage your bills and recharges using the BBPS platform. Use Bajaj Pay and Bajaj Wallet for quick and simple money transfers and transactions.
• Apply for Insta EMI Card and get a pre-approved limit on the app. Explore over 1 million products on the app that can be purchased from a partner store on Easy EMIs.
• Shop from over 100+ brand partners that offer a diverse range of products and services.
• Use specialised tools like EMI calculators, SIP Calculators
• Check your credit score, download loan statements and even get quick customer support—all on the app.

Download the Bajaj Finserv App today and experience the convenience of managing your finances on one app.