Tax Planning Financial Management Decisions

A Presentation on

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What is tax planning?• Exercise carried out by the taxpayer to meet his tax

obligations in proper. Systematic and orderly manner availing all permissible exemptions, deductions and reliefs available under the act as may be applicable to his case

Why is tax planning necessary?

• The tax paid is an addition to the cost. Just as every businessman tries to maximize his profit by reducing the cost, he should also arrange his affairs in such a way, that he pays the least amount of tax.

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Is tax planning confined only to direct taxes? • No. The effect of other taxes like sales-tax, customs

duty and excise duty, are to be taken into account.

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The main objectives of tax planning

• Avail all concessions and relief’s and rebates permissible under the Act.

• Arrange the affairs in a commercial way to minimize the incidence of tax.

• Claim maximum relief where taxes are paid in more than one country.  

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• Become tax compliant and avoid penalties, prosecutions and interest payments.

• Fruitful investment of savings. • Timely compliance of procedural requirements like

tax audit, TDS, TCS, etc. • Appropriate record keeping

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• Avoidance of litigation.• Growth of economy and

its stability.• Pay taxes- not a penny

more, not a penny less.

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Tax management• Planning which leads to filing of various returns on

time, compliance of the applicable provisions of law and avoiding of levy of interest and penalties can be termed as efficient tax management.

• Defaults are avoided and legal compliance is secured.• Penalty of up to Rs. 100,000 for delay in furnishing of

tax audit reports u/s 44AB can be avoided.

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Tax management includes• Compiling and preserving data and supporting

documents evidencing transactions, claims, etc. • Making timely payment of taxes.• TDS and TCS compliance.• Payment of expenses or acceptance of loans or

repayment thereof, over ` 20,000 by account payee bank cheque or bank draft, etc.

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• Compliance with the prescribed requirements like tax audit, certification of international transactions, etc.

• Timely filing of returns, statements, etc.

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• Responding to notices received from the authorities. • Preserving record for the prescribed number of years. • Mentioning PAN, TAN, etc. at appropriate places. • Responding to requests for balance confirmation from the

other assessees.

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Financial Management Decision

• New Capital Investments• Make or Buy • Own or Lease • Retain or Replace • Repair/Scrap or Return

• Export or Domestic Sale• Accounting Standards for

Taxes on Income• Expand or Contract• Shut Down or Continue

Management decisions, which have a bearing on the bottom line are analyzed below from the point of view of income-tax implications.

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Tax management with reference to ‘Capital Structure’ • There are different sources of funds depending upon

the needs, availability, terms, etc. However for availing the tax benefits, there should be proper debt- equity mix in the capital structure and a clear policy on return on capital employed.

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What is the Optimum Capital Structure ?• The optimum capital structure is a mix of equity

capital and debt funds. Their composition depends upon many factors :

• Cost of Capital and also expenditure incurred in rising of such capital.

• Expectation of shareholders by way of dividend, growth etc.

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• Expansion need of the business i.e. the rate by which profits of the business shall be again ploughed back in the business.

• Taxation policy ; and• Rate of return on investment (Equity + Debt funds).

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Tax Considerations• Interest on debt fund is allowed as deduction as it

is business expenditure. Therefore, it may increase the rate of return on owner’s equity.

• Dividend on equity fund is not allowed as deduction as it is the appropriate of profit. Dividend is exempt in the hands of shareholders u/s 10(34) . However, the company declaring the dividend shall pay dividend distribution tax @ 15% + surcharges + education cess.

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• The Cost of raising owner’s fund is treated as capital expenditure therefore not allowed as deduction. However if conditions of Sec. 35D is satisfied then specified expenditures can be amortized.

• The Cost of raising debt fund is treated as revenue expenditure. It can be claimed as deduction in computing the total income.

• Where interest on debt fund is payable outside India, tax should be deducted at source otherwise deduction is not allowed.

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Tax Planning• If the return on investment > rate of interest,

maximum debt funds may be used, since is shall increase the rate of return on equity. However, cost of raising debt fund should be kept in mind.

• If rate of return on investment < rate of interest, minimum debt funds should be used.

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• Where assessee enjoys tax holidays under various provisions of Income-Tax in such case minimum debt fund should be used, since the profit arising from business is fully exempt from tax which increase the rate of return of equity capital. But the borrowed fund reduces the profits (profits less interest) before tax and to the extent exemption is reduce.

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Tax Planning With Reference to ‘Investment’ decision• Some important benefits in Investment in

new plant and machinery:• Additional depreciation as per section 32(1) (iia): 20%

of actual cost shall be allowed in respect of new plant or machinery acquired and installed after 31.1.2005 and used in the manufacturing or production of any article or thing.

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• Depreciation is a significant deduction from taxable income. Plant and machinery relating to generation of power and pollution control equipment, and those relating to Research and Development, etc., are eligible for 100% deduction. Plant and machinery can be acquired, replaced, repaired, purchased or hired or assembled with different tax consequences.

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• Investment allowance will be available for the A.Y. 2014 – 15 and 2015-16 as follows:

• A.Y. 2014-15 – If the aggregate amount of actual cost of new asset exceeds Rs.100 crore, investment allowance will be available for the A.Y. 2014-15. The amount of allowance will be 15 per cent of actual cost of new asset acquired and installed during the previous year 2013-14.

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• The time limit increased from 31 March 2015 to 31 March2017 for claiming investment allowance at 15 per cent of the investment made by a manufacturing company in new plant and machinery (acquired and installed). Further, in respect of investment made on or after 1 April 2014, the threshold of INR1 billion has been reduced to INR250 million

• Asset is obtained on lease, deduction can be claimed in respect of lease rentals and lease management fees and in the case of obtaining an asset on hire, deduction can be claimed in respect of hire charges. By comparing present value of cash outflows a correct decision can be taken.

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Tax Planning With Reference To ‘Make Or Buy’ Decision.• ESTABLISHING A NEW UNIT: if the decision to

manufacture a part or component involves setting up a separate industrial unit, then tax incentives available under sections 10AA, 32, 80-I one has to keep in mind.

• Provision of Section 10AA: if the conditions are satisfied, the assessee can claim deduction under section 10AA from his total income, for a period of 10 consecutive assessment years.

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• Amount of deduction: deduction depends upon quantum of profit derived from export of articles or things or services.

• First 5 years – 100 % of profits and gains derived from the export of articles or thing or from services is deductible.

• Deduction from sixth A.Y. to tenth A.Y. – 50% of profits and gains derived from the export of articles or thing or from services is deductible.

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• Deduction for 11th A.Y. to 15th A.Y. - For the next 5 years, a further deduction would be available to the extent of 50 % of the profit provided an equivalent amount is debited to the profit and loss account of the previous year and credited to special Economic Zone Re-investment Allowance Reserve Account

• Additional depreciation as per section 32(1) : 20% of actual cost shall be allowed in respect of new plant or machinery acquired and installed after 31.1.2005 and used in the manufacturing or production of any article or thing.

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• Amortisation of certain preliminary expenses [sec. 35d]: After the commencement of his business, in connection with the extension of his industrial undertaking or in connection with his setting up a new industrial unit, the assessee shall be allowed a deduction of an amount equal to  one-tenth (1/10 th. ) of such expenditure for each of the ten successive previous years beginning with the previous year in which the business commences or the new [industrial] unit commences production or operation

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• Under section 80-IAB of the Income-tax Act, a deduction of 100% is allowed in respect of profits and gains derived by an undertaking from the business of development of an SEZ notified on or after 1.4.2005 from the total income for any 10 consecutive A.Y. out of fifteen years beginning from the year in which the SEZ is notified by the Central Government.

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• Deduction in respect of profits and gains of certain undertaking in certain special category of states [ Sec. 80-IC]• Amount of deduction: 100% deduction is available for

the first 10 years [ however, in the case of Himachal Pradesh or Uttaranchal, it is 100% for the first 5 years and 30% (25 % in the case of non-corporate assessee) for the next 5 years.

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• Sale of plant and machinery: If buying is cheaper than manufacturing and the assessee decides to “buy” parts/components for a long period of time, he may like to sell the existing plant and machinery. But it should be beginning of the year to realise the fund without affecting the existing efficiency.

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Tax Planning With Reference To ‘Dividend Decision’.• Paying dividend involves outflow of cash. The cash

available for the payment of dividend is affected by the firm’s investment and financing decision.

• The Domestic Company is liable to pay Dividend Distribution Tax at 16.995 per cent on such dividends. The amount of dividend distributed to shareholders shall be increased to such amount as would after reduction of tax on such increased amount be equal to the net distributed profits.

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• Example where Rs.100 is to be distributed to shareholders:

Dividend paid Rs. 100Dividend distributiontax on at 16.995%

16.995

Amount requiredfor distribution

116.995

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Case Study• Arston engg. Ltd. Are considering a proposal to buy a

plant at the cost of Rs. 20L in respect of which applicable depreciation rate is 15%. The FOUR alternatives are available to the company as follows:

1) Utilize Rs. 20L from General Reserve, which is lying in bank’s current a/c for working capital requirement. Alternatively promoters are willing to contribute Rs. 20L from their own funds.

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2) Take a loan of Rs. 20L from financial institution @ 13% p.a. repayable in five annual equal installments.

3) Take the plant on lease from a finance company at the monthly lease rent of Rs. 55,000. The period of lease is five years only.

4) Hire purchase option: down payment Rs. 5,00,000. And monthly installments of Rs. 40,000

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• Present value of Rs.1 @ 15% p.a.:Year P.V. factor1 0.8702 0.7563 0.6584 0.5725 0.497

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