M.

COM IV SEMESTER

MC- 401: TAX PLANNING AND MANAGEMENT

UNIT III

TAX PLANNING THROUGH MANAGERIAL AND

FINANCIAL DECISIONS
3.1. TAX PLANNING THROUGH MANAGERIAL DECISIONS

Management decisions with respect to:

(i) MAKE OR BUY DECISION: This applies to industries where assembly of products
takes place to make a finished product. Like a manufacturing of car, where thousands of
different parts or components are assembled to make a car.
It is quite natural every components or part of a car cannot be manufactured by one company.
Since part manufacture involves cost, time, energy, and different kinds of technology and
expertise. Therefore, in such cases company purchases parts from outside agencies. But
where the cost involved in purchasing from outside market is high, then the company might
go in for in house production.
Apart from costing consideration following factors also go in decision-making process:

1. Utilizations of Capacity
2. Inadequacy Fund
3. Latest Technology
4. Dependence of supplier
5. Labour problem in the factory

What are the cost involved in making?

1. Fixed Cost: Purchased of Plant etc.

2. Variable Cost: Raw Materials, Labour, Electricity etc.

What are the cost involved in buying of a part from outside agency?

1. Buying Cost
2. Inventory Cost

Comparison of the above two cost shall determine which decisions the company shall follow.
But, however it should be kept in mind that while comparing Cost, common cost should not
be taken into account.
It should also be noted that the cost incurred in making a product and buying a product, both
involves incurring of revenue expenditure. Therefore, tax saved in both the cases are same. It
comes into picture only when there is a need for extension or establishment of new unit to
manufacture that new components.
Tax Consideration:
1. Establishing a new Unit: If the decision to manufacture a part or component involves a
setting up a separate industrial unit than tax incentives available u/s 10A, 10B, 32, 80IA and
80IB should be considered.
2. Export: If ‘Make or Buy’ decision is taken for exporting goods then tax incentives
available u/s 80HHC depends upon whether goods manufactured by taxpayer himself are
exported or goods manufactured by others are exported by the taxpayers.
3. Sale of Plant & Machinery: If buying is cheaper than manufacturing and the assessee
decides to buy parts or components for along period of time, he may like to sell the existing
plant and machinery. Tax implication as specified by Sec. 50 has to considered.

(II) REPAIR OR RENOVATE:

REPAIR, REPLACE, RENEWAL OR RENOVATION

The main tax consideration which one has to keep in mind is whether expenditure on repair,
replacement or renewal is deductible as revenue expenditure u/s 30,31,or 37. If the expenditure
is deductible as revenue expenditure under these sections, then cost of financing such
expenditure is reduced to the extent of tax save. On the other hand if such expenditure is not
allowed as deduction u/s 30,31 or 37 then it may be capitalized and on the amount
so capitalized depreciation is available if certain conditions are satisfied
DIFFERENCE BETWEEN REVENUE AND CAPITAL EXPENDITURE
“Repair” implies the existence of a thing has malfunctioned and can be set right by effecting
repairs which may involve replacement of some parts, thereby making the thing as efficient as
it was before or close to it as possible. After repair the thing to which the repair was carried out
continues to be available for use. Replacement is different from repair.
“Replacement” implies the removal or discarding of the things that was in use, by a different
or new thing capable of performing the same function with the same or greater efficiency. The
replacement of a section in a series of machines which are interconnected, in a segment of the
production process which together form an integrated whole may in some circumstances, be
regarded as amounting to repair when without such replacement that unit in that segment will
not function. That logic cannot be extended to the entire manufacturing facility from the stage
of Raw Material to the delivery of the final finished product.
“Current Repair” implies the expenditure must have been incurred to ‘preserve and maintain’
an already existing asset and the object of the expenditure must not be to bring a new asset into
existence of for obtaining a new advantage.
DEDUCTIONS:
Deduction for expenditure on repairs/renewal will be allowed as revenue expenditure in
computation of business income as under: -
Repair of Assets: If the building is a rented building, any expenditure on repairs shall be
allowed as deduction.
It may be noted that if the repairs expenditure are of capital nature it shall not be allowed as
deduction either under section 30, 31 or 37.
Replacement of assets: If the asset has to be replaced, the expenditure incurred on
replacement shall be capital expenditure and the assessee shall only be entitled to depreciation
on such assets and as such, the entire expenditure cannot be claimed as deduction which was
allowed in case of repairs.
(iii) Tax planning in respect of own or lease:
A lease of property is a transfer of right to enjoy such property, made a certain time, in
consideration of a price payable periodically to the transferor by the transferee.
In other words, leasing is an arrangement that provides a person with use & control over an
asset, for a price payable periodically, without having a title of ownership. In case of lease
agreement, the owner of the asset is called the lessor & the user is called the lessee.
When a person needs an asset for his business purpose, he has to decide whether the asset
should be purchased / taken on lease. While taking this decision he should keep in mind the
following factors:
1. Cash position
2. Depreciation
3. Obsolescence risk
4. Residual value
5. Profit margin
6. Consider PAT
1. Cash Position:
(a) When a person has sufficient cash / he can borrow funds at a reasonable rate of interest to
purchase an asset / can acquire the asset, under hire purchase / instalment system, he may decide
to buy it.
(b) The cost of own asset is not deductible in computing the income, but the interest on
borrowed funds/ under hire purchase / instalment system is deductible in computing income.
(c) If he neither has sufficient cash nor he can borrow due to stringent(strict) credit control, he
has to take the asset on lease.
(d) The lease rent is deductible in computing the income.
2. Depreciation:
(a) When the asset is purchased / acquired under hire purchased / acquired under hire purchase
/ installment system, the depreciation is allowed in computing income.
(b) When the asset is taken on lease the depreciation is not allowed to the lessee, because he is
not the owner of the asset, but it is allowed to the lessor. Non- availability of depreciation to
the lessee will increase his tax liability.
If the asset is such on which depreciation is not allowed, example land, the increase/
decrease in the value of the asset in future must be considered. If the asset is such where
increase in the value is expected, it may be purchased otherwise it may be taken on lease.
3. Obsolescence risk: When a plant or machinery is purchased & it becomes obsolete earlier
than its expected working life, it has to be replaced. The replacement cost can be met partly out
of depreciation fund & partly by arranging further cash.
In case of lease the asset will be replaced by the lessor. However, the lessor will also
keep in mind the risk of obsolescence & increase the lease rent to offset such a loss.
4. Residual value: When a person purchases an asset, he has full rights to the value of the asset
at the end of any given period. In the case of asset with larger residual value it is better to
purchase it rather than taken on lease.
5. Profit margin:
(a) When profit margin is low, it is better to purchase the asset. If the assset has been purchased
by borrowed funds the cash outflow would be equal to loan installment, interest payment&
slightly higher tax.
(b) In case of leasing the lease rent would be equal to part of the cost of asset to lessor, interest
on investment & profit to the lessor.
(c) The cash outflow will be equal to lease rent less nominal tax saving.
(d) In case of lease, the profit of the lessor will be the loss to the lessee.
6. Consider profit after tax:
(a) It is an important consideration in tax planning.
(b) The assessee should follow such a method for obtaining an asset which reduces his tax
liability & the profits after tax are greater.
(c) For this purpose some people suggest that own funds should not be used in purchase of an
asset because interest on own funds is not deductible in computing the income.
(d) Whereas, interest on borrowed funds is deductible.
Conclusion: As far as possible the asset should be purchased & not taken on lease because the
cost of use of the purchased is less than the cost of lease rent.
However, where the assessee is suffering from a liquidity crunch & cannot invest in an asset
nor can be avail substantial credit from the suppliers / money lenders, he should take an asset
on lease.
3.2. TAX EXEMPTION ON EXPORTS OF GOODS

The Supreme Court (SC) has laid down the principles for claiming exemption under the Central
Sales Tax Act, 1956 (CSTA) with regard to the penultimate sale of goods by a dealer to an
exporter, who effects the actual exports of goods from the country.

The underlying provisions as prescribed under the relevant Section 5 of the CSTA, inter alia
relating to exports of goods from India. Originally, this provision only exempted the actual
exports from the country from the levy of sales tax. This led to the insertion of sub section 3 of
Section 5 of the CSTA whereby the last sale or purchase occasioning the exports of goods was
also granted the benefit of exemption. However, notwithstanding this insertion, the claim for
exemption must still pass muster under Article 286 of the Constitution which prohibits the
imposition of tax on any sale or purchase of goods in the course of the import of goods into or
exports of goods out of the territory of India. Consequently, the claimant for the exemption
would still need to establish the identity of the goods so sold to have been exported out of India,
to qualify for the exemption, notwithstanding the insertion of sub section 3 as above.

As a result, the following principles as being relevant: -

• to constitute a sale in the course of export there must be an intention on the part of both
the buyer and the seller to export.
• there must be an obligation to export, and there must be an actual export.
• the obligation could arise for any reason.
• to occasion the export, there must exist such a bond between the contract of sale and
the actual exportation that each link was inextricably connected with the one
immediately preceding it.

The phrase 'sale in the course of export' comprised of three essentials: -

(i) that there must be a sale.

(ii) that goods must actually be exported and
(iii) that the sale must be a part and parcel of the export.

3.3. CAPITAL STRUCTURE decision also plays a major role. Mixture of debt and equity
fund should be balanced, to maximize the return on capital and minimize the tax liability.
Interest on debt is allowed as deduction whereas dividend on equity fund is not allowed as
deduction.

Short Term Tax Planning : Short range Tax Planning means the planning thought of and
executed at the end of the income year to reduce taxable income in a legal way. Example:
Suppose, at the end of the income year, an assessee finds his taxes have been too high in
comparison with last year and he intends to reduce it. Now, he may do that, to a great extent
by making proper arrangements to get the maximum tax rebate u/s 88. Such plan does not
involve any long-term commitment, yet it results in substantial savings in tax.

1. Cost of Capital and also expenditure incurred in raising of such capital.

2. Expectation of shareholders by way of dividend, growth etc.
3. Expansion need of the business i.e. the rate by which profits of the business shall be
again ploughed back in the business.
4. Taxation policy; and
 5. Rate of return on investment (Equity + Debt funds).

Tax Consideration:

• Interest on debt fund is allowed as deduction as it is a 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 @ 12.5% + surcharges +
education cess.
• The Cost 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 dent fund is treaded as revenue expenditure. It can be claimed as
deduction in computing the total income.
• Where the assesses is entitled to incentives u/s 10A etc. maximum equity fund should
be utilized.
• Where interest on debt fund is payable outside India, tax should be deducted at source
otherwise deduction is not allowed.

TAX PLANNING

1. 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.
2. if rate of return on investment < rate of interest, minimum debt funds should be used.
3. 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
funds reduces the profits (profits less interest) before tax and to the extent exemption
is reduce.

The balance of capital structure shall depend upon maximizing the return on capital employed
which is computed by using following formula:
3.3. DIVIDEND POLICY

Dividend is the subject matter of double taxation on the part of payer and receiver, to reduce
tax liability while distributing dividend we use some technics so that one can reduce tax liability
When a company receives dividend from another company it is known as intercorporate
dividend.

DEEMED DIVIDEND – Sec 2(22)(e) of IT act. Loans and advances given to Directors and
family member of closely held companies, who holds more than 10% of voting rights or have
substantial interest in such companies, such loans and advances treated as Deemed Dividend.
It is taxable in the hands of shareholders and not in the hands of company. However, it will
increase tax liability of its shareholders.

• Ask company not to give loans and advances

• Reduce voting power to less than 10%
• shouldn’t borrow from closely held company Where a loan in the hands of a shareholder
or concern (mentioned as substantial interest and 10% voting power) has been taxed as
deemed dividend, such loan shouldn’t repaid to the closely held company. It should be
adjusted against the dividends declared by the company in future. The dividends
declared in the future and adjusted against the loan is not treated as dividend declared.
Thus, the double taxation liability can be avoided When a Domestic company receives
dividend including Deemed dividend from another Domestic company except loan
from a closely held company It is exempted u/s 10(34). However, the Domestic
company who is declaring, distributing or paying dividend is liable to pay tax on such
amount u/s 115-0 in addition to tax on its total income.
• Conditions for claiming Domestic company Dividend
1. The amount of dividend received by the Domestic company during the financial year
if the following conditions are satisfied:
a. Dividend is received from its subsidiary company
b. The subsidiary company has paid Dividend distribution u/s 115-0 c. The domestic
company is not a subsidiary company of another company
 2. The amount for dividend paid to any person for, or on behalf of new pension
system trust: A company shall be subsidiary of another company if such other
company holds more than half in the nominal value of the equity share capital of the
company.
When a company issues Bonus shares to its equity shareholders it is not a deemed
dividend. Hence, a domestic company may issue bonus shares to its equity shareholders
instead of dividend in cash to reduce tax liability. However, it will increase tax liability
of its shareholders.
The tax liability of the company can be reduced by purchase of own shared by the
company instead of distribution of dividend Entitled to not less than 20% of the income
of the concern or 20% voting right in that company.
BONUS SHARES: When a company issues shares to its existing shareholders in lieu
of dividend such shares are termed as Bonus Shares. By issue of Bonus shares a
company capitalizes its profit in computing income.
• Expenditure incurred on issue of bonus shares is capital expenditure, hence not
deducted in computing the income of the company
• Where bonus shares are issued to the equity shareholders, the value of the shares is not
taxed as dividend distribution. However, when redeemable preference shares are issued
as Bonus shares, on their redemption, the amount shall be taxed a dividend distribution
• Where bonus shares are issued to the preference shareholders, on their issue it is deemed
to dividend and liable to pay tax
• When an equity shareholder sells the Bonus shares, the cost of bonus shares is taken as
nil. Hence, the whole value of net consideration (consideration less selling expenses, if
any) is treated as long or short term capital gain:
1) An equity shareholder may transfer his Bonus shares after one year from
allotment to a firm or an association of persons as capital contribution. The
amount recorded in the books of the Firm/AOP for such shares will be cost of
acquisition for the Firm/AOP and long-term capital gain to transferor.
Now, when the Firm/AOP will sell these share as long-term capital asset it will
be entitled to deduct the indexed cost of acquisition instead of nil cost as
applicable to equity shareholder. Alternatively, such shares may be sold to a
relative after one year of their allotment. The selling price will be the long-term
capital gains of the allotted of the Bonus shares for the year of sale. Whenever,
 the relative will sell these shares he will get the benefit of indexation of the cost
of acquisition.
2) A preference shareholder may convert first preference shares into equity
shares and thereafter receive Bonus shares. This will reduce the tax liability at
least at the time of issue of bonus shares.
3) A company may capitalize its profit by converting partly paid shares into
fully paid up shares instead of issue of Bonus Share. This conversion will not
be deemed dividend. Further, the benefit of indexation for the price paid by the
shareholder will be available from the date of allotment of shares.
4) Where Bonus Share are received by a firm it may transfer such shares to
partners by sale, when such shares are transferred by sale, the buyer will get the
benefit of indexation cost.

3.4. TAX PLANNING WITH RESPECT TO AMALGAMATION AND MERGERS

Under Income Tax Act, 1961 Section 2(1B) of Income Tax Act defines ‘amalgamation’ as
merger of one or more companies with another company or merger of two or more companies
to from one company in such a manner that: -
1. All the property of the amalgamating company or companies immediately before the
amalgamation becomes the property of the amalgamated company by virtue of the
amalgamation.
2. All the liabilities of the amalgamating company or companies immediately before the
amalgamation becomes the liabilities of the amalgamated company by virtue of the
amalgamation
3. Shareholders holding at least three-fourths in value of the shares in the amalgamating
company or companies (other than shares already held therein immediately before the
amalgamated company or its nominee) becomes the shareholders of the amalgamated company
by virtue of the amalgamation.(Example: Say, X Ltd merges with Y Ltd in a scheme of
amalgamation and
immediately before the amalgamation, Y Ltd held 20% of shares in X Ltd, the above mention
edcondition will be satisfied if shareholders holding not less than 75% in the value of remaining
80% of shares in X Ltd i.e. 60% thereof, become shareholders in Y Ltd by virtue of
amalgamation)The motive of giving this definition is that the benefits/concession under
Income Tax Act, 1961shall be available to both amalgamating company and amalgamated
company only when all the conditions, mentioned in the said section,
are satisfied. ‘Amalgamating company’ means company which is merging and ‘amalgamated
company’ means the company with which it merges or the company which is formed after
merger.
However, acquisition of property of one company by another is not ‘amalgamation’.
Income Tax Act defines ‘amalgamation’ as merger of one or more companies with another
company or merger of two or more companies to from one company. Let us take an example
of X Ltd and Y Ltd. Here following situations may emerge: -
(a) X Ltd Merges with Y Ltd. Thus, X Ltd goes out of existence. Here X Ltd is
Amalgamating Company and Y Ltd is Amalgamated Company.
(b) X Ltd and Y Ltd both merges and form a new company say, Z Ltd. Thus, both
X Ltd and Y Ltd goes out of existence and form a new company Z Ltd. Here X
Ltd and Y Ltd are Amalgamated Company and Z Ltd is Amalgamated
Company.
Tax Benefits in case of Amalgamation and merger
If an amalgamation takes place within the meaning of section 2(1B) of the Income Tax
Act,1961, the following tax reliefs and benefits shall available: -
1. Tax Relief to the Amalgamating Company:
a) Exemption from Capital Gains Tax [Sec. 47(vi)]: Under section 47(vi) of the Income-tax Act,
capital gain arising from the transfer of assets by the amalgamating companies to the Indian
Amalgamated Company is exempt from tax as such transfer will not be regarded as a
transfer for the purpose of Capital Gain.
b) Exemption from Capital Gains Tax in case of International Restructuring [Sec.47(via)] : Under
Section 47(via), in case of amalgamation of foreign companies, transfer of shares held in
Indian company by amalgamating foreign company to amalgamated foreign company is
exempt from tax, if the following two conditions are satisfied.
c) At least twenty-five per cent of the shareholders of the amalgamating foreign company
continue to remain shareholders of the amalgamated foreign company, and
d) Such transfer does not attract tax on capital gains in the country, in which the amalgamating
company is incorporated
2. Tax Relief to the shareholders of an Amalgamating Company:
a. Exemption from Capital Gains Tax [Sec 47(vii)]:
Under section 47(vii) of the Income-tax Act, capital gains arising from the transfer of shares
by a shareholder of the amalgamating companies are exempt from tax as such transactions will
not be regarded as a transfer for capital gain purpose, if:
 • The transfer is made in consideration of the allotment to him of shares in the
amalgamated company; and
• Amalgamated company is an Indian company.3.

Tax Relief to the Amalgamated Company:

a) Carry Forward and Set Off of Accumulated loss and unabsorbed depreciation of the
amalgamating company [Sec. 72A]: Section 72A of the Income Tax Act, 1961 deals with
the mergers of the sick companies with healthy companies and to take advantage of the
carry forward of accumulated losses and unabsorbed depreciation of the amalgamating
company. But the benefits under this section with respect to unabsorbed depreciation
and carry forward losses are available only if the followings conditions are fulfilled:-
• There should be an amalgamation of –
(a) a company owning an industrial undertaking (Note 1) or ship or a hotel with another
company, or
(b) a banking company referred in section 5(c) of the Banking Regulation Act, 1949 with a
specified bank (Note 2), or
(c) one or more public sector company or companies engaged in the business of operation of
aircraft with one or more public sector company or companies engaged in similar business.
• The amalgamated company should be an Indian Company.
• The amalgamating company should be engaged in the business, in which the
accumulated loss occurred or depreciation remains unabsorbed, for 3 years or more.
• The amalgamating company should held continuously as on the date of amalgamation
at least three-fourth of the book value of the fixed assets held by it two years prior to
the date of amalgamation.
• The amalgamated company holds continuously for a minimum period of five years
from the date of amalgamation at least three-fourths in the book value of fixed assets
of the amalgamating company acquired in a scheme of amalgamation.
• The amalgamated company continues the business of the amalgamating company for a
minimum period of five years from the date of amalgamation.
• The amalgamated company fulfils such other conditions as may be prescribed to ensure
the revival of the business of the amalgamating company or to ensure that the
amalgamation is for genuine business purpose.
 b) Expenditure on scientific research [Sec. 35(5)]: When an amalgamating company transfers
any asset represented by capital expenditure on the scientific research to the
amalgamated Indian company in a scheme of amalgamation provisions of section 35
shall be applicable-
• Unabsorbed expenditure on scientific research of the amalgamating company will be
allowed to be carried forward and set off in the hands of the amalgamated company,
• If such asset ceases to be used in the previous year for scientific research related to the
business of amalgamated company and is sold by the amalgamated company the sale
price to the extend of cost of asset shall be treated as business income and the excess of
sale price over the cost shall be subject to the provisions of capital gain.
c) Amortization of expenditure in case of Amalgamation [Sec. 35DD]:
Under Sec 35DDfor expenditure incurred in connection with the amalgamation the assessee
shall be allowed a deduction of an amount equal to one-fifth of such expenditure for each of
the five successive previous years beginning with the previous year in which the amalgamation
takes place.
d) Treatment of preliminary expenses [Sec. 35D(5)]:
When and amalgamating company merges with an amalgamated company under a scheme of
amalgamation, the amount of preliminary expenses of the amalgamating company to
the extend not yet written off shall be allowed as deduction to the amalgamated company
in the same manner as would have been allowed to the amalgamating company.
e) Expenditure for obtaining a licence to operate telecommunication services [Sec.35ABB(6)]:
Where in a scheme of amalgamation, the amalgamating company sells or otherwise transfer
its licence to the amalgamated company (Being an Indian Company),the provisions of Section
35ABB which were applicable to the amalgamating company shall become applicable in the
same manner to the amalgamated company, consequently:
• The expenditure on acquisition on license, not yet written off, shall be allowed to the
amalgamated company in the same number of balance installments.
• Where such licence is sold by the amalgamated company, the treatment of the
deficiency/surplus will be same as would have been in the case of amalgamating
company.
f) Treatment of capital expenditure on family planning [U/S 36(1)(ix)]:
If Asset representing capital expenditure on family planning is transferred by the
amalgamating company to the amalgamated company under a scheme of amalgamation, such
expenditure shall be allowed as deduction to the amalgamated company in the same manner as
would have been allowed to the amalgamating company expenditure shall be allowed as
deduction to the amalgamated company in the same manner as would have been allowed to the
amalgamating company.

g) Treatment of bad debts [Sec. 36(1)(vii)]:

When due to amalgamation debts of the amalgamating company has been taken over by
amalgamated company, and subsequently, such debts turn out to be bad, it shall be allowed as
deduction to the amalgamated company.
DOUBLE TAXATION TREATIES
To finance the welfare and the administrative expenditure, governments around the world
impose certain taxes on their subjects. In cases, where cross country economic activity is
carried out, it is a tricky affair to identify
and justify the appropriate jurisdiction of tax authorities. In order to mitigate the hardships of
multiple jurisdictions, the Governments enter into bilateral arrangements, which are commonly
denoted as “Double Taxation Avoidance Agreements”
Double Taxation Avoidance Agreements
DTAA refers to an accord between two countries, aiming at elimination of double taxation.
These are bilateral economic agreements wherein the countries concerned assess the sacrifices
and advantages which the treaty brings for each contracting nation. It would promote exchange
of goods, persons, services and investment of capital among such countries. Indian Government
is actively pushing DTAA negotiations with several countries to help its residents in
understanding their tax jurisdictions and accountability towards the appropriate authorities. So
far India has signed DTAA with 81 countries and discussion is on with many
others. The natures of DTAA‟s entered by India are greatly diverse in their nature and contents.
Objectives
DTAA treaties must help in avoiding and alleviating the burden of double taxation prevailing
in the international arena. The tax treaties must clarify the taxpayer to know with certainty of
his potential tax liability in the country, where he is carrying on economic activities. Tax Trea
tiesmust ensure that there is no prejudice between foreign tax payers who has permanent
enterprise in the source countries and domestic tax payers of such countries. Treaties are made
with the aim of allocation of taxes between treaty nations and the prevention of tax avoidance.
The treaties must also ensure that equal and fair treatment of tax payers having different
residential status, resolving differences in taxing the income and exchange of information and
other details among treaty partners.
Classification
Double taxation avoidance agreements may be classified into comprehensive agreements and
limited agreements based on the scope of such agreements. Comprehensive Double Taxation
Avoidance Agreements provide for taxes on income, capital gains and capital investments
whereas Limited Double Taxation Avoidance Agreements denote income from shipping and
air transport or legacy and gifts. Comprehensive agreements ensure that the taxpayers in both
the countries would be treated on equitable manner in respect of the issues relating to double
taxation.

Active & Passive Income

Passive Income refers to income derived from investment in tangible / intangible assets eg.
Immovable property, dividend, interest, royalties, capital gains, pensions etc. Active income is
the income derived from carrying on active cross border business operations or by personal
effort and exertion in case of employment e.g. Business profits, shipping, air transport,
employment etc.
Current Scenario in India
The Indian Income Tax Act, 1961 administrates the taxation of income accrued in India. As
per Section 5 of the Income Tax Act, 1961 residents of India are liable to tax on their global
income and non-residents are taxed only on income that has its source in India. The Provisions
of DTAA override the general provisions of taxing statute of a particular country. It is now
well settled that in India the provisions of the DTAA override the provisions of the domestic
statute. Moreover, with the insertion of Sec.90 (2) in the Indian Income Tax Act, it is clear that
assessee have an option of choosing to be governed either by the provisions of particular DTAA
or the provisions of the Income Tax Act, whichever are more beneficial. Further if Income tax
Act itself does not levy any tax on some income then Tax Treaty has no power to levy any tax
on such income. Section 90(2) of the Income Tax Act recognizes this principle.
Relief to the taxpayer
In order to prevent the hardship of double taxation, relief is provided to the taxpayer. Such
reliefis provided by two ways:
Bilateral Relief
Bilateral relief is provided in section 90 and 90A of the Indian Income Tax Act. Bilateral relief
is provided through following methods:
(i) Exemption Method
One method of avoiding double taxation is for the residence country to altogether exclude
foreign income from its tax base. The country of source is then given exclusive right to tax
such incomes. This is known as complete exemption method and is sometimes followed in
respect
of profits attributable to foreign permanent establishments or income from immovable proper
ty. Indian tax treaties with Denmark, Norway and Sweden embody with respect to certain
incomes.
(ii) Credit Method
This method reflects the underline concept that the resident remains liable in the country of
residence on its global income, however as far the quantum of tax liabilities is concerned credit
for tax paid in the source country is given by the residence country against its domestic tax as
if the foreign tax were paid to the country of residence itself.
(iii) Tax Sparing
One of the aims of the Indian Double Taxation Avoidance Agreements is to stimulate foreign
investment flows in India from foreign developed countries. One way to achieve this aim is to
let the investor to preserve to himself/itself benefits of tax incentives available in India for such
investments. This is done through “Tax Sparing”. Here the tax credit is allowed by the country
of its residence, not only in respect of taxes actually paid by it in India but also in respect of
those taxes India forgoes due to its fiscal incentive provisions under the Indian Income Tax
Act.
Unilateral Relief
Unilateral Relief is provided in section 91 of the Income Tax Act. The aforesaid method is
depending on bilateral activity of both the countries. However, no country will have such an
agreement with every country in the world. In order to avoid double taxation in such cases,
country of residence itself may provide relief on unilateral basis. Apart from relief to persons
of a country where India has entered in Double Taxation Avoidance Agreement, there is relief
given even in cases where the Government of India has not entered into DTA agreement with
any foreign country. In such cases if any resident Indian produces evidences to show that, he
has paid any tax in any country with which the Government of India has not entered into a
DTA agreement, tax relief on that part of his income which suffered taxation in the foreign
country, to the extent of tax so paid in such foreign country, or the tax leviable in India under
the Income Tax Act on such income whichever is less shall be allowed as deduction u/s 91
while calculating his tax liabilities on such income
REVIEW QUESTIONS

Short Answer Type Questions

Write short note on:

I. Short term & Long term tax planning.

II. Deemed Dividend.
III. Bonus Shares.
IV. Amalgamation of company as per income tax act 1961.
V. Double Taxation Treaties.
VI. Bilateral Relief under section 90 and 90A of the Indian Income Tax Act.

Long Answer Type Questions

I. Discuss the management decision to make or buy considering tax provisions.

II. Differentiate between repair & renovate. State the deduction available in respect of
repair & renovate.
III. What are the factors management should keep in mind in taking decision to lease or
own?
IV. Discuss the tax provision in order to optimise the capital structure of firm.
V. Tax Benefits in case of Amalgamation and merger.

******************