ASSIGNMENT OF: CORPORATE TAX PLANNING

Topic: Tax Planning With Reference To Financial

Management Decisions

SUBMITTED TO, Prof:Dhreej Sharma Roll No: 6391 MBA 2ndYr( E )

SUBMITTED BY, Gurwinder Singh

(SCHOOL OF MANAGEMENT STUDIES, PUNJABI UNIVERSITY PATIALA)

INTRODUCTION:
Tax planning is the Exercise undertaken to minimize tax liability through the best use of all available allowances, deductions, exclusions, exemptions, etc., to reduce income and/or capital gains. Tax Planning involves planning in order to avail all exemptions, deductions and rebates provided in Act. The Income Tax law itself provides for various methods for Tax Planning, Generally it is provided under exemptions u/s 10, deductions u/s 80C to 80U and rebates and reliefs. Some of the provisions are enumerated below:

Investment in securities provided u/s 10(15) . Interest on such securities is fully exempt from tax. Exemptions u/s 10A, 10B, and 10BA Residential Status of the person Choice of accounting system Choice of organization.

For availing benefits, one should resort to bonafidemeans by complying with the provisions of law in letter and in spirit. Where a person buys machinery instead of hiring it, he is availing the benefit of depreciation. If is his exclusive right either to buy or lease it . In the same manner to choice the form of organization, capital structure, buys or make products are the assesses exclusive right. One may look for various tax incentives in the above said transactions provided in this Act, for reduction of tax liability. All this transaction involves tax planning. This all is the meaning of tax planning but when we talked about tax planning reference to financial decisions it includes following: Capital structure decision Dividend policy Bonus shares

Tax planning is vital for every company's major decisions. This article enlists and discusses few of the important decisions taken by management and its relation with tax planning under Indian Income Tax Act perspective.

Tax Management with reference to -Deemed Dividend

1. Introduction 2.Any Distribution Entailing Release Etc. 3.Any Distribution By Way Of Debenture Etc. 4.Distribution To Shareholders On Liquidation 5.Distribution On Reduction Of Capital 6.Payment By Way Of Advance Or Loan To Shareholders 7.Tax Planning Through Issue Of Bonus Shares 8.Tax Planning Through Purchase Of Own Shares Or Distribution Of Dividend

INTRODUCTION 10(34) : Exempted of Dividend Applicable Not Applicable 115O : DDT Applicable Not Applicable 194 : TDS Not Applicable Applicable

2(22)(a) to (d) 2(22)(e)

1. General Meaning of Dividend : It is the sum received by the Shareholders of a Company on the distribution of its profits. However Sec. 2(22) define dividend which are notionally or by friction of law is treated as dividend. 2. Dividend Is not impressed with character of Profit : Dividend in its ordinary connotation means the sum paid to or received by a shareholder proportionate to his shareholding in a company out of the total sum distributed. Dividend distributed by a Company being a share of its profits declared as distributable among the shareholders, is not impressed with the character of the profits from which it reaches the hands of the shareholders. 3. A Dividend u/s 205 of the Companies Act can be paid only out of the profits of a company whether for that year or out of the profits of the company for any previous financial years as set out in that section, and in the manner set out in that section. 4. While reading Sec.2(22) stress on these sentences particularly the italicized words : (a) To the extent to which distribution is attributable to the accumulated profits. (b) To the extent to which the company Possesses accumulated profits. (c) Distribution which entail the release of companys assets.

5. As per sec. 2(22) following payments or distribution are not treated as dividend.. (a) any payment made by a company on purchase of its own shares from a shareholder in accordance with the provisions of Sec. 77A of the Companies Act, 1956. (b) any distribution of shares pursuant to a demerger by the resulting company to the shareholders of the demerged Company ( whether or not there is a reduction of capital in the demerged Company). [ SEC. 2(22)(a) ] : ANY DISTRIBUTION ENTAILING RELEASE ETC. (1).Any distribution (2).by a company (3). of accumulated profits, whether capitalized or not (4). if such contribution entails the release by the company to its shareholders of all or any part of the assets of the company: 1. Computation of accumulated profits : Accumulated Profits means commercial profit upto the date of distribution and it comprises of : 1. Current Profit including Capital Gain 2. General Reserve , Investment allowance reserve etc. 3. Tax Free incomes including agricultural income. But does not include 1. Provisions of taxation and dividend 2. Depreciation Reserve 3. Revaluation Reserve. 2. What is Capitalized Accumulated Profits :Where the Accumulated Profit is capitalized by issue of Bonus Shares. 3. What do you mean by release of Companys Assets. Where the distribution is made in cash or in kind to the shareholders it means there is a release of companys assets. 4.When the Assets are distributed u/s 2(22)(a), the market value of the assets on the date of distribution is taken for computing dividend. No Capital gain arises since it is a Gift.

[ SEC. 2(22)(b) ] : ANY DISTRIBUTION BY WAY OF DEBENTURE ETC. 1. Any distribution to its shareholders by a company of 2. Debenture, Debentures-Stock or Deposit Certificates in any form, whether with or without interest, to equity shareholders or preference shareholders ; and 3.Any distribution of Bonus Shares to its Preference Shareholders. 4. to the extent to which the company possesses accumulated profits, whether capitalize or not. Note : 1. In above case the distribution need not entail release of assets of the company as it is required u/s 2(22)(a). 2. And this section is vary specific to define what is dividend like distribution of debenture to shareholders to the extent of accumulated profits shall be treated as Dividend. 3. It may be seen that issue of Bonus Shares to Preference Shareholders is treated as Dividend u/s 2(22)(b). But this is not so in case of issue of Bonus shares to equity shareholders either in Sec. 2(22)(a) or (b).

[ SEC. 2(22)(c) ] : DISTRIBUTION TO SHAREHOLDERS ON LIQUIDATION Any distribution to its shareholders by a company on its liquidation , to the extent to which Distribution is attributable to the accumulated profits, whether capitalized or not, immediately before its liquidation. Note : 1. Computation of Accumulated profits : 1. The Company which is in Liquidation : Accumulated Profits include all profits of the company upto the date of liquidation. 2. Where the company is in liquidation due to compulsory acquisition : Accumulated Profits include all profits of he company upto the date of liquidation but it excludes profits of the company prior to the 3 years immediately preceding the PY in which such acquisition took place. 2. Thus the amount distributed by a company on reduction of its share capital has two components distribution attributable to accumulated profits and distribution attributable to capital.

[ SEC. 2(22)(d) ] : DISTRIBUTION ON REDUCTION OF CAPITAL any distribution to its shareholders by a company on the reduction of its capital, to the extent to which the company possesses accumulated pro fits which arose after the end of the previous year ending next before the 1st day of April, 1933, whether such accumulated profits have been capitalised or not; >> Redemption of Preference Shares at premium shall gave rise to Capital Gain and shall not be treated as Deemed Dividend. [ SEC. 2(22)(e) ] : PAYMENT BY WAY OF ADVANCE OR LOAN TO SHAREHOLDERS (1) .any payment by a company, not being a company in which the public are substantially, [ i.e. closely held company] (2) . any sum made after the 31st day of May, 1987 (3.) by way of advance or loan to a shareholder, being a person who is the beneficial owner of shares holding not less than 10% of the voting power, OR (4) to any concern in which such shareholder is a member or a partner and in which he has a substantial interest (hereinafter referred to as concern) "person who has a substantial interest in the company", in relation to a company, means a person who is the beneficial owner of shares, not being shares entitled to a fixed rate of dividend whether with or without aright to participate in profits, carrying not less than 20% of the voting power; at any time during the relevant PY. [ Sec. 2(32)]. OR (5) any payment by any such company on behalf, or for the individual benefit, of any such shareholder (6) o the extent to which the company in either case possesses accumulated profits; But Dividend does not include. (i) any advance or loan made to a shareholder 58[or the said concern] by a company in the ordinary course of its business, where the lending of money is a substantial part of the business of the company; (ii) any dividend paid by a company which is set off by the company against the whole or any part of any sum previously paid by it and treated as a dividend within the meaning of sub-clause (e), to the extent to which it is so set off.

What is Capitalized Accumulated Profit :Where the accumulated profit is capitalized by issue of Bonus Shares. Note : 1. This section is applicable only to closely held company 2. It may be noted that this section uses the word payment instead of distribution. 3. On analyzing it may be said that any borrowing by a registered shareholder who is having substantial interest, such borrowing shall be treated as dividend. 4. Concern means a Hindu Undivided Family, or a Firm or a Association Person or a Body of Individuals or a Company. 5. Ascertainment of accumulated Profit is done at the time of each and every loan. 6. The company is not liable to pay dividend distribution tax where payment is made u/s 2(22)(e) also the payment u/s 2(22)(e) is not exempt u/s 10(34) . The Company is also liable to deduct Tax at Source u/s 194. 7. Repayment of Loan shall not have any impact on applicability of section 2(22)(e). 8. For the purpose of Sec. 2(22)(e), accumulated profits get reduced by the amount deemed as dividend u/s 2(22)(e) even if no adjustment is made in the books of account. TAX PLANNING THROUGH ISSUE OF BONUS SHARES When Bonus Shares are issued to the equity shareholders, the value of the shares is not taxed as dividend distributed. However, where redeemable preference shares are issued as Bonus shares, on their redemption, the amount shall be taxed as dividend distributed. Where Bonus Shares are issued to the Preference Shareholders, on their issue it is deemed to be dividend and liable to tax. Expenses on issue of Bonus Shares is not allowed as deduction since capital expenditure. TAX PLANNING THROUGH PURCHASE OF OWN SHARES OR DISTRIBUTION OF DIVIDEND Purchase of Own Shares :

Where the company purchase its own shares, the payment refund by shareholders is not treated as dividend. However as per Sec. 64A, when a company purchases its own shares from a Shareholders, the capital gain arising to shareholders is chargeable to Tax.

The Capital Gain shall be computed u/s 48. Indexation of cost of acquisition Value of the year of purchase shares . acquisition Index value of the year of acquisition of share

. X Cost of

1.

The Shareholders shall pay Tax on LTCG.

Thus if a company purchases its own shares instead of distributing dividend, it can reduce its tax liability.

Tax Management with reference to Capital Structure'

CAPITAL STRUCTURE DECISIONS What is the Optimum Capital Structure : The optimum capital structure is a mix of equity capital and debt funds. Their composition depends upon many factors namely : 1. Cost of Capital and also expenditure incurred in raising of such capital. 2. Expectation of shareholders by way of dividend, growth etc. 3. Expansion need of the business i.e. the rate by which profits of the business shall be again ploughed back in the business. 4. Taxation policy ; and 5. Rate of return on investment ( Equity + Debt funds ). TAX CONSIDERATIONS 1. Interest on debt fund is allowed as deduction as it is a business expenditure. Therefore, it may increase the rate of return on owners equity. 2. Dividend on equity fund is not allowed as deduction as it is the appropriate of profit. Dividend is exempt in the hands of shareholders u/s 10(34) . However, the company declaring the dividend shall pay dividend distribution tax @ 12.5% + surcharges + education cess. 3. The Cost raising owners fund is treated as capital expenditure therefore not allowed as deduction. However if conditions of Sec. 35D is satisfied then specified expenditures can be amortized. 4. The Cost of raising dent fund is treaded as revenue expenditure. It can be claimed as deduction in computing the total income. 5. Where the assesses is entitled to incentives u/s 10A etc. maximum equity fund should be utilized. 6. Where interest on debt fund is payable outside India, tax should be deducted at source otherwise deduction is not allowed.

TAX PLANNING 1. If the return on investment > rate of interest , maximum debt funds may be used, since is shall increase the rate of return on equity . However, cost of raising debt fund should be kept in mind. 2. if rate of return on investment < rate of interest, minimum debt funds should be used. 3. Where assessee enjoys tax holidays under various provisions of Income-Tax in such case minimum debt fund should be used, since the profit arising from business is fully exempt from tax which increase the rate of return of equity capital. But the borrowed funds reduces the profits ( profits less interest) before tax and to the extent exemption is reduce. The balance of capital structure shall depend upon maximizing the return on capital employed which is computed by using following formula : Distributable Profit _________________________ X 100 Equity Capital