Tag: Advanced Tax Laws

Corporate Tax Planning And Tax Management – Advanced Tax Laws and Practice Important Questions

Question 1.
State with brief reason, whether the following relate to tax planning, tax avoidance, or tax evasion:

1. Setting up of a liaison office in India by a foreign company, instead of a full-fledged establishment to run its business activities in India.
2. Investment in bonds approved for purposes of section 54EC.
3. Businessman claiming depreciation on a refrigerator purchased for residential use.
4. Visiting a foreign country for a certain number of days to reduce the number of days of stay in India.
5. The assessee has two residential houses. He wants to sell a vacant site purchased 6 years back. To avail exemption under section 54F, he gifts a residential house to his major son.

Answer:
(1) Setting up of a liaison office in India by a foreign company, instead of a full-fledged establishment to run its business activities in India is to reap the benefit of the DTAA instead of coming under the provisions of section 9 of the Income-tax Act, and thus is an act of Tax Planning.

(2) Investment in Bonds approved u/s 54EC will reduce tax liability relating to Capital Gains. It is an act of Tax Planning.

(3) Businessman claiming depreciation on a refrigerator purchased for residential use is an act of Tax Evasion because of wrongly claiming depreciation on personal assets by showing as business assets.

(4) Visiting a foreign country to reduce the number of days of stay in India is a measure of Tax avoidance with regard to residential status, which may have an impact on the taxability total income.

(5) Gifting a house property to a major son with a view to come within the eligibility norms of an exemption section is though legally permissible but is an act of Tax Avoidance.

Question 2.
State with reason, whether the following acts can be considered as an act of Tax Planning, Tax Management, Tax Avoidance or Tax Evasion:

1. Starting a business in an industrially backward State will entitle an assessee to claim a deduction under section 80-IB.
2. Transferring of assets to another person without adequate consideration.
3. Installation of Air Conditioner costing ₹ 75,000 at the residence of Director as per terms of appointment; but treating it as Plant installed in Quality Control Section in the factory.
4. Mr. D is a working partner in a firm and he is entitled to a salary of ₹ 30,000 per month. He treats this as salary instead of business income.
5. X&Y Ltd. maintains adequate records and registers of tax deducted at source by it to enable timely compliance of legal provisions.

Answer:
(1) Starting a business in an industrially backward State which will entitle an assessee to claim a deduction is an act of Tax Planning because the incidence of tax is minimized using the exemptions/deduction provided in the Income Tax Act, 1961.

(2) Transferring assets to another person without adequate consideration is an act of Tax Avoidance because the element of mala fide motive is involved to avoid payment of tax.

(3) Installation of Air Conditioner costing ₹ 75000 at the residence of Director as per the terms of appointment but treating it as plant installed in Quality Control Section in the factory is an act of Tax Evasion because of suppression of fact. This is with the objective to treat factory assets for claiming depreciation to be deducted from business income.

(4) Tax Evasion because Mr. D tries to reduce his tax liability by misrepresenting the income as salary instead of business income, thereby claiming the standard deduction.

(5) X & Y maintain adequate records and registers of tax deducted at source by it to enable timely compliances of legal provisions is an Act of Tax Management because it involves compliance of law regularly.

It enables the company to manage the affairs of business efficiently for timely payment of tax and submission of returns.

Question 3.
Specify with brief reason, whether the following acts can be considered as an act of (i) Tax management; or (ii) Tax planning; or (iii) Tax
evasion; or (iv) Tax avoidance:

1. To reduce tax payable, Sunil Varma an individual, paid ₹ 55,000 as of life insurance premium on the policy of his minor son.
2. A foreign company has an Indian subsidiary that is selling its product to the parent company at a price of ₹ 100 per unit while the same product is sold to another foreign company at ₹ 200 per unit.
3. A company claiming depreciation on the motor car which is being used by director for personal purposes.

Answer:
(1) Premium paid on the life insurance policy of minor son is allowed as deduction under section 80C of the Income-tax Act, 1961. Therefore,
₹ 55,000 paid, by Mr. Sunil Varma, as premium on the life insurance policy of his minor son is an act of Tax Planning.

(2) The transaction which is not at Arm’s Length Price ‘ALP’ is an act of Tax Avoidance. In this case, an Indian subsidiary, while selling its products, charging less amount from its foreign parent company and shifting profits to outside India in order to avoid tax liability in India and therefore is an act of Tax Avoidance as the transaction is not at arm’s length price.

(3) Claiming depreciation on the motor cars being used for personal purposes is not allowed under section 32 of the Income Tax Act, 1961. Therefore, the depreciation claimed by the company on the motor car which is being used by the director for personal purposes is an act of Tax Evasion.

Question 4.
Specify whether the following acts can be considered as (i) Tax planning, or (ii) Tax management, or (iii) Tax evasion.

1. P deposits ₹ 1,00,000 in Public Provident Fund (PPF) account so as to reduce his total income from ₹ 3,40,000 to ₹ 2,40,000.
2. SQL Ltd. maintains the register of tax deductions at the source affected by it to enable timely compliance.
3. An individual taxpayer making a tax saver fixed deposit of ₹ 1,00,000 in a nationalized bank.
4. A bank obtaining declaration from depositors in Form No. 15G/15H and forwarding the same to income-tax authorities.
5. Z debits his household expenses as business expenses in the books.

Answer:
(1) Depositing an amount to the Public Provident Fund (PPF) in order to reduce the total income and tax liability is an act of Tax Planning. Therefore, a deposit of ₹ 1,00,000 in ‘PPF’ by P to reduce his total income from ₹ 3,40,000 to ₹ 2,40,000 is an act of Tax Planning.

(2) Maintenance of Register of Tax Deduction at Source to enable timely compliance is an act of Tax Management. Therefore, the maintenance of the TDS registers by SQL Ltd. to enable timely compliance is an act of Tax Management.

(3) Investment in tax saver fixed deposits is allowed as deduction u/s 80C of the Income Tax Act, 1961 and is an act of Tax Planning. Therefore, depositing ₹ 1,00,000 in tax saver fixed deposit by an individual taxpayer is an act of Tax Planning.

(4) Obtaining declaration from depositors by a bank in Form 15G/ 15H and forwarding the same to the Income Tax Authorities is an act of
Tax Management.

(5) Claiming the household expenses as business expenses in the books of account is not allowed as deduction u/s 37 of the Income Tax Act, 1961 and is an act of Tax Evasion. Therefore, the act of Z debiting his household expenses as business expenses is an act of Tax Evasion.

Question 5.
Specify whether the following acts can be considered as an act of Tax management, tax planning, or tax evasion.

1. Surbhi issues a credit note for ₹ 36,000 payable to Suresh, who is the son of Surjit, managing director of the company. The purpose is to increase his income from ₹ 1,00,000 to ₹ 1,36,000 and reduce his income correspondingly.
2. Z Ltd. deducts tax at source but fails to deposit the same in the Government treasury.
3. B transferred 1,000 debentures of a company to his son C before the due date of interest to reduce his tax liability.

Answer:
1. Tax Evasion:
Surbhi Ltd. has issued a credit note to Suresh with a view to transferring part of its income to Suresh.
Suresh being an individual will be liable to tax at normal rates applicable to the individual, which, in this case, will be lower than the rate applicable to Surbhi Ltd. had such transfer of income not been affected, the income would have been taxed in hands of Surbhi Ltd. at a higher rate of 30%. Such an act is a model of tax evasion.

2. Improper Tax management:
In this case, the company will be liable to pay interest and penalty.

3. Tax Avoidance:
In this case, Mr. X wants to avoid his tax liability by transferring the debentures before the due date of interest to his son.

Question 6.
Distinguish between ‘tax planning’ and ‘tax avoidance.
Answer:

Tax Planning	Tax Avoidance
Tax planning is an act within the four corners of the tax laws. It is a means to avail the benefits legally permissible under the Act.	It complies with the legal language of the law but not the spirit of the law.
Tax planning is a permissible legal right that enables the taxpayer to maximize his return net of taxes.	It refers to reducing the tax liability by finding out loopholes in the law.
Tax planning has judicial approval.	The concept can be considered heinous to tax evasion. Government brings amendments to curb such practices and to plug the loopholes.
It does not result in a levy of penalty and prosecution as it is within the language and spirit of the law.	It may result in disregarding the transaction done to avoid tax and may or may not result in penalties and prosecution against the person engaged in it.
An individual who made the investment in PPF to claim deduction under section 80C is an example of tax planning.	An asset transferred by one person to another person without consideration/ without adequate consideration may be treated as an example of tax avoidance.

Question 7.
Distinguish between ‘tax planning’ and ‘tax evasion ‘.

Tax Planning	Tax Evasion
It is an act within four corners of tax laws. It is a means to avail benefits legally permissible.	It is an attempt to avoid tax by misrepresentation of facts and falsification of accounts
It is a permissible legal right that enables the taxpayer to maximize his return net of taxes.	It is a legal offense that may lead to penalties and prosecution.
It enables the assessee to have more cash flow in order to expand the business.	It distorts the economy and results in black money generation.
It is a professional exercise.	It encourages bribery and weakens the economic and political situation of the country.
It has judicial approval.	It is denounced by courts as anti-social

Question 8.
Distinguish between “Diversion of Income and Application of Income”
Answer:

Diversion of Income	Application of Income
Income never reaches the assessee as his own income. By virtue of an obligation, the income is diverted at the source before it reaches the assessee.	Income reaches the assessee as his own income and its subsequently applied to discharge an obligation.
Here, the obligation is on the source of income.	Here, the obligation is on the receipt of income i.e. after income reaches the assessee.
There is an overriding title by virtue of which diversion of income takes place.	There is no overriding title in this case.
In case of diversion, the income is not included in the income of the assessee.	In the case of application, income is included in the income of the assessee.
Since the assessee does not have a title, income cannot be said to have accrued or arisen.	Income is said to have accrued or aris-en and therefore is taxable in hands of the assessee.

Question 9.
Peer Ltd. took over the running business of a Ramu, a sole proprietor by a sale deed. As per the sale deed, Peer Ltd. undertook to pay overriding charges of ₹ 15,000 p.a. to Ramu’s wife in addition to the sale consideration. The sale deed also specifically mentioned that the amount was charged on the net profits of Peer Ltd., who had accepted that obligation as a condition of purchase of the going concern. Examine, in the light of decided case law that whether the payment of overriding charges by Peer Ltd. is in the nature of diversion of income or application of income.
Answer:
The facts of the case are similar to that of the case Jit & Pal X-Rays (P.) Ltd. v. CIT(2004) 134 Taxman 62 (All), where the Allahabad High Court observed that the overriding charge which had been created in favor of the wife of the sole-proprietor was an integral part of the sale deed by which the going concern was transferred to the assessee. The obligation, therefore, was attached to the very source of income i.e. the going concern transferred to the assessee by the sale deed. The sale deed also specifically mentioned that the amount in question was charged on the net profits of the assessee-company and the assessee-company had accepted that obligation as a condition of purchase of the going concern. Hence, it is clearly a case of diversion of income by an overriding charge and not a mere application of income. Thus, the payment of overriding charges by Peer Ltd. to Ramu’s wife is a case of diversion of income and hence allowed to be deducted from Income of Peer Ltd.

Question 10.
Why is tax planning necessary?
Answer:
Tax planning is necessary on account of the following reasons: –
1. The basic objective of tax planning is to reduce the incidence of tax in a legitimate manner. Because of a lack of awareness of the legal requirements, an assessee may not be in a position to take advantage of the various deductions and exemptions allowed under the tax laws.

2. An assessee has to acquire good knowledge of the tax laws and plan his affairs in such a way that he will be in a position to avail the various concessions admissible to them and thus reduce the tax liability to the maximum extent possible.

3. Tax planning also helps in the reduction of litigation which involves wast-age of valuable time and money.

4. Planning is very essential in choosing the areas where investments can be made. In order to encourage investments in certain areas, the Government provides various tax incentives.

5. Tax planning also results in an increase in profits which can legitimately be used for expanding business or setting up new ventures.

6. It facilitates taking of various managerial decisions such as whether to go for modernization and replacement of plant and machinery, buy or take assets on a lease, close or continue the business, etc. g. Tax planning is also necessary to meet the tax liability in time without affecting the financial condition of the taxpayers.

Question 11.
Examine the doctrine of form and substance in the context of tax planning?
Answer:
The following are certain principles enunciated by the Courts on the question as to whether it is the form or substance of a transaction, which

1. will prevail in income-tax matters:
Form of the transaction is to be considered in case of genuine transactions – It is well settled that when a transaction is arranged in one form known to the law, it will attract tax liability whereas, if it is entered into in another form which is equally lawful, it may not. Therefore, in considering whether a transaction attracts tax or not, the form of transaction put through is to be considered and not the substance. However, this rule applies only to genuine transactions.

2. True Legal relation is a crucial element for taxability:
It is open for the authorities to pierce the corporate veil and look behind the legal facade at the reality of the transaction. The taxing authority is entitled j as well as bound to determine the true legal relation resulting from a j transaction. The true legal relationship arising from a transaction alone | determines the taxability of a receipt arising from the transaction.

3. Substance (i.e. actual nature of expenses) is relevant and not the form:
In order to determine whether a particular item of expenditure is of revenue or capital nature, the substance and not merely the form should be looked into.

Question 12.
Global Ltd. is a widely-held company engaged in power generation in Assam. At present, the company is having a capital of ₹ 10 crores in fully paid equity shares. The company is considering a proposal to increase its power generation capacity which will require ₹ 5 crores. The additional capital required can be raised either by the issue of fully paid equity shares or by the issue of 10% debentures. Directors of the company want to raise the funds through equity shares as the company can have fully owned capital. Will you accept the proposal at a 20% rate of return (pre-tax) and a 30% rate of tax? Give reasons in support of your answer.
Answer:
Computation of Expected Rate of Return on Capital Employed Figures in ₹

Particulars	Proposal I	Proposal II
	Issue of equity shares	Issue of 10% Debentures
Equity share capital	15,00,00,000	10,00,00,000
10% Debenture	–	5,00,00,000
Therefore, Total Capital Employed	15,00,00,000	15,00,00,000
PBIT (Expected Rate of return on capital em-ployed @ 20%)	3,00,00,000	3,00,00,000
Less: Interest on Debentures at 10%	–	(50,00,000)
Profit Before Tax (PBT)	3,00,00,000	2,50,00,000
Less: Tax @ 30% on PBT	(90,00,000)	(75,00,000)
Profit After Tax (PAT)	2,10,00,000	1,75,00,000
Expected rate of return for shareholders	14%	17.50%

Decision:
The proposal of deriving additional capital by issuing fully paid-up equity shares is not acceptable as it will give a lesser rate of return to shareholders in the future. Therefore, it is beneficial to raise the additional funds through the issue of 10% debentures as it will increase the rate of return to shareholders from 14% to 17.50%.

Question 13.
Does a company want to raise capital of ₹ 40,00,000 for a project where earnings before tax would be 30% of the capital employed? The company can raise debt finance @ 12% p.a. The following three alternatives for raising capital are available for the company:

• ₹ 40,00,000 by equity capital
• ₹ 20,00,000 by equity capital and ₹ 20,00,000 by loans
• ₹ 8,00,000 by equity capital and ₹ 32,00,000 by answer:

Assume that the company would distribute the entire amount of profits as dividends. The tax rate is 31.20%. Work out which one of the above three alternatives should the company opt to minimize its tax liability?
Answer:
Analysis of financing options to minimize the tax liability of the company Figures in ₹

Particulars	Alternative 1	Alternative 2	Alternative 3
Earnings Before Interest and Tax (40,00,000 × 30%)	12,00,000	12,00,000	12,00,000
Less: Interest	–	(2,40,000) (20,00,000 × 12%)	(3,84,000) (32,00,000 × 12%)
Earnings Before Tax	12,00,000	9,60,000	8,16,000
Less: Tax @ 31.20%	(3,74,400)	(2,99,520)	(2,54,592)
Earnings After Tax available for Equity Shareholders	8,25,600	6,60,480	5,61,408
Rate of return on equity share capital (e/Share Capital × 100)	20.64%	33.02%	70.18%

Decision:
Since Alternative 3 offers the maximum rate of return on equity share capital, the company should opt for Alternative 3.

Questions 14.
Ravi Glass Ltd., a widely held company is considering a major expansion of its activities for which an additional investment of ₹ 3 Crores is required. The company has the following three options/alternatives for the financing of the proposed additional investment of ₹ 3 crores:

• By issue of Equity shares and raise the equity share capital only.
• ₹ 2 crores from the issue of Equity shares and ₹ 1 crore by issue of 15% debentures.
• ₹ 1 crore from the issue of Equity shares, ₹ 1 crore from the issue of 15% debentures, and the remaining ₹ 1 crore by taking a bank loan on interest payable at 15% p.a.

The expected rate of return on the new investment has been worked out at 30%. The corporate rate of tax for the time being on the income is 31.20%. The company has proposed to declare the total net profits as dividends. You are required to suggest to the company which is the best alternative to be undertaken for the purpose of the proposed investment. Assume that no other taxes are being payable/to be charged on the distributed profits.
Answer:
Computation of Expected rate of return on equity share capital: Figures in ₹

Particulars	Proposal I Issue of Equity shares only	Proposal II Issue of Equity shares and 15% Debentures	Proposal III Issue of Equity Shares, Bank loan @ 15% and 15% Debentures
Earnings Before Interest and Tax (₹ 3,00,00,000 × 3096)	90,00,000	90,00,000	90,00,000
Less: Interest @ 15% on Debentures	–	(15,00,000) (₹ 1,00,00,000 × 15%)	(15,00,000) (₹ 1,00,00,000 × 15%)
Less: Interest on Bank Loan	–	–	(15,00,000) (₹ 1,00,00,000 × 15%)
Earnings Before Tax	90,00,000	75,00,000	60,00,000
Less: Tax @ 31.2% of EBT	(28,08,000) (90,00,000 × 31.2%)	(23,40,000) (75,00,000 × 31.2%)	(18,72,000) (60,00,000 × 31.2%)
Earnings After Tax	61,92,000	51,60,000	41,28,000
Expected rate of return on equity share capital (f / Equity Share Capital × 100)	20.64%	25.80%	41.28%

Decision/Conclusion:
The rate of return on equity is highest in the case of the third alternative. Therefore, the company should opt for the third alternative.

Question 15.
X Ltd. has a share capital of ₹ 60,00,000. For the expansion of business, it requires an additional ₹ 60,00,000. To finance the project, the company has three options:

• Issue of Equity shares only.
• Issue of equity shares of ₹ 30,00,000 and 12% debentures amounting to ₹ 30,00,000.
• Issue of equity shares of ₹ 15,00,000, issue of 12% debentures of ₹ 30,00,000, and the remaining amount from borrowings from the bank at 20% interest per annum.

Assuming that the expected rate of return is 25%, advise which alternative the company should opt to maximize the rate of return. The rate of tax is 31.20%.
Answer:
Computation of Return on Equity share capital for X Ltd. Figures in ₹

Particulars	Alternative 1 Issue of equity shares only	Alternative 2 Issue of equity shares and Debentures	Alternative 3 Issue of equity shares, debentures, and borrowings from the bank
Earnings Before Interest and Tax (₹ 1,20,00,000 × 25%)	30,00,000	30,00,000	30,00,000
Less: Interest	–	3,60,000 (₹ 30,00,000 × 1296)	6,60,000 (30,00,000 × 12%) + (₹ 15,00,000 × 2096)
Earnings After Tax	30,00,000	26,40,000	23,40,000
Less: Tax @ 31.20%	9,36,000	8,23,680	7,30,080
Earnings After Tax available to equity shareholders	20,64,000	18,16,320	16,09,920
Return on Equity share capital (c/Eq uity Share Capital × 100)	17.20%	20.18%	21.47%

Conclusion:
The company should opt for Alternative 3 as Return on equity share capital is highest under that option.

Questions 16.
A is employed with XYZ Ltd. His salary is ₹ 1,00,000 per month. He is also paid a house rent allowance of ₹ 20,000 per month. His wife B is also employed at a salary of ₹ 40,000 per month with ABC Ltd. where A holds 20% shares.

B does not hold adequate qualifications for the post which she is holding. B is the owner of a house that is self-occupied by the family. The house was constructed in the year 2018-19 with borrowed funds. Suggest a scheme for tax planning to minimize the tax liability for the financial year 2020-21. (Assessment Year 2021-22).
Answer:
A is advised to reduce his shareholdings with XYZ Ltd. from 20% to 1 19% to avoid clubbing of salary income of B (A’s wife) u/s 64( 1 )(iv).

B should not treat the house as self-occupied. She should let it out to A and issue a rent receipt of an amount say ₹ 40,000 per month. On the basis of rent receipt, A is entitled to claim the exemption in respect of House Rent Allowance ‘HRA’ to reduce his tax liability. Besides, B can claim the exemption in respect of interest payable on housing loans.

Question 17.
Vijay is employed with Sunder Ltd., at a monthly salary of ₹ 45,000. He also receives ₹ 5,000 per month as a house rent allowance. he deposits ₹ 40,000 in the PPF account. He also pays ₹ 30,000 as tuition fees for his two children.

Vijay’s wife, Isha is employed with Chander Ltd., at a monthly salary of ₹ 25,000, where Vijay holds 21% of the shares of the company. Isha is not adequately qualified for the post held by her in Chander Ltd. Isha owns a house used as a self-occupied house by the family. The municipal value of the house is ₹ 3,60,000. It was constructed with borrowed funds in 2019-20. Interest on the loan is ₹ 1,80,000 p.a. Isha insured the house and paid an insurance premium of ₹ 8,000 to United India Insurance Company. She also paid ₹ 20,000 as municipal taxes.

Suggest a scheme of tax planning for both Vijay and Isha to minimize their tax liability during the financial year 2020-21.
Answer:
Some of the Tax planning measures for Vijay and Isha could be:
(1) Vijay holds a substantial interest (2196) in Chander Ltd. where Isha holds a post for which she is not adequately qualified. Thus, the remuneration received by Isha would be clubbed in the income of Vijay. To avoid | this, Vijay may reduce his shareholding in Chander Ltd. to 1996.

(2) Vijay and Isha may request their respective employers to restructure their salaries, as follows:

• Restructure salaries to break up the monthly salary into basic pay, conveyance allowance/car facility, leave travel facility, medical reimbursement, and telephone reimbursement, etc. This will reduce the amount of taxable salary.
• There are several employees’ welfare schemes such as recognized provident fund, approved superannuation fund, gratuity fund. Payments made towards such schemes are eligible for deductions. So, Vijay and Isha may request their employer to include these welfare schemes and make contributions towards the same.

(3) Currently Isha is treating the house as self-occupied by the family; she may rent out this to Vijay against a rent receipt. This will enable Vijay in claiming the deduction for House Rent Allowance.

(4) Isha may claim the deduction for the principal amount and the interest amount paid for the funds borrowed for the construction of the house. For the principal amount, the deduction could be claimed for up to ₹ 1,50,000, and for interest, the amount deduction could be claimed up to ₹ 2,00,000.

Question 18.
A, B, and C are planning to start a retail business. The profits of the business for the year are estimated to be ₹ 20,00,000. Two alternatives are available to them regarding the selection of form of organization:

1. A Partnership Firm:

• Capital introduced by each partner: ₹ 20,00,000
• Interest on capital at 20%
• Salary ₹ 3,00,000 p.a. to each
• Profits are to be distributed equally.

2. A Company:

• Share Capital of ₹ 4,00,000 each.
• Loan of ₹ 16,00,000 by each @ 12%.
• Salary of ₹ 3,00,000 p.a. to each.
• Remaining profits are to be distributed equally as dividends Advise, which alternative is better from the tax point of view.

Answer:
Alternative 1: Partnership Firm
Computation of tax outflow under this option:

Particulars	Amount (₹)	Amount (₹)
Profits as an estimate of the firm		20,00,000
Less: Interest on capital (₹ 20,00,000 × 12% × 3)		7,20,000
Book Profits		12,80,000
Less: Allowable Remuneration towards partners
Lower of following 2:-
Actual Remuneration towards working partners ₹ 3,00,000 × 3 partners) and;	9,00,000
Maximum Limit: ? 3,00,000 × 90% + Balance Book Profits × 60% = 2,70,000 + ₹ 5,88,000	8,58,000
Therefore, Allowable remuneration		8,58,000
Profits and Gains from Business or Profession/Total Income of firm		4,22,000
Tax Liability @30%	1,26,600
Add: Health and Education Cess @ 4%	5,064	1,31,664
Rounded off to nearest of ₹ 10u/s 288B		1,31,660
Partners Total Income (Each partner)
Interest to the extent allowed in the firm (₹ 20,00,000 × 1296)	2,40,000
Salary (To the extent allowed in the firm) {₹ 8,58,000/3}	2,86,000
Share of profit from the firm {Fully Exempt u/s 10(2A) of Income Tax Act]	–	5,26,000
Tax liability of each partner
On an income of ₹ 2,50,000	–
On ₹ 2,50,000 to ₹ 5,00,000, Tax@ 5%	12,500
On income between ₹ 5,00,000 to ₹ 10,00,000, Tax at 2096 (₹ 26,000 × 20%)	5,200
Sub Total	17,700
Add: Health and Education Cess @ 4%	708
Total Tax each partner	18,408
Rounded off to nearest of ₹ 10 u/s 288B		18,410
Therefore, Tax liability of 3 partners (₹ 18,410 × 3)		55,230
Therefore, Total Tax Outflow under this option (₹ 1,31,660 + ₹ 55,230)		1,86,890

Alternative 2: Company
Computation of Total tax outflow under this option:

Particulars	Amount(₹)	Amount (₹)
Profits as an estimate of the company		20,00,000
Less: Interest on Loan (₹ 16,00,000 × 12%)		5,76,000
Less: Salary (₹ 3,00,000 × 3)		9,00,000
Profits and Gains from Business or Profession/Total Income		5,24,000
Tax Liability at 25%		1,31,000
Add: Health and Education Cess @ 4%		5,240
Total Tax payable by the company		1,36,240
Profit After Tax Available for distribution as dividend (₹ 5,24,000 – 1,36,240)		3,87,760
Shareholders/Director’s Total Income (Each)
Income from Salary	3,00,000
Less: Standard Deduction u/s 16(id)	(50,000)
Net Taxable Salary		2,50,000
Income from Other Sources:
Interest on Loan (₹ 16,00,000 × 12%)	1,92,000
Dividend (₹ 3,87,760)/3	1,29,253	3,21,253
Total Income		5,71,253
Rounded off to nearest of ₹ 10u/s 288B		5,71,250
Tax liability of each partner:
On an income of ₹ 2,50,000	–
₹ 2,50,000 to ₹ 5,00,000, Tax at 5%	12,500
On income between ₹ 5,00,000 to ₹ 10,00,000, Tax at 2096 (₹ 71,250 × 20%)	14,250
Sub-Total	25,750
Add: Health and Education Cess @ 4%	1,030	26,780
Therefore, Tax payable by 3 shareholders/directors (₹ 26,780 × 3)		80,340
Therefore, Total tax outflow (₹ 1,36,240 + ₹ 80,340)		2,16,580

Advice:
Since overall tax outflow is less in the option of the firm than a company, it is advisable to start a new business in the form of a partnership firm.

Note:
Keeping in view amendments made by Finance Act, 2020 applicable w.e.f. A.Y. 2021-22 (Relevant to RY. 2020-21), Dividend is taxable in hands of recip¬ient i.e. shareholders & hence, it is included in the total income of shareholders and tax is calculated on total income as per normal slab rates applicable to individuals. There will be no implication of Dividend Distribution Tax (DDT) for dividends declared, paid, or distributed on or after 01.04.2020.

Further, it is assumed that the individual assessee has not opted for an alternative mechanism to compute tax as per section 115BAC of the Income Tax Act, hence normal rates of tax are applied.

Author’s Note:
In the view that ICSI is asking questions restricted to 5 marks only in recent exams, such lengthy questions may not be asked. However, it has been included here as any part of such question could be asked individually. Further, for conceptual clarity with respect to selection of the type of entity: Partnership Firm v/s Company the question is must be covered.

Questions 19.
From the following information, advice as to which shall be a better option, i.e., repair or replacement of machine:

• The cost of repair is ₹ 90,000 and the machine will work for 4 years.
• An expenditure of ₹ 18,00,000 shall be incurred on the purchase of a new machine and the scrap value of the machine after 10 years would be, ₹ 72,000.
• On purchase of the new machine, the production will increase and the profit of the organization will increase from ₹ 9,00,000 to ₹ 15,00,000 per year.
• The rate of interest is 15% (on purchase).
• The old machine can be sold at present for ₹ 1,50,000 and after 4 years it would be sold for ₹ 30,000.
• The rate of income tax is 30% and no surcharge is payable. Health & education cess is applicable as per rules.

Answer:
Comparative statement showing After-Tax Profit from different alternatives: Figures in ₹

Particulars	Repair	Replacement
Annual Repairing Expenses (Note 1)	22,500	–
Depreciation on the new machine (Note 2)	–	1,72,800
Interest on ? 18,00,000 at 15% p.a.	–	2,70,000
Depreciation on the old machine	30,000	–
Total Expenses	52,500	4,42,800
Expected Profit	9,00,000	15,00,000
Less: Total Expenses	52,500	4,42,800
Net Profit Before Tax	8,47,500	10,57,200
Less: Income Tax @ 31.20% (Rounded off u/s 288B) (Tax at 30% + Health and Education Cess @ 4%)	2,64,420	3,29,850
Profit After Tax	5,83,080	7,27,350

Decision:
It is better to replace the old machine with the new one as overall profit is higher in that option as compared to the under the option of repairing the machine.

Note:
Annual Repairing expenses = ₹ 90,000/4 = ₹ 22,500
Depreciation on New Machine = (₹ 18,00,000 – ₹ 72,000)/10 = ₹ 1,72,800
Depreciation on existing machine = (₹ 1,50,000 – ₹ 30,000)/4 = ₹ 30,000

Question 20.
Sure Success Ltd. wants to acquire an asset costing ₹ 1,00,000. It has 2 options available, the first one is buying the asset by taking a loan repayable in 5 installments of ₹ 20,000 each with 14% interest per annum. The second is leasing the asset for which the annual lease rental charge is ₹ 30,000 up to 5 years. The lessor charges 1% as a processing fee in the first year. Assume Internal Rate of Return to be 10%.

The Present Value factors are

Year	1	2	3	4	5
PV Factor	.909	.826	.751	.683	.621

Assuming that the payments are made at the end of the year, suggest which alternative is better for the company. The rate of depreciation is 15% while the tax rate is 31.20%.
Answer:

I. If the Asset is taken on lease
Computation of Present Value of Net Cash Outflows under this option: Figures in ₹

Year	Lease Rentals	Tax savings at 31.20%	Net Cash Outflow	Present Value Factor @ 10%	Present Value (? )
1	31,000*	9,672	21,328	0.909	19,387
2	30,000	9,360	20,640	0.826	17,049
3	30,000	9,360	20,640	0.751	15,501
4	30,000	9,360	20,640	0.683	14,097
5	30,000	9,360	20,640	0.621	12,817
					78,851

“Processing Fees is assumed at 1% of original cost of asset. Therefore, ₹ 1,00,000 × 196 = ₹ 1,000. Therefore, Total outflow in year 1 = ₹ 30,000 + ₹ 1,000 = ₹ 31,000. Sum of Present value under this option shall be ₹ 78,851.

II. If the Asset is bought using Loan funds as given:
Computation of Present Value of Net Cash Outflows under this option: Figures in ₹

Particulars	Year 1	Year 2	Year 3	Year 4	Year 5
Payment of Loan (Principal)	20,000	20,000	20,000	20,000	20,000
Interest	14,000	11,200	8,400	5,600	2,800
Gross Outflow	34,000	31,200	28,400	25,600	22,800
Depreciation @ 15%	15,000	12,750	10,838	9,212	7,830
Total of Interest and Depreciation	29,000	23,950	19,238	14,812	10,630
Tax savings @31.12%	9,048	7,472	6,002	4,621	3,317
Net Cash Outflow	24,952	23,728	22,398	20,979	19,483
PV Factor	0.909	0.826	0.751	0.683	0.621
PV of Outflow	22,681	19,599	16,821	14,328	12,099

Therefore, some of the present value of net cash outflow under this option shall be ₹ 85,528.

Decision:
It is advisable to opt for taking the asset on lease as the sum of present value p of net cash outflow is lower under this option.

Question 21.
An Ltd. wants to acquire a machine on 1st April 2020. It will cost ₹ 60,00,000. It is expected to have a useful life of 5 years. Scrap Value will be? 10,000. If the machine is purchased through borrowed funds, the rate of interest is 11.5% p.a. Loan is repayable at the end of 5 years. If the machine is acquired through lease, lease rent would be ₹ 16,00,000 p.a. Profit before depreciation and tax are expected to be ₹ 4.5 crores every year. Depreciation is charged at 15% p.a. on Written Down Value. Besides, the additional depreciation is available in the first year. Investment allowance is, however, not available. The average rate of tax may be taken at 31.20%.

An Ltd. seeks your advice whether it should –
a. Acquire the machine through own funds or borrowed funds or
b. Take it on lease.
Present Value factor shall be taken at 10%. At this rate, present values of Re.l are – Year 1: 0.9091, year 2: 0.8264, Year 3: 0.7513, Year 4: 0.6830 and Year 5: 0.6209.
Answer:
I: If the Asset is bought with own funds:
Computation of Present Value of Net Cash Outflows under this option:

Particulars	Amount (₹)
Gross Cash Outflow at year 0	60,00,000
Less: Present Value of savings in tax on account of depreciation (Note 1)	(10,22,700)
Less: Present Value of Salvage value at end of year 5 (₹ 10,000 × 0.6209)	(6,209)
Therefore, the Present Value of Net Cash Outflows under this option	49,71,091

Note 1
Computation of Present Value of savings in tax on account of depreciation: Figures in ₹

Particulars	Year 1	Year 2	Year 3	Year 4	Year 5
Written Down Value	60,00,000	39,00,000	33,15,000	28,17,750	23,95,087
Depreciation at 15% on Written Down Value	21,00,000 (60,00,000 × 15%) + (60,00,000 × 20%#)	5,85,000 (₹ 39,00,000 × 15%)	4,97,250 (₹ 33,15,000 × 15%)	4,22,663 (₹ 28,17,750 × 15%)	3,59,263 (₹ 23,95,087 × 15%)
Tax Savings at 31.20% on above	6,55,200 (₹ 21,00,000 × 31.20%	1,82,520 (₹ 5,85,000 × 31.20%)	1,55,142 (₹ 4,97,250 × 31.20%)	1,31,871 (₹ 4,22,663 × 31.20%)	1,12,090 (₹ 3,59,263 × 31.20%)
PV Factor at 10%	0.9091	0.8264	0.7513	0.6830	0.6209
Present Value (c × d)	5,95,642	1,50,835	1,16,558	90,068	69,597

# In year 1, there is additional depreciation. The rate of such additional depreciation is 20% of the Actual Cost of the asset.

Some of the Present Value of Tax savings on account of depreciation is ₹ 10,22,700

II: If Asset is bought with Loan Funds
Computation of Present Value of Net Cash Outflows under this option: Figures in ₹

Particulars	Year 1	Year 2	Year 3	Year 4	Year 5
Repayment of Loan	–	–	–	–	60,00,000
Interest ( ₹60,00,000 × 11.5%)	6,90,000	6,90,000	6,90,000	6,90,000	6,90,000
Gross Outflow	6,90,000	6,90,000	6,90,000	6,90,000	66,80,000 (66,90,000 – 10,000 being scrap value)
Depreciation (5) 15% (Ref: Note 1)	21,00,000	5,85,000	4,97,250	4,22,663	3,59,263
Total of Depreci-ation and Interest	27,90,000	12,75,000	11,87,250	11,12,663	10,49,263
Tax Savings on above @ 31.20%	8,70,480	3,97,800	3,70,422	3,47,151	3,27,370
Net Cash Outflow	(1,80,480)	2,92,200	3,19,578	3,42,849	63,52,630
PV Factors at 10%	0.9091	0.8264	0.7513	0.6830	0.6209
Present Value	(1,64,074)	2,41,474	2,40,099	2,34,166	39,44,348

Some of the Present Value of net cash outflows under this option shall be ₹ 44,96,013

III: If Asset is taken on lease
Computation of Present Value of Net Cash Outflow under this option: Figures in ₹

Particulars	Year 1	Year 2	Year 3	Year 4	Year 5
Lease Rentals i.e. Gross Outflow	16,00,0000	16,00,000	16,00,000	16,00,000	16,00,000
Less: Tax Savings @ 31.20%	4,99,200	4,99,200	4,99,200	4,99,200	4,99,200
Net Cash Outflow	11,00,800	11,00,800	11,00,800	11,00,800	11,00,800
PV Factor at 10%	0.9091	0.8264	0.7513	0.6830	0.6209
Present Value	10,00,737	9,09,701	8,27,031	7,51,846	6,83,487

Therefore, some of the present value of net cash outflows shall be ₹ 41,72,902

Notes:
1. In Option III, instead of applying PV factors for each year from year 1 to year 5, students may apply the Present Value Annuity Factor as Net Outflows are common at ₹ 11,00,800 each year.

2. In Option I and Option II, there is Short Term Capital Loss at end of year 5 as the asset is sold only for ₹ 10,000 against WDV of ₹ 20,35,824 (₹ 23,95,087 less ₹ 3,59,263). However, such Short-Term Capital loss is neglected for decision making as it can be set off only against capital gains (either Long Term or Short Term). Hence, the assumption is that in a given case such loss will not account for any savings in tax.

3. Profit Before Depreciation and Tax is the same under every option and hence is immaterial in decision making. Therefore, it is neglected and the decision is based on the outflows.

Decision:
It is advisable to take the asset on lease as the sum of the present value of net cash outflows is least under that option.

Author’s Note:
Numerical based on “Purchase of Asset v/s Taking Asset on Lease” as covered above are not asked these days in Exams. However, we have included it above as some part of it might be asked for lower weightage of say 5 marks AND also, for conceptual clarity, it is important to solve such questions. The theory question on the said issue can be attempted only if a student knows logic which best could be understood through numerical.

Question 22.
Suresh is employed in Delhi and is drawing ₹ 50,000 per month as salary. Besides, he got a one-month salary as a bonus. He is given an option by the employer, either to accept HRA or a rent-free accommodation which is owned by the employer. HRA is payable @ ₹ 10,000 per month, while the rent for accommodation in Delhi is ₹ 12,000 per month. Advise Suresh, whether it would be beneficial for him to avail of HRA or rent-free accommodation provided by the employer.
Answer:
Computation of tax liability of Suresh, in case he accepts Rent Free Accommodation:

Particulars	Amount (₹)
Basic Salary (₹ 50,000 × 12)	6,00,000
Bonus (One month’s salary)	50,000
Valuation of Rent-Free Accommodation (₹ 6,00,000 + ₹ 50,000) × 15%	97,500
Therefore, Gross Salary	7,47,500
Less: Standard Deduction under section 16(ia)	(50,000)
Net taxable salary/Total Income	6,97,500
Tax liability
On first ₹ 2,50,000	–
On ? 2,50,000 to ₹ 5,00,000, Tax @ 5%	12,500
On ? 5,00,000 to ₹ 10,00,000, Tax @ 20% (₹ 1,97,500 × 20%)	39,500
Sub Total	52,000
Add: Health and Education Cess @ 4%	2,080
Net Tax liability	54,080

Salary for valuation of perquisite of accommodation is “Basic + D.A. (TOE) + Any Commission + Bonus + Any other monetary benefits + Taxable element of allowances”.
Computation of tax liability of Suresh in case if he accepts HRA:

Particulars	Amount (₹)
Basic Salary (₹ 50,000 × 12)	6,00,000
Bonus	50,000
Taxable House Rent Allowance (refer Note)	36,000
Gross Taxable Salary	6,86,000
Less: Standard Deduction under section 16(id)	(50,000)
Net Taxable Salary/Total Income	6,36,000
Tax liability
On income up to ₹ 2,50,000	–
On income between ₹ 2,50,000 to ₹ 5,00,000, tax at 5%	12,500
On income between ₹ 5,00,000 to ₹ 10,00,000, tax @ 20% (₹ 6,36,000 – ₹ 5,00,000) x 20%	27,200
Sub Total	39,700
Add: Health and Education Cess @ 4%	1,588
Total tax	41,288
Rounded off to nearest of ₹ 10 under section 288B	41,290

Working Note:
Taxable House Rent Allowance is computed as follows:

Particulars	Amount (₹)	Amount (₹)
HRA received (₹ 10,000 x 12)		1,20,000
Less: Exempted u/s 10(13A): Least of following 3:-
i.HRA received	1,20,000
ii Rent Paid less 10% of salary* (₹ 12,000 x 12) -(₹ 6,00,000 x 10%)	84,000
iii. 50% # of salary (₹ 6,00,000 x 50%)	3,00,000
Therefore, Exemption		84,000
Taxable HRA		36,000

’Salary for purpose of HRA = Basic + D.A. (Terms of Employment) + Commission (% of sales) i.e ₹ 6,00,000 #50% when rent paid in Mumbai, Delhi, Kolkata, Chennai.

Computation of Net take away of Suresh under both the options: Figures in ₹

Particulars	Accommodation	HRA
Basic Salary	6,00,000	6,00,000
Bonus	50,000	50,000
Accommodation/HRA	–	1,20,000
Gross Inflow	6,50,000	7,70,000
Less: Taxes Payable	(54,080)	(41,290)
Less: Rent Payable	–	(1,44,000)
Net Cash Inflows	5,95,920	5,84,710

Notes:

1. It is assumed that both the houses i.e. the one under the HRA option and the one under the Accommodation option are identical.
2. the decision cannot be taken only on basis of tax outflow as under option of HRA, the assessee is making an extra payment of Rent of ₹ 2,000 from his pocket, as HRA received, is ₹ 10,000 per month, but rent paid is ₹ 12,000 p.m. Such outflow is not involved in the Accommodation option.

Decision:
Since overall net cash inflow is higher under the option of Accommodation, it is advisable to opt for the same instead of HRA.

Question 23.
Make an analysis between the purchase and taking on the lease of an asset for the purpose of business by the assessee considering the Income Tax provisions and the benefits available. Which option is considered to be better as per tax provisions and other benefits?
Answer:
Analysis between Purchase of an assets and taking the assets on Lease for the purpose of business: –
(1) In case of purchase, depreciation is allowed under section 32. On the other hand, depreciation will not be allowed u/s 32 in case of assets taken on lease.
This principle has also been upheld by the Hon’ble Supreme Court in the case of ICDS Ltd. v. CIT(2013) 350 ITR 527.

(2) In the case of a lease, lease rent paid will be allowed as a deduction u/s 37(1) as revenue expenditure. Repairs are also allowable under section 31.

(3) In case of purchase, insurance premium, current repairs are allowed as deduction u/s 31, and interest on borrowed funds is deductible u/s 36 a revenue expenditure.

(4) Purchase of machinery would create tangible assets which can also be a mortgage in case of finance needs whereas in the case of assets taken on lease, it is not possible.

(5) In the case of the purchase option, residual value at the end of useful life belongs to the Lo owner. Capital gains tax liability or savings should also be taken Into consideration.

The benefits available as to tax payments are to be worked out separately under both the situations and be analyzed to find out which option is better. However, taking of an asset by investing own funds be always found to be better because of the available benefits under the tax laws and having of tangible assets In the business.

Question 24.
What are areas of tax planning with reference to the location of business?
Answer:
The Income Tax Act. 1961 provides for various benefits based on the location of the business. The various areas of tax planning in relation thereto arc as follows:

1. Special provisions in respect of newly established units in Special Economic Zone (Section 10M)
2. Deduction In respect of profits and gains from industrial undertakings or enterprises engaged in infrastructure development, etc. (Section 80-IA)
3. Deduction in respect of profits and gains by an undertaking or enterprise engaged in the development of special economic zone (Section 80-lAB)
4. Special provisions in respect of specified business (Section 80-lAC)
5. Deduction in respect of profits and gains from certain industrial undertakings other than infrastructure development undertakings, etc. (Section 80.18)
6. Deductions in respect of profits and gains from housing projects (Section 80-IBA)
7. Special provisions in respect of certain undertakings or enterprises in certain special category states (Section 80-IC)
8. Special provisions in respect of certain undertakings in north-eastern states (Section 804E)
9. Deduction in respect of certain incomes of offshore banking units and international financial services center (Section SOLA)

Question 25.
The Board of Directors of your company Is In a dilemma whether to purchase outright the machines for their company or to acquire them through leasing Advice on tax implications.
Or;
Explain leasing wI. buying of a business asset as a tool of tax planning.
Answer:
In recent years, leasing has become a popular source of financing in India. Leasing is a financial arrangement whereby an organization is vested with the use and control over assets without a title of ownership, in consideration of lease rent for a period of time. The person who leases i.e. the owner is called lessor while the person who takes the asset on lease is called the lessee. The decision to lease or buy an asset with borrowed funds can be made after considering the following:

1. Owned/Borrowed Funds: If the asset is purchased through owned funds, there will be a heavy initial outlay and funds will be locked up being denied other investment opportunities. If the asset is purchased through borrowed funds, then apart from interest payments, the provision would have to be made for payment of loan installments. Lease Reniais: In a lease option, annual lease rentals results in significant
recurring expenditure.

2. Tax implications: The lease rentals are deductible for income tax. purposes as operating expenses of the concern. In case assets arc purchased, the assessee will be entitled to a deduction of depreciation. In the case of the purchase of assets with borrowed funds, the interest payment will also be deductible.

3. The costs of operating the asset art Irrelevant since It Is the same irrespective of the mode of acquisition. However, if operating costs are different in the case of ownership or lease, then they should be considered. In case the firm owns the asset, it has full right over residual value at end of the useful life of the asset, in respect of which capital gains/loss may have to be computed. However, in the case of a lease, the residual value doesn’t belong to the firm.

Author’s Note:
Institute has not been asking such theory questions from tax planning in recent times. However, they have been included in this book so that students could get conceptual clarity on these issues. Hence, it is advisable to thoroughly go through such questions as well.

Corporate Tax Planning And Tax Management Notes

• Concept and illustrations of Tax Planning, Tax Management, Tax Avoidance, and Tax Evasion.
• Areas of corporate tax planning:

1. Form of organization/ownership pattern.
2. Locational aspects.
3. Nature of business.
4. Tax planning in respect of corporate restructuring.
5. Tax planning in respect of financial management.
6. Tax planning with respect to Non-resident companies.
7. Tax planning in respect of employee’s remuneration.
8. Tax planning in respect of court rulings and legislative amendments.

• Concept and illustrations of Tax Planning, Tax Management, Tax Avoidance, and Tax Evasion.
• Areas of corporate tax planning:

1. Form of organization/ownership pattern.
2. Locational aspects.
3. Nature of business.
4. Tax planning in respect of corporate restructuring.
5. Tax planning in respect of financial management.
6. Tax planning with respect to Non-resident companies.
7. Tax planning in respect of employee’s remuneration.
8. Tax planning in respect of court rulings and legislative amendments.

CS Professional Advance Tax Law Notes