Interest tax shield

The interest tax shield is the corporate tax saving from debt's tax-deductible interest payments. Annually it equals interest paid × tax rate and explains why the WACC uses the after-tax cost of debt rather than the pre-tax rate.

ByHoang TruongUpdated July 2, 2026

FrameworkCapital structure theory

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A firm paying €500,000 in annual interest at a 25% corporate tax rate saves €125,000 in tax each year — the interest tax shield. That saving is why the after-tax cost of a 6% coupon bond is only 4.5%, the rate entered into the WACC formula as the cost of debt.

Where it fits

TopicCost of Capital & WACCCoreSubjectCorporate FinanceCoreTopicCapital Structure & LeverageCore

The formula

LaTeX

\text{Annual tax shield} = \text{Interest paid} \times t

Variables

$I n t er es tp ai d$: Annual interest payments on outstanding debt
$t$: Corporate tax rate (as a decimal)

The tax shield arises because interest is deductible from taxable income before tax is applied. A firm paying €500,000 in annual interest at a 25% tax rate saves €125,000 each year.

LaTeX

k_d = r_d \times (1 - t)

Variables

$r_{d}$: Pre-tax cost of debt: the coupon rate or yield to maturity on the debt
$t$: Corporate tax rate (as a decimal)

This is the rate entered in the WACC formula as the cost of debt. A 6% coupon bond with a 25% corporate tax rate has an after-tax cost of 4.5%.

Check yourself

PracticeCORE

Castleton plc carries €5,000,000 of outstanding debt at an annual coupon rate of 6%. The corporate tax rate is 25%. What is the annual value of the interest tax shield?

Select an answer to check your understanding.