Notes on Corporate Tax planning PDF

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LESSON 1 (a) Tax planning, tax management, tax evasion and tax avoidance (b) Types of companies, residential status of companies and tax incidence (A) TAX PLANNING, TAX MANAGEMENT, TAX EVASION AND TAX AVOIDANCE 1. STRUCTURE 1 Concept of Planning 1 Tax Management 1 Objectives of Tax Planning 1 Import...

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LESSON 1

(a) Tax planning, tax management, tax evasion and tax avoidance (b) Types of companies, residential status of companies and tax incidence (A)

TAX PLANNING, TAX MANAGEMENT, TAX EVASION AND TAX AVOIDANCE

1. STRUCTURE 1.1 Concept of Planning 1.2 Tax Management 1.3 Objectives of Tax Planning 1.4 Importance of Tax Planning 1.5 Essential of Tax Planning 1.6 Tax Evasion and Tax Avoidance 1.7 Difference Between Tax Planning and Tax Management 1.8 Difference Between Tax Planning and ‘Tax Evasion’ 1.9 Difference Between Tax Avoidance and Tax Evasion 1.10 Definition of Company (Section 2(17) 1.11 Types of Companies 1.12 Residence of a Company (Section 6(3) 1.13 Incidence of Tax 1.14 Incomes Received or Deemed to be Received in India (Section 7) 1.15 Income Accruing or Arising in India or Deemed to be Accrued Tax payment has never been a pleasure for any tax payer. Though tax is defined as a contribution by the people to the government but it is a levy and an unpleasant burden on every assessee. Tax is defined as something which taxes your strength, your patience or your resources it uses nearly all of them so that you have great difficulty in carrying out what you are trying to do. It is a task which requires lot of mental and physical efforts. One tries to reduce tax burden by many means because tax is reduction in his disposable income which he earned from his physical and mental efforts. Therefore every tax payer tries to minimise the burden of tax by his own means. 1.1

CONCEPT OF TAX PLANNING

Tax Planning is an exercise undertaken to minimise tax liability through the best use of all available allowances, deductions, exclusions, exemptions, etc., 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 and rebates so that tax liability reduces to minimum. In other words, all arrangements by which the tax is saved by ways and means which comply with the legal obligations and requirements and are not colourable devices or tactics to meet the letters of law but the spirit behind these, would constitute tax planning. The Hon'ble Supreme Court in McDowell & Co. v. CIT (1985) 154 ITR 148 has observed that "tax planning may be legitimate provided it is within the framework of the law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid payment of tax by resorting to dubious methods." Tax

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planning should not be done with intent to defraud the revenue; though all transactions entered into by an assessee could be legally correct, yet on the whole these transactions may be devised to defraud the revenue. All such devices where statute is followed in strict words but actually spirit behind the statute is marred would be termed as colourable devices and they do not form part of tax planning. All transactions in respect of tax planning must to be in accordance with the true spirit of statute and should be correct in form and substance. Various judicial pronouncements have laid down that substance and form of the transactions shall be seen in totality to determine the net effect of a particular transaction. The Hon'ble Supreme Court in the case of CIT v. B M Kharwar (1969) 72 ITR 603 has held that, "The taxing authority is entitled and is indeed bound to determine the true legal relation resulting from a transaction. If the parties have chosen to conceal by a device the legal relation, it is open to the taxing authorities to unravel the device and to determine the true character of relationship. But the legal effect of a transaction cannot be displaced by a probing into substance of the transaction." In brief tax planning may be defined as an arrangement of one's financial affairs in such a way that without violating in any way the legal provisions of an Act, full advantages are taken of all exemptions, deductions, rebates and reliefs permitted under the Income Taxact, so that the burden of the taxation on an assessee, as far as possible be the least. Actually the exemptions, deductions, rebates and reliefs have been provided by the legislature to achieve certain social and economic goals. For example section 80IB of the Income Tax Act, 1961 provides deduction from gross total income in respect of profits from newly established industrial undertakings in industrially backward State or industrially backward district as may be notified in this behalf. The object of the tax concession is clear, i.e., economic development of industrially backward district or State. Section 80C provides deduction from gross total income, if an individual or H.U.F. saves the amount and invests or deposits it in the prescribed schemes. The deduction has been provided to encourage savings and investments for economic development of the country. Thus, if a person takes .the advantages of the aforesaid deductions, he not only reduces his tax liability but also helps in achieving the objective of the legislature, which is lawful, social and ethical. Thus, tax planning is an act within the four corners of the Act and it is not a colourable device to avoid the tax liability. 1.2

TAX MANAGEMENT

Tax planning is a broader term which requires management of affairs in such a way that results in the reduction in minimisation of tax liability. Tax planning is not possible without tax management. It refers to the compliance of statutory provisions of law. Some important areas of tax management are as stated below. (i) Deduction of tax at source u/s 194 to 196 (ii) Payment of tax and self assessment u/s 140A (iii) Payment of tax an demand u/s 220 (iv) Maintenance of accounts u/s 44AA (v) Audit of accounts u/s 44AB (vi) Payment of cess, duty or fees, bonus and commission to employees etc v/s 43B (vii) Furnishing return of income u/s 139 (viii) Documentation and maintenance of tax files etc. (ix) Review of order received from tax Authorities.

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OBJECTIVES OF TAX PLANNING

The objective of tax planning is to minimise tax liability and to avail maximum benefits of the taxation laws within their framework. The objectives of tax planning cannot be regarded as offending any concept of the taxation laws and subjected to reprehension of reducing the inflow of revenue to the Government coffers, so long as the tax planning measures are in conformity with the statute laws and the judicial expositions thereof. The Basic objectives of tax planning are: (a) (b) (c) (d) (e) (f)

Reduction of tax liability Minimisation of litigation Productive investment Reduction in cost Healthy growth of economy Employment generation (a) Reduction in tax liability: The basic objective of tax planning is to reduce the tax liability so that enough surplus out of profits remains with the earner of it for his personal and social needs and also for future investments in his business. This is only possible by planning his tax affairs properly and availing the deductions, exemptions and reliefs, etc. which are admissible under the Acts. He can succeed in doing so by updating his knowledge about the various concessions available in the taxation laws and the conditions to be fulfilled to avail them. (b) Minimisation of litigation: There is always a tug-of-war between the tax payers and the tax administrators. The tax payers try their best to pay the least tax and the tax administrators attempt to extract the maximum. This sometimes results in prolonged litigation. Actually the main reason of litigation lies in tax avoidance and not in tax planning. Whenever a tax payer wants to reduce his tax liability by finding a loophole in the Act and title tax administrator does not agree with the interpretation of the assessee under which he is demanding exemption, deduction or relief, it results in litigation. A good tax planning is always based on clear words of the statute or in conformity with the provisions of the taxation laws. In such a case the chances of litigation are minimised. (c) Productive investment: A proper tax planning brings fiscal discipline in the functioning of a tax payer and reduces the transfer of money, from the person who has earned it by hard labour, to the Government for waste and misuse. The amount so saved enhances the capacity of the tax payer for expansion and growth, which in turn increases the tax revenue of the Government. (d) Reduction in cost: Incidence of tax (direct and indirect) forms a part of cost of production. The reduction of tax by tax planning reduces the overall cost. It results in more sale, more profit and more tax revenue and more investment. (e) Healthy growth of economy: The growth of a nation's economy depends upon the growth of its peoples. Savings through tax planning devices foster the growth of economy while savings through tax evasion lead to generation of black money, the evils of which are obvious. The tax planning plays an important role in the development of backward districts and backward states and development of infrastructure facilities or in other words it takes the economy in the intended direction. (f) Employment generation: The amount saved by tax planning is generally invested in commencement of new undertakings or expansion of the business. This creates new employment opportunities in the society. Further, taxation laws are so complicated that by and large tax payers cannot plan their affairs efficiently. Hence, such persons need services of

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chartered accountants, financial advisers and lawyers. Such persons join the business concerns either as employees or provide their services as tax experts. 1.4

IMPORTANCE OF TAX PLANNING

Though the basic objective of the planning is to minimise the tax liability of tax payer yet following are the some considerations which are important for tax planning(i) When an assessee has not claimed all the deductions and relief, before the assessment is completed, he is not allowed to claim them at the time of appeal. It was held in CIT u/s Gurjargravures Ltd. (1972) 84 ITR 723 that if there is no tax planning and there are lapses on the part of the assessee, the benefit would be the least. (ii) Tax planning exercise is more reliable since the Companies Act, and other allied laws narrow down the scope for tax evasion and tax avoidance techniques, driving a taxpayer to a situation where he will be subjected to severe penal consequences. (iii)

(iv)

(v) (vi)

(vii)

Presently, companies are supposed to promote those activities and programmes, which are of public interest and good for a civilised society. In order to encourage these, the Government has provided them with incentives in the tax laws. Hence a planner has to be well versed with the laws concerning incentives. With increase in profits, the amount of corporate tax also increases and it necessitates the devotion of adequate time on tax planning to minimise' tax burden. Tax planning enables a company to bear the burden of both direct and indirect taxation during inflation. It enables companies to make proper expense planning, capital budgeting, sales promotion planning etc. Repairs, renewals, modernisation and replacement of plant and machinery are indispensable for an industry for its continuous growth. The need for capital formation in the corporate sector cannot be ignored and heavy taxation reduces the inflow of corporate funds. Capital formation helps in replacing the technologically obsolete and outdated plant and machinery and enables carrying on of manufacturing operation with a new and more sophisticated system. Any decision of this kind would involve huge capital expenditure which is financed generally by ploughing back the profits, utilisation of reserves and surplus along with the availing of deductions. Availability of accumulated profits, reserves and surpluses and claiming such expenses as revenue expenditure are possible through proper implementation of tax planning techniques. In current days of credit squeeze and dear money conditions, even a rupee of tax decently saved may be taken as an interest-free loan from the Government, which perhaps, an assessee need not repay. It is rightly said that money saved is money earned.

Thus, any legitimate step taken by an assessee directed towards maximising tax benefits, keeping in view the intention of law, will not only help it but also the society since it promotes the spirit behind the legal provisions. All those assessees which practice tax planning may have the satisfaction that they are contributing their best to the nation's broad objectives and goals in a welfare State like ours. At the same time, the law makes the fulfillment of certain conditions obligatory before allowing the benefits to be claimed by the assessees. In this way, the assessees, besides helping themselves, also help in securing the objectives, tasks and goals set before them by the country.

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ESSENTIALS OF TAX PLANNING

Successful tax planning techniques should have following attributes: (a) It should be based on uptodate knowledge of tax laws. Not only is an uptodate knowledge of the statute law necessary, assessee must also be aware of judgments made various by the courts. In addition, one must keep track of the circulars, notifications, clarifications and Administrative instructions issued by the CBDT from time to time. (b) The disclosure of all material information and furnishing the same to the income-tax department is an absolute pre-requisite of tax planning as concealment in any form would attract the penalty clauses - the penalty often ranging from 100 to 300% of the amount of tax sought to be evaded. (c) Whatever is planned should not simply satisfy the requirements of law by complying with legal provisions as stated and meeting the tax obligations but also should be within the framework of law. It means that sham transactions or make-believe transactions or colourable devices, which are entered into just with a view to misuse the legal provisions, must be avoided. Every citizen is obliged to honestly pay the taxes. Therefore, only colourable devices resorted to by the tax payers for evading a tax liability will have to be ignored by the court. Accordingly, a tax planning within the four corners of the taxation laws is not to be turned down only because it legitimately reduces the tax inflow to the Government. A genuine tax-planning device, aimed at carrying out the rules of law and courts' decisions and to overcome heavy burden of taxation, if fully valid and ethical. (d) A planning model must be capable of attainment of the desired objectives of a business and be suitable to its possible future changes. Therefore, all the important areas of corporate planning, whether related to strategic planning, project planning or operational planning involving tax considerations for long-term or short-term management objectives and policies should be strictly scrutinised in relative situations. Foresight is the essence of a business. Tax planning is one of its important attributes. 1.6

TAX EVASION AND TAX AVOIDANCE

In the context of not paying tax, there are generally two methods which are used by the assesses. They are (1) Tax Evasion (2) Tax Avoidance. (1)

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. Tax evasion may involve stating an untrue statement knowingly, submitting misleading documents, suppression of facts, not maintaining proper books of accounts of income earned (if required under the law) omission of material facts in assessments etc. An assessee who dishonestly claims the benefit under the statute by making false statements, would be guilty of tax evasion.

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Thus when a person reduces his total income by making false claims or by withholding the information regarding his real income, so that his tax liability is reduced, is known as tax evasion. Tax evasion is not only illegal but it is also immoral, anti-social and anti-national practice. Therefore, under the direct tax laws, provisions have been made for imposition of heavy penalty and procedure of prosecution proceedings against tax evaders. A tax evader reduces his taxable income by one or more of the following steps : (a) Unrecorded sales. (b) Claiming bogus expenses, bad debts and losses etc. (c) Charging personal expenses as business expenses, e.g., car expenses, telephone expenses, travelling expenses, medical expenses incurred for self or family may be shown in the account books as business expenses. (d) Submission of bogus receipts for charitable donations for claiming deduction u/s 80G. (e) Non-disclosure of capital gains on sale of asset. (f) Non-disclosure of income from 'Benami transactions'. (2)

Tax Avoidance: The line of demarcation between tax planning and tax avoidance is very thin and blurred. There could be elements of malafide motive involved in tax avoidance also. Any planning which, though done strictly according to legal requirements defeats the basic intention of the Legislature behind the statute could be termed as instance of tax avoidance. It is usually done by adjusting the affairs in such a manner that there is no infringement of taxation laws and by taking full advantage of the loopholes therein so as to attract the least incidence of tax. Earlier tax avoidance was considered completely legitimate, but at present it may be illegitimate in certain situations only. In the latest judgement of the Supreme Court in McDowell's case 1985 (154 ITR 148) SC, tax avoidance has been considered as heinous as tax evasion and a crime against society. Most of the amendments are now aimed at plugging loopholes and curbing practice of tax avoidance. Per Jagadisan J. [in Aruna Group of Estates vs. State of Madras (1965) 55 ITR 642 (Mad.)], observed "Avoidance of tax is not tax evasion and it carries no ignominy with it, for it is a sound law and; certainly, not bad morality, for anybody to so arrange his affairs as to reduce the burnt of taxation to a minimum." However, now the Supreme Court is of the view that the colourable devices to avoid tax should not be encouraged and this is the duty of the court to expose the persons who avoid tax and refuse to approve such practice because the social evils of tax avoidance are manifold, which may be summarised as below: (a) substantial loss of much needed public revenue, particularly in a welfare state like India; (b) serious disturbance caused to the economy of the country by piling up of mountains of black money directly causing inflation; (c) large hidden loss to the community by some of the best brains in the country being involved in the perpetual war waged between tax avoider and his expert team of advisers, lawyers and accountants on one side, and Tax Officer and perhaps hot so skilful advisers on the other side; (d) sense of injustice and inequality of those who are unwilling or unable to profit by it; (e) Tactics of transferring the burden of tax liability to the shoulders of the guideless, good citizens from those of artful dodgers.

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One may not agree with the issue of generating black money by avoidance of tax. In legal tax avoidance the money neither goes out of books nor it is spent unnecessarily but it is used for further expansion of business. In CWT vs. Arvind Norottam [(1988) 173 ITR 479] the Supreme Court has observed, "It is true that tax avoidance in an undeveloped country should not be encouraged on practical as well as ideological grounds. Recently the legislature has inserted the provisions in direct and indirect tax laws for checking tax avoidance. But so long there are loopholes in the laws, tax avoidance cannot be checked by the courts. The function of judiciary in India is clearly not legislative, ...