CONCEPT OF TAX PLANNING AND

SPECIFIC MANAGEMENT DECISIONS

CHANIKA GOEL (1886532)

RITIKA SACHDEVA (1886586)
M.Com Semester 4 (TUT GROUP A)
UNDERSTANDING THE TERMS….
 TAX PLANNING- is the arrangement of financial activities
in such a way that maximum tax benefits are enjoyed by
making use of all beneficial provision in the tax laws.
 TAX AVOIDANCE- is minimizing the incidence of tax by
adjusting the affairs in such a way that although it is
within the four corners of the taxation laws but the
advantage is taken by finding out loopholes in the laws.
In short it is the art of dodging tax without breaking the
law.
Colorable devices cannot be a part of tax planning and it is
wrong to encourage the belief that it is honorable to
avoid payment of tax by resorting to dubious method.
 TAX EVASION- Tax evasion is an illegal activity in which a
person or entity deliberately avoids paying a true tax
liability. Those caught evading taxes are generally
subject to criminal charges and substantial penalties.
 TAX MANAGEMENT- The objective of Tax Management is
to comply with the provisions of Income Tax Law and its
allied rules.
 Tax Management deals with filing of Return in time,
getting the accounts audited, deducting tax at source
etc. It helps in avoiding payment of interest, penalty,
prosecution etc. and is essential for every assesses.
DIFFERENCE BETWEEN:-
 TAX PLANNING  TAX MANAGEMENT

1. Tax planning a wider term and 1. Tax management is a narrower term

include tax management. and the first step towards tax
2. Tax planning emphasis on planning.
minimization of tax burden. 2. It emphasizes on compliance of legal
3. Tax planning helps in decision formalities for minimization of tax.
making. 3. Tax management helps in complying
4. Tax planning involves comparison of the conditions for effective decision
various alternatives before selecting making.
the best one. 4. It involves maintenance of accounts
5. Tax planning looks at future in prescribed forms, filing of return,
benefits. payment of taxes, etc.
6. Tax planning helps to claim various 5. Tax management relates to past
benefits of tax. present and future.
6. Tax management helps in complying
the conditions for effective decision
making.
DIFFERENCE BETWEEN:-
 TAX AVOIDANCE  TAX EVASION
1. Tax avoidance means 1. Tax evasion means avoiding of
planning for minimization of tax liability illegally.
tax according to legal
requirement but it defeats 2. Tax evasion involves use of
the basic intentions of the unfair means.
legislature.
2. Tax avoidance takes into
accounts various lacunas of
law. 3. Tax evasion is unlawful.
3. It is lawful but involves the
element of mala fide
intentions. 4. Tax evasion involves avoidance
4. Tax avoidance is planning of payment of tax after the
before the actual liability for liability of tax has arisen.
tax comes into existence.
SPECIFY WITH REASONS WHETHER THE
FOLLOWING ACTS CAN BE CONSIDERED AS-
A) TAX PLANNING OR B) TAX MANAGEMENT OR
C) TAX EVASION???

1.) Bionics Ltd. Maintains a register of

tax deduction at source to
compliance with tax authorities
appropriately.

TAX MANAGEMENT
 2.) Climatrol Pvt. Ltd. Engaged in the business
of manufacturing and supplying of water
coolers. Manufacturing of water coolers
actually takes place at Faridabad(Haryana), but
for availing tax benefits Climatrol Pvt. Ltd.
Shows this manufacturing of water coolers in
Jammu and Kashmir in their books.

TAX EVASION
 3.) PQR industries Ltd. Installed an air
conditioner at the residence of a director as per
his terms of his appointment; but treats it as
fitted in quality control section in the factory for
the purpose of computing depreciation at
higher rate.

TAX EVASION
 4.) G Ltd. Planned to buy a machinery to
manufacture a component for its assembly
operations instead of buying it from the market
and to avail tax benefit on account of
depreciation on machinery.

TAX PLANNING
 5.) Y Ltd. Acquired new plant and machinery
with borrowed funds from a bank to avail tax
benefit with respect to interest payments on
account of this loan, though it has sufficient
cash at bank.

TAX PLANNING
SPECIFIC MANAGEMENT DECISION

 CAPITAL MIX:- A capital structure is said to be

optimum when it has a mix of debt and equity
that will yield the lowest possible weighted
average cost of capital to the company or gets
maximum return on equity share capital.
 At the same time the capital mix should not
have high debt equity ratio.
CAPITAL MIX
 Q.) An Indian company is considering three different proposals of
raising Rs. 1200000 for a project where earning before tax
estimated as 36% of the capital employed. The company can
raise this entire amount either by issue of equity share entirely or
combination along with borrowing from a bank @12% p.a. or by
issuing of debentures and any capital mix of three sources, which
of the following three alternatives should it opt for:
a) Entire Rs. 1200000 to be raised through equity share capital
b) Rs. 600000 from equity shares and Rs. 300000 from each
other sources available.
c) Rs. 400000 from each source available.
Assume the company shall distribute the entire amount of profits as
dividend and applicable corporate tax rate is 30.9%.
What will be your answer, if return on capital employed before tax is
12% instead of 36%, other things reaming the same?
SOLUTION-
PARTICULARS ALTERNATIVE
A B C
EQUITY SHARE 1200000 600000 400000
CAPITAL
LOAN FROM - 300000 400000
BANK@12%
DEBENTURES - 300000 400000
ISSUED @14%
TOTAL INVESTMENT 1200000 1200000 1200000
EBIT(@ 36% OF 432000 432000 432000
CAPITAL EMPLOYED)
LESS:- interest on - 36000 48000
loan @ 12%
LESS:- interest on - 42000 56000
debenture @ 14%
Earning Before Tax 432000 354000 328000
LESS:- Tax @ 30.9% 133488 109386 101352
SOLUTION-
PARTICULARS ALTERNATIVES
A B C
EARNINGS AFTER 298510 244610 226648
TAX(1)

TAX ON DIVIDEND 52687 43174 40003

TO BE
DISTRIBUTED@
17.65% (2)

AMOUNT OF 245823 201436 186645

DIVIDEND
DISRTIBUTED (1-2)

RETURN ON 20.48% 33.57% 46.66%

EQUITY SHARE *
CAPITAL
DECISION-

 As the return on equity employed is highest

(46.66%) in ALTERNATIVE C i.e. Rs. 400000
from each source namely, equity, debentures
and loan from bank is the best alternative and
company should go for it.
IF RETURN ON CAPITAL EMPLOYED IS 12%?
PARTICULARS ALTERNATIVES
A B C
EBIT(12% OF CAPITAL 144000 144000 144000
EMPLOYED)
LESS:- INTEREST ON - 36000 48000
LOAN @12%
LESS:- INTEREST ON - 42000 56000
DEBENTURES@ 14%
EBT 144000 66000 40000
LESS:- TAX@ 30.9% 44496 20394 12360
EAT 99504 45606 27640
LESS:- TAX ON 17562 8050 4878
DIVIDEND @17.65%
AMOUNT OF 81942 37556 22762
DIVIDEND
DISTRIBUTED
RETURN ON EQUITY 6.82% 5.92% 5.69%
SHARE CAPITAL *
DECISION:-

 As the return on equity employed is highest

(6.82%) in ALTERNATIVE A i.e. entire
Rs.1200000 raised from issue of equity
shares, it is the best alternative and company
should go for it.
TAX PLANNING WITH REFERENCE TO
LEASE V/S PURCHASE
A lease of property is a transfer of right to enjoy such
property, made a certain time, in consideration of a price
payable periodically to the transferor by the transferee.

In other words, leasing is an arrangement that provides a

person with use & control over an asset, for a price payable
periodically, without having a title of ownership. In case of
lease agreement the owner of the asset is called the lessor
& the user is called the lessee.

When a person needs an asset for his business purpose, he

has to decide whether the asset should be purchased /
taken on lease.
TAX PLANNING WITH REFERENCE TO
LEASE V/S PURCHASE
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 out rightly or may be taken on
loan. Where the asset is taken on loan interest amount can either
be claimed as revenue expenditure .
Note :
Since the lease rentals and loan are repayable in instalments,
then the cash outflow for each separate year should be
converted into present value of today’s cost.
HOW TO SOLVE QUESTIONS
Where the Asset is Leased :
1. Compute the processing fees in year in which it is payable.
2. Compute Lease Rental spread over a number of years.
3. Compute Cash Outflow (processing fees + lease rental) spread
over a number of years.
4. Compute Tax saved on deduction claimed ( processing fees +
lease rental) spread over a number of years.
5. Compute adjusted cash Outflow which is ( 3 – 4 )
6. Compute present value of adjusted cash outflow.
BUY V/S LEASE
Q. An assessee, who carries on a business, acquires a
machinery costing Rs.1,00,000. This machinery has a life of 5
years.
Decide which one is a better alternative – buy or lease – in the
following situation:
The Rate of Depreciation is 15%.
Tax Rate: 30.9%
Cost of Capital: 14%
In case , the machinery is taken on LEASE :
Lease Cost: Rs.34000 per annum for 5 years.

PVF table is given below @ 14% for next 5 years.

Year 1 Year 2 Year 3 Year 4 Year 5
0.877 0.769 0.675 0.592 0.519
EVALUATION OF DECISION TO BUY

Year Amount of Tax Saving PVF Present

Depreciation on @ Worth of
@ 15% Depreciation 14% Tax
(WDV) Savings
1 15000 4635 0.877 4065
2 12750 3940 0.769 3030
3 10838 3349 0.675 2261
4 9212 2847 0.592 1685
5 7830 2419 0.519 1255
12296

Working Notes :
Tax Saving on Depreciation = Amount of Depreciation * Tax Rate of 30.9%
Present Worth of Tax Savings = Tax Saving on Depreciation * PVF @ 14%
EVALUATION OF DECISION TO BUY

Calculation of Net Cash Outflow

Cash Outflow on account of purchase of machinery 1,00,000

Less: Present Value of Tax Savings on account of Depreciation (12,296)
______
= Net Cash Outflow 87,704
______
EVALUATION OF DECISION TO LEASE
Year Lease Tax Differential PVF Present
Rental Saving Cash @ Value of
on Outflow 14% Differential
Lease Cash
Rental Outflow
1 34000 10506 23494 0.877 20604
2 34000 10506 23494 0.769 18067
3 34000 10506 23494 0.675 15858
4 34000 10506 23494 0.592 13908
5 34000 10506 23494 0.519 12193
80,630

Working Notes:
1. Tax Saving on Lease Rental = Amount of Lease Rental * Tax Rate of 30.9%
2. Differential Cash Outflow = Lease Rental – Tax Saving on Lease Rental
3. Present Value of Differential Cash Outflow = Differential Cash Outflow * PVF @ 14%
FINAL DECISION

As the Net Cash Outflow in the case of

Lease (Rs.80,630) is less as compared to
the Net Cash Outflow in case of Buy
(Rs.87,704) , the company should go for
taking the machinery on LEASE.
HOW TO SOLVE QUESTIONS
Where the Asset is Purchased on Loan :
1. Compute Repayment of Loan spread over a number of years.
2. Compute Interest on Loan spread over a number of years.
3. Compute each Outflow ( Interest + repayment of Loan) spread
over a number of years.
4. Compute Depreciation on Assets spread over a number of years.
5. Compute Tax saved on deduction claimed ( Interest +
depreciation) spread over a number of years.
6. Compute adjusted cash outflow which is ( 3 – 5 )

7. Compute present value of adjusted cash outflow.

LOAN V/S LEASE
Q. R Ltd., a manufacturing company needs a generator for its activities. The cost is
Rs.1,00,000. On making enquiries, it is learnt that the company has two options.
Option 1: Buying the asset by taking a loan of Rs.1,00,000 repayable in five equal
instalments of Rs.20,000 each along with interest @ 12% p.a.
Option 2: Leasing the asset for which annual lease rental is Rs.30,000 up to 5 years.
The lessor charges 1% processing fees in first year.
As the Tax Manager advise the company management on which option should be
selected.
Additional Information :
 Tax rate applicable to the company is 30.9%.

 The Depreciation Rate is 15% (plus additional depreciation : 20%).

 Assuming internal rate of return 10% for present value factor. PVF Table is given
below @ 10% for next 5 years.

Year 1 Year 2 Year 3 Year 4 Year 5

0.909 0.826 0.751 0.683 0.621
EVALUATION OF DECISION TO TAKE LOAN

Calculation of Gross Cash Outflows on account of

Loan
Year Loan Principal Interest Gross
Repayment amount in the @ 12% Cash
(Instalment) beginning of Outflow
the year
1 20000 100000 12000 32000
2 20000 80000 9600 29600
3 20000 60000 7200 27200
4 20000 40000 4800 24800
5 20000 20000 2400 22400

Gross Cash Outflow = Loan Repayment ( Instalment Amount) + Interest Amount

EVALUATION OF DECISION TO TAKE LOAN

Calculation of Present Value of Net Cash Outflows

Year Gross Depreciation Interest Tax Net PVF Present
Outflow (1) (2) Savings Outflow @ Value of
on 10% Net
(1)+(2) Outflow

1 32000 35000 12000 14523 17477 0.909 15887

2 29600 9750 9600 5979 23621 0.826 19511
3 27200 8288 7200 4786 22414 0.751 16833
4 24800 7044 4800 3660 21140 0.683 14439
5 22400 5988 2400 2592 19808 0.621 12301
78,971

Total Present Value of Net Cash Outflows= Rs. 78,971

EVALUATION OF DECISION TO TAKE LOAN

Working Notes:
1. Tax Savings = Tax Rate(30.9%) *
{Depreciation + Interest Amount}
2. Net Outflow = Gross Outflow – Tax Savings

3. Present Value of Net Outflow = Net Outflow

* PVF @ 10%
EVALUATION OF DECISION TO TAKE
LEASE

Year Lease Processing Gross Tax Net Cash PVF @ Present

Rental Fees Outflow Saving Outflow 10% Value of
Net Cash
Outflow

1 30000 1000 31000 9579 21421 0.909 19472

2 30000 - 30000 9270 20730 0.826 17123
3 30000 - 30000 9270 20730 0.751 15568
4 30000 - 30000 9270 20730 0.683 14159
5 30000 - 30000 9270 20730 0.621 12873
79,195
FINAL DECISION

As the Net Cash Outflow in the case of Loan

(Rs.78,971) is less as compared to the Net
Cash Outflow in case of Lease (Rs.79,195) ,
the company should take the asset on a
LOAN.
REFERENCES:-
 http://incometaxmanagement.com/Pages/Tax-
Management-Procedure/5-4-Difference-Between-Tax-
Planning-And-Tax-Management.html
 http://incometaxmanagement.com/Pages/Tax-
Management-Procedure/5-5-The-Difference-Between-Tax-
Avoidance-And-Tax-Evasion.html
 http://incometaxmanagement.com/Pages/Tax-
Management-Managerial-Financial-Decisions/Tax-
Management-Managerial-Financial-Decisions-
CONTETNS.html
 Book on DIRECT TAXES(Law and Practice) by V.K. SINGHANIA
and KAPIL SINGHANIA.
 Previous year unsolved question papers.