Tax planning concepts

Tax Planning Introduction

1. Post Graduate and Research Department of Commerce TAX PLANNING AND MANAGEMENT Dr. S. CHANDRASEKARAN Assistant Professor of Commerce PG & Research Department of Commerce Vivekananda College Tiruvedakam West Madurai

2. TAX PLANNING

3. TAX PLANNING CONCEPTS TAX PLANNING TAX EVASION TAX AVOIDANCE TAX MANAGEMENT

4. Introduction Before knowing about the concept of tax planning, it is necessary to know the meaning of 'tax' and its imposition. Under dictionary meaning, the word 'tax' means 'a rate or sum of money levied on persons or property for the benefit of the State'. Section 2(43) of the Income Tax Act, 1961, defines 'tax'. Tax means income tax chargeable under the provisions of this Act. There are three stages in the imposition of tax : ( i ) There is the declaration of liability, that is the part of the statute which determines what persons in respect of what property are liable. (ii) There is the assessment. (iii) Method of recovery if the person taxed does not voluntarily pay. According to the Supreme Court the components which enter into the concept of a tax are:

5. ( i ) The character ofthe imposition known by its nature which prescribes the taxable event attracting the levy. (ii) A clear indication of the person on whom the levy is imposed and who is obliged to pay the tax. (iii) The rate at which the tax is imposed. (iv) The measure to which the rate will be applied for computing the tax liability. If these components are not clearly and definitely ascertainable, it is difficult to say that the levy exists in point of law. The rate of tax being very high at present, it has become necessary to arrange the fiscal affairs in such a way as to attract least tax. This can be done by three ways : (1) Tax Planning, (2) Tax Evasion, (3) Tax Avoidance.

6. TAX PLANNING 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 advantage is taken of all exemptions, deductions, rebates and reliefs permitted under the Act, so that the burden of the taxation on an assessee, as far as possible, 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.

7. 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 advantage 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.

8. TAX EVASION 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 institution of prosecution proceedings against tax evaders. The tax evader reduces his taxable income by one or more of the following steps: (1) Unrecorded sales. (2) Claiming bogus expenses, bad debts and losses.

9. ( 3) 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. (4) Submission of bogus receipts for charitable donations for deduction u/s 80G. (5) Non-disclosure of capital gains on sale of asset. (6) Non-disclosure of income from ' Benami transactions'. In brief to evade tax he suppresses or omits receipts, inflates expenses and claims bogus deductions.

10. TAX AVOIDANCE Tax avoidance is an art of dodging tax without actually breaking the law. It is a method of reducing tax incidence by availing of certain loopholes in the law. The Royal Commission on Taxation for Canada has explained the concept of 'avoidance of tax' as under: 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 provision or lack of provision in the law. It excludes fraud, concealment or other illegal measures. In other words, 'tax avoidance' is a device which technically satisfies the requirement of the law but in fact it is not in accordance with the legislative intent. .

11. "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, and may be summarised as under: (a) substantial loss of much needed public revenue, particularly in a welfare state like ours; (b) serious disturbance caused to the economy of the country by piling up of mountains of black money directly causing inflation;

12. (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 not so skilful advisers on the other side; (d) sense of injustice and inequality which tax avoidance arouses in the breasts of those who are unwilling or unable to profit by it; (e) ethics (or lack of it) of transferring the burden of tax liability to the shoulders of the guideless, good citizens from those of artful dodgers. 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.

13. TAX MANAGEMENT Tax planning is not possible without tax management. Tax management refers to the compliance with the statutory provisions of law. Tax management covers matters relating to : ( i ) compliance with legal formalities; (ii) taking steps to avail various tax incentives; (iii) saving from consequences of non-compliance of statutory duties, i.e., savings from penal interest, penalties and prosecutions; (iv) review of department's orders and if need be apply for rectification of mistake, filing appeal, request for revision or settlement of a case. Some important areas of tax management are discussed here in brief:

14. 1. Deduction of tax at source (A) The person making the prescribed payments should deduct tax at source at the prescribed rates. (B) The tax deducted at source should be paid to the Central Government within the time as prescribed in Rule 30 of the Income Tax Rules, 1962. (C) He should furnish to the recipient of income a certificate regarding tax deducted at source in the prescribed Form No. 16 or 16A as the case may be, as under: ( i ) TDS from salary (Form No. 16)-Up to 15th June of the following financial year. (ii) TDS from any other payment (Form No. 16A)-Quarterly within fifteen days from, (a) 31st July, (b) 31st October; (c) 31st January; (d) 31st May. (D) He should furnish quarterly returns regarding tax deduction at source and not deduction of tax at source in certain cases.

15. 2. Collection of tax at source ( i ) Every seller should collect tax at source on profits and gains from business of trading in alcoholic liquor or forest produce etc. as provided in section 206C. (ii) Every person, who grants lease or a license or transfers any right or interest in any parking lot or toll plaza or mine or quarry should collect tax at source as provided in section 206C. (iii) A seller, who receives any amount as consideration for sale of a motor vehicle of the value exceeding f ten lakh , shall at the time of receipt of such amount, collect from him one percent of the sale consideration as income tax. He should also comply with the conditions laid down in section 206C regarding payment of tax to the Central Government and issue a certificate to the buyer regarding tax collected at source.

16. 3. Payment of tax (1) Advance payment of tax. An assessee who is liable to pay tax during a financial year `10,000 or more he has to pay advance tax as under: (A) I. on or before 15th June-Not less than 15% of advance tax. II. on or before 15th September-Not less than 45% of the advance tax less the amount paid in first instalment. III. on or before 15th December-Not less than 75% of the advance tax less the amount paid in first and second instalments. IV. on or before 15th March-100% of the advance tax less the amount paid in earlier instalments. (B) An eligible assessee in respect of eligible business (see Sec. 44AD) or eligible profession (see Sec. 44ADA) shall pay the whole amount of advance tax on or before 15th March of the relevant previous year.

17. (2) Tax on self-assessment. Before furnishing the return of income an assessee should compute the tax on his total income declared in the return and interest payable under the provisions of this Act for delay in filing the return or any default or delay in payment of advance tax. If any tax or interest is due, it should be paid before furnishing the return and the proof of such payment must be furnished along with the return. (Sec. 140A) (3) Payment on demand. When a notice of demand IS received from the department, the amount should be paid within 30 days of the service of the notice or within the specified period in the notice of demand, as the case may be. (Sec. 220)

18. 4. Maintenance of accounts Every businessman or a professional must maintain such books and documents as may enable the A.O. to compute the total income of the assessee. However, where it is compulsory to maintain books of account and other documents as provided in section 44AA and Rule 6F, it should be maintained as provided and retained to avoid penalty under section 271A. 5. Audit of accounts In all cases audit of accounts is not necessary. However, where the turnover or gross receipts in business for the previous year exceeds rupees one crore and in profession it exceeds ` 50 lakh the audit is compulsory. (Sec. 44AB and Rule 6G) Further to claim deduction under certain sections the audit report is required in prescribed form, e.g., Sections For audit Report Form No 80IA 10CCB 80IB 10CCB 80JJAA 10DA

19. 6. Payment of certain sums ( i ) Any sum payable by him by way of : (a) tax, duty, cess or fees under any law, or b) as bonus or commission to employees, or (c) interest on loan from public financial institution, etc., or (d) interest on loan or advance from scheduled banks, or (e) encashment of leave at the credit of employee,

20. 7. Fulfilment of conditions to claim or retain a deduction (a) Where a capital asset has been transferred and the assessee wants to claim exemption on capital gains u/s 54D or 54EC or 54G or 54GA, the tax manager must ensure that (a) the new eligible asset is acquired or the amount is deposited in the Capital Gains Account Scheme, 1988, before, the due date of furnishing the return; and (b) the new eligible asset is acquired within the specified period and it (new asset) is not transferred within a period of three years from the date of acquisition so that the exempted capital gains do not become chargeable-to tax. (b) Where the assessee has claimed exemption on long-term capital gains u/s 54EC and he has invested long-term capital gains in the specified bonds within six months from the date of transfer of original assets, such bonds are not transferred within three years from the date of acquisition.  

21. 8. Furnishing the return of income The tax manager must ensure that the return of income is furnished on or before the due date of furnishing the return [u/s 139(1)] otherwise the assessee will lose the right to carry-forward and set-off the losses and become liable to penal interest, penalty, prosecution or fine or both. 9. Documentation and maintenance of records Documentation is an indispensable ingredient of tax management. An assessee should keep reliable, complete and updated documentation of all the relevant tax files so that the documentary evidence can be made available at a short notice whenever it is required. In absence, thereof, an assessee may lose of case for want of proper documentary evidence. Maintenance of account books, records, vouchers, bills, correspondence and agreements, etc. is also a part of tax management. Wherever separate accounts are required for claiming tax benefit.

22. 10. Review of orders It is an important function of tax management to review the assessment order and other orders received from the tax department. If there is an apparent mistake in the order, an application for rectification should be made. If the order is prejudicial to the interest of the assessee and it is advisable to file an appeal, revision or an application for settlement of the case steps should be taken in this direction. In such a case the opinion of the experts may be sought or they may be engaged for the purpose.

23. DIFFERENCE BETWEEN 'TAX PLANNING' AND 'TAX EVASION' 1. Tax planning is an Act within the four corners of the Act to achieve certain social and economic objectives and it is not a colourable device to avoid the tax. Tax evasion is a deliberate attempt on the part of tax payer by misrepresentation of facts, falsification of accounts including downright fraud. 2. Tax planning is a legal right and a social responsibility. By tax planning certain social and economic objectives are achieved. Tax evasion is a legal offence coupled with penalty and prosecution. 3. Tax planning requires thorough knowledge of the relevant Acts, social, economic and political situation of the country while tax evasion requires boldness to infringe the law.

24. 4. Tax planning helps in economic development of the country by providing additional funds for investment in desired channels while tax evasion generates black money which is generally utilized for smuggling, bribery, extravagant expenses on luxury. 5. A tax planner enjoys his fruits freely and he does not suffer from high blood pressure, whereas a tax evader remains always in anxiety of search and seizure. As our society has become 'money society', whatever the evils of black money may be, it has become a part of the life of most of the people. The Legislature has initiated steps to curb black money by passing Black Money Act and Prevention of Money Laundring Act. This, if implemented effectively can go a long way in checking the menace of black money.

25. DIFFERENCE BETWEEN TAX PLANNING AND TAX AVOIDANCE 1. In tax planning the letter and the spirit of the law are followed while in tax avoidance the tax is reduced by taking advantage of the loopholes of the law. 2. Tax planning is permanent while tax avoidance is temporary. However, no penalty can be imposed either in case of tax planning or in case of tax avoidance.

26. DIFFERENCE BETWEEN TAX AVOIDANCE AND TAX EVASION 1.Tax avoidance is legal but tax evasion is illegal. 2.In case of tax avoidance the objects and spirit of the law are not followed while in the case of tax evasion the provisions of the law are flouted. 3. In case of tax avoidance no penalty can be imposed while in case oftax evasion the person is liable to penalty and prosecution. 4. In case of tax avoidance, black money is not generated, hence, it is not very harmful to the society. In case of tax evasion, black money is generated which is mostly used for unproductive purposes.

27. DIFFERENCE BETWEEN 'TAX PLANNING' AND 'TAX MANAGEMENT' Tax planning primarily aims at adopting an arrangement so as to bring about the least incidence of tax under the four corners of law. On the other hand, tax management comprises a wider field like compliance with the statutory provisions of law, prospective planning so as to ease the financial constraints if any, that would arise when discharging the commitments through payment of tax, keeping close watch and monitoring the statutory requirements of other laws, claiming the due reliefs arising on account of double taxation avoidance agreements or claiming unilateral relief, etc. Thus, whilst tax planning is the pivot which enables the drawing up of the different incentives and keep the incidence of tax low, the tax management is the revolving wheel, which translates the policy in terms of results. The difference between tax planning and tax management are :

28. 1. Tax planning is a wider-term. It includes tax management. Tax management is the first step towards tax planning. 2. The primary aim of tax planning is minimising incidence of tax, whereas main aim of management is compliance with legal formalities. 3. Tax planning is not essential for every assessee; while tax management is essential for every person, otherwise he may be liable for penal interest, penalty and prosecution. For example, a person may not be reducing his tax liability by claiming any exemption, deduction, relief, etc. in computing his total income but ifhe is liable to pay advance tax or responsible for deduction of tax at source, etc. he has to comply with all legal formalities. 4. Tax planning is a guide in decision making while tax management is a regular feature of an undertaking.

29. 5. In tax planning exemptions, deductions and reliefs are claimed while in tax management the conditions are complied with to claim the exemptions, deductions and reliefs. 6. In tax planning alternative economic activities are studied and an activity with least incidence of tax is selected. Whereas tax management includes maintenance of accounts in prescribed form, get these audited, filing the required forms and returns, payment of taxes, etc. 7. Tax planning essentially looks at future benefits arising out of present actions. Tax management relates to past, present and future. In respect of appeals, revision, rectification of mistakes, etc. it deals with the past. Maintenance of records, self-assessment, filing the return and other documents, keeping pace with the changes, etc. are present activities. Follow-up plans, etc. are in future.

30. PRECAUTIONS IN TAX PLANNING (1) Tax planning requires analysis of the tax implication of any decision involving finance. Such analysis should precede the decision, for once the decision has been implemented in ignorance of law, the tax obligations have to be met. (2) Tax planning cannot be attempted in isolation. Due attention has to be paid to allied laws and economic factors also. Similarly, Sec. 80IE of the Income Tax Act provides deduction from gross total income in respect of profits from newly established industrial undertakings in North-Eastern States, but this area may require additional overheads to be incurred like transport, higher salaries/wages to trained and technical staff, etc. and may thus nullify the benefit of this incentive.

31. (3) While tax planning one has to keep in view all the direct tax laws (the Income Tax Act and the Wealth Tax Act). The amount of one kind of tax saved through tax planning should not result in payment more of the other tax. The net result of tax planning should be the least of all the taxes taken together. . (4) Tax planning should not be based on tax avoidance. The tax avoidance is based on availing of certain loopholes in the law. Whenever the loopholes come to light they will be checked by amendments in the law. Consequently, the planning based on such loopholes will fail. (5) Tax planning should not be based on the basis of decisions of High Courts or the Supreme Court. When a decision is not in consonance of the intent of the legislature, sometimes the law is amended retrospectively or prospectively. In this connection some of the decisions and their fate may be noted:

32. (6) Tax planning is done for a financial activity which a person proposes to carry out in near future. So the tax manager should keep in mind that the tax benefits which were available earlier but which have been discontinued for the business commencing in the current year or in the following year, are not considered or their reference for tax planning is not made. Otherwise a wrong decision may be taken. For example, a deduction under section 80IE from gross total income was allowed to a newly established small-scale industrial undertaking which began to manufacture or produce articles before 1.4.2002. Now for a person who is planning-to commence a small-scale industrial undertaking, in the current year the consideration of tax benefit under section 80IB has no relevance.

33. (7) Some people are of the opinion that claiming the deduction for expenses, which are expressly allowed under the Act, is tax planning. If a person does not claim the expenses which he has incurred and which are deductible in computing the income shows ignorance of the law. Tax planning presupposes thorough knowledge of tax laws. Tax planning is possible only for an economic activity where alternatives are available. In such a case he can choose the best alternative in order to attract least tax liability. For example, a senior citizen wants to invest ` 5,00,000 who is liable to pay tax on his total income @30%. Suppose he has three options for investment at the time of investment : ( i ) Senior Citizen Savings Scheme @ 9%, (ii) Fixed deposit in a bank @ 7.5%, and (iii) Bonds of a financial institution @ 8%. In the three cases his net income would be : ( i ) ` 45,000 - 13,500 Tax = ` 31,500 (ii) ` 37,500 - 11,250 Tax = ` 26,250 (iii) ` 40,000 - 12,000 Tax = ` 28,000 Thus he should invest in Senior Citizen Saving Scheme.

34. NEED FOR TAX PLANNING   1. Reduction in tax liability 2. Minimisation of litigation 3. Productive investment 4. Reduction in cost 5. Healthy growth of economy 6. Employment generation

35. LIMITATIONS OF TAX PLANNING 1. When an assessee has not claimed exemption, deduction or relief for which he is entitled to, before the assessment is completed, he is not allowed to claim it as rectification of mistake or in appeal or revision. 2. Tax planning cannot be done in isolation. Other economic factors, apart from the Income Tax Act and other Economic Laws (e.g., Partnership Law or Company Law) have to be considered before taking any decision in respect of reducing the tax liability. This puts a limitation on the scope of tax planning. 3. Sometimes a decision taken for tax advantage leads a favour some of the family members at the cost of others in terms of individual property or income rights. This may cause irritations and imbalances in the family. Hence, social, moral and psychological implications force not to go beyond a certain level for tax reduction.

36. 4. With increase in profits, the quantum of tax also increases. It necessitates the devotion of adequate time on tax planning. Otherwise this time might have been used for some productive purposes. 5. The direct tax laws are amended frequently either by the Direct Tax Laws (Amendment) Act or by the Finance Act. This puts an hindrance in making a long-term tax planning. The tax payers are not sure whether the tax advantages granted at present by the legislature will continue in near future? So, they hesitate in taking a long-term decision for their economic activities resulting a slow growth of the economy. 6. The tax incentives are allowed on fulfilment of certain conditions. Sometimes it is very difficult to fulfil those conditions and the tax payers are not in a position to avail the incentives.