SEM 3 FINANCE FALL 2013

MF0012 & TAXATION MANAGEMENT

Q1. Explain the concept of tax planning and the factors to be

considered in tax planning. Give the difference between tax planning
and tax evasion. (Concept of tax planning, Factors in tax planning,
Differences between tax planning and tax evasion)
Answer:
Concept of 'Tax Planning'
Logical analysis of a financial situation or plan from a tax perspective, to align financial goals
with tax efficiency planning. The purpose of tax planning is to discover how to accomplish all of
the other elements of a financial plan in the most tax-efficient manner possible. Tax planning
thus allows the other elements of a financial plan to interact more effectively by minimizing tax
liability.
Factors Affecting the Tax Planning
The following factors are essential for effective tax planning:
1. Residential status and citizenship of the assessee: We know that a
non-resident in India is not liable to pay income-tax on incomes which accrue or arise and are
also received outside India, whereas a resident in India is liable to pay income-tax on such
incomes. Therefore, every assessee would like to be a non-resident in India, if he has any
income which accrues or arises outside India.
2. Heads of income/assets to be included in computing net wealth: Before the Tax-planner
goes in for his task; he has to have a full picture of the sources of income of the tax payer and
the members of his family. Though total income includes all income from whatever source
derived, the scope of tax planning is not similar in respect of all sources of income. The
assessee can avail the benefits of exemption and
deductions under each head of income. Further he can avail the benefit of rebate and relief
under the Act.
3. Latest legal position: It is the foremost duty of a tax-planner to keep him fully conversant
with the latest position of the taxation laws along with the allied laws and also the judicial
pronouncements in respect thereof. For this purpose he must have a thorough and up-to-date
understanding of the annual Finance Acts, the Taxation Laws Amendments, the amendments, if
any, of the allied laws, the latest judicial pronouncements of the High Courts and the Supreme
Court, various Circulars of the Central Board of Direct Taxes which seek to clarify the legal
position in so far as the Revenue is concerned.
4. Form vs Substance: A tax planner has to bear in mind the following principles enunciated by
the courts on the question whether form or substance of a transaction should prevail in Incometax matters. (a) Form of transaction: When a transaction is arranged in one form known to law, it
will attract tax liability while, if it is entered into another form which is equally lawful, it may not.
(b) Genuineness of transaction: It is important to observe whether the transaction is a genuine
or not. If in case it is not then in such a situation depiction of truth is needed and it is not the
question of form and substance. It will be open to the authorities to pierce the corporate veil and
look behind the legal faade, at the reality of the transaction.

Q2. Explain the process of tax payment. (Explanation of whole

process
of
tax
payment
through:
Individuals, Partnerships, Companies)
Answer:
Introduction to tax - Tax constitutes a major form of revenue for most of the Governments
across the world. Taxes are levied and spent by the government for the development of the
country like infrastructure, healthcare, defense etc. Taxes can be categorized into two broad
categories namely direct tax and indirect tax. A tax paid directly by the person on whom it is
levied is known as direct tax. Taxes where the person paying and the person whom it is levied
upon are two different people are an indirect tax. Example of direct tax is income tax and an
example of indirect tax is sales tax.
Advance tax - Payment of tax liability by a person before the end of financial year is called
Advance tax. This is applicable only in case of Income tax of an individual or a business entity. A
simple question arises as why somebody would like to pay taxes in advance.
Are you liable to pay advance tax?
Advance tax is payable only when an assessees total tax liability is exceeding Rs 10,000.
Advance tax Rates and Dates
For non corporate assessee installments of advance tax is to be paid as per the below

30% of tax payable should be paid as advance tax on or before 15th September

60% of tax payable should be paid as advance tax on or before 15th December

100% of tax payable should be paid as advance tax on or before 15th January

There are 4 installments of advance tax for corporate assessee.

15% of tax payable should be paid as advance tax on or before 15th June

45% of tax payable should be paid as advance tax on or before 15th September

75% of tax payable should be paid as advance tax on or before 15th December

100% of tax payable should be paid as advance tax on or before 15th March

Consequences of nonpayment of advance tax

If the amount of advance tax paid is less you will have to pay penalty interest as per the below
For Non Corporate assessee

If advance tax paid in the first two installments is less than specified, simple interest @
1% per month is charged on the deficit amount for a period of 3 months.

If the aggregate of advance tax paid is less than 90% of tax payable on 15th March
penalty of simple interest @ 1% per month is charged on the amount shortfall until the
tax is paid

For Corporate assessee

Simple interest @ of 1% is charged on the deficit amount for a term of 3 months if you have
failed to pay advance tax or if advance tax paid is less than tax due as per the above slab. For
the 4th and final installment if the advance tax paid is less than 90% of tax payable simple
interest @ 1% per month is charged on the deficit from 1st April until the tax is fully paid.

Q3. Write short notes on:(Capital gain, Cost of acquisition, Cost of

improvement, Expenditure on transfer, Transfer)
Answer:
Capital gain
When we buy any kind of property for a lower price and then subsequently sell it at a higher
price, we make a gain. The gain on sale of a capital asset is called capital gain. This gain is not
a regular income like salary, or house rent. It is a one-time gain; in other words the capital gain
is not recurring, i.e., not occur again and again periodically. Opposite of gain is called loss;
therefore, there can be a loss under the head capital gain. We are not using the term capital
loss, as it is incorrect. Capital loss means the loss on account of destruction or damage of
capital asset. Thus, whenever there is a loss on sale of any capital asset it will be termed as
loss under the head capital gain.
Cost of acquisition
The cost of acquisition of an asset would normally be taken to be the price at which the asset
was acquired by the assessed. Such price may litigation expenses incurred for having the
shares registered in his name (as company refused to register the same) is part of the cost of
acquisition and that incurred for gaining better voting rights is cost of improvement.
Expenditure on transfer
It refer to expenses necessary for effecting transfer, e.g. brokerage, commission paid for
securing a purchaser, cost of stamp, traveling expenses, incurred in connection with transfer,
litigation expenditure for claiming enhancement of compensation, etc.
Transfer

The liability to tax on capital gains arises only if there is a transfer of capital asset. The term
transfer in relation to a capital asset, includes:
1. Sale, exchange or relinquishment of the capital asset, or
2. The extinguishment of any rights therein [e.g. where shares are forfeited by the company, it is
extinguishment of the right in the shares. The capital loss on forfeiture of shares is deductible]
3. The compulsory acquisition thereof under any law, or
4. Conversion of asset into stock-in-trade.
5. Any transaction which has the effect of allowing the possession of any immovable property in
part performance of a contract of the nature referred to in section 53 A of the Transfer of
Property Act, 1882; or
6. Any transaction [by way of becoming a member of shareholder in co-operative arrangements]
which has the effect of transferring or enabling the enjoyment of any immovable property.
7. The maturity or redemption of a zero coupon bond.

Q4. Explain the computations of Tax in two aspects given below:

Tax provision for Computation of Total income of firms
Computation of partnership firms book profit.
(Steps to be explained for the computation of total income of firms, Steps for
computation of partnership firms)
Answer:
Tax Provisions for Computation of Total Income of the Firm
Total income of the partnership firm will be determined as a separate entity and it will be
computed under various heads of income. However, while computing taxable profits under the
head profits and gains of business or profession, a deduction is allowable to the firm on
account of interest and remuneration payable to the partners. Deduction of interest to a partner
is allowable u/s 36 and remuneration to a working partner will be allowed u/s 37.
Therefore, deductions on account of interest and remuneration to the partners can be claimed
under Section 36 or 37, as the case may be, but these will be subject to the conditions
prescribed by Section 40(b), which are as under:
1. Payment of salary, bonus, commission or remuneration by whatever name called, to a nonworking partner shall not be allowed as deduction.
2. Payment of remuneration to working partners and interest to any partner will be allowed as
deduction only when it is authorized by and is in accordance with partnership deed.
3. Payment of remuneration/interest, although authorized by the partnership deed but which
relates to a period prior to the date of such partnership deed, shall not be allowed.
4. Interest payable to a partner, although authorized by the partnership deed shall be allowable
as a deduction subject to a maximum of 12% simple interest per annum. If the partnership deed
provides for interest at less than 12% p.a., the deduction of interest shall be allowed to the
extent provided by the partnership deed.
5. The payment of remuneration to working partner, although relates to a period after the date of
the partnership deed and authorized by the partnership deed, shall be allowed as a deduction
only to the extent of the following limits
a) In the case of a firm carrying on a specified profession:
i) On the first Rs. 1,00,000 of the
book profit or in case of a loss
ii) On the next Rs. 1,00,000 of the
book profit

Rs. 50,000 or at the rate of 90% of

the book profit, whichever is more;
at the rate of 60%

iii) On the balance of the book profit

b) In the case of any other firm:
i) On the first Rs. 75,000 of the book
profit, or in case of a loss
ii) On the next Rs. 75,000 of the book
profit
iii) On the balance of the book profit

at the rate of 40%

Rs. 50,000 or at the rate of 90% of
the book profit, whichever is more;
at the rate of 60%
at the rate of 40%

Computation of book profit

Book Profit, as stated above, will be computed as under:
Step 1: Compute the income of the firm under the head profit and gains of business or
profession as per Sections 28 to 44D i.e. start with the net profit as per profit and loss account
and make additions and deductions as per Sections 28 to 44D explained under the chapter
Business or Profession. Interest paid/payable to partners in excess of 12% shall also be
disallowed as per Section 40(b).
Step 2: Add aggregate amount of remuneration paid/payable to all the partners (whether
working or non working) of the firm, if it has been debited to profit and loss account.
1. For purpose of book profit, only income under the head Business or Profession is to be
computed. Therefore, if there is income chargeable to tax under the heads Income from House
Property, Capital gains and Income from other sources, credited to profit and loss account
that will be deducted from the net profit to compute book profit. Similarly expenses on such
incomes which are taxable under other heads will be added back if they are debited to profit and
loss account.
2. Brought forward business loss will not be deducted for computation of book profit but
unabsorbed depreciation brought forward from earlier years will be deducted as unabsorbed
depreciation is allowable as deduction under Section. However, for allowing unabsorbed
depreciation, brought
forward business loss shall have to be notionally allowed first from the current business income.
Q5. Explain the service tax law in India. Give the concept of negative list. (Introduction of
service tax law in India, Concept of negative list) 5, 5
Answer:
Service Tax
We have with us extensive experience in handling the demands of Service Tax Consultancy
services that comprise areas like

Service Tax Registration

Consultancy on Services as per the applicability of Service tax Act

Filing of Service Tax returns in ST-3

Consultancy on deposit of monthly service tax of corporate and individuals

Maintenance of Service Tax Records

Liasioning with respective Authorities

Here, our rich experience allows us to successfully handle all matters pertaining to services
including handling of departmental audits. Working in close relation with client organizations, we

analyze their needs and based on that perform execution of services, thus ensuring best
possible service support is offered from our end. Some of the factors that distinguish us from
others include:

Rich experience in the field

Capability to offer prompt and reliable services

Service areas include:

Preparation of returns & challans

Handling departmental audit

Regarding credit claims

Negative List
Negative list of services means that all services, excluding those specified in negative list will be
subject to service tax. However, in addition to items included in negative list, there will be
exemptions, abatements and composition schemes as issued by the CBEC from time to time.
The Mega Exemption Notification issued by the CBEC and the issuance of guidance paper on
the new approach to service tax has mentioned 38 services on which service tax shall be
exempt. All the other services, i.e. which are not mentioned in the negative list, will attract
service tax liability.
Some of the services covered in the negative list category are as follows:
i) Health care services by a clinical establishment, an authorized medical practitioner or paramedics
ii) Services provided by an individual as an advocate or a partnership firm of advocates by way
of legal services to ;
a) an advocate or partnership firm of advocates providing legal services
b) any person other than a business entity;
c) a business entity with a turnover up to rupees ten lakh in the preceding financial year
iii) Services provided to a recognized sports body bya) an individual as a player, referee,
umpire, coach or team manager for participation in a sporting event organized by a recognized
sports body;
b) another recognized sports body
iv) auxiliary educational services and renting of immovable property by educational institutions
in respect of education
v) Services by way of training or coaching in recreational activities relating to arts, culture or
sports
vi) Temporary transfer or permitting the use or enjoyment of a copyright covered under section
13 of the Indian Copyright Act, 1957 relating to original literary, dramatic, musical, artistic works
or cinematograph films
vii) Services provided in relation to serving of food or beverages by a restaurant, eating joint or a
mess, other than those having (i) the facility of air-conditioning or central air-heating in any part
of the establishment, at any time during the year, and (ii) a license to serve alcoholic beverages

Therefore, with the exception of 38 services as specifically provided by the CBEC under
negative list, all other services will come under the 12%3 service tax bracket.

Q6. Identify and explain the major considerations in capital structure planning. Explain
two approaches in dividend policy and factors affecting dividend decisions. (Major
considerations in capital structure planning, Two approaches in dividend policy, Factors
affecting dividend decisions) 6, 2, 2
Answer:
Major considerations in capital structure planning
The capital structure depends primarily on number of factors like the nature of industry,
gestation period, certainty with which the profit will accrue after the undertaking goes into
commercial production and the likely quantum of return on investment. It is therefore important
to understand that, different types of capital structure would be required for different types of
business undertakings. However, the finance manager should take into consideration following
factors while planning the capital structure:
1. Risk is of two kinds, i.e. financial risk and business risk: In the context of capital
structure planning, financial risk is relevant. Financial risk also is of two types:
(a) Risk of cash insolvency: As a firm raises more debt, its risk of cash insolvency increases.
(b) Risk of variation in the expected earnings available to equity shareholders: In case a firm
has higher debt content in capital structure, the risk of variations in expected earnings available
to equity shareholders will be higher. This is because of trading on equity.
2. Cost of capital: Cost is an important consideration in capital structure decisions. It is obvious
that a business should be at least capable of earning enough revenue to meet its cost of capital
and finance its growth.
3. Control: Along with cost and risk factors, the control aspect is also an important
consideration in planning the capital structure. When a company issues further equity shares, it
automatically dilutes the controlling interest of the present owners.
4. Trading on equity: A company may raise funds either by the issue of shares or by
borrowings. Borrowings carry a fixed rate of interest and this interest is payable irrespective of
the fact whether there is profit or not.
5. Corporate taxation: Under the Income Tax law, dividend on shares is not deductible while
interest paid on borrowed capital is allowed as deduction for computing taxable income.
6. Government policies: Government policies are a major factor in determining capital
structure. For example, a change in the lending policies of financial institutions may mean a
complete change in the financial pattern to be followed in the companies.
7. Legal requirements: The finance manager has to keep in view the legal requirements while
deciding about the capital structure of the company.
8. Marketability: To obtain a balanced capital structure it is necessary to consider the ability of
the company to market corporate securities.
9. Maneuverability: Maneuverability is required to have as many alternatives as possible at the
time of expanding or contracting the requirements of funds.
10. Flexibility: Flexibility refers to the capacity of the business and its management to adjust to
expected and unexpected changes in circumstances
11. Timing: Closely related to flexibility is the timing for the issue of securities. Proper timing of
a security issue often brings substantial savings because of the dynamic nature of the capital
market.

12. Size of the company: Small companies rely heavily on owners funds while large
companies are generally considered to be less risky by investors and therefore, they can issue
different types of securities.
Dividend Policy
Two possible approaches to Dividend Decisions:
1. As a long-term financing decision: In this approach, all the firms after
tax profits can be considered as a source of long-term financing. Thus, the payment of cash
dividends reduces the funds available to finance growth and either restricts growth or forces the
firm to find out other financing sources. Thus, the firm might accept a guideline to retain
earnings as long as either of the conditions exists.
a) Sufficient profitable projects are available: Acceptances of highly profitable projects represent
a growth goal for most of the firms. As long as such projects are available, the firm can retain
earnings to finance them.
b) Capital structure needs equity funds: Among a variety of sources of long term funds and to
avoid the high risk associated with excessive debt, the firm must have a balance of debt and
equity financing. Because of the costs of floating common shares, retained earnings are
profitable as equity financing.
With either of the guidelines, cash dividends are viewed as a remainder.
2. As maximisation of wealth: With this approach, the firm recognizes that the payment of
dividends has a strong influence on the market price of the common shares.
Factors affecting dividend decisions
Most investors have two forms of return from the purchase of common shares. These are:
1. Capital gains: The investor expects an increase in the market value of the common shares
over a period of time. For example, if the stock is purchased at Rs. 40/- and sold for Rs. 60/-,
the investor will realize a capital gain of Rs. 20/-. Capital gain may be defined as the profit
resulting from the sale of capital investments, in this case, common shares.
2. Dividends: The investor expects at some point, a distribution of the firms earnings. From
mature and stable organizations, most investors expect regular dividends to be declared and
paid on the common shares. This expectation takes priority over the desire to retain earnings to
finance expansion and growth.