| In their celebrated papers, Modigliani and Miller (1958) argued that the capital structure decision and dividend policy is a matter of irrelevance, affecting neither the value of corporation nor its cost of capital. Their theories are founded on a series of assumptions, such as homogeneous expectation; symmetric information; and perfect market. In a perfect market there is not tax at all, but in the modern society, taxation is inevitability for every individual and firm. Many scholars in foreign countries devoted themselves to the issue on how taxation affects the capital structure decisions. They have conducted a lot of theoretical studies and empirical analyses, and put forward various theories with different ideas. However, little research on this problem has been done in China so far. It is known that there exist many differences in taxation between China and other countries mentioned in the previous study, therefore, my paper try to perform a theoretical in the previous study, therefore, my paper try to perform a theoretical study about the question how taxation in China affects the capital structure policies. Based on the MM theorem, this paper takes the tax effect of capital structure decision as the master clew and extends the hypothesis that there is not tax at all step by step. The paper integrate the tax system in China with the financial data in the annals of listed corporations to investigate the tax effect of capital structure decision of public listed corporations in China from theory and empirical aspect respectively. According to the above analyses, the paper gives some corresponding suggestions about how to benefit from the tax effect of capital structure more sufficiently to certain concrete Industries. The paper is composed of four sections:In the section 1, I review the modified and extended models of the MM theorem. Based on the irrelevant theory of the MM theorem, I expatiate on that it's necessary to add the individual income tax and the corporation tax to it ,then I present the extended model.In the section 2, founded on conclusion that some literatures have suggested I extend Miller's model (1977) through bringing in the capital gains tax and dividends payout ratio. According to the information the model reflected we can estimate whether the tax effect of capital structure is used sufficiently at the present time. For the corporations that have not utilized the tax effect (they can be called 'corporations with the potential tax effect') we can increase the ratio of debt in the capital structure to increase the corporate value and also estimate how much the dividends policy influence the tax effect. Furthermore, according to the tax system at present I construct the model of tax effect of capital structure that assort with the situation of our country. On the assumption that:(1) Corporate aftertax gain will be paid the shareholders in the proportion of b(0≤b≤1), and as the capital gains the remainder part will be paid the shareholders through shares repurchase.(2)There is no new investment in the corporations, namely net investment is zero.And when taking corporate income tax , personal income tax and capital gains tax into account corporate value iswhere=Value of a levered corporation;= Value of a unlevered corporation;=Income tax rate of a unlevered corporation; =Dividend personal income tax rate;=Interest personal income tax rate;=Capital gains tax rate;= Debt value of equity of levered corporation; According to the above model I gain some conclusion as follow:(1) If (1- TC ) × [b× (1- TS )+ (1- b) (1- TG)]< (1-TB ), under keeping dividend policy the level of and corresponding tax rate at present, corporation will benefit from the tax effect of the capital structure decision trough increase the ratio of debt in the capital structure;(2) If (1- TC ) × [b× (1- TS )+ (1- b) (1- TG)] > (1-TB ), under keeping dividend policy and the level of corresponding tax rate at present, that increasing the ratio of debt in the capital...
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