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 claiminginvestment allowance at 15 per cent of the investment made by amanufacturing company in new plant and machinery (acquired and installed).Further, in respect of investment made on or after 1 April 2014, thethreshold of INR1 billion has been reduced to INR250 million

• Asset is obtained on lease, deduction can be claimed in respect of leaserentals and lease management fees and in the case of obtaining anasset on hire, deduction can be claimed in respect of hire charges. Bycomparing present value of cash outflows a correct decision can betaken.

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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 furtherdeduction would be available to the extent of 50 % of the profit provided anequivalent amount is debited to the profit and loss account of the previousyear and credited to special Economic Zone Re-investment AllowanceReserve Account

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

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• Amortisation of certain preliminary expenses [sec. 35d]: Afterthe commencement of his business, in connection with the extensionof his industrial undertaking or in connection with his setting up anew industrial unit, the assessee shall be allowed a deduction of anamount equal to one-tenth (1/10 th. ) of such expenditure for each ofthe ten successive previous years beginning with the previous year inwhich the business commences or the new [industrial] unitcommences 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. 100

Dividend distribution

tax on at 16.995%

16.995

Amount required

for 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. factor

1 0.870

2 0.756

3 0.658

4 0.572

5 0.497

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