Corporate tax planning for make or buy decision.

This is the presentation related to tax planning process of make or buy decision.

1. CORPORATE TAX AND PLANNING By: Yusra Khatoon How does ‘Tax Planning’ helps in the process of ‘Make or Buy’ decision.

2. What is Tax Planning?

3. Precautions in Tax Planning Tax planning requires analysis of the tax implication of any decision involving finance. Tax planning cannot be attempted in isolation. Due attention has to be paid to allied laws and economic factors also. Section 80-IE of the Income Tax Act provides deduction from gross total income in respects of profits from newly established undertakings. In tax planning one has to keep in view all direct tax laws. Tax planning should not be based on tax avoidance. Tax planning should not be based on decision of the High Courts or the Supreme Court some of the cases are: CIT vs. R.R. Bajoria (1988) CIT vs. B.C. Srinivasa (1981) Cloth Traders (P) Ltd. Vs. Addl. CIT (1979) Tax planning is done for a financial activity which a person proposes to carry out in near future. Some people are of the opinion that claiming the deduction for expenses, which are expressly allowed under the Act, is tax planning.

4. Tax Considerations 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 a case it may be liable to capital gains tax. If a new industrial (unit) is established to make the product, which fulfils the conditions laid down in Section 80-IB/ 80- IC of the Act, a deduction will be allowed the condition in computing the income of the undertaking (unit) for tax purposes. If the product, either manufactured or purchased, is a capital asset, its cost will not be allowed as a deduction in computing the income. However, if the asset is such on depreciation is allowed, it will be allowed in both the cases i.e , manufactured or purchased. 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.

5. MAKE OR BUY DECISION

6. Make or Buy

7. CRITERIA FOR MAKE

8. CRITERIA FOR BUY

9. Approaches for Make or Buy Decision

10. 1. SIMPLE COST ANALYSIS A make or buy cost analysis involves a determination and comparison of the cost to make the part and the cost to buy it. The final make or buy decision must be based on a careful weighing of the cost considerations and various quantitative considerations. It is concerned with finding the actual expenditure incurred on a given product and finding the total value of economic resources used to produce a product

11. EXAMPLE A company has been buying a part of machinery for Rs.1000/- each. It has an extra capacity that can be used to produce the same. The annual fixed cost of the unused capacity is Rs.10,00,000/-. If the company decided to make the product it will incur material cost of Rs.350/- per unit, labour cost of Rs 300 per unit and variable overhead cost of Rs 100/- per unit. The future demand is estimated as 5000 units. Which decision is profitable for the company.

12. SOL U TION Gi ven data : Fixed cost : Rs. 10,00,000 Labour cost : Rs. 300/unit Material cost : Rs. 350/unit Overhead cost : Rs 100/unit Demand : 5000 units Buying price : Rs. 1000 each

13. Cost of making - Total Cost = FC + VC FC = Rs.10,00,000 VC/unit = material cost + Labour cost + Overhead cost =300 + 350 + 100 = Rs. 750/unit Demand = 5000 units Total Variable cost = 5000 × 750 = Rs. 37,50,000/- Total cost = FC + VC = 10,00,000 + 37,50,000 = Rs.47,50,000/- Cost of buying - TC = FC + Buying cost = 10,00,000 + (5000 × 1000) = Rs. 60,00,000/- Decision : Since the cost of making is < cost of buying it is decided to make the product

14. 2. ECONOMIC ANALYSIS The following models are used Purchase model Manufacturing model

15. EXAMPLE A part of the machine has a yearly demand of 3000 units. The different costs in respect of make or buy are as given below Details Buy Make Item cost/unit Rs.10 Rs.8.0 Procurement cost/order Rs.150 - Setup cost/setup Rs.80/- Annual carrying cost/year Rs.2.0 Rs.1.50/- Production rate/year - 10,000 units

16. SOL U TION Purchase Model D = 3000 Units/Year C = Rs.150/order C c = Rs.2.0/item/year P = Rs. 10/unit 1 𝐶 𝐶 2𝐶 𝑜 𝐷 Q = √ = 670.82 units TC = 3000 x 10 + 3000 x 150/670.82 + 670.82 x2/2 = Rs. 31,341.64

17. SOL U TION TC = 3000 x 8 + 3000 x 80/676.12 + 1.5(10,000-3000)676.12/2 x 10000 = Rs. 24,709.93 Decision : Since the cost of making the item is < the cost of Producing it is decided to make the product Manufacturing Model 2 Q = √ 2𝐶 𝑜 𝑟 𝐶 𝑐 [1− 𝑟 𝑘 ] = 676.12

18. 3. BREAK-EVEN-POINT ANALYSIS The break-even point of any two variable situations is the point or the value at which they become equal as a result of a common variable. Break-even-point(B.E.P.)=Fixed cost/Purchasing price–Variable price OR B.E.P=Fixed cost/Contribution*Selling Price (Contribution= sales - variable cost or fixed cost + profit) (Profit= total contribution- fixed cost)

19. EXAMPLE A manufacturer of TV buys TV cabinet at Rs 500 each. In case the company makes it within the factory the fixed and variable costs would be Rs.4,00,000 and Rs 300 per cabinet respectively. Should the manufacturer make or buy the cabinet if the demand is 1500 TV cabinet

20. SOL U TION Selling price / unit = Rs. 500/- Variable cost / unit = Rs. 300/- Fixed cost = Rs. 4,00,000 BEP = 4,00,000/(500-300) = 2,000 units Decision : Since the demand is < the BEP the company should buy

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