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A Project report On Tax Planning with reference to specific Business Decisions

TAXATION Submitted to:


Mrs. Meghna Dangi

Submitted By:
Hetaxi Patel Ekta Kochar Nishtha Intwala Gunjan Bhang Parthasarthy Chowdhary

Tax Planning With Reference To Financial Management Decision


Tax planning with reference to financial management can be divided in three parts i.e: 1. Capital Structure Decision 2. Dividend Policy 3. Bonus Shares

Capital Structure Decision:


An optimum capital structure is one which maximises shareholders return. The advantage of having an optimum capital structure are: Maximise the value of assets of the company and wealth of its owner Minimises the cost of capital which results in finding inbuilt additional investment opportunities Under the tax laws, dividend on shares is not deductible and distributed profit is subjected to tax law.

Problem:
Q.1 X Ltd. Is a widely held company. It is currently considering a major expansion of its production facilities and the following alternatives are available. Particular Alternative I Alternative II Share capital Debenture (14%) Loan from bank@ 18% 5,00,00,000 2,00,00,000 2,00,00,000 1,00,00,000 Alternative III 1,00,00,000 1,50,00,000 2,50,00,000

Expected rate of return before tax is 25%. The rate of dividend of the company since 1980 is not less than20% and the date dividend declaration is June 30every year.

Ans:

Particular

Alternative I

Alternative II

Alternative III 1,25,00,000

Return on 5crore Less : Interest on debenture Interest on Loan Taxable Profit= Tax@30% Return on equity Rate

1,25,00,000

1,25,00,000

1,25,00,000 40,55,625 84,44,375 16.89%

28,00,000 18,00,000 79,00,000 24,41,100 54,58,900 27.29%

21,00,000 45,00,000 59,00,000 18,23,100 40,76,900 40.77%

TAX PLANNING REFERENCE TO MANAGERIAL DECISIONS:


Tax Management with reference to Lease or Buy Decisions

LEASE OR BUY DECISIONS Assets may purchased or taken on lease. Apart from tax angle other factors also are important in taking lease or buy decisions like rate of change in technology.

Advantages when Assets are taken on Lease : Lease Rental can be claimed as deduction as revenue expenditure. However Depreciation cannot be claimed since assets are not owned by the assessee.

Advantage when Assets are Purchased : Depreciation on specified assets can be claimed as deduction u/s 32. the Assets may be purchased outrightly or may be taken on loan. Where the asset is taken on loan interest amount can either be claimed as revenue expenditure or can be capitalized. But where interest is paid after the asset is first put us use, the deduction on account of interest shall be claimed as revenue expenditure, i.e. such interest cannot be capitalized.

Tax Management with reference to Repair, Replace, Renewal Or Renovation


REPAIR, REPLACE, RENEWAL OR RENOVATION The main tax consideration which one has to keep in mind is whether expenditure on repair, replacement or renewal is deductible as revenue expenditure u/s 30,31, or 37(1). It the expenditure is deductible as revenue expenditure under these sections, then cost of financing such expenditure is reduced to the extent of tax save. On the other hand if such expenditure is not allowed as deduction u/s 30,31 or 37(1) then it may be capitalized and on the amount so capitalized depreciation is available if certain conditions are satisfied.

DIFFERENCE BETWEEN REVENUE AND CAPITAL EXPENDITURE Capital Expenditure Cost of acquisition and installment charges of a fixed asset is a capital expenditure. Expenditure incurred to free oneself from a capital liability is a capital expenditure. Expenditure incurred towards acquisition of a source of income is a capital expenditure. Expenditure incurred to increase the operating capacity of fixed assets is capital expenditure. Expenditure incurred for obtaining capital by issue of shares is a capital expenditure Revenue Expenditure Purchase price of a current asset for resale or manufacture is a revenue expenditure. Expenditure incurred to free oneself from a revenue liability is a revenue expenditure. Expenditure incurred towards an income is a revenue expenditure. Expenditure incurred to maintain the fixed assets is a revenue expenditure Expenditure incurred towards raising loans or issue of debentures is a revenue expenditure.

Tax Management with reference to Sale of Scientific Research Asset'

Sale of Scientific Research Asset SCIENTIFIC RESEARCH ASSET SOLD AFTER HAVING BEEN USED FOR THE PURPOSE OF BUSINESS. As per explanation 1 to section 43(1) where an asset is used in the business after is ceases to be used for scientific research related to that business the actual cost of the asset to be included in the relevant block of asset shall be taken as nil as 100% deduction has already been allowed. If such asset is sold then the value of block shall be reduce by the sale value of the asset. SECTION 41(3). SCIENTIFIC RESEARCH ASSET SOLD WITHOUT HAVING BEEN USED FOR THE PURPOSE OF BUSINESS As per explanation section 41(3)

(1) Where an asset representing expenditure of a capital nature on scientific research, is sold, (2) without having been used for other purposes, and (3) the proceeds of the sale together with the actual amount of the educations made, the amount of the deduction exceed the amount of the capital expenditure (4) the excess or the amount of the deductions so made, whichever is the less, (5) shall be chargeable to income-tax as income of the business or profession of the previous year in which the sale took place. The Clause is applicable even if the business is not in existence during PY. ANALYSIS : Profit from Business = Sale price or cost whichever is lower. Capital Gain = Sale consideration minus cost of acquisition . If LTCA minus indexed cost of acquisition. There can be no loss under the head Capital Gain TAX PLANNING VIEW : Tax planning question can be whether the scientific research asset should be sold by using for the purpose of business or without being used for the purpose of business.

Scientific research asset can either be sold without being used for the purpose of business as such. Sale of scientific research asset as such shall give rise to capital gain which can be either short-tem capital gain or long-term capital gain.

Sale of Scientific Research Asset after it is put to use for the purpose of business shall reduce the depreciation for subsequent years. Capital gain shall arise depending upon the block of asset. As per section 50 Capital Gain can arise only if on the last day of the PY.

Block of Assets do not exist ; or WDV is Zero.

MAKE OR BUY Many costing or non-costing considerations guide the decision relating to make or buy. Some of these considerations are : Utilization of capacity. Inadequacy of funds. Latest technology Variable cost of manufacturing vis-vis purchase price Dependence upon supplier Labor problems in the factory,etc

The following tax considerations one has to keep in mind while taking make or buy decision Establishing a new unit

Sale of plant and machinery

CASE STUDY:X ltd manufactures electric pumping sets. The company has the option to either make or buy from the market component Y used in manufacture of the set. The following details are available: The component will be manufactured on new machine costing Rs 1 lakh with a life of 10 years. Material required cost Rs 2 per kg and wages Re.0.30 per hour. The salary of the foreman employed is Rs 1500 per month and other variable overheads include Rs 20,000 for manufacturing 25000 components per year. Material requirements is 25000 kgs. and requires 50,000 labour hours. The component is available in the market at Rs 4.30 per piece. Will it be profitable to make or to buy the component? Does it make any difference if the component can be manufactured on an existing machine?

SOLUTION:The cost estimate of manufacture will be:

Material @ Rs 2 kg (25000*Rs.2) Labour @Rs 0.30 hour ( 50,000*Re.0.30) Foremans salary (Rs 1500*12) Variable overhead Total variable cost Cost per unit(i.e.,Rs 103000/25000) (a) Fixed cost Cost of new machine (net of Taxes) Net fixed cost per unit (i.e .,Rs 82015/250000 units to be manufactured in 10 years ) (b) Total [(a)+(b)] Conclusion If new machine is required Rs Cost of manufacturing Cost of buying Which one is better 4.448 4.30 Buy If existing machine can be used Rs 4.12 4.30 Make

Tax Planning in respect of employees remuneration


Factors require in employee remuneration: While calculating business income of the employer, remuneration paid to employees is fully deductible. Any remuneration received by the employees is taxable in their hands at concessional rates to minimise their tax bill and to maximise their take home pay.

Deduction of remuneration in the hand of employer: Payment of salary/allowance and prequisites to employees is alowable as deduction under section 37(1). The employer has to ensure that proper tax is deducted at source under section 192.

Remuneration Planning: Broad objectives of remuneration planning are as follows: 1. Whatever is paid by employer is deductible in the hands of the employer while calculating business income of the employer. 2. In the hands of the employee it is not chargeable to tax to it is subject to lower tax incidence . Remuneration should be paid in the form of basic salary, different allowances and different perquisites. Those are as follows: Salary: Basic salary may be taken at 25% to 30% of total pay package. There is not any rule. However, tax liability can be reduced if basic salary is reduced than and expenditure by the employer on allowance and perquisites is increased. Allowances: Education allowances for two children may be given. Transport allowance for commuting between office and residence of Rs. 800 per month may be given wherever it is possible. Uniform allowances may be given if the employeer has uniform code in the organization.

Helper allowances also may be given for engaging a halper at residence to complete office work after office houres. Research allowances can be given for conducting a research on behalf of employer.

Perquisites: Rent free house may be given if the employee is interested in employers accommodation. If the employee owns a house which he has occupied for his own residence, the house may be taken by the employer on self lease and the same house may be allotted to the employee as rent free perquisites.

Other perquisites given to employees: Tea, coffee, snacks, lunch/dinner in factory or office. Conference participants fees. Computer or laptop for office and private use. LTC twice in a block of 4 years. Medical reimbursement of actual expenditure up to Rs. 15000 per year. Medi-claim insurance premium for employee and his family members. Motor-car for office and private use along with driver. Telephone at residence along with mobile phone. Staff welfare expenses. Free holiday home. Gift in kind. Club including health club. Scholarship to children.

Case Study:

TAX PLANNING WITH REFRENCE TO RECEIPT OF INSURANCE COMPENSATION

Insurance Claim: A claim is something that one party owes another. Someone may make a legal claim for money, or property, or for Social Security benefits. A claim also means an interest in, as in a possessory claim, or right to possession, or a claim of title to land. In Vania Silk Mills (P.)Ltd.v. CIT(1991), The Supreme Court held that insurance Claim received on account of destruction of asset is not Chargeable to tax as destruction does not amount to transfer. The effect of the judgment has been nullified to some extent by inserting sub- section (1A) in section 45 with effect from the assessment year 2000-01.

The two conductions should be satisfied in section 45 (1A) is applicable. First conduction is to see whether the compensation is received because of damages to or destruction of any capital assent. nsurance compensation towards destruction of capital assets is chargeable to capital gains as Section 45(1A) covers a wide gamut of causes for the loss, such as (i) flood, typhoon, cyclone, hurricane, earthquake; (ii) riot or civil disturbance; (iii) accidental fire or explosion; and (iv) action by an enemy or action taken in combating an enemy, whether with or without declaration of war. Destruction of capital assets, if any, in the recent terror attacks is covered by item (iv) above. The amount of insurance compensation received in respect of capital assets destroyed is taxable. However, when such compensation is used for replacing the destroyed assets then it will be tax neutral because of the block asset concept of classification of assets. Insurance compensation received for other consumables (other than capital assets) however would be chargeable to tax just like the sale of those items.

Where Section 45(1A) is not applicable

If the two conduction are not satisfied than section 45(1A) will not applicable and, consequently, insurance compensation (if is a Capital receipts) will not be Chargeable to tax as per ruling given by the Supreme Court in Vania Silk Mills (P.) Ltd. Consider a case where a road accident takes place in which vehicles and machinery or furniture being carried are destroyed. A Ship being over weighted is suck and assets are lost. The receipt of insurance compensation in such circumstances is not chargeable to tax under section 45(1A). The reasons for destruction being other than those mentioned in the condition two. The compensation received will have to be dealt with as per the Supreme Courts judgment in case of Vania Silk Mills (P.) Ltd. If the two conductions are not satisfied and insurance compensation is a revenue Receipt, then section 45(1A) is not applicable but the receipt may be taxable as trading Receipt under section 28 or 56. For instance, insurance compensation for theft of Stock-in-trade is not taxable under section 45(1A) but it will be taxable as business Income U/S 28.

CASE STUDY X Ltd is a manufacturing company. On April 1, 2010, it owns Plant A and Plant B (depreciation rate; 15 %; depreciated value of block being Rs. 2, 40,000). Plant C (depreciation rate 15%) is purchased by the company on June 10, 2010 for Rs. 60,000. It is put to use on the same day. Find out the tax consequences in the following different situations: 1. Plant B is destroyed by fire on January 25, 2011. Rs. 10,000, being the compensation is paid by the insurance company on February 10, 2011. 2. Suppose insurance compensation in situation (1) is Rs. 3, 70,000. 3. Plant A, B and C are destroyed by fire on January 25, 2011. Compensation paid by insurance company on February 10, 2011 is Rs. 20,000. 4. Suppose in situation (3) insurance compensation is Rs. 4, 00,000.

Particulars

Situation Situation Situation Situation 1 2 3 4 Rs. Rs.


2,40,000

Rs.
2,40,000

Rs.
2,40,000

Depreciated value of block (consisting of Plant A and B) on April 1, 2010. Add: Cost of Plant C purchased during
2010-11 Less: Money payable in respect of assets destroyed during 2010-11 (subject to maximum of Rs. 3,00,000)

2,40,000

60,000 (10,000) 2,90,000

60,000 (3,00,000) Nil

60,000 (20,000) 2,80,000

60,000 (3,00,000) Nil

Written down value on March 31,20ll Depreciation for the previous year 2010 -11 (normal depreciation @ 15% of WDV(not available when WDV is zero or block is empty) + additional depreciation @ 20% of Rs. 60,000) Depreciation value of block on April 1, 2011 (*block ceases to exist) Capital gain (Sec 45(1A) read with sec. 50) Sale consideration (being the amount of compensation) Less: Cost of acquisition as per section 50 (*section 50 is not applicable as the block does not cease to exist or written down value of the block is not reduced to zero) Short-term capital gain/loss for the assessment year 2011 -12.

55,500 2,34,500

12,000 Nil

12,000 -----

12,000 ------

10,000

3,70,000

20,000

4,00,000

NA*

3,00,000

3,00,000

3,00,000

-----

70,000

(2,80,000)

1,00,000

TAX PLANNING WITH REFERENCE TO SALE OF SCIENTIFIC RESEARCH ASSET

Section 41, inter alia, seeks to tax the profits arising on the sale of an asset representing expenditure of a capital nature on scientific research. Such an asset might be sold, discarded, demolished or destroyed, either after having been used for the purposes of the business on cessation of its use for other purpose of scientific research related to the business or without having been used for other purposes. In either case, tax liability could arise. In the first case, where the asset is sold, etc., after having been used for the purposes of business, the money payable in respect of such asset together with the amount of scrap value, if any, could be brought to charge under section 41(1) the provisions of which are wide enough to cover such situations and to bring to tax that amount of deductions allowed in earlier years. It may be noted that in such cases, the actual cost of the concerned asset u/s 43 (1) read with explanation would be nil and no depreciation would be allowed by virtue of section 35(2)(iv). Where the asset representing expenditure of a capital nature on Scientific Research is sold without having been used for other purposes, then the case would come u/s 41(3) and if the proceeds of sale together with the total amount of deductions made u/s 35 exceed the amount of capital expenditure, the excess or the amount of deduction so made whichever is less, will be charged to tax as income of the business of the previous year in which the sale took place.

Case Study:
XYZ ltd., a paper manufacturing concern, purchases a machine on March 1, 2002 for Rs. 6,10,000 for its laboratory with a view to improving the quality of art paper manufactured by the company. 1. What will be the amount of deduction u/s 35 on account of capital expenditure of Rs. 6,10,000 for the A.Y. 2002-03? 2. If the research activity for which the aforesaid machine was purchased ceases in 2010 and the machinery is brought into the business on November 1, 2010 (market value of machinery: Rs. 2,30,000); depreciation admissible at the rate of 15%; depreciated value of the relevant block of assets on April 1, 2010 is Rs. 14.07.860, the scientific research machine is sold for Rs. 1,90,000 on April 4, 2011, what will be the amount of depreciation and amount of chargeable profit u/s 41(3)? 3. If the research activity for which the machine was purchased ceases on November 1, 2010 (market value of machinery: Rs. 2,30,000) and the machine is sold on April 4, 2011 without using it for another purpose; sale price beinga) b) c) d) Soln: 1. As the scientific research is related to the business of the assessee, the whole of the capital expenditure of Rs. 6,10,000 is allowable as deduction u/s 35(2)(ia) for A.Y. 2002-03. 2. The machine is brought into the business proper on November 1, 2010. Profit arising on the sale of machinery is, in this case, not chargeable u/s 41(3). This provision would not apply as the section covers only such assets which are represented by expenditure of capital nature on scientific research that is sold without having been used for any other purpose. Rs.1,90,000 Rs. 5,40,000 Rs. 8,10,000 Rs. 15,00,000

Tax treatment of depreciation will be as under:Rs. Depreciated value of the block of assets on April 1, 2010 Add: Cost of machine transferred from Laboratory on November 1, 2010 [i.e. Rs. 6,10,000 deduction of Rs. 6,10,000 claimed u/s 35] Written Down Value Less: Depreciation for the P.Y. 2010-11 [15% of 1407860] Depreciated value of the block of assets on April 1, 2011 Less: Sale proceeds of Machine sold on April 4, 2011 Written Down Value Less: depreciation for P.Y. 2011-12 Depreciated value of the block of assets on April 1, 2012 Nil 14,07,860 2,11,179 11,96,681 1,90,000 10,06,681 1,51,002 8,55,679 14,07,860

3. Tax treatment should be as under: If sale price is 1,90,000 Amount chargeable u/s 41(3) Capital gains u/s 45 Sale proceeds Less: indexed cost of acquisition Long Term Capital Gain/(loss) 1,90,000 11,24,061 (9,34,061) 5,40,000 11,24,061 (5,84,061) 8,10,000 11,24,061 (3,14,061) 15,00,000 11,24,061 3,75,939 1,90,000 5,40,000 5,40,000 8,10,000 6,10,000 15,00,000 6,10,000

TAX PLANNING WITH REFERENCE TO DISTRIBUTION OF ASSETS BY COMPANIES IN LIQUIDATION


Where the assets of a company are distributed to its shareholders on its liquidation, such distribution shall not be regarded as a transfer by the company for the purposes of section 45 [Section 46(1)]. This section is restricted in its application to the circumstances mentioned therein i.e., the assets of the company must be distributed in specie to shareholders on liquidation of the company. If, however, the liquidator sells the assets of the company resulting in capital gain and distributes the funds so collected, the company will be liable to pay tax on such gains. Shareholders receive money or other assets from the company on its liquidation. They will be chargeable to income-tax under the head capital gains in respect of the market value of the assets received on the date of distribution, or the moneys so received by them. The portion of the distribution which is attributable to the accumulated profits of the company is to be treated as dividend income of the shareholder u/s 2(22)(c). The same will be deducted from the amount received/fair market value for the purpose of determining the consideration for computation of capital gains. Capital gains tax on subsequent sale by the shareholders If the shareholder, after receipt of any such asset on liquidation of the company, transfers it within the meaning of Section 45 at a price which is in excess of his cost of acquisition determined in the manner aforesaid, such excess becomes taxable in his hands under section 45. Section 46(1) applicability is given as under: Condition 1 Condition 2 Condition 3 Assets are distributed by company Assets are distributed at time of liquidation Assets are distributed to shareholder

If all conditions are satisfied then such distribution wont be considered as a transfer and capital gain is not chargeable in hands of company. But if the liquidator sells the assets and distributes cash to the shareholders, then this section wont apply. The company shall be liable to pay capital gain arising from sale of assets.

When a shareholder receives money or other assets at the time of liquidation of the company, section 46(2) is applicable. Capital gain u/s 46(2) shall be determined as follows1. Find out the money received and the market value of other assets on the date of distribution. The word asset does not mean capital asset. It may be capital asset or any other asset. 2. Find out the amount treated as dividend u/s 2(22)(c). 3. The excess of (1) over (2) is treated as full value of consideration received on transfer of shares. 4. From the consideration as calculated above, deduct cost of acquisition/indexed cost of acquisition, expenditure on sale, etc., to find out capital gain.

Case Study
X purchases 4,000 equity shares in Y Ltd on April 6, 1985 at the rate Rs. 2 per share. Y ltd. goes into liquidation on June 30, 2011. The balance sheet of the company as on June 30, 2011 is as followsRs. 40,000 equity shares 4,00,000 10,000 Debentures (non-listed) of Z Ltd. (cost: Rs. 9,00,000) at the time of acquisition on May 1, 2010 Accumulated profit Provision dividend tax 30,00,000 4,86,675 Cash in hand 10,86,675 Rs. 28,00,000

38,86,675

38,86,675

The assets are distributed to the shareholders. Consequently, X gets 1,000 debentures in Z Ltd. (market value: Rs. 3,00,000) and Rs. 60,000 in cash on June 30,2011. He transfers 1,000 debentures on April 6, 2012 for Rs. 3,10,000. Find out tax consequences of these transactions.

Soln: Y Ltd.- During the previous year 2011-12, the company has distributed assets to its shareholders at the time of liquidation. Even if the cost of debentures is Rs. 9 lakh and the market value is Rs. 28 lakh, the surplus is not taxable, as by virtue of Section 46(1) such distribution is not regarded as transfer as all 3 conditions are satisfied. Rs. Total distribution to shareholders Out of which amount to be treated as dividend u/s 2(22)(c) to the extent of accumulated profit Tax on dividend[15% (+ surcharge + EC + SHEC for FY 2011-12) of Rs. 30,00,000] Income of X at the time of liquidation of the company [A.Y. 2012-13]Amount received by X on June 30, 2011 Less: Dividend on which Y ltd. has paid dividend tax Balance which is treated as full value of consideration on transfer of 4,000 shares in Y Ltd. Less: indexed cost of acquisition [4000 2 785/133] Long term capital gain Income of X for AY 2013-14 Sale consideration of 1000 debentures in z Ltd. on April 6, 2012 Less: Cost of acquisition on June 30, 2011 Short term capital gain 3,10,000 2,80,000 30,000 60,000 47,218 12,782 3,60,000 3,00,000 4, 86,675 30,00,000 34,00,000

REFERENCES:
ww.incometaxmanagement.com/Pages/Tax-Management-Managerial-FinancialDecisions/Tax-Management-Managerial-Financial-Decisions-CONTETNS.html http://www.thehindubusinessline.in/mentor/2008/12/01/stories/2008120150610600.htm