We only pay tax if the project company is making profits. Most projects, including renewable energy projects, typically build up losses during the construction and early operating years. So it's quite normal for there to be a tax loss during the project's life. We'll only pay tax if we're making a profit in the current year and all the previous tax losses have all been used up, we will pay tax on what remains of the profit after the losses have been used. So we pay tax when we're making a profit, but if we make a loss, we don't get a refund. All we get is the ability to carry that loss forward and use it at a future date when we are back in profit. So we need to distinguish between taxable profits and tax losses. The formula we need is if the taxable profit, after using all of our losses is bigger than zero, then take that taxable profit number times by the tax rate. That's how much tax you will need to pay. However, if it's not bigger than zero, then zero no tax will be payable. Do not model a cash flow inwards as some sort of tax refund because you're making a loss. That's not how tax losses work. You only get to carry the loss forward and use it in the future. Tax losses known as net operating losses or NOLs are accumulated. So we could have multiple years of tax losses and we add them all together and offset them against the profit. That may take a number of years. To use up all of the losses, we need to add a line into the tax calculation to account for any operating losses brought forward from a previous year. So in the example that's on screen, we have taxable income 100, a loss from last year of 20. So we have net income of 80 on which we will pay tax. If the tax rate is 25%, that means tax payable is 20. So the formula we need is look back at last year. If last year's taxable income was less than zero, use that number, otherwise zero. So that's how we would've used the number or derived the number of minus 20. You only bring forward losses. Do not bring forward a positive number, a profit from the previous year because we would've already paid tax on that in the previous year. It's only losses we want to carry forward.

We need to be aware that depreciation, which is an income statement expense, can be at different rates in our income statement that might be used for tax purposes. The tax percentage of depreciation is set by the legislation of the country you're working in. In some countries, you may be permitted to use a higher rate of depreciation, which will reduce your taxable profit in the early years of the project. So you have A larger depreciation deduction that will reduce the amount of tax you need to pay in the early years of the project. That improves the cashflow profile and therefore the net present value interest is generally tax deductible, but there are what we call thin capitalization rules where interest deductibility is restricted. We just need to be aware that if we step outside of those rules, some portion of the interest may not be allowable for tax purposes. As long as we're within the rules. Though, the true cost of interest after tax is the interest rate multiplied by one minus the tax rate because we get a tax deduction for our interest, it effectively makes debt a much cheaper form of finance because the interest is tax deductible. Once we've worked out how much tax is owed, we need to work out when we will actually pay it. Usually it's not all paid immediately. In most countries, companies pay tax and installments some during the year in which the profit is being earned and some in the subsequent year. The proportion that we pay in the first year versus the next year is one of the assumptions that's held in our inputs area. The total tax we need to pay goes in the income statement. Remembering the income statement isn't trying to work out how much cash we spend. It is just trying to record the net income for the year. So it works out how much tax belongs in the current year's income statement. If some of that has already been paid by the end of the year, it goes in our cashflow. It's negative cashflow, money leaving the project company to pay the government. Anything that is owed but not yet paid is a balance sheet liability. If you're doing an annual model, the formula to work out how much cash will be paid each year is this year's tax times the percentage you need to pay now, plus last year's tax times. The percentage that you get to pay one year later, which is usually one minus the percentage you have to pay during the first year.