Tax planning

Concept
Logical analysis of a financial situation or plan from a tax perspective, to align financial goals with tax efficiency planning. The purpose of tax planning is to discover how to accomplish all of the other elements of a financial plan in the most tax-efficient manner possible. Tax planning thus allows the other elements of a financial plan to interact more effectively by minimizing tax

Essential features of tax planning are as follows: a) It comprises arrangements by which tax laws are fully complied. b) All legal obligations and transactions are met. c) Transactions do not take form of colorable devices (i.e. those devices where statute is followed in strict words but actually spirit behind the statute is marred would be termed as colorable devices). d) There is no intention to deceit the legal spirit behind the tax law.

What is Tax evasion? All the methods by which tax liability is illegally avoided are termed as tax evasion. An assesses guilty of tax evasion may be punished under the relevant laws. Tax evasion may involve stating an untrue statement knowingly, submitting misleading documents, suppression of facts, not maintaining proper accounts of income earned, omission of material facts on assessment. All such procedures and methods are required by the statute to be abided with but the assesses who dishonestly claims the benefit under the statute before complying with the said abidance by making false statements, would be within the ambit of tax evasion.

Case 1

X is an individual. For the assessment year 2008-09, has gross total income is Rs. 2,40,000 Tax on Rs. 2,40,000 is Rs. 23,460. To reduce his tax liability, he deposits Rs. 50,000 in public provident fund account. Consequently, his taxable income and tax liability thereof will be reduced to Rs. 1,90,000 and Rs. 13,260 respectively.

Case 2 X LTD is a chemical manufacturing company. It has factory in Haryana near Delhi border. Within the factory campus piece of land of 2000 square meter is lying unutilized. The company wants to start a new unit to manufacture computer components. If this manufacturing unit is started in the existing factory campus, deduction under section 80IB is not available. However, it the new unit is started in Jammu& Kashmir, the company can claim deduction under section SO-IB. To get the benefit of deduction under section 80-IB, the company starts the new unit in a village near lamina The company has two option under one of the options, deduction under section 80-IB is not available. However, this deduction is available under the other option. To get the benefit of deduction under section 80-IB the new unit has been started in Jammu& Kashmir. As the tax liability has boon reduced get the benefit of deduction available under the income tax, it is tax planning. Case 3 Suppose in case 2, the process of manufacturing actually takes place in Haryana. To get the benefit of deduction under section 80-IB, the company takes a factory building on rent in a village in Jammu and only on paper it is shown that the new manufacturing unit is situated in a village near Jammu. As the company want to reduce the tax liability by making incorrect statement about the location of manufacturing process, it is tax evasion. Case 4 If a sum of money is gifted by a husband to his wife, income generated there from is taxable in the hands of husband under the clubbing provisions of section 64(1). Section 64(1)is not applicable is gift is made by the same person out of the funds of his Hindu undivided family in capacity as karta of the family. If gift is made by karta of the family to his wife, clubbing provisions can be avoided and ultimate tax laibility will be reduced. However, the tax liability will be reduced by taking the help of a loophole in the but within the legal framework. It is tax avoidance.

Objective of tax planning are:

1. Reduction of tax liability: By resorting to tax planning a taxpayer can derive the maximum tax saving by arranging his in accordance with the requirement of the law. 2. Minimizing Litigation: By resorting to tax planning a taxpayer fulfils all the requirements of tax statutes and thus, avoids protracted litigation 3. Productive Investment: The tax laws contain various rebates and deductions on making investing in specified sector. Tax planning makes use of this beneficial provision & thereby achieves two fold objective of holding the resources for socially productive project and relieving the tax payer from the burnt of taxation by converting the earning into means of further earnings. 4. Healthy Growth of Economy: Tax planning forces saving of earning by legally sanctioned devices and thus helps in capital formation and growth of the economy. 5. Economic Stability: Tax planning results in economic stability by way of availing of avenues for productive investment by the taxpayer & holding of resources for national project aimed at general prosperity

Essential features of tax planning are as follows: a) It comprises arrangements by which tax laws are fully complied. b) All legal obligations and transactions are met. c) Transactions do not take form of colorable devices (i.e. those devices where statute is followed in strict words but actually spirit behind the statute is marred would be termed as colorable devices). d) There is no intention to deceit the legal spirit behind the tax law.

Tax planning of management decision

Managerial decision is influenced by a number of factors depending on the facts of a case. They are not always guided by tax considerations. However it would be better if tax factor is also analyzed before making such decision. The role of tax factor in a few important business problems is being analyzed for the purpose of management decision. Capital structure: Capital structure refers to various sources through which a project can be finished. The financing can be done either through own funds, through loan funds or through a combination of both. Thus capital structure comprises either of debt or equity or equity or combination of both. Capital structure decisions are required to be made either at a time of commencement of business or at the time of major expansion of a project. The following factors may be taken into account while deciding the capital structure. Risk: In case of debt, repayments of principal and interest have to be made as per loan agreement, irrespective of profits. Failure to do so in time may lead to bankruptcy and closure of business. On the other hand, no such contractual payments are required to be made if the project is financed through equity. Thus debt carries more risk as compared to equity.

2- Control: Financing through equity may lead to a decrease on the promoters control over the company as other shareholder would also participate in the decision making process. On the other hand, financing through debt would lead to the better control of the promoter.

3- Gestation period: Debt service would be difficult into a long gestation period. Accordingly. Financing through equity may be preferred as compared to debt in this case. 4- Shareholder satisfaction:In order to keep the shareholder satisfied, the company should ensure that the capital structure does not adversely affect the - Earnings per share - Dividend - Market price of the share

5- Debt equity ratio: Generally debt equity ratio is regarded 2:1 as an ideal ratio. In the case the existing debt equity ratio is 1:1, debt may be preferred. On the other hand, if debt equity ratio is 3:1, equity may be preferred. 6- Marketability of shares: Financing can be raised through equity route only if the shares are marketable, that is if the people are willing to buy the shares. If the shares are not marketable, debt is the other option to arrange the finance. 7- Future rate of return: The effect of the proposed capital structure on the future rate of return after tax on equity should also be kept in mind while making the capital structure decision.

Tax planning for the employees Tax consideration for employees- employees should keep in mind the following conditions to avoid tax disallowance which are as under.

1- Bifurcation of salary into exempted perquisites and allowances: An employer may devise a suitable structure of salaries, dividing them into perquisites and allowances which are wholly exempt or partially exempt to minimize the incidence of tax of the employees. For example a part of the salary may be paid in form of the allowance or perquisites which are exempt with various sections like section 10 of income tax act.

2- DA to be paid as part of basic salary: -

Tax planner should ensure that dearness allowance will be part of basic salary. This will reduce the tax liability on house rent allowance, gratuity and commuted pension in the hands of employees. 3- Salaries earned outside India: Under section 5 and section 6 of income tax act, where an employee has earned remuneration outside India, he should avoid its receipt in India. Besides, he should also plan his residential status in such year either to be non-resident or non-ordinary resident to avoid tax liability in India.

4- Claim for the exemption under section 10:Where any remuneration is exempted from tax, the employee is advised to claim exemption to avoid or reduce his liability of tax. 5- Chargeability of salary: Under section 15 of income tax act, salary is taxable on due basis or receipt basis whichever is earlier. Whenever he gets salary of more than 12 months in one previous year he should make a claim of relief under section 89 of income tax act. Tax avoidance v. Tax evasion The following are the broad areas of distinction between the two: Tax avoidance Tax evasion 1. Any planning of tax which aims at 1. All methods by which tax liability is reducing or negating tax liability in legally illegally avoided is termed as tax evasion. recognised permissible ways can be termed as an instance of tax avoidance. 2. Tax evasion is an attempt to evade tax 2. Tax avoidance iaTces4nteraccpunt the liability with the help of unfair loopholes of law. means/methods. 3. Tax avoidance is tax hedging within the 3. Tax evasion is tax omission. framework of law . 4. Tax avoidance has legal sanction 4. Tax evasion is unlawful and an assessee guilty of tax evasion may be punished under the relevant laws. 5. Tax avoidance is intentional tax planning 5. Tax evasion is intentional attempt to before the actual tax liability arises. avoid payment of tax after the liability to tax has arisen.

6.Tax planning v. Tax managementTax management involves the procedures of compliance with the statutory provisions of law. The following are the broad areas of distinction between tax planning and tax management. Tax planning Tax management 1. The objective of tax planning is to reduce 1. The objective of tax management is to the tax liability to the minimum. comply with the provisions of law. 2. Tax planning is futuristic in its approach. 2. Tax management relates to past (i.e. assessment proceedings, rectification, revision, appeals etc.), present (filing of return of income on time on the basis of updated records) and future (corrective action). 3. Tax planning is very wide in its coverage and includes tax management. 3. Tax management has a limited scope, i.e., it deals with specific activities such as filing of returns of income on time, drafting appeals, deduction of tax at source on time, updating records from 4. The benefits arising from tax planning time to time, etc. are substantial particularly in the long run. 4. As a result of effective tax management, penalty, penal interest, prosecution, etc., can be avoided.

Tax planning with refereance setting up of new business