MODULE 2:

TAX PLANNING 14 Hours

Tax planning, Tax avoidance and Tax evasion – Meaning and difference. Areas of tax
planning- Tax planning with respect to Setting up New Business-Form of
Organization, Tax planning with respect to location and Nature of Business. Tax
Planning with reference to Financial Managerial Decisions-Capital Structure Decision,
Dividend Policy, Inter-Corporate Dividends and Bonus Shares, Specific Managerial
Decisions- Purchase of asset, Lease, Installment, Hire, Make or buy, Repair, replace,
renewal or renovation, Tax planning for Distribution of Assets by Companies in
liquidation, Amalgamation and Demerger.

Taxes are the compulsory contribution by the citizens of a country for meeting
different government expenditures. There are three stages in the imposition of tax by
the government.

Tax planning and management focuses efficient administration of tax procedures and
minimization of tax liability through eligible schemes. Through this chapter We can
discuss about the basic concepts of Tax Planning, Tax Management, Tax Evasion and
Tax Avoidance.

TAX
•TAX PLANNING

MANAGEMENT
•TAX EVASION

Practices
•TAX AVOIDANCE
TAX PLANNING :

Tax Planning is an exercise undertaken to minimize tax liability through the best use
of all available exemptions, deductions, rebates and reliefs to reduce income. Tax
planning can be defined as an arrangement of one’s financial and business affairs by
taking legitimately in full benefit of all deductions, exemptions, allowances, reliefs and
rebates so that tax liability reduces to minimum.

Actually the allowances, deductions, exemptions, rebates and reliefs were given as per
legal regulations to achieve social and economic goals. For instance deductions as
per 80C for individuals and HUF aim to encourage saving and investment habits
for the economic prosperity of the country.
Example of tax planning: where a person buys machinery instead of hiring it, he is
availing the benefit of depreciation. It is his exclusive right either to buy or lease it. In
the same manner to choice the form of organization, capital structure, buys or make
products are the assessee’s exclusive right. One may look for various incentives in the
above said transactions provided in Income Tax Act, for reduction of tax liability. All
this transactions involves tax planning.

TAX EVASION :

It refers to a situation where a person tries to reduce his tax liability by

deliberately suppressing the income or by inflating the expenditure showing the
income lower than the actual income and resorting to various types of deliberate
manipulations. An assessee guilty of tax evasion is punishable under the relevant
laws. Under direct tax laws provisions have been made for imposition of heavy penalty
and institution of prosecution proceeding against tax evaders.

The tax evaders reduce his taxable income by one or more of the following steps: (a)
Non-disclosure of capital gains on sale of asset.

(b) Non-disclosure of income from ‘Binami transactions’.

(c) Willfully not recording or partial recording of incomes. Eg: sales, rent, fees, etc. (d)
Charging personal expenses as business expenses. Eg: car expenses, telephone
expenses, medical expenses incurred for self or family recorded in business books.

(e) Submission of bogus receipts for charitable donations under section 80 G.

TAX AVOIDANCE :

Tax avoidance is a method reducing tax incidence by availing of certain loopholes

in the law. The Royal Commission on Taxation for Canada has explained the concept
of tax avoidance as under: For our purposes the expression “Tax Avoidance” will be
used to describe every attempt by legal means to prevent or reduce tax liability which
would otherwise be incurred, by taking advantage of some provisions or lack of
provisions of law.

DIFFERENCE BETWEEN TAX PLANNING, TAX AVOIDANCE, AND TAX

EVASION

BASIS TAX PLANNING TAX TAX EVASION

AVOIDANCE
Meaning Way of The Assesse Illegal way of
Minimizing the tax legally takes reducing tax
liability by advantages of liability by
availing fullloopholes in the deliberately
advantages of the tax laws suppressing
Act through incomes
exemptions,
deductions,
rebates, and relief
Aim of Practice Saving of Tax Hedging of Tax Concealment of
(to minimize the Tax
risk)
Nature Morale in Nature Immoral in Nature Illegal and
and bends the law objectionable
without breaking it
Result Advantage in long Advantage in Short Penalty will be
Run run imposed
Legal Implication Uses the benefits Loopholes in the Over rules the law
of Law Law

Specify whether the following acts can be considered as an act of (a) tax planning; or
(b) tax evasion.

(a) Mr. A invests in Public Provident Fund so as to reduce tax payable.

 (b) X Ltd installed an air conditioner at the residence of a director as per terms of
his appointment; but treats it as fitted in quality control section in the factory.
This is with the objective to treat it as plant for the purpose of computing
depreciation.
Solution:
(a) Investment in PPF is a part of tax planning.
(b) Air conditioner is installed in the director’s residence. But by fraud the
company claiming depreciation of Air conditioner in the company’s books to
reduce tax burden. So it is tax evasion.

AREAS OF TAX PLANNING

1. Tax Planning with respect to Location and Nature of Business.
2. Tax planning with respect to Setting up of New Business-Forms of Business
Organization.
3. Tax Planning with Respect to location and Financial Management Decisions.

I. TAX PLANNING WITH RESPECT TO LOCATION AND NATURE OF

BUSINESS.

On the Basis of location , nature or size of Business the following tax benefits are
available under the Income Tax Act:

1. Agricultural Income is fully exempted (Sec 10(1)).

2. Newly established industrial undertaking in free trade zones Sec10A.
3. Income from newly established units in special economic zone, is exempted
from tax for consecutive 15 assessments years up to specified limit Sec 10
AA
4. Newly established 100% export oriented industry undertaking 10B.
5. Deduction in respect of profit and gains from infrastructure development
undertaking (Sec 80 IA).
6. Deduction in respect of profits and gains other than infrastructure
development undertakings. (sec 80 IB).
7. Deduction in respect of profits and gains from certain industrial undertaking
in certain special category states ( Sec 80 IC).
8. Deduction in respect of profits and gains from certain undertaking in North-
eastern States ( sec 80 IE).
 9. When an assesses derives income from business of collecting and processing
of Bio Degradable waste, he is entitled to a deduction of an amount equal to
whole of such income for 5 assessment years. ( 80JJA).
10.Deduction in respect of Profits and gains from Housing project ( Sec 80
IBA).

II. TAX PLANNING WITH RESPECT TO FORM OF BUSINESS

ORGANISATION.

A Business can either be individual or Joint Hindu Family or a firm or Joint

Stock company. The Best form of Business Organization from tax point of view is
one which attracts minimum tax liability.

I. Individual:
An individual pays tax on his total income at prescribed rates on the basis of
Slab rate system. So being an individual he is entitled to following
deductions from his gross total Income for the assessment year 2020-2021.
1. Under section 80 C:
Applicable: For Individual and HUF
Deduction Amount: Amt contributed or 1,50,000(WEL).
Investment In: Investment in Life Insurance Premium, Employee
contribution to FD’s, Provident Fund, Investment in Shares or debentures
in Public Company engaged in creation of new infrastructure facility.
Investment in National Savings Certificate.
2. Under Section 80 CCC:
Applicable: for individual
only.
Deduction Amt : Amt contributed or 1,50,000 (WEL).
Investment in: Pension Scheme of Central Government
3. Under Section 80 CCG:
Applicable : Individuals
only.
Deduction Amt: 50% of Investment or 25,000 (WEL)
Investment in: Equity Savings Scheme.

4. Under Section 80 CCF:

 Applicable: Individual and HUF
Deduction Amount: up to 20,000
Investment in : Long Term Infrastructure Bonds.
5. Under Section 80D:
Applicable: Individual and
HUF.
Deduction Amt: Insurance premium paid or 25000 Rs in case or Non
Senior Citizen and in case of senior citizen 50,000 (WEL).
Investment in: Contribution towards medical insurance premium which
is been framed by general Insurance Company or any other approved
insurer.
NOTE: Deduction is available only if premium is paid through Cheque or
DD
6. Under Section 80 DD:
Applicable: Individual and
HUF.
Deduction Amt: 75,000. This deduction is in respect of maintenance
including medical treatment of a dependent person with disability (
Spouse) (Children) parents, brothers and sisters.
Disability deduction will be as follows:
1. 40%: NIL
2. 40% to 80% : Rs 75,000
3. Above 80%: Rs 1,25,000
7. Under Section 80 DDB:
Applicable for: Individual and
HUF
Deduction Amt: Actual Treatment expenses or Rs 40,000 in case of Non
senior citizen and 1,00,000 in case of senior citizen ( WEL)
Any Expenditure incurred for Medical treatment of specific disease like
Cancer AIDS etc
8. Under section 80 E
Applicable for: Individual only.
Deduction amount: Full amount paid as interest only.
Expenditure: If any interest paid on Higher Education loan taken for
Assesses Higher Education.

9. Under Section 80 EE.

 Applicable for: Individuals only
Deduction amt: Max50,000 0r Actual Interest paid.(WEL).
Investment in: Interest payable on loan taken in the financial year from
2016-2017 onwards from any financial institution for acquisition of
residential House.
10.Under Section 80 G:
Applicable for : All the Assesees.
Deduction Amount :

Donation Eligible for

Donation Eligible for
50% Deduction
100% Deduction

DONATION ELIGIBLE FOR 100% DEDUCTION:

1. Prime Minister national Relief Fund.

2. National Foundation for Communal Harmony.
3. CM earth quake relief fund Maharashtra.
4. Andhra Pradesh Chief Minister Cyclone relief fund.
5. National Sports Fund.
6. National Cultural Fund.
7. National Defense Fund set up by Central govt.
8. Any Fund set up by Govt of Gujarat relief to Victims of earthquake in Gujarat.
9. Central Welfare fund of Army, Air force, and Indian Navel Fund.
10.National Trust for welfare of person with Mental Retardation and Multiple
disability.

DONATION ELIGIBLE FOR 50%.

1. Prime Minister National Draught relief fund.
2. National Children’s relief fund.
3. Jawarahalal Nehdru memorial Fund.
4. Indira Gandhi Memorial Fund.
5. Rajeev Gandhi Foundation.

11. Under Section 80 GG

Applicable for : Individual
only:
Deduction Amt: Max 5000 or 25% of total income (WEL).
Expenditure: If any rent paid by assesses for his residence. ( Assesses should
not be getting any HRA allowance).
12. Under Section 80 GGA :
Applicable for : Allowed to all Assesses
Deduction Amount: Any amount paid to a research association which
undertakes scientific research, or sum paid to a college, university, or any other
institution to be used for Scientific research.
NOTE: Donation should be made in Cash or by cheque, or by draft.
However cash donations in excess of Rs 10,000 are not allowed as
Deduction. 100% of amount Contributed or donated will be considered for
deduction.
13. Under Section 80 U:
Applicable: Individual
Only
Deduction Amt: Fixed amount of 75000
Expenditure: For Asseesee suffering with disability(Blindness, low vision,
leprosy cured, Mental retardation, mental illness.)
NOTE: In case of severe Disability Deduction amount of Rs 1,25,000 is
allowed.
 II. HUF( Hindu Undivided Family)
A joint Hindu family pays tax on its total income at prescribed rates on the
basis of slab System. A Hindu Undivided family is entitled to the deduction
from its gross total income U/S 80c, 80 D, 80DD, etc..

III. A FIRM: A firm will pay tax on its total income @ 30% for the assessment
Year 2020-2021.
Following are the Deductions available to partners:
1. Interest on Capital or loan given to the firm at the rate mentioned in the
partnership Deed is but not exceeding 12% ( Any interest that exceeds 12%
are taxable).
2. Remuneration to working partners is
Deducted; Actual Amount of Remuneration
OR
Remuneration Allowable as per sec 40
(b) a) On 1st 3,00,000 of 90% or 1,50,000
i.e 2,70,000 or 1,50,000 (WEH)

b) On remaining balance 60% of Book Profits.

A firm is liable to pay surcharge @ 12% if total Income exceeds one crore.

A firm is also liable to pay Health and education Cess @4% on the amount of income
tax and surcharge for the Assessment Year 2019-2020.

IV. A COMPANY
A Domestic Company is liable to pay tax for the assessment Year 2020-2021
A. When total turnover in previous year does not exceed 400 crore @ 25%.
B. When total turnover in previous year exceeds 400 Crore @ 30%.
Surcharge: @ 7% if total income exceeds Rs 1 crore but does not exceed Rs
10 crore and 12% if total income exceeds 10 crore.
Further Company is also liable to pay health and education Cess @ 4% on
the amount of income tax and surcharge.
Deduction are Available: 80IA, 80IAB, 80 IAC, 80 IB, 80IC, 80ID, 80IE,
80JJA from Gross total Income.
 III. Tax Planning with Respect to Financial Management
Decision
1. Tax Planning With respect to capital structure decisions:
Before commencing a new project a vital managerial decision regarding
selecting right type of capital structure has to be taken. An optimum capital
Structure is one which maximizes shareholders return.
The Advantages of having optimum capital are 2 fold. It Maximizes the Value of
the assets of the company an wealth of its owner and minimizes the cost of
capital which in turn, raises the ability to find in built additional investment
minimizes the cost of capital which, in turn, raises its ability to find inbuilt
additional investment opportunities.
The Tax planner should properly balance risk, cost, control, and tax
consideration. In Capital Structure decisions, the cost of capital is an important
consideration along with risk factor. One of the main reason for raising finance
through borrowing ( as against issue of equity shares is to increase earnings on
equity share capital. But excessive use of debt capital increases the financial risk
of the company.
Under tax Law, dividends on shares are not deductible, while interest paid on
borrowed capital allowed as deduction under section 36(1). Cost of raising
finance through borrowing is deductible in the year in which it is incurred .
Because of foresaid provision, corporate taxation policy plays an important role
in determining the choice between different sources of financing.

PROBLEM 1: Vinay co Ltd is a widely Held Company. It is currently

considering a major expansion of its production facilities and the following
alternatives are available.
 Particulars Alternative Alternative Alternative
1 2 3
Share capital 5,00,00,000 2,00,00,000 1,00,00,000
Debentures -------------- 2,00,00,000 1,50,00,000
Loan From financial _ 1,00,00,000 2,50,00,000
Institution/Bank@ 18%

Expected rate of return ( Before tax) is 25%. The rate of dividend of the
company since 1990 is not less than 20% and date of dividend declaration is
June 20 every year.

Problem 2:
Three companies raised the capital as under:
particulars Company 1 Company 2 Company 3
Capital 2,00,000 1,60,000 40,000
Loans ----------- 40,000 1,60,000
Total Investments 2,00,000 2,00,000 2,00,000
1. Rate of Interest : 10%
2. Rate of Return : 25% 10% 8%
3. Rate of Tax : 30%
4. Explain whose capital Structure is Best and why.

PROBLEM 3:
The Director of a domestic company whose existing capital is Rs 1 crore all
in equity Shares, proposes to expand its business for which an additional
investment of Rs 50 lakh would be needed. The Entire money can be raised
by either issue of equity Shares or by issue of 10 % Debentures. They decide
in favor of issue of equity Shares.
As a Tax consultant do you approve the proposal? Assume that rate of return
is 20% and rate of income tax is 30%

PROBLEM 4:
A Ltd is a widely held company. It proposes to increase its production for
which it will require Rs 1,00,00,000. The company proposes the following 3
alternatives for the structure of the additional capital.
Particulars Alternative 1 Alternative 2 Alternative 3
Share Capital 1,00,00,000 40,00,000 20,00,000
10% Debenture --------- 40,00,000 30,00,000
 Loan from FI @ --------- 20,00,000 50,00,000
12%
The Expected return on capital employed in business is 25% ( before tax).
Generally, companies engaged in similar business are paying 20% dividend
on its share capital. Assume tax rate is 30% and Surcharge @ 5% and H&EC
3%.
You have to advise the company as to which alternatives it should be choose
for the capital structure so as to pay maximum dividend to shareholders.

PROBLEM 5:
The Bharath Company wants to raise the capital of Rs 20,00,000 for a
Project where earnings before tax shall be 40% of the capital employed. The
company can raise debt fund @ 18% per annum. Suggest, which of the
following 3 alternatives should it opt for.
a. Rs 20,00,000 to be raised by Equity capital.
b. Rs 16,00,000 by equity and 4,00,000 by loans
c. Rs 40,00,000 by equity capital and Rs 16,00,000 by loans.
d. Assume the company shall distribute the entire amount of profits as
dividends and tax rate is at 33.99%and DDT is 17.304%.

TAX PLANNING WITH RESPECT TO DIVIDEND POLICY

DIVIDENDS: In ordinary Language dividend means the sum received by a

shareholder of a company on the distribution of its profits.

Dividends in means amount paid to or received by a shareholder in

proportion to his shareholding in a company, out of the total sum distributed.

The Following Distributions or payments by a company to its share Holders are

deemed as Dividends to the extent of accumulated profits of the Company:
So what’s this deemed Dividends?

Deemed Dividends is the dividend which is not actually paid as dividends but
assumed to be dividend under taxation as per Income Tax Rule.

So What is Accumulated Profits?

The Portion of net profits that is retained by a company instead of being distributed as
Dividends. Any Accumulated income is typically used by a company to reinvest in its
principal Business or to pay its debts. Accumulated Income appears under
Shareholders equity on Corporation’s balance Sheet.

So Under Section 2(22) the following payments or distribution by a company to its

Shareholders are to be treated as Deemed Dividends to the extent of Accumulated
Profits.

a. Any Distribution entailing the release of Company’s Assests.

b. Any Distribution of debentures, Deposits Stock or Bonus shares to preference
share Holders.
c. Distribution on Liquidation of Company.
d. Distribution on Reduction of Capital.
e. Any Payment by a closely held Company by a way of advances or loan to a
shareholder ( being a person who is the Beneficial owner of Shares) having at
least 10% of the voting power.
Advances or Loans received by HUF from closely Held Company is taxable as
deemed Dividend U/S 2(22).

SOME ASPECTS RELATED TO DIVIDENDS.

1. Normal Dividends: Any Dividends declared by a company at its annual general

meeting shall be deemed to be the income of the previous year in which it is
2declared. It is Normal Dividend.
2. Interim Dividends: Any dividends declared by the company at any time prior to
the annual general Meeting.
3. Place Accrual: U/S 9 (1), dividend paid by Indian company outside India shall
be deemed to accrue or arise in India.
4. Dividend Paid by foreign Company outside India is not deemed to accure or
arise in India.
5. If Dividends for several years is declared in some later years and paid in lump
sum in the later year, the dividends shall be deemed to be the income of the
previous year in which they are declared.

NOTE:

1. Dividend must not be paid out of Capital.

2. Dividends must be paid only out of after tax

profits. TAX LIABILITY ON DIVIDENDS ( AY-

2020-2021)

1. The Company shall be liable to pay tax on dividends distributed U/S 115-O
2. The Share Holders are not liable to pay tax on dividend income.

If a person is resident in India, receives dividends in aggregate exceeding Ten

Lakhs rupees from domestic company or companies, he will be liable to pay tax on
such dividends @ 10% plus surcharge and Cess.

TAX PLANNING IN REALTION TO DIVIDEND INCOME

1. A domestic Company may issue Bonus Shares to its equity shareholders in lieu
of dividend in cash. By this method it can avoid the tax U/S 115-O on dividend
Distributed.
2. Payment made by a closely Held Company to a Share Holder who is Beneficial
owner of holding more than 10% of the equity Shares of the company or on his
behalf or for his benefit is deemed to be dividend to the extent of accumulated
profits. However if this has to be reduced shareholder should reduce his holding
(voting power to less than 10%).
3. Similarly When closely held company makes a payment to Concern, in which
shareholders has substantial Interests ( more than 20% of voting right) Should
not borrow from closely Held company. Other wise, it would be treated as
deemed dividends in the hands of the company.
4. When a loan in the hands of shareholders and concern, mentioned in 2 and 3 has
been taxed as deemed dividend, such loan should not be repaid to the Closely-
Held company. It should be treated as or adjusted against the dividends declared
by the company in Future. The Dividends declared in future and adjusted against
loan is not treated as dividends declared. Thus double taxation can be avoided.
PROBLEM 1:

Out of Rs 30,00,000 share capital of Rs 100 per share, the company reduces Rs
3,00,000 Share capital at Rs 10 per share. The profits of the company were 1,50,000
after the payment of dividends distribution tax. Mr Ram holds 500 shares of the
company. Compute the amount of deemed dividends U/S 2 (22)(d).

Amount Received by Mr Ram = 500Shares 3,00,000 =Rs 5,000

30,000 Shares
Amount received out of accumulated profits
500 shares 1,50,000 =Rs 2,500
30,000 Shares
Hence, Deemed Dividend
=2500 PROBLEM 2:
An Indian Company with paid up (for cash) share capital of Rs 10,00,000 divided into
10,000 equity shares of Rs 100 each went into liquidation on 30 th June 2016 On that
date its reserves created out of profits amounted to Rs 7,00,000 and the balance
credited to its profit and loss account was Rs 50,000. The liquidator realized the assets
at the prices considerably in excess of their Book value and after meeting and
providing for all liabilities including the liability for taxation had distributable sum of
Rs 26,50,000 which he duly distributed to shareholders in 2019-2020.
S Ltd, a holder of 500 shares acquired by it on 1 st July 1997 at cost of Rs 10,000
approaches you for advice as to treatment for income tax purpose for the amount
received by it from the liquidator. The fair market value of shares of S ltd on 1-4-2001
was Rs 15,000. The cost of inflation index for 2001-2002 was 100 for 2019-2020 is
272 Dully Discuss. Calculate the amount of Deemed Dividends
Particulars Amt
Amount received by S Ltd 1,32,500
500 shares/10,000 Shares *26,50,000 (Distributed Sum)
Less: Amount Deemed dividend 37,500
500 Shares/10,000 shares * 7,50,000( accumulated profits)
Deemed Income 95,000
Less: Indexed Cost of Acquisition Shares (15,000*272/100) 40,800
Long Term capital Gain( Shares held by S Ltd for more than 12 54,200
months)
PROBLEM 3:
Mr Ramesh took loan of Rs 1,00,000 on 10-9-2019 from a company in which the
public are not substantially interested. The company also paid insurance premium Rs
5000 on his behalf. He holds 25% equity shares of the company. On the date of loan
and paying the premium the accumulated profits of the company were Rs 80,000.
Subsequently in the same year the company declared dividends to its shareholders. The
dividends on the share Holdings of Mr Ramesh amounting to Rs 15,000 was set off
against amount of loan etc.
Solution:

Amount of Loan taken 1,00,000

Add: Insurance Premium paid on his behalf 5000

Total amount taken from the company 1,05,000

Accumulated Profits of the company (80,000)

Hence Deemed Dividends shall be Rs 80,000

(Loan or accumulated Profits W.E.L)

The amount of actual dividend Rs 15,000 is set off against loan etc. hence such
dividend ( Rs 15,000)hence such dividends is not to be treated as dividend distributed
by the company U/S 115-O

PROBLEM 4:

X co Ltd ( a closely Held company engaged in trading) having accumulated profts of

Rs 5,00,000 advanced loan of Rs 1,00,000 to a partnership firm on 15.4.2017. Mr Ram
possesses 15% of equity shares in X co ltd and has 25% shares in profits of the firm. Is
Mr. Ram or firm liable to tax in the given case?

SOLUTION:

If a closely held company which possesses accumulated profits, grants a loan or

advance to a shareholders, who possesses at least 10% of voting power in the
company, it is deemed to be dividend to the extent of accumulated profits or
loan/advance, which ever is less.
Similarly if the loan/advance is given to a concern in which such a shareholder has
substantial interest ( entitled to a at least 20% profits of the concern not being the
company) it will be deemed to be dividend to the extent of loan/ advance or
accumulated profits, whichever is less.

In the given case, Mr Ram Possesses 15% equity shares in X co ltd. And 25% shares of
profits in the firm, hence a loan of Rs 1,00,000 given to the firm shall be the deemed to
the firm for tax purpose U/S 2 (22) (e).On Such Deemed Dividend to the firm for tax
purpose,

INTER CORPORATE DIVIDENDS AND BONUS SHARES

Inter Corporate Dividends: When a company receives dividend from another company
it is known as inter-corporate dividend.

Tax Liability: When a domestic company receives dividend (including deemed

dividend) from another domestic company it is exempt U/s 10(34). However, the
domestic company who is declaring distributing or paying dividends is liable to pay
tax on such amounts U/S 115-O in addition to tax on its total Income at 15%

TAX PLANNING

When a company issues bonus shares to its equity share holders, it is not deemed
dividends and the company is not liable to pay tax on such deemed dividend. Hence, a
domestic company may issue bonus shares to its equity share holders instead of
dividend in cash to reduce its tax liability.

BONUS SHARES: When a company issue shares to the existing share holders in lieu
of dividends such shares are termed as “Bonus Shares” By issue of Bonus Shares
company capitalizes its profits and widens its capital Base.

Where Bonus Shares are issued to the equity shareholders, the value of the shares is
not taxed as dividend distributed. However, when redeemable preference shares are
issued as Bonus shares, on their redemption, the amount shall be taxed as dividend
distributed.

When Bonus Shares are issued to the preference shareholders, on their issue it is
deemed to be dividend and liable to tax.
Tax Planning Through Purchase of Own Shares instead of Distribution of Dividend.

When a domestic company distributes dividends to its share holders, the company is
liable to tax on dividends distributed U/S 115-O. however purchase of own shares by a
company from share holders is not deemed to be dividend distribution.

Where a company purchases its own shares from a share holder, then the capital gains
shall be chargeable to tax in the hands of transferor. The capital gain shall be computed
in the year which such shares are purchased by the company.
Thus if the company purchases its own shares instead of dividends, it can reduce its tax liability.

TAX PLANNING AND MANAGERIAL DECISIONS

1. Tax Planning in Respect to Own or Lease

A lease of property is a transfer of right to enjoy such property, made for 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 the use and 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 and the user is
called the Lessee.

When a person needs an asset for his business purposes, he has to decide whether the
asset should be purchased or taken on lease. While taking this decision he should keep
in mind the following factors.

1. Cash position: When a person has sufficient cash or he can borrow funds at a
reasonable rate of interest to purchase an asset or can acquire the asset under
Hire Purchase/installment system, he may decide to buy it. The Cost of own
asset is not deductible in computing the income nut the interest on borrowed
funds or under hire purchase/installment system is deductible in computing the
income.
2. Depreciation: when the asset is purchased or acquired under hire purchase
system /installment system, depreciation is allowed in computing the income.
When asset is taken on lease basis the depreciation is not allowed to the lessee,
 because he is not the owner of the asset, but it is allowed to lessor. So non
availability of depreciation to the lessee will increase his tax liability.
3. Obsolescence Risk: When Plant and Machinery is purchased and 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 and partly arranged
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 and 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 large
residual value it is better to purchase it rather than taken on lease.
5. Consider after tax: it is an important consideration in tax planning. The Assessee
should follow such a method for obtaining an asset which reduces his tax
liability and the profits after tax are greater. 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, whereas
interest on borrowed funds is deductible.

CONCLUSION: As far as possible the asset should be purchased and not taken
on lease because the cost of use of the asset purchased is less than the cot of
lease asset. However, where the assesses is suffering from liquidity crunch and
cannot invest in an asset nor can he avail substantial credit from the suppliers or
money lenders, he should take an asset on lease
PROBLEM: 1

The Management of X ltd wants to acquire a new machine. The Cash Price of the
Machine is Rs 1,00,000. The company has enough cash reserve to finance the
purchase. However, it seeks your advice, whether from the point of view of tax
planning, it should buy the machine or get it on lease . On the basis of the following
particulars, explain the suitability of each alternatives.

1. Rate of Income tax 35%.

2. Rate of Depreciation is 25%
3. Expected life of machine is 9 Years.
4. Lease Rent: Rs 31,000 per annum for 1st 5 Year and 300 per year afterwards.
5. Present Value of Rs 1 discounted at 14%:
1) 0.877, 2)0.769, 3) 0.675, 4)0.592, 5) 0.519, 6) 0.456, 7) 0.400.
8)0.351, 9) 0.308

Problem 2: Decide which one is better alternative – Lease or Buy in the following
situations:

Tax rate: 35%, Cost of Capital: 12% , Depreciation @ 25%, Lease Rent= 32,000 per
annum for 5 Years. Cost of Machine 1,00,000.

Present Value of Rs 1 discounted @ 12% is as follows:

Y1= 0.893, Y2= 0.797, Y3=0.712, Y4=0.636, Y5=0.567.

The Asset is sold for Rs 5000 at the end of 5 year period.

Assume STCL is set off against the STCG at the end of 5 Year.

Problem:3
From the following information determine whether the assessee should
purchase an asset or take on lease:
1. Cost of the Asset= 1,00,000
2. Rate of Depreciation 15%
3. Rate of Interest 10%
4. Rate of Repayment of loan by the assesssee is Rs 20,000.
5. Rate of tax 30.9%
6. Residual Value Rs 20,000 after 5 Years.
 7. Profit of the Assessee Rs 1,00,000 before depreciation, interest and
tax/before lease rent and tax.
8. Lease Rent Rs 30,000 P.A.
9. If the Present Value at 10% is Given in the problem:

Years 1 2 3 4 5
0.909 0.826 0.751 0.683 0.621
10.On the basis of information given determine whether an asset should be
purchased or taken on lease
 Problem:4
From the following information determine whether the assessee should
purchase an asset or take on lease:
Cost of the Asset= 1,00,000
Rate of Depreciation 15%
Rate of Interest 10%
Rate of Repayment of loan by the assesssee is Rs 20,000.
Rate of tax 30.9%
Residual Value Rs 20,000 after 5 Years.
Profit of the Assessee Rs1,00,000 before depreciation, interest and tax/before
lease rent and tax.
Lease Rent Rs 30,000 P.A.

HIRE PURCHASE AND INSTALMENT SALE;

HIRE PURCHASE; In case of Hire Purchase the title in goods does not passed to the buyer
till last installment of price paid and thereby option to buy the good is exercised. The payment
in hire purchase includes an element of hire charges. The relationship between the hirer and
owner is the bailee and bailor.
INSTALLMENT PURCHASE; In this case the title in goods passés immediately to the
buyer and payment of installments are only a financial arrangement between buyer and the
seller. The relationship between the buyer and seller is debtor and creditor. The lien in the
goods remains with the seller till all installments has been paid.
When asset is purchased by installments, the assessee can claim depreciation on the
entire purchase price as per agreement.

When asset is purchased on Hire Purchase, the depreciation is allowable on Cash

Down Payment Basis price of the asset and hire charges is allowable expense.

When Asset is obtained on hire, Hire Charges can be claimed as deduction.

Problem 1:

From the Following Particulars determine whether the assessee (X Ltd) should purchase the machine
by installments or Hire it.

1. Cost of 5 annual instalments of Rs 2,00,000 each payable in the begning of each year.

2. Hire Charges Rs1,50,000 per annum for eight Years payable in the Begning of each

year. 3.Residual Value Rs 50,000 after eight year.

4.Rate of Depreciation @15%

5.Cost of capital @ 10%.

6. Rate of Tax @30%

Present Value @10% is 0.0.909, 0.826, 0.751, 0.683, 0.621, 0.564, 0.5130, 0.467.

Loss on Sale of Machine is set-off against short-term capital gain.

1. Tax Planning with Respect to Make or Buy Decision;

When the Business Concern requires a product or any part of component of the product
for its exsting unit, it has to decide whether it should make the product, part of
component or buy it from other manufacturers. Some of the important factors affecting
such decisions are;

1. Whether for manufacture infrastructural facilities are available or not.

2. Whether the present capacity of the undertaking is fully utilized. If not, it can
be utilized in making the required product.
3. If an additional unit is required for manufacturing the required product, the
concern possesses adequate funds for establishing the unit and the whole
production of the unit will be consumed by the concern or there is market for
the sale of production.
4. Whether the product is available in the market at reasonable price and easily,
5. If the Cost of Manufacture of a product/Component is lower than the cost
of Purchase, it may be manufactured.
6. If the Product is not manufactured it has to be imported then import trade
control regulations and foreign exchange control regulations have also a role.

Tax Consideration:
1. If a concern has surplus capacity and even decide to buy a product it may
require to sell a part of its plant and machinery. In such Cases it may be
liable to capital gains tax.
2. If a new industrial undertaking (unit) is established to make the product,
which fulfills the conditions laid down in Section 80-IB and 80IC of the
Act, a deduction will be allowed in computing the income of the
undertaking (unit) for tax Purpose.
3. If the product, either manufactured or purchased, is a capital asset, its cost
will not be allowed as deduction in computing the income. However, if the
asset is such on which depreciation is allowed, it will be allowed in both
the cases i.e. Manufactured or purchased.
4. If the product is a consumable one, raw material is required to replace a
worn out part at the time of repair, its cost will be treated as revenue expense
and deductible in computing the income

Problem 1:

A motor car company requires 10,000units of part of car engines. From the
following information suggest to the company whether it should make the part
itself or buy it from the Market.

Total cost of 10,000

Units Direct material

20,000

Direct Labour 80,000

Variable Factory Over head

40,000 Fixed Factory Over Head

80,000 Total Cost = 2,20,000

A manufacturer offers to sell the same part @ Rs 20 per Unit. If the company manufactures
the part, it does not require any additional facility.
Problem 2: A company requires 20,000 units of a component every year for the
next 5 years. The component can either be manufactured by the company in its
factory or be purchased from the market. From the following information
suggest the company whether it should make the component or buy it from the
market.

1. Material Cost per unit Rs 4

2. Labor Cost per Unit Rs 6
3. Variable Overhead cost per unit Rs 2
4. If the company manufactures the part, it has to purchase a machine by taking
a loan from the bank. The present value of net cash outflow in this regard in
5 years will be 1,00,000.

The component is available in the market at (a) Rs 12.50 per unit, (b) Rs 14 per unit.
Problem 3:

A company requires a component. From the following information suggest too the
company whether it should make the component or buy it from the market.

A. Making the Component

1. A New Machine will be purchased for Rs 10,00,000. After 5 Years it will

be sold for Rs 2,00,000. If there is any loss on sale of machine, it will be set
off against any other short term capital gain.
2. Rate of depreciation 15%
3. Manufacturing cost of component
: Year 1 Rs 14,00,000
Year 2 Rs 16,00,000
Year 3 Rs 18,00,000
Year 4 Rs 20,00,000
Year 5 Rs 24,00,000
4. Rate of tax 30%
Buying the Component Year 1 Rs 20,00,000 Year 2 Rs 22,00,000 Year 3 Rs 24,00,000 Year
4 Rs 26,00,000 Year 5 Rs 30,00,000
Tax planning with Respect to Repair, Replace or
Renovation of an Asset.
From the accounting point of view a person can debit the expenses incurred on
repair or replacement of an asset, in profit and loss account. But to show a better
profitability or to replacement the gross block of asset so that higher amount of
loans could be taken from the banks or financial institutions, the expenses on
replacement of an asset are capitalized. When expenses incurred on replacement
of an asset are capitalized, this increases the tax liability
From tax point of view the person is not at a liberty to capitalize not to
capitalize the expenses incurred on replacement of a part of asset or the asset
itself. Lets see the provision of IT Act regarding the deduction of expenses
incurred on repairs and renewal/replacement of an assets.

DEDUCTION OF EXPENSES INCURRED ON REPAIRS

Where an assessee uses a building for the purpose of business or profession, he
is entitled to a deduction of the amount paid on account of “Current repairs” to
the premises. If he has taken the building on rent and has undertaken to bear
cost of repairs to premises, he is entitled to a deduction of the amount paid on
such repairs. Similarly if the assessee uses any machinery, plant, or furniture for
the purpose of his business or profession he is entitled to a deduction, in
computing his income, the amount paid on account of Current repairs.
Now the question is that what is the Meaning of the expression ‘repairs’ and
‘current repairs’
Bombay High court has observed that the expression ‘repairs’ mean any
expenditure incurred to preserve and maintain an existing asset. The object of
the expenditure is neither to bring a new asset into existence nor to obtain any
fresh advantage.
As Regard the expression ‘ Current repairs’ Delhi High Court in Spinning and
Weaving Mills Co Ltd(1993) has observed that current repair mean repairs
which are required to be carried out from time to time as and when defect arises.
If there has been wear and tear on an item, like the floors of a building, over a
number of years and ultimately they are replaced, then such replacements
cannot be regarded as current repairs.
The Allahabad high court; has said that Current repair mean petty repairs usally
carried out periodically and does not include repairs or renewals costing large
sum of money which has to be spent after a machine has been used for a number
of Years.
REPLACEMENT or RENEWAL: Where an expenditure incurred to bring a
new asset into existence or to obtain a new fresh advantage it is considered as
replacement or renewal. The Replacement may be of defective parts or
replacement of entire machinery or a substantial part of the entire machinery. If
the replacement is of parts only, the expenditure for such replacement s
deductible n computing the income. On the other hand if the replacement is the
whole machinery with the view to bring the new asset into existence, the
expenditure will not be allowed as deduction being capital in nature. However,
on such asset the depreciation may be allowed u/s 32.
Tax Planning:
1. As far as Possible a part of the asset should be replaced and not the entire
asset. In the case of replacement of a part of asset, the cost of replacement is
allowed as deduction in computing the income for tax purpose. On the Other
Hand the Cost of Replacement of the asset itself is treated as Capital expense.