Tax Planning under

Income Tax Laws

Key Words / Outline

Slide 1-2

Tax Planning
Tax planning means dealing with the tax matters of a
taxpayer with a view to maximizing the after-tax rate of
return on investments after ensuring voluntary tax
compliance. For this purpose, each taxpayer has to
1.
2.
3.
4.
5.

ensure that proper records are kept;

deduct tax at source where it is necessary;
pay advance tax in time, if applicable;
file returns in time;
comply with notices received from the tax
authorities; and
6. be aware of legal remedies where it does not
have its rights under the law recognized.

Slide 1-3

Tax Functions
Tax function activities are those activities which
are concerned with fiscal issues. These functions
are of two types:
(1) Tax Compliance Activities:
Tax compliance activities are those activities which
include the functions or obligations according to the
provisions of various fiscal statutes.
(2) Tax Planning Activities:
Tax planning means dealing with the tax matters of
a taxpayer with a view to maximizing the after-tax
rate of return on investments after ensuring
voluntary tax compliance.

Slide 1-4

Tax Evasion, Avoidance & Planning

Tax Evasion:
Tax evasion is equivalent to tax cheating.
Tax cheating describes deliberate acts of
noncompliance and does not entail the difficulty of
legal proof of tax evasion (Webley et al. 1991).
In evading tax one is knowingly breaking the law.
This has social and psychological consequences
such as stigma and guilt and involves confronting
different costs since there is a risk of being caught
and fined or sent to prison (Webley et al. 1991).

Slide 1-5

Tax Evasion, Avoidance & Planning

Tax Evasion: contd
The expression Tax evasion means illegally
hiding income or concealing the particulars of
income or concealing the particular source or
sources of income or in manipulating the
accounts so as to inflate the expenditure and
other outgoings with a view to illegally reduce
the burden of taxation. Hence, tax evasion is
illegal and unethical (Lakhotia and Lakhotia
1998).

Slide 1-6

Tax Evasion, Avoidance & Planning

Tax Avoidance:
According to Justice Jagadisan J., Avoidance
of tax is not tax evasion and it carries no
ignominy* with it, for, it is sound law and,
certainly, not bad morality, for anybody to so
arrange his affairs as to reduce the brunt** of
taxation to a minimum mentioned in the
verdict of Aruna Group of Estate v. State of
Madras (1965) case (Palkhivala and Palkhivala
1976).
*public disgrace or dishonor

**the main impact or force, as of an attack

Slide 1-7

Tax Evasion, Avoidance & Planning

Tax Avoidance: contd
Avoidance involves every attempt by legal
means to prevent or reduce tax liability which
would otherwise be incurred, by taking
advantage of some provision or lack of
provision in the law it presupposes the
existence of alternatives, one of which would
result in less tax than the other (Report of the
Royal Commission of Taxation 1966, 538; vide
Webley et al. 1991).

Slide 1-8

Tax Evasion, Avoidance & Planning

Tax Avoidance: contd
Tax avoidance is the art of dodging taxes
without breaking the law. tax avoidance
means of traveling within the framework of the
law or acting as per the language of the law
only in form, but murdering the very spirit of the
law and thus acting against the intention of the
law and defeating the purpose of the particular
legal enactment (Lakhotia and Lakhotia 1998).

Slide 1-9

Tax Evasion, Avoidance & Planning

Tax Avoidance: contd
Perhaps the most celebrated statement made in defense of tax
avoidance came from the pen of Judge Learned Hand. In a
dissenting opinion, in Commissioner v. Newman (1947), he
once said:
Over and over again courts have said that there is nothing
sinister* in so arranging ones affairs as to keep taxes as low as
possible. Everybody does so, rich or poor, and all do right, for
nobody owes any public duty to pay more than the law demands:
taxes are enforced exactions, not voluntary contributions. To
demand more in the name of morals is mere cant**.
*evil or productive of evil

**insincere or hypocritical statements of high ideals

Slide 1-10

Tax Evasion, Avoidance & Planning

Tax Planning:
Tax planning takes maximum advantage of
the exemptions, deductions, rebates, reliefs
and other tax concessions allowed by
taxation statutes, leading to the reduction of
the tax liability of the tax payer (Lakhotia and
Lakhotia 1998).

Slide 1-11

Tax Evasion, Avoidance & Planning

Tax Planning: contd
According to Scholes and Wolfson (1992),
Traditional approaches to tax planning fail to
recognize that effective tax planning and tax
minimization are very different things. The reason
is that in a world of costly contracting,
implementation of tax-minimizing strategies may
introduce significant costs along nontax
dimensions. Therefore, the tax-minimization
strategy may be undesirable. After all, a particular
easy way to avoid paying taxes is to avoid
investing in profitable ventures. Thus, effective tax
planning means not to minimize tax, but to
maximize after-tax rates of return on assets.

Slide 1-12

Tax Evasion, Avoidance & Planning

Legal

Ethical

Desirable

Tax
Avoidance

May or May
not be1

May or May
not be2

Tax
Planning

Tax Evasion

When used as an art of dodging taxes without breaking the law or acting
as per the language of the law only in form, but murdering the very spirit
of the law and thus unethical from the viewpoint of policymakers
1

When acting against the intention of the law & every attempt by legal means
to prevent or reduce tax liability and thus avoiding profitable venture also.
2

Slide 1-13

Tax Formula & Traditional Tax Planning

Tax Planning Formula
Aggregate Income

Exclusions
=
Gross Income

Allowable Deductions
=
Taxable Income

Tax Rate
=
Gross Tax

Tax Credit & Tax Rebate

=
Tax Payable

Tax Planning Action

Maximize

Maximize

Minimize

Maximize

Slide 1-14

TRADITIONAL TAX PLANNING TECHNIQUES

..contd

Traditional Tax Planning Techniques based on Tax Formula

Traditional tax planning is based on maximizing the tax-favored

status and minimizing the tax-disfavored status.
Since the ultimate objective of traditional tax planning is the
minimization of the bottom line (i.e., the minimization of the
net tax payable), the rules of simple arithmetic suggest that tax
planning must necessarily involve:
Maximization of tax credits/rebates/reliefs,
Minimization of the applicable tax rate(s), and
Maximization of deductions and/or exclusions.
In other words, the items on all even-numbered lines in the
above formula constitute the critical variables in tax
planning.

Slide 1-15

TRADITIONAL TAX PLANNING TECHNIQUES

..contd

1. Maximization of Exclusions:
Exclusions are the incomes which are not included in the tax-base of the
income tax [total income as defined u/s 2(65), the scope of which is
outlined u/s 17 and computed u/s 43 according to the heads of income u/s
20, but to be reported under the heads mentioned in the Form of Return of
Income (Form IT-GA for non-company assessees and Form IT-GHA for
companies) u/r 24].
Under section 44(1), any income or class of income or the income of any
person or class of persons specified in Part A, Sixth Schedule shall be
exempt from the tax, and shall be excluded from the computation of total
income.
Along with this list under Part A, Sixth Schedule, Government has issued a
number of S.R.O. u/s 44(4) of the ITO to extend this exclusion list.
Some SROs issued u/s 60(1) of the Income-tax Act 1922 are still in force
for similar exclusion purpose.
The business entities which have been allowed tax holiday u/s 46A or
under any SRO are able to exclude their income enjoying tax holiday.

Slide 1-16

TRADITIONAL TAX PLANNING TECHNIQUES

..contd

2. Maximization of Deductions:
Except Salaries head u/s 21, all other statutory heads of income have
provisions of deductions:
Sec. 23 for deductions from Interest on securities,
Sec. 25 for deductions from Income from house property,
Sec. 27 for deductions from Agricultural income,
Sec. 29 for deductions from Income from business or profession [along
with section 30 for inadmissible expenses from Income from business or
profession],
Sec. 32(1) for deductions from Capital gains [along with section 32(12)
for restricted deductions from Capital gains], and
Sec. 34 for deductions from Income from other sources.
All these deductions are subject to limits, and conditions and subject to
evidential proofs.
So a business entity must be careful about these conditions, limits and
authenticity of the transactions and thereby, disallowances may be avoided
and deductions can be maximized.

Slide 1-17

TRADITIONAL TAX PLANNING TECHNIQUES

..contd

2. Maximization of Deductions:

..contd

Loss as a Deduction:
Under section 37, in the year of loss, losses under any head other than two losses loss in
speculation business and capital loss can be set-off against other head(s) except against
speculation business income and capital gain.
But one speculation business loss can be set off against other speculation business income
only and one capital loss can be set off against other capital gain only.
From AY 2007-08, loss from business or profession is restricted to set off against
income from house property.
Under other provisions of sections 38-42, set-off of losses can be done in future six successive
income years only against the concerned head of income and applicable only for following
incomes:
Speculation business income (u/s 39),
Capital gains (u/s 40), and
Other business income (u/s 38),
Agricultural income (u/s 41)

But in case of capital loss, carry-forward can be done after deduction of Taka 5,000 [u/s 40(3)].
Loss will be calculated for carry-forward after deducting any cash subsidy from the Government
[second proviso to section 37].
Loss due to depreciation can be carried forward for unlimited period [u/s 42].
In case of loss, how to maximize the setting-off of the loss in the year concerned should
be given special attention and in case of unset-off losses, special tax planning regarding
accounting method can help to set off those losses before the expiry of the time limits.

Slide 1-18

TRADITIONAL TAX PLANNING TECHNIQUES

..contd

3. Minimization of Tax Rate(s):

Marginal tax rate (MTR) is the relevant tax rate for any
business decision.
As stated by Sommerfeld et al. (1980), the marginal tax rate
is to business affairs what the law of gravity is to physics.
Just as water seeks its lowest level (due to the laws of gravity),
so also taxable income seeks its lowest marginal tax rate.
The tax planning objective is achieved, of course, when the
marginal tax rate is minimized.

4. Maximization of Credits/Rebates/Relief :

Final emphasis for tax planning is to be given to maximize tax

credits, tax rebates and tax reliefs.
Again these are subject to conditions, limits and special
applicability.

Slide 1-19

TRADITIONAL TAX PLANNING TECHNIQUES

..contd

Alternative View of Tax Planning Opportunities

An alternative way of viewing tax-planning opportunities is to observe

that income tax is constrained by:
Time, Entity, and Accounting method.
Since income tax rates start over with each new tax year and because
very few taxpayers have a constant level of taxable income in each year,
there tend to be high-tax years and low-tax years.
The tax value of a deduction is directly dependent on the marginal tax
bracket of the party reporting it.
Obviously, therefore, taxpayers tend to recognize losses and other
deductions in high-tax years and to defer the recognition of taxable
income to low-tax years.
To the extent that a taxpayer can control tax timing, s/he should do so
only after giving full considerations to the time value of money.
Sometimes the financial cost of deferral is greater than the tax benefit.

Slide 1-20

TRADITIONAL TAX PLANNING TECHNIQUES

..contd

Alternative View of Tax Planning Opportunities

..contd

Method of Accounting in ITO:

All income classifiable under the head:

Agricultural income [u/s 26 & 27],

Income from business or profession [u/s 28-30, 30A] or
Income from other sources [u/s 33, 34, 36 & 43]

shall be computed in accordance with the method of accounting regularly

employed by the business entity [sec. 35(1)].
However, every public or private company as defined in the Companies Act, 1913 or
1994 shall, with the return of income required to be filed under the ITO for any
income year, furnish a copy of the trading account, P&L account and the balance
sheet in respect of that income year certified by a CA [sec. 35(3)].
Where no method of accounting has been regularly employed, or if the method
employed is such that, in the opinion of the DCT, the income of the assessee cannot
be properly deduced therefrom; or where a company fails to furnish financial
statements certified by a CA with its return, the income of the entity shall be
computed on such basis & in such manner as the DCT may think fit [sec. 35(4)].

Slide 1-21

TRADITIONAL TAX PLANNING TECHNIQUES

..contd

Alternative View of Tax Planning Opportunities

..contd

Method of Accounting in ITO:

The method of accounting may be:
Mercantile system (or accrual basis) or
Cash system (or cash basis) or
Hybrid system (i.e., mixture of these two for separate heads of income).
However, in the income tax laws, few incomes must be
computed under a specific accounting method. For instance,
Dividend is taxable under cash system [u/s 19(7)],
Income from house property is taxable under cash system
[S.R.O. No. 454-L/80 dt. 31.12.80], and
Advance salary income are taxable under cash system [u/s 21(1)
(b)] subject to a relief u/s 172.

Slide 1-22

TRADITIONAL TAX PLANNING TECHNIQUES

..contd

Alternative View of Tax Planning Opportunities

..contd

Owner/Operator (O/O) of a Company: Shareholder Director of

a Private Company :
The time constraint may also be important in case of working with a closely held
private company as a shareholder director, i.e., the owner/operator (O/O).
The salaries with arrangement of TDS of the director are an allowable deduction
with some other limits u/s 30 in case of determining the total income of the
company.
The salaries are taxable in the hand of the director subject to the exclusions
under rules 33 and 33A-33J and Part A, Sixth Schedule.
The method of accounting followed by the company may be mercantile system,
but the accounting method followed by the director may be cash system.
Depending on this entity level advantage (as O/O of the company), a year-end
bonus to the director may be shown as a deduction under accrual basis but the
O/O is not required to show it as an income until the time of receipt.
Even income year might be different from the entity to its O/O.
Such accounting legerdemain* is a common practice for tax planning purpose.
*trick; magic; deception

Slide 1-23

TRADITIONAL TAX PLANNING TECHNIQUES

Traditional tax planning is equivalent to tax avoidance with the main
purpose of legal reduction of tax liability.

Tax Planning Principles:

Taxes decrease if income earned by entity is subject to a low rate.
Taxes decrease if payment can be deferred to a later year, because
tax deferred is tax reduced.
Taxes decrease if income is generated in a low rate jurisdiction.
Taxes decrease if income is taxed at a preferential rate.

Relevant Tax Rate:

For planning purposes only relevant rate is rate at which the
transaction will be taxed, i.e., marginal tax rate (MTR) rate at which
next Taka of income will be taxed. The MTR may change as follows:
(a) higher bracket due to more income, or
(b) law may be changed and a new rate is prescribed.

Slide 1-24

TRADITIONAL TAX PLANNING TECHNIQUES

..contd

Factors Affecting Tax Planning:

Choice of Entity: Which entity undertakes the transaction? Different entities have
different tax rates. Pass-through entities (sole-proprietorship) allow shifting income
to owner and one level of tax. Non-pass-through entities (companies) are subject to
double taxation, once at corporate level and then again at the shareholder level.
Period of Transaction: Over what period does transaction take place? Tax deferred
is tax saved based upon time value of money. Common techniques are to
accelerate deductions (e.g., following accelerated depreciation) and to defer income
(e.g., through installment sale). A taxpayer has to consider when taxes are actually
paid (e.g., quarterly estimates versus end of year computation).
Tax Jurisdictions: In which jurisdiction does the transaction take place? Tax liability
depends whether the income will be accrued in foreign country (subject to
exemption or tax relief) or Bangladesh or whether the income will be earned by
establishing the entity in a low tax zone or a high tax zone.
Character of Income: What is the character of the income? Depending on the
income character, certain types of income are exempted fully or partially. Certain
types of income are taxed at preferential rates (e.g., capital gain on transfer of
stocks and shares of non-listed private limited company taxed @ 15%, dividend
income from shares taxed to companies @ 15%).

Slide 1-25

TRADITIONAL TAX PLANNING TECHNIQUES

..contd

Tax is a Function of 3 Variables:

A final tax liability is a function of three (3) variables:
the law,
the facts, and
the administrative (and sometimes judicial) process.
If any taxpayer is not satisfied with either the law or the administrative
and judicial processes, there is relatively little that s/he can do
(unless, of course, s/he has enough money and clout to get a tax law
change).
The facts, however, are generally amenable to modification.
If a taxpayer is wise enough to understand when and how to modify
them, s/he may very well reduce her/his tax liability significantly.
The most highly qualified professional tax experts earn most of their
lucrative fees by giving advice on alternative ways of arranging facts.
In other words, most professional tax planning is little more than the
prearrangement of facts in the most tax-favored way.

TAX PLANNING under the SCHOLESWOLFSON PARADIGM

Scholes-Wolfson have adopted a contractual perspective for
their paradigm & suggested 3 key aspects of tax planning globally:
1. Multilateral Approach: All contracting parties must be taken
into account in tax planning, which allows a global or
multilateral, rather than a unilateral, approach.
2. Importance of Hidden Taxes: All taxes (both implicit tax and
explicit tax) must be taken into account considering the global
measures of taxes. Implicit tax is the decrease in return due to
availing tax favored investment and explicit tax is the tax
deposited in the treasury.
3. Importance of Nontax Costs: All costs of business must be
considered, not just taxes.
Thus, the paradigm is based on consideration of
ALL PARTIES, ALL TAXES, ALL COSTS.
These are also prerequisites of Effective Tax Planning.

Slide 1-27

Why Tax Planning Arises?

Progressive Taxation, Subsidy and Provision to
arrange taxpayers affairs to minimize tax-bite
Gives rise to marginal tax rate (MTR) that widely varies

From one
contracting
party to the
next

For a given
contracting
party over
time

For a given
contracting party over
different economic
activities

Types of Corporate Tax Planning

Types of corporate income tax planning activities:
Converting income from one type to another
(ordinary income vs. capital gain; regular income vs.
windfall income; domestic income vs. foreign income;
loss under one head vs. set-off of the loss against
another head or carry-forward & set-off against same
head);
Shifting income from one pocket to another
(taxable vs. tax-exempt sources); and
Shifting income from one time period to another
(delaying recognition of income, if tax rates are
constant or declining over time, instant salary vs.
deferred compensation)

SOME PROHIBITIVE TAX DOCTRINES

Constructive-Receipt Doctrine
Business Purpose Doctrine
Substance-over-Form Doctrine
Step Transaction Doctrine [Related-Party
versus Arms-Length Contracts]
Assignment-of-Income Doctrine

SOME PROHIBITIVE TAX DOCTRINES

Constructive-Receipt Doctrine
Various incomes deemed to be received u/s 19 [eg, difference between the price
paid and the fair market value (FMV), if the price paid is less than FMV for assets,
not being stock-in-trade or stocks and shares, purchased u/s 19(8); benefit or
advantage on account of cancellation of indebtedness u/s 19(11)]
Business Purpose Doctrine
Sec. 29(1)(xxvii): Any expense not being personal or capital nature, exclusively
incurred for business purpose will be allowed as deduction
Substance-over-Form Doctrine
Any transaction shall be accepted by considering its substance & not the mere
legal form
Step Transaction Doctrine [Related-Party versus Arms-Length Contracts]
Tax authority worries about related-party transactions more than arms-length
transactions, because related parties can form any type of arranged contracts
between them and thereby lower tax also. Parties with opposing interest cannot
always afford to write a tax-favored contract.
Assignment-of-Income Doctrine
Sec. 43(3) and 43(4): Clubbing of income, i.e., income of others may be
combined to tax at higher marginal rate [Sec. 43(3): Income of spouse or minor
child; Sec. 43(4): Income of other persons]

TAX CLIENTELES
Marginal Investor: Taxpayers who are indifferent between purchasing two
equally risky assets, the returns to which are taxed differently, are called the
marginal investors.
Tax Clientele (inframarginal investor): Taxpayers that prefer one
investment over another are referred to as the tax clientele for the preferred
investment. Unless investors correctly identify their proper tax clientele, they
will not maximize their after-tax rates of return. The clientele for an
investment is the taxpayer with marginal explicit tax rates (METR) below
implicit tax rate.
Example: Say, pretax return on fully taxable bond = 10%, and fully taxexempted return on government security = 7%, then implicit tax rate on
government security = (10% 7%)/10% = 30%. The clientele for fully
taxable bond are taxpayers with METR below implicit tax rate 30%. A
taxpayer with 20% METR will earn 8% [=10%(120%)] after-tax by investing
in fully taxable bond, 1% greater than in tax-exempt government security.

TAX ARBITRAGE

Tax Arbitrage the purchase of one asset (a

long position) and the sale of another (a
short position) to create a sure profit
despite a zero level of net investment. Two
types of tax arbitrage:
- Organizational-form tax arbitrage (OFTA)
- Clientele-based tax arbitrage (CBTA)
Guideline for arbitrage: Since the clientele for an
investment is the taxpayer with marginal explicit
tax rates (METR) below implicit tax rate, so
arbitrage will work when METR>Implicit tax rate.

TAX ARBITRAGE

Classification

Type of
taxpayers

Long Position in

Short Position in

Organizational-form

All taxpayers

An asset or
productive activity
through a favorably
taxed
organizational form

An asset or
productive activity
through an
unfavorably taxed
organizational form

Clientelebased

High-tax-rate
taxpayers

A relatively taxfavored asset (one

that bears a
relatively high
implicit tax)

A relatively taxdisfavored asset

(one that bears a
relatively more
explicit tax)

Low-tax-rate
taxpayers

A relatively taxdisfavored asset

A relatively taxfavored asset

Arbitrage

TAX ARBITRAGE

Tax arbitrage is prevented by tax-rule

restrictions and market frictions.
Market Friction transaction costs incurred by
taxpayers in the marketplace that make certain taxplanning strategies costly.
Tax-Rule Restriction restraints imposed by the
tax authority that prevent taxpayers from using
certain tax arbitrage techniques to reduce taxes in
socially undesirable ways.

Slide 1-35

End of the Presentation

Thank you.