Question

Why do income taxes not apply to the cost of equity?

Answer 1

Cost of Equity would not attract income taxes as dividends or return on capital is not tax deductible.

Dividends and return on capital are usually paid to the owner's of the company and these payments are not tax deductible for a company thus there would be no impact of income taxes on Cost of Equity.

However while calculating cost of debt there is impact of income tax as we take the after tax cost of debt. As the company pays interest on the debt it has taken, it would not be required to pay taxes on such interest amount. The business can claim Interest as business expense. For this reason while calculating Cost of debt we use the formula Interest rate(1-Tax rate).