Chapter-28 Tax Planning Chapter Synopsis/Contents; ST 28.1: Prelude 28.2: What is meant by Tax 28.3: Principles of Tax Plan 28.4: Benefits & 28.6: Techniques Planing ning Limitations of Tax Planning or Methods 28.7: Aids to Perception Questions 8 ., 28.1; Prelude Tax isa compulsory payment to the Government by the persons who come under the orbit of taxing law. Assessees in general don't like to pay tax on taxable income or property which they earn with hard work, sacrifice of leisure and incurring physical or mental effort. This'sometimes give rise to tax evasion and tax avoidance. of Tax Planning Tax evasion is an offense, illegal activity and unwarranted. It means illegal hiding or concealment of income or their sources & manipulating accounts thereof (see : Lakhotia & Lakhotia, 1998, p.9) On the other hand Tax avoidance is an attempt by legal iaeans taking tax loopholes or ambiguity into consideration, to Prevent or reduce tax liability (see : Royal commission of Taxation, 1966, p.538). It is the art of dodging taxes without breaking tax. law provisions, ee 5 Tax planning is the art and techniques to reduce tax liability by adopting certain Strategies, taking full advantages of exclusion and deductions and arraigning transactions in a way that result in lesser tax liability In this context, from a narrow seuse, tax planning and tax avoidance are sometimes use’ interchangeably, But in reat sense, there are some differences. In case of tax avoidance tax loopholes, ambiguity and complexity are exploited to reduce tax burden. Thus if it is not a legal offence, it can be said to be moral offence. On the other hand, tax planning is taking advantage of maximum deductions, exemptions, tebate, relief and arranging activities, investment and transaction, SO as to reduce tax Durden, It is legally permitted & morally permissible. Effective tax planning is thus aimed at by p on to maximize enjoyment of income, savings & return on assets. It is a las to achieve some future goal for the betterment of living, enrichment of wellbeing & enhancement of wealth for self and family. Toxation.75,Tax Plannin’ ioe advance abou y 28.2: What is meant by Tax Plame jeserminin res, aFFANECTTIEN advance: * ‘uireren a eo man objective or 208 ities: rransaction, iNVeStmeny, range os on pnysicah mental and set" og, Tax Planning isp, ter (aX savings than for merg, sate! mi 2 Te: ‘on the planning of the Activities Planning is deciding in ae activities to be performed; ensuring © mobilization process etc. to achieve @! : can be said to be a decision taken 10 advance (0 4! nimi such a way so that future tax liability Ca" beanies cording, resource utilization can be maximized : th yn to achieve ag protection of future income from taxation 1. mo searching for deductions. This definition ¢mP™" that attract less tax. “alia wake maximum advantages op planning 48 T° in leading to reduction of ta Lakhotia & Lakkotia identify tax concessiO exemptions, deductions, rebates, relief and other lowever, Tax planning, it 5 actions. 3 liability. It emphasizes mainly on tax reliefs related activities $0 8S 10 attra 3 nning, practical perspective takes into consideratio n both as to pla . 7 fo the maximum. less tax liability & taking advantages of tax relief provisions 28.3: Principles of Tax Planning ia A ial it e kept . Anes ‘Some basic principles underline tax planning Which need to P a are : i) Advanced planning Take into consideration existing provisions of tax laws, investment & economic « environment and plan the activities so as to achieve long term benefit. Sometimes shor term benefit, income & facilities may be better to sacrifice for long term benefit & future protection of income, wealth & benefit. i ii) Keep it legal It is not desirable to take undue future risk and unpleasant encounters from tat authorities, Plan activities in art environment that is treated as legal. Honesty does pay not the dishonesty. ‘ ‘ 4 sty. In legal environment better options can be taken, what is required is te strategic choice. iii) Disciplined Action Make plan consciously, After conten si ts dering and weighi: 3 ae wt es of existing facilities for stares coe ess a ee ot situation, proper acti id work in a diccirii, ‘ick to it. Analyse and again may be eae work ina disciplined way, Zig-za f tnt in the way to achieve desi ; ig-zag and fluctuation desired Roal. a 2sTax Planning -577 iv) Careful thinking ‘ake time to thi . Tal ink and to come to a decision. Hurried decision can not be fruitful in e. Think ahead, ‘ fore. Th take into consideration the past trend and future probable situation. rrax laws change every year significantly specially as to rate and deduction. Careful tninking and fact based decision is warranted, vy) Money Value y ve ot pe i changes. Weight your benefit interms of future money value and interms of real benefit in future compared to current value and benefit. Short term sacrifice & losses may be significantly enhanced in future giving rise to future comfort, safety & well being. 4 s 28.4: Benefits & Limitations of Tax Plannin; 3 A) Benefits e Me Benefits of tax planning goes to assessees mainly. But tax authorities and exchequer can also.be benefited in the sense that adoption of tax planning may induce assessee to avoid tax evasion activities which is detrimental to tax revenue. It can also save an assessee from taking unlawful and dishonest activities. The benefits to an assessee, in short, can be pointed out as follows: i) It helps lessening tax burden: So helps better li ving condition. ii) It helps an assessee to enhance saving which can lead to investment and betterment of economic life of the assessee and the country. i . iii) It helps creation of better relation between tax payer and tax officials, as in the pretext of tax evasion & avoidance harassment of tax payer by tax officials can be reduced to minimum. iv) Assessee feels comfort as to his earning, tax payment & satisfaction as to tax payment. Anxiety is reduced as to earning, tax payment and investment etc. vy) Conducive tax environment in’the country prevails. Estimation of tax revenue becomes stable & more or less better predictable. »Tax Planning -578 B) Limitations = hange every year ce Tax laws are significantly complex. Tax 1aws ti and maintain stability gp Presenting budgets. So it is difficult to go for better tax ae : *: ‘ 4 the plan. In such a context following limitations can be list tions etc. Changes ting : exemp! ‘ relief, deduction, ax liability in future, i) Tax provisions specially tax rate, ; ; n 5 that will attract Jess t and again. So it is very difficult to plan activities ions, Exemptions ‘ .s tax concess ii) During a year some S.R.Os are issued which change! etc. So plan can be defeated by such changes. i d investment environment, iii) Future is unertion as to economic condition, saving ies also may occur Which Certain unwarranted situation in the life & activities of the asse can adversely affect tax planning. o Imost an order of the day. So estimate iv) Money value changes. Inflation is a ae ; ; tax protecti future benefit becomes difficult & inexact, Thus planning future activities for tax pi ion may became defective. ‘V) Plan need to be adjusted based an future changes. But in case of tax planning such adjustment may be difficult and may not be fruitful. hig 28.5: General Strategies and, Policies OO Several strategies are seen to have been applied in the context of tax planning. Following are some of them : i) Balancing fluctuation of Tax rate, ii) Deferring tax liability, iii) Inyesting in tax free income, iv) Leveraging investments, V) Shifting deductions from low bracket tax payer to high bracket tax payer, + vi) Shifting income from high bracket tax payer to low bracket tax payer, vii) Optimizing tax credit. i sale The basic principles underlying these strategies can be identified as follows: 1 a. a eae caer cg one valentin sti b) Tax decreases if income eared by entity is Subject to low rate. ‘ c) Tax decreases if payment can be defferred to latter period, d) Tax decreases if income can be taxed at preferential rate, e) Tax decreases if income is earned by low rate jurisdiction, ENTax Planning -579 In the abate context a brief discussion of the strategies and Policies are now in order. i) Balancing Tax Rate Income tax rates are progressive or under slab system, Here the more the income, the more the tax. In such a situation if one expects, specially self employed parsons or businessmen, that his/her/their incomes are likely to fluctuate year to year than this strategy may be useful if One expects substantial change of income in the next year, he can try to arrange timing of receipt in favourable way, try to receive at earlier time or at latter period. The question of deductions may also.be considered. Time of deduction allowable can also be adjusted P ii) Deferring Tax Liability deferring may be considered from two angles : deferring income, accelerating deductions & exemptions, It can also be considered combindly. Tax liability can be reduced by delay in receiving, adjusting payment until it is more advantageous (in the concerned items, where it is possible). Pension plan, Benevolent fund eté. are considered as examples of deferring tax liability. Because the portion of your income you place in these plans are not taxed until you receive it in latter period & that under certain condition it may not be taxable receipt. iii) Investing in Tax-free Income Tax free income is of two types— One is tax exempted income; income on which tax is not chargeable. Another is imputed income — income & enjoyment received by a person which is non assessable. For example, govt. or tax authority may declare that one of the items, say tax free govt. security is tax exempt. Income of this investment will thus not to be taxed. As to imputed income it can be said that employer provides a house to employee - its notional value or estimated value upto certain extent will not be taxable. iv) Leveraging Investment Leveraging is debt-equity arrangement. Debt capital may lead to the borrowing of money to increase total capital or property one holds in a business. Interest on borrowed capital is allowed as allowable deduction which can minimize taxable income, But caution should be taken as to whether excess borrowing becomes unfayourable, increase risk & control in the business. ee Me y) Shifting Deductions from Low bracket to High bracket Tax payers A tax unit may have different sources of income i.e. income from securities, income from house property, income from business etc. Some exemptions are allowed under each. There may be some allowable deductions which one can shift from one head to another through proper planning & reduce’ tax ani ere Deon ie beTax Planning +581 li) Driving income from Non-assessable item: ems short term benefit only, it needs to ade in real estate-purchase of land, be beneficial, For sale of Flat or investment is m , depreciation is allowed as pel T LT. Rule, A lanned & careful use can gi e rise to extended life & the ssessee can be be af sod nefited, ivy) Investment in Residential house will give tax benefit to the tax payer & his family. However, assessee need to analyze cost- benefit as to Owning a house & residing in rented house from longer Perspective, ¥) Sharing Income with Family members A family may have several earning members. Now income of husband, wife, minor child are aggregated as per section 44 of I.T. Ofdinance. Now, if wife has some source of income, husband has some sources of income then their share can be relegated. Two Tax files can be opened for each by showing separate "khana" and income & total income will thus be divided & slab of tax rate may thus become lesser, Further, income of the family may be divided to family members. This is an advantageous way which will reduce tax burden due to lessening income of some members & attracting lower tax liability, vi) Creation of Trust & WAKF Estate , Trust i: arrangement ‘when a person transfer the right of property to another Person, aati right is grantor & person receiving the right is trustee. Income of trust ot char & receipts thereof is non house property used for charitable or religious purpose ; i: aM 0ing -582 a ¢ business houses are tries to shift income tof tax efit & this can also 5, Through ity gets take advantage of honourrarium & benefi sometimes use this tax avoidance technique producing property out of his hand & at the same time bee used to control flow of income to the beneficiaries In Bangladesh some WAKF estates are found ete rit, Trust. Here also tax payment can be avoided or minimized alil oa great extent resembles to vil) Gift fo wife, sons & daughters at not tax opted veka Gift can be made to wife, sons & daughters W’ eae Tse them for ivestmen in long term be beneficial in the sense that those receiving 8! a tax payer to ones having or business. This help shift of taxable property from hi gh brac! no tax liability or lesser tax liability. Deferring income or expenditure ime adjustment as {0 e whi receiving income - to receive Assesse to get tax benefit through ti , it wi neficial in next year, or paying exp.-at earlier or latter time, can Se ether it will be ber I as, to tax rate or whether maximum allowable deductions can be adjusted for his benefit. For example, an assessee can open fixed deposit account or purchase Fixed Deposit Receipt (FDR.) This will help him to defer interest income & take benefit of change of money — value. ix) Investment in Savings Instruments Some saving instruments like 5 years Defence certificate, postal saving certificates etc. may be tax exempted. Previously in most of these cases exemptions akin But now the interest on these has been made subject,to tax @ 10% at source. But this js treated as final payment. So the assessee who are under higher tax bracket can invest in those securities & pay tax only 10% which provides a significant tax advantages. - x) Advantages of Fringe benefit” ati gk Gace uly FOP Shela wi csc acc en AR house rent subsidy @ 50% of B.S. ? Tk. 15, ae 2 Senter: eo be: i per month. So employer can provide jouse allowance to that extent which falls within exemption limit. Cases of some othe! benefits like Group insurance, Benevolent fund, Welf: ane fund et, can also be considered within maximum allowable fringe benefit relief, - xi) Purchase of discounted ‘bonds “One can rhase such bond by taking loan. ThisTax Planning —583 nice long term gain. However, there is a tisk factor, bond may go sdur because .of continuing poor financial condition of the issuing enterprise. This require knowled sgt bond market, capability of forecast as to economic condition Ree ied eee Enjoying tax credit in full Tax credit income/investment allowances advantage specially in case of life insurance need to be evaluated & advantages upto maxim S need to be carefully studied every year. Full Premium, group insurance, investment etc. um limit be enjoyed. B) Tax planning Techniques for Business i) Forms of Business There are different types of business, of which, three are main; sole tradership, partnership & company. Sole-tradership in the context of*income tax is “pass through entity" as it is not taxed Separately rather income goes to owners & he Pays tax on it by aggregating income from different other sources, Partnership & company falls in the category of "Non-pass through" as these are taxed as a separate entity from owners. Partnership firm pays tax and share of income is added with partners’ income, However, he gets rebate on partnership income. Similarly Company also pay tax as a separate entity — & shareholders also pay tax on dividend. In such a context an evaluation based on quantum of investible fund, tax rates applicable, benefit or disadvantages of double tax specially in case of Company should be made as to which type will provide tax advantage. In fact it is very complex & ‘complicated decision. But the effect of types of business cannot be ignored. ii) Payment of Fringe Benefit to the maximum A business should enjoy maximum tax deduction facilities through proper planning. Here attention need to be given to fringe benefits payable to employees. There is, however, maximum limit that can be allowed. Taking it into consideration, business houses can Provide maximum possible benefits so that employee morale in one hand increase & tax liability on the other decreases. Here maximum house allowance benefit, conveyance facilities. food & tiffin subsidy at work place, contribution to employees welfare fund, Tuning school or hospitals for employers can be cited as avenues in this regard. iii) Setting up Recognized provident fund Provident fund for recognition by 1.T. authority need to fulfill certain’ conditions. Business should try for such recognition as contribution of employer to recognized PR. is 4n allowable exp. Moreover, this type of P.F. is advantages to employees too. Similarly, Tavatinn-74—584 Tax Planning established in a Busines, . o ed to be Workers welfare fund, Benevolent fund and like others n® house both for tax advantages & help to employees: yment.. The situation of iv) Deferring income & expenditure te ye & Pa . f present deductions ing incom flow, d. Income Tax advantages may be availed by deferri re expected income evaluate & current income level, tax rate, futu iment sales Program cay relevant to quantum income etc. need to be * yw insta! payment may be adjusted. For example, to defer income La ag Payment Fr ery ni be introduced which will contribute towards deferred reve metric bill of December maybe ment of el difference in tax lial hese can be paid ear be taken there of. bility. Repairs can by items may be delayed by 2/3 months etc. Say Pay! ly too. Which one js delayed to January & this can make a significant deferred, premium payment can be deferred or advantageous need to be examined & decisions to v) Maximize capital gain Capital gains are taxed at lower rate th mid & high bracket tax payer. So this can be emphi sale of fixed assets after some year at a comfo maintenance of assets, foresight & adjustability with changi estate, blue chip securities can be examples along with m an ordinary &. regular profit in the context of asized through selection of transactions, table margin. This requires proper ing situation. Investment in real odern machineries etc. in this regard. vi) Availing Tax favoured program a) Accelerated Depreciation allowance: Accelerated depreciation is an alternative to Tax-holiday. Here within two years one can write off value of assets with two advantages. Frst, big depreciation expenses may lead to huge total allowable deductions leading to loss which can be carried forward for next some years. Thus tax need not be paid for some years. On the other hand life of machineries will extend much more beyond its depreciated value time period which will contribute towards income without relevat! depreciation cost. This is also beneficial. b) Investment in industries having Tax-holiday facilities: Tax holiday fo" certain industries are given to accelerate industrial development. i id for certain period, which period vary for different regions aint hs ee One can evaluate such facility & enjoy it to avoid payment of tax for certain cme Here pee eet OA etait rep bs evahoted & corgert so alse 7 ae i v ” peek ferent x hlidy pei indifferent areas also need evaluation in terms —_—/"* Wlanning ~535 vii) Financial leverage an interest is de Loan interest is deductible, So in Capital structure Planning one should evaluate debt.- a However, if there is set norm as to debt-equity it ith excessive debt taking risk, funds to tax favored avenues A business may have some excess fund, reserved f i 5 Or short or mediun term. A wise z warra . é decision is sti for best use Specially taking tax factor into consideretion. Such as. investment in tax free Securities, concession On interest bearing securities ete, : tions allowed & i equity ratio to take maximum advantage isto be taken into consideration along w viii) Investment of available ix) Availing maximum deduct Expenditure for Research & Devel x) Misc. Matters Besides the above, there are many other avenues which can be considered for tax planning. Such as, investment in export activities which will provide tax rebate on earning, performing social responsibilities which will provide tax concessions & enhance prestige of business, choosing method of accounting keeping the existing compliance provision into consideration, adopting tax favoured transactions and activities etc. In the context of tax planning both as an individual & business the underlying mportance may go to three main factors : a) Take action early and thoroughly & not giving only importance to tax deduction cilities rather to other tax favored activities. b) Take economic state'into consideration. Excessive attention to present savings may 0t be worthwhile without consideration of long term saying & solvency. c) Disciplined action is warranted. Planning need to be based oe sound footing Onsidering benefits of alternatives & that once decision is taken, strict discipline & stick to Scision may be rewarding. : ‘ f f In fact tax planning is complex but rewarding. Proper evaluation, knowledge of tax \vironment & socio-political and economic environment is necessary for success in the La oy giana ge