CU-BBA-SEM III-Corporate Tax Planning-SECOND DRAFT

providing technical know-how used in its business in Mumbai during the previous year 2020-21. 3. Explain the tax implications of remuneration received by individuals who are not citizens of India as per section 10(6) of the Income-tax Act, 1961. 4. Elaborately discuss about the exempt income of non-residents. 5. Briefly discuss about the following in the context of section 9 of the Income Tax Act, 1961. a) Income from salaries earned in India b) Income from salaries payable by the Government for services rendered outside India c) Dividend paid by an Indian company outside India d) Interest e) Royalty B. Multiple Choice Questions 1. A foreign national's remuneration received as an employee of a foreign firm for services done during his stay in India is tax-free. One of the requirements for the aforesaid revenue to be excluded is that the total time of stay in the PY does not exceed _________days. a. 80 days b. 150 days c. 90 days d. 182 days 2. Mrs. Neena Kansal, is resident of Singapore since year 2000. She holds an NRE account with Bank of Baroda, New Delhi Branch. Interest of ₹ 10,000 was credited to such account during financial year 2020-21. Such interest income shall be ________ in the hands of Mrs. Neena Kansal. a. Taxed in the year in which it is credited b. Exempt c. Taxed in the year in accrued d. None of these 3. All firms and LLPs will be taxed at a flat rate of ___ 101 a. 20% b. 22% c. 25% d. 30% CU IDOL SELF LEARNING MATERIAL (SLM)

4. The remuneration earned by an individual who is not an Indian citizen for services as an official of a foreign state's embassy, high commission, legation, commission, consulate, or trade representation, or as a member of their staff, is exempt, provided a. The remuneration received by our corresponding Government officials resident in such foreign countries should be exempt b. The official should not be engaged in any other business or profession or employment in India. c. Both of these d. None of these 5. Any fees for technical services will be deemed to accrue or arise in India if they are payable by a person who is resident in India. The exception to this is a. When the fees are paid for technical services used in a business or profession carried on by the person outside of India. b. When the fees are paid for technical services for the purpose of making or earning money from any source outside of India. c. Either (a) or (b) d. Neither (a) nor (b) Answers 1-c, 2-b, 3-d, 4-c, 5-c 6.8 REFERENCES  V.K. Singhania,DirectTaxes,Taxman Publication (P)Ltd.,Delhi,Latestedition.  Lakhotia R.N., Income Tax Planning Handbook, Vision Books, New Delhi, Latestedition.  H.C. Mehrotra–IncomeTaxLaw&Practice.  Bhagwati Prasad: LawandPracticeofIncomeTaxinIndia  H.P.Ranina:CorporateTaxation: AHandbook(Taxmann).  V.S.Datey:IndirectTaxes– LawandPractice(TaxmannPublicationsLimited).V.S.Datey:IndirectTaxes– LawandPractice(TaxmannPublicationsLimited). 102 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT 7: TAX PLANNING AND FINANCIAL MANAGEMENT STRUCTURE 7.0 Learning Objectives 7.1 Meaning of Capital Structure 7.2 Designing Capital Structure 7.3 Concepts for designing optimal capital structure 7.4 Optimal capital structure 7.5 Tax considerations 7.6 Capital rationing 7.7 Tax Consideration with respect to dividend 7.8 Tax Consideration with respect to bonus shares 7.9 Summary 7.10Keywords 7.11Learning Activity 7.12Unit End Questions 7.13References 7.0 LEARNING OBJECTIVES After studying this unit students will be able to  Understand the meaning of capital structure  Learn about design of capital structure  Understand the tax implications of dividend and bonus shares. 7.1 INTRODUCTION Broadly speaking, the choice in the matter of financing a new unit or business would be between capital and borrowings. New units being set up by existing units or companies would have the possibility of using retained profits. In the case of a company, the means of finance are as follows: (i) Share capital. (ii) Debentures. (iii) Other borrowed moneys. (iv) Generation of funds through profits. While the return on share capital is a charge on the profits after tax, the return on loans to the lenders is a charge on the profits before tax. Thus, recourse to borrowings would offer a tax advantage which will be reflected in a higher rate of return on the owner’s capital. 103 CU IDOL SELF LEARNING MATERIAL (SLM)

7.2 MEANING OF CAPITAL STRUCTURE Capital structure is the combination of capitals from different sources of finance. The equity shareholders' money, preference share capital, and long-term external obligations make up a company's capital. The company's requirement for capital and the cost of capital are used to determine the source and amount of capital. However, a company's goal is to maximise its value, and this is the primary consideration for determining the best capital structure. The choice on capital structure refers to the types of financing (which sources to tap), their actual requirements (the amount to be funded), and their relative proportions (mix) in overall capitalisation. When funds are needed to finance investments, the capital structure must be considered. A demand for raising funds generates a new capital structure since a decision has to be made as to the quantity and forms of financing. 7.3 DESIGNING CAPITAL STRUCTURE A company can raise capital for its investment plans from a variety of sources in varied quantities. It can: a) Exclusively use debt (in case of existing company), or b) Exclusively use equity capital, or c) Exclusively use preference share capital (in case of existing company), or d) Use a combination of debt and equity in different proportions, or e) Use a combination of debt, equity and preference capital in different proportions, or f) Use a combination of debt and preference capital in different proportion (in case of existing company). The choice of the combination of these sources is called capital structure mix. But the question is which of the pattern should the firm choose? Factors Governing Capital Structure While choosing a suitable financing pattern, certain fundamental principles should be kept in mind, which are discussed below: (a) Cost Principle:An optimum pattern or capital structure, according to this notion, is one that minimises capital structure costs while maximising earnings per share (EPS). For e.g. Debt capital is cheaper than equity capital from the point of its cost and interest being deductible for income tax purpose, whereas no such deduction is allowed for dividends. (b) Risk Principle: According to this principle, reliance is placed more on common equity for financing capital requirements than excessive use of debt. Use of more and more debt means higher commitment in form of interest payout. This would lead to erosion of 104 CU IDOL SELF LEARNING MATERIAL (SLM)

shareholders value in unfavourable business situation. There are two risks associated with this principle: i) Business risk:Because of the environment in which the company must function, it is an inherent risk that is represented by the unpredictability of earnings before interest and taxes (EBIT). Revenues and expenses, in turn, determine variability. Demand for firm products, price changes, and the proportion of fixed costs in total cost all affect revenues and expenses. ii) Financial risk: It is a risk associated with the availability of earnings per share caused by use of financial leverage. It is the additional risk borne by the shareholders when a firm uses debt in addition to equity financing. Generally, a firm should neither be exposed to high degree of business risk and low degree of financial risk or vice-versa, so that shareholders do not bear a higher risk. (c) Control Principle:The finance manager should keep in mind that existing management control and ownership should not be disrupted while developing a capital structure. Issue of new equity will dilute existing control pattern and also it involves higher cost. Issue of more debt causes no dilution in control but causes a higher degree of financial risk. (d) Flexibility Principle: By flexibility it means that the management chooses such a combination of sources of financing which it finds easier to adjust according to changes in need of funds in future too. While debt could be interchanged (If the company is loaded with a debt of 18% and funds are available at 15%, it can return old debt with new debt, at a lesser interest rate), but the same option may not be available in case of equity investment. (e) Other Considerations: Besides above principles, other factors such as nature of industry, timing of issue and competition in the industry should also be considered. Industries facing severe competition also resort to more equity than debt. Thus, a finance manager in designing a suitable pattern of capital structure must bring about satisfactory compromise between the above principles. The compromise can be reached by assigning weights to these principles in terms of various characteristics of the company. 7.4CONCEPTS FOR DESIGNING OPTIMAL STRUCTURE 105 CU IDOL SELF LEARNING MATERIAL (SLM)

The capital structure decisions are so significant in financial management, as they influence debt – equity mix which ultimately affects shareholders return and risk. Since cost of debt is cheaper, firm prefers to borrow rather than to raise from equity. So long as return on investment is more than the cost of borrowing, extra borrowing increases the earnings per share. However, beyond a limit, it increases the risk and share price may fall because shareholders may assume that their investment is associated with more risk. For an appropriate debt -equity mix, let us discuss some key concepts: - Leverages: There are two leverages associated with the study of capital structure, namely operating leverage and financial leverage. Operating leverage: - Operating leverage exists when a firm has a fixed cost that must be defrayed regardless of volume of business. It is described as a company's ability to magnify the effects of fluctuations in sales on earnings before interest and taxes by using fixed operational costs. In simple words, the percentage change in profits accompanying a change in volume is greater than the percentage change in volume. Operating leverage can also be defined in terms of Degree of Operating Leverage (DOL). Operating leverage exists when the proportionate change in EBIT as a result of a given change in sales is greater than the proportionate change in sales. The bigger the operating leverage, the higher the DOL. Therefore, DOL exists when Percentage change in EBIT/Percentage change in Sales is > 1 Financial leverage: - Financial leverage involves the use of fixed cost of financing and refers to the mix of debt and equity in the capitalisation of a firm. Financial leverage is a superstructure built on the operating leverage. It results from the presence of fixed financial charges in the firm’s income stream. They are to be paid regardless of the amount of EBIT available to pay them. After paying them, the operating profits belong to the ordinary shareholders. In simple words, financial leverage involves the use of funds obtained at a fixed cost in the hope of increasing the return to the shareholders. When the firm makes more on the assets purchased with the funds than the fixed cost of their use, it is said to have positive financial leverage. Financial Leverage is also called as “Trading on Equity”. The degree of financial leverage can be found out as: Percentage change in Earnings before interest and tax (EBIT) Percentage change in Earnings per share (EPS) 106 CU IDOL SELF LEARNING MATERIAL (SLM)

Positive Financial Leverage occurs when the result of above is greater than 1. Operating Leverage vis-à-vis Financial Leverage: - A company having higher operating leverage should be accompanied by a low financial leverage and vice versa, otherwise it will face problems of insolvency and inadequate liquidity. Thus, a combination of both the leverages is a challenging task. However, the determination of optimal level of debt is a formidable task and is a major policy decision. Determination of optimal level of debt involves equalising between return and risk. EBIT-EPS analysis is a widely used tool for determining a company's debt level. By calculating the indifference point, a comparison of various methods of financing can be drawn. It refers to the EBIT level at which EPS remains constant regardless of the debt-equity mix. For a better understanding, the ideas of leverages and EBIT-EPS analysis will be discussed individually. Coverage Ratio: The ability of a company to utilise debt in its capital structure can also be measured using the EBIT/Interest coverage ratio. The higher the ratio, the more certain it is that interest payments will be made. Cash flow Analysis:It's a useful tool for analysing EBIT-EPS and determining the best capital structure. Cash flow in unfavourable situations should be studied to establish debt capacity. A high debt equity ratio is not risky if the company has the ability to generate cash flows. It would, therefore, be possible to increase the debt until cash flows equal the risk set out by debt. The main drawback of this approach is that it fails to take into account uncertainty due to technological developments or changes in political climate. These approaches as discussed above do not provide solution to the problem of determining an appropriate level of debt. However, with the information available a range can be determined for an optimum level of debt in the capital structure. 7.5 OPTIMAL CAPITAL STRUCTURE The theory of optimal capital structure deals with the issue of the right mix of debt and equity in the long-term capital structure of a firm. This theory states that if a company takes on debt, the value of the firm increases up to a point. Beyond that point if debt continues to increase then the value of the firm will start to decrease. Similarly, if the company is unable to repay the debt within the set time frame, it may harm the company's reputation in the market and may make it difficult to collect additional debt. As a result, the company should choose its capital structure carefully, taking into account the aforementioned criteria. 7.6 TAX CONSIDERATIONS 107 CU IDOL SELF LEARNING MATERIAL (SLM)

i) Interest on debt fund is allowed as deduction as it is a business expenditure. Therefore, it may increase the rate of return on owner’s equity. ii) As it is the appropriate of profit, dividends on equity funds are not recognised as a deduction. Dividends are tax-free in the hands of shareholders under Section 10(34) of the Income Tax Act. The company declaring the dividend, on the other hand, must pay a 10% dividend distribution tax plus surcharges and cess. iii) The cost of raising the owner's fund is considered a capital expense, so it cannot be deducted. Specific expenditures can be amortised if the conditions of Section 35D are met. iv) The cost of raising the borrowed financing is considered a revenue expense. It is allowable as a deduction when calculating total income. v) When an assessee is eligible for incentives under Section 10A, etc., the maximum equity fund should be used. vi) Where interest on debt fund is payable outside India, tax should be deducted at source otherwise deduction is not allowed Tax Planning i) If the rate of return on investment exceeds the rate of interest, the maximum loan funds may be used to boost the rate of return on equity. However, cost of raising debt fund should be kept in mind. ii) if rate of return on investment < rate of interest, minimum debt funds should be used. iii) When an assessee is entitled to tax holidays under various provisions of the Income Tax Act, a minimal debt fund should be used since business profits are tax-free, increasing the rate of return on equity capital. However, borrowed money diminish profits (profits less interest) before taxation, reducing the amount of exemption available. iv) The balance of capital structure shall depend upon maximizing the return on capital employed which is computed by using following formula: Distributable Profit/ Equity Capital × 100 7.7 TAX CONSIDERATION WITH RESPECT TO DIVIDEND MEANING OF DIVIDEND UNDER THE INCOME TAX ACT, 1961 The following receipts are deemed to be dividends under section 2(22): (a) Distribution of accumulated profits, entailing the release of company’s assets - Any distribution of accumulated profits, whether capitalised or not, by a company to its shareholders is dividend if it entails the release of all or any part of its assets. 108 CU IDOL SELF LEARNING MATERIAL (SLM)

Note: If accumulated profits are distributed in cash, it is dividend in the hands of the shareholders. When accumulated earnings are paid in kind, such as through the delivery of shares etc. entailing the release of company assets, the market value of such shares on the day of distribution is regarded dividend in the shareholder's hands. (b) Distribution of debentures, deposit certificates to shareholders and bonus shares to preference shareholders - Any debenture, debenture stock, or deposit certificate issued by a company to its shareholders in any form, whether with or without interest, and any distribution of bonus shares to preference shareholders to the extent that the company has accumulated profits, whether capitalised or not, will be deemed a dividend. In the hands of the preference shareholder, the market value of such bonus shares is considered a dividend. Debentures, debenture stock, and other similar instruments should be evaluated at market rate, or according to recognised valuation standards if there is no market pricing. Note: Bonus shares issued to equity stockholders are not considered a dividend. (c) Distribution on liquidation - Dividend income is defined as any distribution given to a company's shareholders on its liquidation, to the degree that the distribution is attributable to the company's accumulated profits immediately before its dissolution, whether capitalised or not. Note: Any distribution made from the company's profits after the date of liquidation cannot be considered a dividend. It's a repayment towards capital. (d) Distribution on reduction of capital - A company's distribution to its shareholders on the reduction of its capital, to the degree that the company had accumulated earnings, whether capitalised or not, is deemed to be a dividend. (e) Advance or loan by a closely held company to its shareholder – To the extent of the accumulated earnings, any payment by a company in which the public has no considerable interest of any money by means of advance or loan to any shareholder who is the beneficial owner of 10% or more of the voting power of the firm is regarded to be dividend. If the loan is not covered by the accumulated profits, it is not deemed to be dividend. Advance or loan by a closely held company to a specified concern - Any payment made by a company in which the public has no substantial interest to any concern (i.e., HUF/ Firm/ AOP/ BOI/ Company) in which a shareholder has beneficial ownership of at least 10% of the equity shares and in which he has a substantial interest (i.e., at least 20% share of the concern's income) will be deemed to be a dividend. Any payments made by a closely held firm on behalf of, or for the benefit of, a single shareholder are also deemed dividends. In all circumstances, however, the maximum dividend is limited to the amount of accrued earnings. 109 CU IDOL SELF LEARNING MATERIAL (SLM)

Exceptions: The following payments or loan given would not be deemed as dividend: (i) Loan granted in the ordinary course of business - The loan or advance to a shareholder or to the specified concern is not deemed to be dividend if it is made in the ordinary course of business and lending of money is a significant component of the company's business. (ii) Dividend paid is set off against the deemed dividend - If a loan was previously treated as a dividend and the company then declares and distributes a dividend to all of its shareholders, including the borrowing shareholder, and the dividend is set off by the company against the previous borrowing, the adjusted amount will not be treated as a dividend again. Note: Subsequent repayment of loan or charge of interest at market rate does not make any difference in the applicability of section 2(22)(e). Other exceptions Apart from the exceptions cited above, the following also do not constitute “dividend” - (i) Distribution in respect of non-participating shares issued for full cash consideration – Any distribution made in accordance with (c) or (d) in respect of any share issued for full cash consideration and the holder of such share is not entitled to participate in the surplus asset in the event of liquidation. (ii) Payment on buy back of shares - Any payment made by a company to a shareholder for the acquisition of its own shares in accordance with section 77A of the Companies Act, 1956; (iii) Distribution of shares to the shareholders on demerger by the resulting company - Any distribution of shares on 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). Meaning of “accumulated profits” All profits of the company up to the date of distribution or payment of dividend are included in accumulated profits in points (a), (b), (d), and (e). All profits of the company up to the date of liquidation, whether capitalised or not, are included in accumulated profits (point c). However, where an undertaking is liquidated as a result of the Government or any corporation owned or controlled by the Government acquiring it by force, the accumulated profits do not include any profits made by the company prior to the three previous years immediately preceding the year in which the acquisition took place. In the event of an amalgamated company, the amalgamating company's accumulated earnings, whether capitalised or not, on the date of amalgamation are included in the amalgamated company's cumulative profits, whether capitalised or not, or loss, as the case may be. 110 CU IDOL SELF LEARNING MATERIAL (SLM)

Taxability Any income by way of dividend received from a company, whether domestic or foreign, is taxable in the hands of shareholder at normal rates of tax. However, dividend distributed by a domestic company before 1.4.2020 and received by the shareholders on or after 1.4.2020 and on which dividend distribution tax under section 115-O, if applicable, has been paid would be exempt in the hands of the shareholders except dividend chargeable to tax u/s 115BBDA. Up to F.Y. 2019-20, domestic company was liable to pay additional income-tax u/s 115-O @15% [30%, in respect of deemed dividend u/s 2(22)(e)] on dividend distributed by it, consequent to which dividend was exempt in the hands of shareholder u/s 10(34) except dividend chargeable to tax u/s 115BBDA. Tax on certain dividends distributed by domestic companies before 1.4.2020 but received on or after 1.4.2020 [Section 115BBDA] (i) Any income by way of aggregate dividend in excess of ₹ 10 lakh distributed by domestic companies before 1.4.2020 but received on or after 1.4.2020 shall be chargeable to tax in the case of specified assessee who resident in India is, at the rate of 10% [further, increased by surcharge, if applicable and health and education cess @4%]. (ii) Meaning of certain terms Term Meaning Specified Assessee A person, resident in India, other than ➢Domestic Company ➢ a fund or institution or trust or any university or other educational institution or any hospital or other medical institution referred to in section 10(23C) (iv)/(v)/(vi)/(via) ➢ a trust or institution registered under section 12A or 12AA Dividend Includes dividend referred under section 2(22)(a) to (d) but shall not include sub-clause (e) thereof. Table 7.1 Meaning of certain terms (iii) Further, the taxation of dividend income in excess ₹ 10 lakh shall be on gross basis i.e., no deduction in respect of any expenditure or allowance or set-off of loss shall be allowed to the assessee in computing the income by way of dividends. Illustration MNO (P) Ltd. is a company in which the public are not substantially interested. K is a shareholder of the company holding 15% of the equity shares. The accumulated profits of the company as on 1.10.2020 amounted to ₹ 10,00,000. The company lent ₹ 1,00,000 to K by an account payee bank draft on 1.10.2020. The loan was not connected with the business of the 111 CU IDOL SELF LEARNING MATERIAL (SLM)

company. K repaid the loan to the company by an account payee bank draft on 30.3.2021. Examine the impact of K taking out a loan and repaying it on the computation of his total income for the assessment year 2021-22. Solution According to section 2(22)(e), any payment by a company in which the public has no substantial interest in the form of an advance or loan to a shareholder, defined as a person who is the beneficial owner of shares with at least 10% voting power, is treated as a dividend to the extent that the company has accumulated profits. In this scenario, MNO (P) Ltd. is a company in which the general public has little interest. On 1.10.2020, the company had accumulated profits of ₹10,00,000. The company did not grant K a loan in the course of its business. K owns more than ten percent of the company's equity shares.Assuming that K's voting power is proportional to his shareholding, section 2(22)(e) applies. In the hands of Mr. K, a deemed dividend of ₹1,00,000 under section 2(22)(e) would be taxable at the normal rate of tax. The liability arises under section 2(22)(e) the moment the shareholder borrows the loan, and it makes no difference whether the loan is repaid before the end of the accounting year or not. As a result, K's return of the loan to the company on 30.3.2021 will have no effect on the taxability of the deemed dividend of ₹1,00,000. 7.8 TAX CONSIDERATION WITH RESPECT TO BONUS SHARES When redeemable preference shares are issued as bonus shares to equity shareholders, there will almost certainly be a release of assets in the shareholders' favour upon redemption of such bonus preference shares; such payoff of bonus share will be taxable as dividend under section 2(22)(a) of the Income Tax Act. Where bonus shares are issued to the preference shareholders, on their issue it is deemed to be dividend and liable to tax. When a shareholder sells the bonus shares, the cost of bonus shares is taken as nil. Bonus shares given to equity shareholders are not treated as dividend. 7.9SUMMARY  Capital structure is the combination of capitals from different sources of finance.  A firm has the choice to raise funds for financing its investment proposals from different sources in different proportions.  Cost Principle: According to this principle, an ideal pattern or capital structure is one that minimizes cost of capital structure and maximizes earnings per share (EPS). 112 CU IDOL SELF LEARNING MATERIAL (SLM)

 Risk Principle: According to this principle, reliance is placed more on common equity for financing capital requirements than excessive use of debt.  Business risk: Because of the environment in which the company must function, it is an inherent risk that is represented by the unpredictability of earnings before interest and taxes (EBIT).  Financial risk: It is a risk associated with the availability of earnings per share caused by use of financial leverage.  Control Principle: The finance manager should keep in mind that existing management control and ownership should not be disrupted while developing a capital structure.  Flexibility Principle: By flexibility it means that the management chooses such a combination of sources of financing which it finds easier to adjust according to changes in need of funds in future too.  The capital structure decisions are so significant in financial management, as they influence debt – equity mix which ultimately affects shareholders return and risk.  When a company has a fixed cost that must be covered regardless of sales level, it has operating leverage.  Financial leverage involves the use of fixed cost of financing and refers to the mix of debt and equity in the capitalization of a firm.  Any income by way of dividend received from a company, whether domestic or foreign, is taxable in the hands of shareholder at normal rates of tax.  Bonus Shares issued to equity shareholders will not be deemed as dividend. 7.10KEYWORDS  EBIT-Earnings before interest and tax  EPS- Earnings per share  DOL – Degree of Operating Leverage 7.11LEARNING ACTIVITY 1. Learn about benefits of investment in ELSS Scheme as provided in Income Tax Act ___________________________________________________________________________ _______________________________________________________________ 2. Learn more about equity and preference shareholders. ___________________________________________________________________________ _____________________________________________________________________ 7.12UNIT END QUESTIONS 113 CU IDOL SELF LEARNING MATERIAL (SLM)

A. Descriptive Questions Short Questions 1. How debt funds increase rate of return on equity? 2. Explain briefly about Optimal capital structure. 3. What are the factors governing Capital structure? 4. Define the meaning of bonus shares and briefly discuss its tax implications. 5. PKC (P) Ltd. is a company in which the public are not substantially interested. K is a shareholder of the company holding 15% of the equity shares. The accumulated profits of the company as on 1.10.2020 amounted to ₹ 10,00,000. The company lent ₹ 1,00,000 to K by an account payee bank draft on 1.10.2020. The loan was not connected with the business of the company. K repaid the loan to the company by an account payee bank draft on 30.3.2021. Examine the impact of K taking out a loan and repaying it on the computation of his total income for the assessment year 2021- 22. Long Questions 1.Explain the key concepts in designing optimal capital structure. 2.An Indian company is evaluating three distinct ideas to raise Rs. 1200000 for a project that is expected to earn 36 percent of the capital invested before taxes. Which of the following three options should the company choose: issuing equity shares entirely or in combination with borrowing from a bank at a rate of 12 percent per annum, or issuing debentures and any capital mix of three sources: a) The entire amount of Rs. 1200000 will be raised via equity share capital. b) Rs. 600,000 from equity shares, plus Rs. 300,000 from all other possible sources. c) Rs. 400000 from all possible sources Assume that the company will pay out the full profit as a dividend and that the applicable corporate tax rate is 30.9 percent.What will be your answer, if return on capital employed before tax is12% instead of 36%, other things reaming the same? 3. Explain in detail about the tax considerations with respect to dividend income. 4. Elaborate about advance or loan by a closely held company to its shareholder in the context of section 2(22)(e) of the Income Tax Act, 1961. Discuss about its exceptions. 5. Explain in detail about operating leverage and financial leverage. B. Multiple choice Questions 1. Positive financial leverage occurs when the result is a. >1 b. <1 c. =1 d. =0 2. The main drawback of cash flow analysis approach is that it fails to take into account a. Uncertainty due to technological developments 114 CU IDOL SELF LEARNING MATERIAL (SLM)

b. Changes in political climate c. Both (a) and (b) d. None of these 3. _________ from a domestic company is exempt in the hands of shareholders. a. Interest b. Dividend c. Both (a) and (b) d. None of these 4. The cost of raising fund is treated as _______________ a. Revenue Expenditure b. Capital Expenditure c. Both (a) and (b) d. None of these 5. _____________ will be taxed as dividend in the hands of equity shareholders. a. Issue of bonus equity shares b. Issue of bonus preference shares c. Redemption of bonus preference shares d. All of these Answers 1-a 2-c 3-b 4-a 5-c 7.13REFERENCES  V.K. Singhania,DirectTaxes,Taxman Publication (P)Ltd.,Delhi,Latestedition.  Lakhotia R.N., Income Tax Planning Handbook, Vision Books, New Delhi, Latestedition.  H.C. Mehrotra–IncomeTaxLaw&Practice.  Bhagwati Prasad: LawandPracticeofIncomeTaxinIndia  H.P.Ranina:CorporateTaxation: AHandbook(Taxmann).  V.S.Datey:IndirectTaxes– LawandPractice(TaxmannPublicationsLimited).V.S.Datey:IndirectTaxes– LawandPractice(TaxmannPublicationsLimited). 115 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT 8: TAX PLANNING IN NEW BUSINESS STRUCTURE 8.0 Learning objectives 8.1 Introduction 8.2 Setting up of Business and Tax Planning 8.3 Tax planning for Business Deductions – Some General Considerations. 8.4 Special Economic Zones 8.5 Hundred Percent Export-oriented Undertakings 8.6 Summary 8.7 Keywords 8.8 Learning Activity 8.9 Unit End Questions 8.10 References 8.0 LEARNING OBJECTIVES After studying this unit students will be able to  Explain about tax planning in setting up of new business  State about business deductions  Discuss about SEZ and EPZ Zones  Learn about Tax benefits of SEZ and EOU  Describe the special provisions in IT Act relating to SEZ and EOU 8.1 INTRODUCTION Setting up of business in the context of the Income-tax Act, 1961 is a concept entirely confined to that Act. It is not the same as the commencement of the business and these two concepts have been clearly distinguished for income-tax purpose. There may be a period of time between the date of establishment and the date of start during which the assessee may incur revenue-related expenses. Under most tax regulations, expenses incurred prior to the date of incorporation are not typically deductible for income tax reasons. But if those are incurred on and from the date of setting up, but before commencement of the business, they may be allowed as deduction for tax purposes provided of course they are revenue in nature and are incurred wholly and exclusively for the purposes of business. It is now practically well settled by various judicial rulings that a business is set up as soon as it is ready to commence production and it is not necessary that actual production should be so 116 CU IDOL SELF LEARNING MATERIAL (SLM)

commenced. Thus, in the case of a company established for manufacturing cement, the business is set up as soon as acquiring of limestone is commenced even if at that time the plant and machinery may not have been installed so that actual manufacturing operations may commence. 8.2 SETTING UP OF BUSINESS AND TAX PLANNING A tax planner should set the start-up date so that the company has the most allowable expenses incurred contemporaneously to the start-up date, keeping in mind that expenses incurred prior to the start-up date are inadmissible as direct deductions, whereas if the expenses are of a revenue nature and are wholly and exclusively incurred for business, they are allowable as direct deductions. The following examples may be noted: (a) This type of expense could be classified as a revenue expenditure. Interest on borrowing, brokerage, legal fees, and other expenses incurred in arranging long-term loans— India Cement Ltd. vs. CIT 60 ITR 52 (SC). (b) Such expenses may be included in the cost of assets that are eligible for depreciation – Challapalli Sugars Ltd. vs. CIT 98 ITR 167 (SC). Explanation 8 to Section 43(1), which states that any interest paid or due in connection with the acquisition of an asset that is related to any period after the asset is first put to use cannot be capitalised, is relevant in this case. (c) Such expenses may be considered preliminary and eligible for amortisation under section 35D over a five-year period. (d) If the expenditure is capital in nature and does not fit into one of the three categories listed above, it may be prohibited, and no depreciation or amortisation relief may be available. 8.3 TAX PLANNING FOR BUSINESS DEDUCTIONS — SOME GENERAL CONSIDERATIONS: There are several matters which affect the assessee’s ability to deduct various expenses for income-tax purposes. Some of the principal considerations to be borne in mind planning for business deductions, are given below: Successful tax planning for business deductions necessitates a detailed grasp of the numerous legislative provisions governing the deductions, as well as knowledge of the statutory rights and constraints that apply to those rights. The general principles that apply to business deductions in tax planning concentrate around their- (a) permissibility. (b) the year in which it is permissible (c) extent of allowability (including any disallowance clauses), and 117 CU IDOL SELF LEARNING MATERIAL (SLM)

(d) carry-forward to future years. Often, the question of expenditure being capital or revenue and the consequences attaching to the likely treatment eventually may also be an important part of the tax planning exercise. This aspect has been discussed at a later stage. One of the most crucial components of tax planning is ensuring that the maximum deduction or allowance is acquired as soon as feasible for the purpose of calculating taxable income. Therefore, while deciding about incurring of capital and revenue expenditure, the assessee should consider the tax treatment of such expenditures and the period within which the benefit of deduction or amortisation would be obtained so that he can estimate and work out cash flow position over a period of time. While tax considerations play a major role in investment decisions, the general principles of financial management and their effect on investment decisions should not be ignored. The tax planner should keep in mind the advantage arising out of minimising the expenditure, especially in the initial years of a business, so that the profits may be maximised and the assessee may be in a position to avail of the various tax incentives like depreciation as also the tax holiday provisions. Depending on the form of accounting used, mercantile or cash, a deduction for expenditure is usually allowed in the year in which it is incurred or paid. In other words, the expense that can be deducted must be claimed in the year in question. If the assessee uses the cash accounting system, the expenditure allowance will be accessible only when the moneys for the expenses are actually paid by the assessee. In the mercantile accounting system, however, if a business liability has clearly emerged during the accounting year, a deduction should be granted. Where accounts are kept on a mercantile basis, if an expenditure is claimed on the ground that it is legally deductible, it can be claimed in the year in which the liability for the expenditure is incurred even though the payment itself is made in a subsequent year. If an assessee following mercantile system fails to claim an expense in the year in which it accrues he loses the right to claim it as a deduction altogether. He cannot claim or make any attempt to reopen the accounts of the earlier year to which the expense relates. The Supreme Court’s decision in C.I.T. vs. Gemini Cashew Sales Corporation (1967) 65 ITR 643 emphasizes the principle that if the liability to make the payment has arisen during the previous year, it must be appropriately regarded as the expenditure of that year and merely because the payment in respect of the expenditure is made in the subsequent year, the assessee would not be entitled to claim deduction in respect thereof in the subsequent year. As pointed out earlier, this is subject to the provisions of section 43B. Normally, deduction can be claimed by the assessee only in respect of those expenses and losses which have been actually incurred by the assessee during the previous year, i.e. after 118 CU IDOL SELF LEARNING MATERIAL (SLM)

the business is set up. However, there are some exceptions to this rule and a tax planner should be aware of the exceptions and make use of them in appropriate cases. For example, expenditure incurred on scientific research before the commencement of the business — capital or revenue during the three years immediately preceding the commencement of the business and coming within the scope of the Explanation to sections 35(1)(i) and 35(1)(ii), capital expenditure incurred prior to commencement of specified business allowed as deduction in the year of commencement of business, in case capitalized under section 35AD, preliminary expenses incurred before commencement of the business and coming within the scope of section 35D, expenditure on prospecting for minerals coming within the scope of section 35E, are cases where the assessee could claim deduction in respect of the expenditure even though the expenditure was not incurred during the previous year. Similarly, the expenditure in respect of which deduction is claimed by the assessee should not be in the nature of capital expenditure. This is again subject to the statutory exceptions contained in provisions like section 35 and 35AD. Again, subject to the statutory exceptions, the expenditure should be incurred wholly and exclusively for the purpose of the business. 8.4 SPECIAL PROVISIONS IN RESPECT OF NEWLY ESTABLISHED UNITS IN SPECIAL ECONOMIC ZONES. (SEC 10AA.) (1) Subject to the provisions of this section, in computing the total income of an assessee, who is an entrepreneur as defined in clause (j) of section 2 of the Special Economic Zones Act, 2005, from his Unit, who begins to manufacture or produce articles or things or provide any services during the previous year relevant to any assessment year beginning on or after April 1, 2006, but before the first day of April, 2021, the following deduction is permitted: (i) for a period of five consecutive assessment years beginning with the assessment year relevant to the previous year in which the Unit begins to manufacture or produce such articles or things or provide services, as the case may be, 100% of profits and gains derived from the export of such articles or things or services, and 50% of such profits and gains for further five assessment years and thereafter. (ii) for the next five assessment years, the amount not more than 50% of the profit as is debited to the profit and loss account of the previous year in respect of which the deduction is to be allowed and credited to a reserve account (to be called the \"Special Economic Zone Re-Investment Reserve Account\") to be created and used for the purposes of the business of the assessee in the manner laid down in sub-section (2). Explanation. —For the avoidance of doubt, the amount of deduction under this section shall be allowed from the assessee's total income computed in accordance with the provisions of this Act prior to giving effect to the provisions of this section, and the deduction under this section shall not exceed such total income of the assessee.] 119 CU IDOL SELF LEARNING MATERIAL (SLM)

(2) Only if the following requirements are met will the deduction under clause (ii) of sub- section (1) be allowed: — (a) the funds deposited in the Special Economic Zone Reinvestment Reserve Account should be used— (i) for the purpose of acquiring machinery or plant that is put to use before the end of the three-year period following the year in which the reserve was established; and (ii) for the purposes of the undertaking's business, other than for distribution as dividends or profits, or for remittance outside India as profits, or for the formation of any asset outside India, till the machinery or plant as specified is acquired. (b) the assessee has furnished, in respect of machinery or plant, the particulars as may be specified by the Central Board of Direct Taxes in this regard under clause (b) of sub-section (1B) of section 10A, along with the return of income for the assessment year relevant to the previous year in which such plant or machinery was first put to use. (3) Any money credited to the Special Economic Zone Reinvestment Reserve Account pursuant to paragraph (ii) of subsection (1), — (a) has been utilised for any purpose other than those referred to in sub-section (2), the amount so utilised; or (b) has not been used by the end of the term stated in sub-clause (i) of clause (a) of sub- section (2), the amount not used is regarded to be profit, — (i) in the year in which the amount was so used, in the instance referred to in subsection (a).; or (ii) in the instance referred to in subsection (b), in the year following the three-year term stated in sub-clause I of clause (a) of sub-section (2), and shall be taxed accordingly: Provided that where in computing the total income of the Unit for any assessment year, its profits and gains had not been included by application of the provisions of sub-section (7B) of section 10A, the undertaking, being the Unit shall be entitled to deduction referred to in this sub-section only for the unexpired period of ten consecutive assessment years and thereafter it shall be eligible for deduction from income as provided in clause (ii) of sub- section (1). Explanation. —For the avoidance of doubt, it is hereby declared that an undertaking, being the Unit, which had already taken advantage of the deductions referred to in section 10A for ten consecutive assessment years prior to the commencement of the Special Economic Zones Act, 2005, shall not be eligible for a deduction from income under this section: Provided further that the period of ten consecutive assessment years referred to above shall be reckoned from the assessment year relevant to the previous year in which a Unit initially located in any free trade zone or export processing zone which is subsequently located in a 120 CU IDOL SELF LEARNING MATERIAL (SLM)

Special Economic Zone as a result of such free trade zone or export processing zone being converted into a Special Economic Zone. Provided also that a Unit initially located in a free trade zone or export processing zone is subsequently located in a Special Economic Zone as a result of such free trade zone or export processing zone being converted into a Special Economic Zone and has completed the ten consecutive assessment years referred to above, it shall not be eligible for the deduction from income as provided in clause (ii) of sub-section (1) with effect from the 1st day of April, 2006. (4) This section applies to any undertaking, being the Unit, which fulfils all the following conditions, namely: — (i) it began or will commence to manufacture or produce products or things or offer services in any Special Economic Zone during the prior year relevant to the assessment year beginning on or after April 1, 2006. (ii) it is not founded through the dissolution or reconstruction of an existing business: This condition shall not apply to any enterprise, being the Unit, formed as a result of the assessee's re-establishment, reconstruction, or resuscitation of the business of any such undertaking as is referred to in section 33B, in the conditions and during the time indicated in that section. (iii) It is not created by the transfer of machinery or plant previously utilised for any purpose to a new enterprise. Explanation. —For the purposes of clause (iii) of this sub-section, the provisions of Explanations 1 and 2 to sub-section (3) of section 80-IA apply as they do for clause (ii) of that sub-section. (5) If any enterprise that is the Unit and is entitled to the deduction under this section is transferred to another undertaking that is the Unit in a scheme of amalgamation or demerger before the end of the term indicated in this section, Then (a) For the previous year in which the amalgamation or demerger occurs, no deduction shall be allowed under this section to the amalgamating or demerged Unit; and (b) the provisions of this section shall apply to the amalgamating or demerged Unit as if the amalgamation or demerger had not occurred. (6) Losses referred to in sub-section (1) of section 72 or sub-section (1) or sub-section (3) of section 74, in so far as they pertain to the enterprise, being the Unit, may be carried forward or set off. (7) The profits derived from the export of articles, things, or services (including computer software), for the purposes of sub-section (1) shall be the amount that bears the same proportion to the profits of the undertaking's business, being the Unit, as the export turnover 121 CU IDOL SELF LEARNING MATERIAL (SLM)

in respect of such articles, things, or services bears to the total turnover of the business carried on by the undersigned. The provisions of this sub-section [as amended by section 6 of the Finance (No. 2) Act, 2009 (33 of 2009] shall apply to the assessment year starting April 1, 2006, and future assessment years. (8) The provisions of sub-sections (5) and (6) of section 10A apply to the articles, things, or services referred to in sub-section (1) as if— (a) the figures, letters, and word \"1st April, 2001\" were replaced with the figures, letters, and word \"1st April, 2006\"; (b) the word \"undertaking\" was replaced with the words \"undertaking, being the Unit.\" (9) The requirements of section 80-IA's subsections (8) and (10) shall, to the extent applicable, apply to the undertaking referred to in this section in the same way that they apply to the undertaking referred to in section 80-IA. (10) If a deduction under this section is claimed and allowed for profits of any of the specified businesses referred to in clause (c) of sub-section (8) of section 35AD for any assessment year, no deduction under the provisions of section 35AD will be allowed for the same or any other assessment year. Explanation 1. —For the purposes of this section, — (i) \"export turnover\" means the consideration in respect of export by the undertaking, being the Unit of articles or things or services received in, or brought into, India by the assessee but does not include freight, telecommunication charges or insurance attributable to the delivery of the articles or things outside India or expenses, if any, incurred in foreign exchange in rendering of services (including computer software) outside India. (ii) \"export in relation to the Special Economic Zones\" means taking goods or providing services out of India from a Special Economic Zone by land, sea, air, or by any other mode, whether physical or otherwise. (iii) \"manufacture\" shall have the same meaning as assigned to it in clause (r) of section 2 of the Special Economic Zones Act, 2005. (iv) \"relevant assessment year\" means any assessment year falling within a period of fifteen consecutive assessment years referred to in this section. (v) \"Special Economic Zone\" and \"Unit\" shall have the same meanings as assigned to them under clauses (za) and (zc) of section 2 of the Special Economic Zones Act, 2005. Explanation 2. —For the avoidance of doubt, earnings and gains gained from on-site creation of computer software (including services for software development) outside India shall be deemed to constitute profits and gains derived from computer software export outside India. 122 CU IDOL SELF LEARNING MATERIAL (SLM)

8.5 SPECIAL PROVISIONS IN RESPECT OF NEWLY ESTABLISHED HUNDRED PER CENT EXPORT-ORIENTED UNDERTAKINGS. (SEC 10B). (1) Subject to the provisions of this section, a deduction of profits and gains derived by a 100 percent export-oriented undertaking from the export of articles, things, or computer software for a period of ten consecutive assessment years beginning with the assessment year relevant to the previous year in which the undertaking begins to manufacture or produce articles, things, or computer software, as the case may be, shall be allowed from the total income of the assessee: The undertaking shall be entitled to the deduction referred to in this sub-section only for the unexpired period of the aforesaid ten consecutive years if its profits and gains were not included in computing the total income of the undertaking for any assessment year by application of the provisions of this section as it stood immediately before its substitution by the Finance Act, 2000. Moreover, for the assessment year beginning on April 1, 2003, the deduction under this sub- section shall be 90% of the profits and gains generated by an undertaking from the export of such products, things, or computer software: Provided furthermore that for the assessment year commencing on April 1, 2012, and subsequent years, no discount under this section shall be permitted to any undertaking: Provided also that an assessee who fails to file a return of income on or before the due date stated in sub-section (1) of section 139 is not entitled to a deduction under this section. (2) This section applies to any entity that meets all of the following criteria: (i) it manufactures or produces any products, things, or computer software. (ii) it is not founded by the division or reconstruction of an existing business: This condition shall not apply to any enterprise founded as a result of the assessee re- establishing, reconstructing, or reviving the business of any such undertaking as is referred to in section 33B, in the conditions and during the time provided in that section. (iii) it is not constituted by the transfer of machinery or plant formerly utilised for any purpose to a new enterprise. Explanation. —For the purposes of clause (iii) of this sub-section, the provisions of Explanation 1 and Explanation 2 to sub-section (2) of section 80-I apply as they do for clause (ii) of that sub-section. (3) This section applies to the undertaking if the assessee receives or brings into India in convertible foreign exchange the sale proceeds of articles or things or computer software 123 CU IDOL SELF LEARNING MATERIAL (SLM)

exported out of India within six months of the previous year's end or within such further period as the competent authority may allow in this regard. Explanation 1. —The Reserve Bank of India or any other authority permitted under any law in force for the time being to regulate payments and dealings in foreign currencies is referred to as a \"competent authority\" for the purposes of this sub-section. Explanation 2. —The sale profits referred to in this sub-section are deemed to have been received in India if they are credited to a separate account maintained for that purpose by the assessee with any bank outside India with Reserve Bank of India authorisation. (4) For the purposes of subsection (1), profits derived from the export of articles, things, or computer software are the amount that bears the same proportion to the profits of the undertaking's business as the export turnover in respect of such articles, things, or computer software bears to the total turnover of the undertaking's business. (5) The deduction under sub-section (1) is not admissible for any assessment year beginning on or after April 1, 2001, unless the assessee submits a report of an accountant, as defined in the Explanation below sub-section (2) of section 288, along with the return of income, certifying that the deduction has been correctly claimed in accordance with the rules. (6) Notwithstanding anything in this Act to the contrary, in calculating the assessee's total income for the previous year relevant to the assessment year immediately following the last of the relevant assessment years, or any prior year relevant to any later assessment year, — (i) section 32, section 32A, section 33, section 35 and clause (ix) of sub-section (1) of section 36 shall apply as if every allowance or deduction referred to therein and relating to or allowable for any of the relevant assessment years [ending before the 1st day of April, 2001], in relation to any building, machinery, plant or furniture used for the purposes of the business of the undertaking in the previous year relevant to such assessment year or any expenditure incurred for the purposes of such business in such previous year had been given full effect to for that assessment year itself and accordingly sub-section (2) of section 32, clause (ii) of sub-section (3) of section 32A, clause (ii) of sub-section (2) of section 33, sub-section (4) of section 35 or the second proviso to clause (ix) of sub-section (1) of section 36, as the case may be, shall not apply in relation to any such allowance or deduction; (ii) No loss referred to in sub-section (1) of section 72 or sub-section (1) or sub-section (3) of section 74, inasmuch as such loss relates to the undertaking's activity, shall be carried forward or set-off if such loss pertains to any of the relevant assessment years ending before April 1, 2001. (iii) no deduction shall be allowed in respect to the profits and gains of the undertaking under section 80HH, section 80HHA, section 80-I, section 80-IA, or section 80-IB; and 124 CU IDOL SELF LEARNING MATERIAL (SLM)

(iv) the written down value of any asset used for the purposes of the undertaking's business shall be computed as if the assessee had claimed and been actually allowed the deduction in respect of depreciation for each of the relevant assessment years in computing the depreciation allowance under section 32. (7) The requirements of section 80-IA's subsections (8) and (10) apply to the undertaking referred to in this section in the same way that they apply to the undertaking referred to in section 80-IA, to the extent possible. (7A) In the event that any undertaking of an Indian company that is entitled to a deduction under this section is transferred to another Indian company in a scheme of amalgamation or demerger before the expiration of the period specified in this section, (a) no deduction shall be admissible under this section to the amalgamating or demerged company for the previous year in which the amalgamation or demerger occurred. (8) Notwithstanding anything in the preceding provisions of this section, if the assessee furnishes to the Assessing Officer a written declaration before the due date for furnishing the return of income under sub-section (1) of section 139 that the provisions of this section may not be made applicable to him, the provisions of this section shall not apply to him for any of the relevant assessment year. Explanation 2. —For the purposes of this section, — (i) \"computer software\" means— (a) any computer programme recorded on any disc, tape, perforated media or other information storage device; or (b) any customized electronic data or any product or service of similar nature as may be notified by the Board, which is transmitted or exported from India to any place outside India by any means. (ii) \"convertible foreign exchange\" means foreign exchange which is for the time being treated by the Reserve Bank of India as convertible foreign exchange for the purposes of 65a[the Foreign Exchange Management Act, 1999 (42 of 1999)], and any rules made thereunder or any other corresponding law for the time being in force; (iii) \"export turnover\" means the consideration in respect of export 66[by the undertaking] of articles or things or computer software received in, or brought into, India by the assessee in convertible foreign exchange in accordance with sub-section (3), but does not include freight, telecommunication charges or insurance attributable to the delivery of the articles or things or computer software outside India or expenses, if any, incurred in foreign exchange in providing the technical services outside India; (iv) \"hundred per cent export-oriented undertaking\" means an undertaking which has been approved as a hundred per cent export-oriented undertaking by the Board appointed in this 125 CU IDOL SELF LEARNING MATERIAL (SLM)

behalf by the Central Government in exercise of the powers conferred by section 1467 of the Industries (Development and Regulation) Act, 1951 (65 of 1951), and the rules made under that Act; (v) \"relevant assessment years\" means any assessment years falling within a period of ten consecutive assessment years, referred to in this section.] Explanation 3. —For the avoidance of doubt, earnings and gains gained from on-site creation of computer software (including services for software development) outside India shall be deemed to constitute profits and gains derived from computer software export outside India. Explanation 4. —The cutting and polishing of precious and semi-precious stones is included in the definition of \"manufacture or produce\" in this section. 8.6SUMMARY  Successful tax planning for business deductions pre-supposes a clear and thorough understanding of the various statutory provisions governing the deductions and an awareness of the statutory rights as well.  One of the most crucial components of tax planning is ensuring that the maximum deduction or allowance is acquired as soon as feasible for the purpose of calculating taxable income.  In India, special economic zones (SEZs) are locations that provide incentives to local enterprises.  SEZs often provide competitive infrastructure, duty-free exports, tax breaks, and other incentives to make doing business easier.  Export-oriented units are those that commit to exporting their entire output.  Manufacturing, services, software development, repair, remaking, reconditioning, and re-engineering, as well as the creation of gold/silver/platinum jewellery and articles, are all possible for EOUs.  A loss carryforward is an accounting practise that reduces tax liabilities by applying the current year's net operating loss (NOL) to future years' net profits. 8.7KEYWORDS  NOL – Net Operating Loss  SEZ - Special Economic Zone  EOU – Export-oriented Unit 8.8 LEARNING ACTIVITY 1. Learn about Slump sale and its tax implications 126 CU IDOL SELF LEARNING MATERIAL (SLM)

___________________________________________________________________________ __________________________________________________________________________ 2. Learn the difference between SEZ and EPZ ___________________________________________________________________________ ___________________________________________________________________________ 8.9UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Explain briefly about some of the business deductions under the Income Tax Act. 2. Describe the meaning of computer software as per the explanation to section 10B of the Income Tax Act. 3. Explain the meaning of “Hundred percent export-oriented undertaking”. 4. ABC Ltd. furnishes you the following information for the year ended 31.3.2021: Particulars ₹ (in lakhs) Total turnover of Unit A located in Special Economic Zone 120 Profit of the business of Unit A 45 Export turnover of Unit A 60 Total turnover of Unit B located in Domestic Tariff Area 225 (DTA) Profit of the business of Unit B 25 Compute deduction under section 10AA for the A.Y. 2021-22, assuming that Y Ltd. commenced operations in SEZ and DTA in the year 2016-17. 5. What are the conditions to be satisfied for claiming deduction for further 5 years under section 10AA(2)? Long Questions 1. Explain in detail about the tax implications when setting up a new business. 2. Briefly explain the special provisions in respect of newly established organisations in special economic zones. 3. Explain in detail about the provisions relating to newly established 100% export- oriented undertakings. 4. Define the following terms in the context of the Income Tax Act,1961. a. Competent Authority b. Computer Software c. Export Turnover d. Convertible Foreign Exchange 127 CU IDOL SELF LEARNING MATERIAL (SLM)

5. Rudra Ltd. has one unit at Special Economic Zone (SEZ) and other unit at Domestic Tariff Area (DTA). The company provides the following details for the previous year 2020-21. Rudra Ltd (₹) Unit in DTA (₹) Particulars Total Sales 6,50,00,000 2,50,00,000 Export Sales 5,60,00,000 1,60,00,000 Net profit 70,00,000 20,00,000 Calculate the eligible deduction under section 10AA of the Income-tax Act, 1961, for the Assessment Year 2021-22, in the following situations: (i) If both the units were set up and start manufacturing from 22-05-2013. (ii) If both the units were set up and start manufacturing from 14-05-2017. B. Multiple choice Questions 1. In case of an 100% EOU the profits derived from such an unit will be allowed as deduction for a period of a. 5 years b. 10 years c. 3 years d. None of these 2. The direct tax exemption in case of an entity in SEZ is a. 100% exemption of Income Tax b. 50% exemption of Income Tax c. 25% exemption of Income Tax d. None of these 3. \"Computer software\" means— a. any computer programme recorded on any disc, tape, perforated media or other information storage device b. any customized electronic data or any product or service of similar nature as may be notified by the Board c. Both (a) and (b) d. None of these. 4. Under section 10A, the deduction allowed for the first five consecutive years are 128 a. 100% of profits and gains derived from the export b. 50% of profits and gains derived from the export c. 150% of profits and gains derived from the export d. None of these CU IDOL SELF LEARNING MATERIAL (SLM)

5. One of the condition to be satisfied for getting exemption under section 10AA is that it shallbegun or begins to manufacture or produce articles or things or provide any service in any SEZ during the previous year relevant to A.Y.2006-07 or any subsequent assessment year but not later than _________. a. AY 2019-20 b. AY 2020-21 c. AY 2021-22 d. AY 2022-23 Answers 1-b,2-a,3-c,4-a, 5-b 8.10REFERENCES  V.K. Singhania,DirectTaxes,Taxman Publication (P)Ltd.,Delhi,Latestedition.  Lakhotia R.N., Income Tax Planning Handbook, Vision Books, New Delhi, Latestedition.  H.C. Mehrotra–IncomeTaxLaw&Practice.  Bhagwati Prasad: LawandPracticeofIncomeTaxinIndia  H.P.Ranina:CorporateTaxation: AHandbook(Taxmann).  V.S.Datey:IndirectTaxes– LawandPractice(TaxmannPublicationsLimited).V.S.Datey:IndirectTaxes– LawandPractice(TaxmannPublicationsLimited). 129 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT 9: TAX PLANNING AND AMALGAMATION STRUCTURE 9.0 Learning Objectives 9.1 Introduction 9.2 Definition of Amalgamation and Demerger as per Income-tax Act, 1961 9.3 Tax Relief to the amalgamating company 9.4 Tax Relief to the shareholders of the amalgamating company 9.5 Tax Relief to the amalgamated company 9.6 Set off and carry forward of losses in an amalgamation and demerger 9.7 Summary 9.8 Keywords 9.9 Learning Activity 9.10 Unit End Questions 9.11 References 9.0 LEARNING OBJECTIVES After studying this unit students will be able to  Explainthe meaning of Amalgamation and Demerger  Learn the tax planning aspects of amalgamation  Set-off and carry forward of losses in case of amalgamation and demerger 9.1 INTRODUCTION A merger or amalgamation, in simple terms, is an arrangement in which the assets of two or more companies are merged into one. It is a legal process in which two or more companies merge to form a new entity, or one or more companies are absorbed by another company, with the result that the amalgamating company ceases to exist and the shareholders of the new or amalgamated company become shareholders of the new or amalgamated company. A demerger is a transaction in which a portion or undertaking of one company is transferred to another company that functions independently of the original. The former company's shareholders are normally awarded an equal share of the new company's ownership. E.g. 1. Maruti Motors and Suzuki, both located in Japan, have merged to establish Maruti Suzuki (India) Ltd. 2. DCM Ltd. was split up into DCM Ltd., DCM Shriram Industries Ltd., and DCM Engineering Industries Ltd., among others. 130 CU IDOL SELF LEARNING MATERIAL (SLM)

9.2 DEFINITION OF AMALGAMATION AND DEMERGER IN THE CONTEXT OF INCOME TAX ACT, 1961 Meaning of Amalgamation u/s 2(1B) In the context of companies, \"amalgamation\" refers to the merging of one or more companies with another company or the merging of two or more companies to form one company (the merging company or companies are referred to as the amalgamating company or companies, and the company with which they merge, or which is formed as a result of the merger as the amalgamated company) in such a way that— (i) By virtue of the amalgamation, all of the assets of the amalgamating company or companies immediately before the amalgamation become the assets of the amalgamated company. (ii) all of the liabilities of the amalgamating company or companies immediately before the amalgamation become the liabilities of the amalgamated company. (iii) By virtue of the amalgamation, shareholders holding not less than three-fourths of the value of the shares in the amalgamating company or companies (other than shares already held therein immediately before the amalgamation by, or by a nominee for, the amalgamated company or its subsidiary) become shareholders of the amalgamated company., otherwise, than as a result of the acquisition of the property of one company by another company pursuant to the purchase of such property by the other company or as a result of the distribution of such property to the other company after the winding up of the first-mentioned company. Meaning of demerger u/s 2(19AA) \"Demerger\", in relation to companies, means the transfer, pursuant to a scheme of arrangement under sections 391 to 394 of the Companies Act, 1956 (1 of 1956), by a demerged company of its one or more undertakings to any resulting company in such a manner that— (i) all the property of the undertaking, being transferred by the demerged company, immediately before the demerger, becomes the property of the resulting company by virtue of the demerger. (ii) all the liabilities relatable to the undertaking, being transferred by the demerged company, immediately before the demerger, become the liabilities of the resulting company by virtue of the demerger. (iii) the property and the liabilities of the undertaking or undertakings being transferred by the demerged company are transferred at values appearing in its books of account immediately before the demerger: 131 CU IDOL SELF LEARNING MATERIAL (SLM)

(iv) the resulting company issues, in consideration of the demerger, its shares to the shareholders of the demerged company on a proportionate basis except where the resulting company itself a shareholder of the demerged company is. (v) the shareholders holding not less than three-fourths in value of the shares in the demerged company (other than shares already held therein immediately before the demerger, or by a nominee for, the resulting company or, its subsidiary) become shareholders of the resulting company or companies by virtue of the demerger, otherwise, than as a result of the acquisition of the property or assets of the demerged company or any undertaking thereof by the resulting company; (vi) the transfer of the undertaking is on a going concern basis. (vii) the demerger is in accordance with the conditions, if any, notified under sub-section (5) of section 72A by the Central Government in this behalf. Explanation 1.—For the purposes of this clause, \"undertaking\" shall include any part of an undertaking, or a unit or division of an undertaking or a business activity taken as a whole but does not include individual assets or liabilities or any combination thereof not constituting a business activity. Explanation 2.—For the purposes of this clause, the liabilities referred to in sub-clause (ii), shall include— (a) the liabilities which arise out of the activities or operations of the undertaking. (b) the specific loans or borrowings (including debentures) raised, incurred and utilised solely for the activities or operations of the undertaking; and (c) in cases, other than those referred to in clause (a) or clause (b), so much of the amounts of general or multipurpose borrowings, if any, of the demerged company as stand in the same proportion which the value of the assets transferred in a demerger bear to the total value of the assets of such demerged company immediately before the demerger. Explanation 3.—For determining the value of the property referred to in sub-clause (iii), any change in the value of assets consequent to their revaluation shall be ignored. Explanation 4.—For the purposes of this clause, the splitting up or the reconstruction of any authority or a body constituted or established under a Central, State or Provincial Act, or a local authority or a public sector company, into separate authorities or bodies or local authorities or companies, as the case may be, shall be deemed to be a demerger if such split up or reconstruction fulfils such conditions as may be notified in the Official Gazette, by the Central Government. Explanation 5.—For the purposes of this clause, the reconstruction or splitting up of a company, which ceased to be a public sector company as a result of transfer of its shares by the Central Government, into separate companies, shall be deemed to be a demerger, if such 132 CU IDOL SELF LEARNING MATERIAL (SLM)

reconstruction or splitting up has been made to give effect to any condition attached to the said transfer of shares and also fulfils such other conditions as may be notified by the Central Government in the Official Gazette. Explanation 6.—For the purposes of this clause, the reconstruction or splitting up of a public sector company into separate companies shall be deemed to be a demerger, if such reconstruction or splitting up has been made to transfer any asset of the demerged company to the resulting company and the resulting company— (i) is a public sector company on the appointed day indicated in such scheme, as may be approved by the Central Government or any other body authorised under the provisions of the Companies Act, 2013 (18 of 2013) or any other law for the time being in force governing such public sector companies in this behalf; and (ii) fulfils such other conditions as may be notified by the Central Government in the Official Gazette in this behalf. 9.3 TAX RELIEF TO THE AMALGAMATING COMPANY Exemption from Capital Gains Tax [Sec. 47(vi)]: Capital gain accruing from the transfer of assets by the amalgamating companies to the Indian amalgamated company is exempt from tax under section 47(vi) of the Income Tax Act since the transfer is not considered a transfer for the purposes of capital gain. Exemption from Capital Gains Tax in case of internal restructuring [Sec. 47(via)]: Transfer of shares held in an Indian company by an amalgamating foreign firm to an amalgamated foreign company is exempt from tax under section 47(via) if the following two requirements are met: (i) At least 25% of the shareholders of the combining firm remain shareholders of the resulting foreign corporation. ii) In the country where the amalgamating company is incorporated, such a transfer is not subject to capital gains tax. 9.4 TAX RELIEF TO THE SHAREHOLDERS OF THE AMALGAMATING COMPANY Exemption from Capital Gains Tax [Sec. 47(vii)]: Under section 47(vii) of the income-tax Act, capital gains arising from the transfer of shares by a shareholder of the amalgamating companies are exempt from tax as such transactions will not be regarded as a transfer for capital gain purpose, if: i) The transfer is made in exchange for the allotment of shares in the merged company to him.; and ii) the amalgamated Company is an Indian company. 133 CU IDOL SELF LEARNING MATERIAL (SLM)

9.5 TAX RELIEF TO THE AMALGAMATED COMPANY Carry forward and set off of accumulated loss and unabsorbed depreciation allowance in amalgamation or demerger, etc. (Sec 72A). Section 72A of the Income-tax Act of 1961 deals with the amalgamation of sick companies with healthy companies in order to take benefit of the amalgamating company's carry forward of accumulated losses and unabsorbed depreciation. But the benefits under this section are available only if the following conditions are fulfilled: An amalgamation of (a) a company owning an industrial undertaking, a ship, or a hotel with another company; or (b) a banking company referred to in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949)27 with a specified bank; or (c) one or more public sector company or companies engaged in the business of aircraft operation with one or more public sector companies. For the purposes of this section, — (a) “accumulated loss” means so much of the loss of the predecessor firm or the proprietary concern or the private company or unlisted public company before conversion into limited liability partnership or the amalgamating company or the demerged company, as the case may be, under the head “Profits and gains of business or profession” (not being a loss sustained in a speculation business) which such predecessor firm or the proprietary concern or the company or amalgamating company or demerged company, would have been entitled to carry forward and set off under the provisions of section 72 if the reorganisation of business or conversion or amalgamation or demerger had not taken place;] (aa) “industrial undertaking” means any undertaking which is engaged in— (i) the manufacture or processing of goods; or (ii) the manufacture of computer software; or (iii) the business of generation or distribution of electricity or any other form of power; or (iiia) the business of providing telecommunication services, whether basic or cellular, including radio paging, domestic satellite service, network of trunking, broadband network and internet services; or] (iv) mining; or (v) the construction of ships, aircrafts or rail systems;] (b) “unabsorbed depreciation” means so much of the allowance for depreciation of the predecessor firm or the proprietary concern or the private company or unlisted public company before conversion into limited liability partnership or the amalgamating company or the demerged company, as the case may be, which remains to be allowed and which would have been allowed to the predecessor firm or the proprietary concern or the company or amalgamating company or demerged company, as the case may be, under the provisions of 134 CU IDOL SELF LEARNING MATERIAL (SLM)

this Act, if the reorganisation of business or conversion or amalgamation or demerger had not taken place; (c) “specified bank” means the State Bank of India constituted under the State Bank of India Act, 1955 (23 of 1955) or a subsidiary bank as defined in the State Bank of India (Subsidiary Banks) Act, 1959 (38 of 1959) or a corresponding new bank constituted under section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 (5 of 1970) or under section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 (40 of 1980). 9.6 PROVISIONS RELATING TO CARRY FORWARD AND SET OFF OF ACCUMULATED LOSS AND UNABSORBED DEPRECIATION ALLOWANCE IN AMALGAMATION OR DEMERGER, ETC. (SEC 72A). (1) Where there has been an amalgamation of— (a) a company owning an industrial undertaking or a ship or a hotel with another company; or (b) a banking company referred to in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949)27 with a specified bank; or (c) one or more public sector company or companies engaged in the business of operation of aircraft with one or more public sector company or companies engaged in similar business, then, notwithstanding anything contained in any other provision of this Act, the accumulated loss and the unabsorbed depreciation of the amalgamating company shall be deemed to be the loss or, as the case may be, allowance for unabsorbed depreciation of the amalgamated company for the previous year in which the amalgamation was effected, and other provisions of this Act relating to set off and carry forward of loss and allowance for depreciation shall apply accordingly. (2) Notwithstanding anything contained in sub-section (1), the accumulated loss shall not be set off or carried forward and the unabsorbed depreciation shall not be allowed in the assessment of the amalgamated company unless— (a) The amalgamating company— (i) has been engaged in the business, in which the accumulated loss occurred, or depreciation remains unabsorbed, for three or more years; (ii) has held continuously as on the date of the amalgamation at least three-fourths of the book value of fixed assets held by it two years prior to the date of amalgamation. (b) The amalgamated company— 135 CU IDOL SELF LEARNING MATERIAL (SLM)

(i) holds continuously for a minimum period of five years from the date of amalgamation at least three-fourths of the book value of fixed assets of the amalgamating company acquired in a scheme of amalgamation. (ii) continues the business of the amalgamating company for a minimum period of five years from the date of amalgamation. (iii) fulfils such other conditions as may be prescribed to ensure the revival of the business of the amalgamating company or to ensure that the amalgamation is for genuine business purpose. (3) In a case where any of the conditions laid down in sub-section (2) are not complied with, the set off of loss or allowance of depreciation made in any previous year in the hands of the amalgamated company shall be deemed to be the income of the amalgamated company chargeable to tax for the year in which such conditions are not complied with. (4) Notwithstanding anything contained in any other provisions of this Act, in the case of a demerger, the accumulated loss and the allowance for unabsorbed depreciation of the demerged company shall— (a) where such loss or unabsorbed depreciation is directly relatable to the undertakings transferred to the resulting company, be allowed to be carried forward and set off in the hands of the resulting company. (b) where such loss or unabsorbed depreciation is not directly relatable to the undertakings transferred to the resulting company, be apportioned between the demerged company and the resulting company in the same proportion in which the assets of the undertakings have been retained by the demerged company and transferred to the resulting company and be allowed to be carried forward and set off in the hands of the demerged company or the resulting company, as the case may be. (5) The Central Government may, for the purposes of this Act, by notification in the Official Gazette, specify such conditions as it considers necessary to ensure that the demerger is for genuine business purposes. (6) Where there has been reorganisation of business, whereby, a firm is succeeded by a company fulfilling the conditions laid down in clause (xiii) of section 47 or a proprietary concern is succeeded by a company fulfilling the conditions laid down in clause (xiv) of section 47, then, notwithstanding anything contained in any other provision of this Act, the accumulated loss and the unabsorbed depreciation of the predecessor firm or the proprietary concern, as the case may be, shall be deemed to be the loss or allowance for depreciation of the successor company for the purpose of previous year in which business reorganisation was effected and other provisions of this Act relating to set off and carry forward of loss and allowance for depreciation shall apply accordingly: 136 CU IDOL SELF LEARNING MATERIAL (SLM)

Provided that if any of the conditions laid down in the proviso to clause (xiii) or the proviso to clause (xiv) to section 47 are not complied with, the set off of loss or allowance of depreciation made in any previous year in the hands of the successor company, shall be deemed to be the income of the company chargeable to tax in the year in which such conditions are not complied with. (6A) Where there has been reorganisation of business whereby a private company or unlisted public company is succeeded by a limited liability partnership fulfilling the conditions laid down in the proviso to clause (xiiib) of section 47, then, notwithstanding anything contained in any other provision of this Act, the accumulated loss and the unabsorbed depreciation of the predecessor company, shall be deemed to be the loss or allowance for depreciation of the successor limited liability partnership for the purpose of the previous year in which business reorganisation was effected and other provisions of this Act relating to set off and carry forward of loss and allowance for depreciation shall apply accordingly : Provided that if any of the conditions laid down in the proviso to clause (xiiib) of section 47 are not complied with, the set off of loss or allowance of depreciation made in any previous year in the hands of the successor limited liability partnership, shall be deemed to be the income of the limited liability partnership chargeable to tax in the year in which such conditions are not complied with.] (7) For the purposes of this section, — (a) “accumulated loss” means so much of the loss of the predecessor firm or the proprietary concern or the private company or unlisted public company before conversion into limited liability partnership or the amalgamating company or the demerged company, as the case may be, under the head “Profits and gains of business or profession” (not being a loss sustained in a speculation business) which such predecessor firm or the proprietary concern or the company or amalgamating company or demerged company, would have been entitled to carry forward and set off under the provisions of section 72 if the reorganisation of business or conversion or amalgamation or demerger had not taken place;] (aa) “industrial undertaking” means any undertaking which is engaged in— (i) the manufacture or processing of goods; or (ii) the manufacture of computer software; or (iii) the business of generation or distribution of electricity or any other form of power; or (iiia) the business of providing telecommunication services, whether basic or cellular, including radio paging, domestic satellite service, network of trunking, broadband network and internet services; or] 137 CU IDOL SELF LEARNING MATERIAL (SLM)

(iv) mining; or (v) the construction of ships, aircrafts or rail systems;] (b) “unabsorbed depreciation” means so much of the allowance for depreciation of the predecessor firm or the proprietary concern or the private company or unlisted public company before conversion into limited liability partnership or the amalgamating company or the demerged company, as the case may be, which remains to be allowed and which would have been allowed to the predecessor firm or the proprietary concern or the company or amalgamating company or demerged company, as the case may be, under the provisions of this Act, if the reorganisation of business or conversion or amalgamation or demerger had not taken place; (c) “specified bank” means the State Bank of India constituted under the State Bank of India Act, 1955 (23 of 1955) or a subsidiary bank as defined in the State Bank of India (Subsidiary Banks) Act, 1959 (38 of 1959) or a corresponding new bank constituted under section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 (5 of 1970) or under section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 (40 of 1980). 9.7SUMMARY  Amalgamation is a legal process in which two or more companies merge to form a new entity, or one or more companies are absorbed by another. As a result, the amalgamating company ceases to exist, and the shareholders of the new or amalgamated company become shareholders of the new or amalgamated company.  A demerger is a transaction in which a portion or undertaking of one company is transferred to another company that functions independently of the original. The former company's shareholders are normally awarded an equal share of the new company's ownership.  Capital gain arising from the transfer of assets by the amalgamating companies to the Indian amalgamated company is exempt from tax under section 47(vi) of the Income Tax Act, since such transfer will not be regarded as a transfer for the purpose of Capital Gains Tax.  Under section 47(vii) of the income-tax Act, capital gains arising from the transfer of shares by a shareholder of the amalgamating companies are exempt from tax as such transactions will not be regarded as a transfer for capital gain purpose, if:  The transfer is made in exchange for the allotment of shares in the merged company to him.; and  the amalgamated Company is an Indian company. 138 CU IDOL SELF LEARNING MATERIAL (SLM)

9.8 KEYWORDS  Amalgamating Company – are those two or more companies which willingly unite to carry on their business activities jointly.  Amalgamated Company – is a newly formed union of two or more amalgamating companies  Demerger-A de-merger (or \"demerger\") allows a large company, such as a conglomerate, to split off its various brands or business units 9.9LEARNING ACTIVITY 1. Learn about Vijaya Bank and Dena Bank merger with Bank of Baroda in 2019. ___________________________________________________________________________ ___________________________________________________________________________ 2. Learn the causes of merger of Idea with Vodafone and the merger effect. ___________________________________________________________________________ ___________________________________________________________________________ 9.10 UNIT END QUESTIONS A.Descriptive Questions Short Questions 1. Write a short note about allowability of deductions in case of Amalgamation 2. Explain briefly about carry forward of losses in case of Amalgamation 3. Describe the following terms in the context of sec 72A of the Income-tax Act, 1961 a. Unabsorbed depreciation b. Accumulated losses c. Industrial undertaking 4. Define the term Amalgamation. 5. Briefly discuss about the tax relief available to the amalgamating company. Long Questions 1. Discuss the tax implications of Amalgamated Company and its share holders 2. Discuss about the capital gains tax implication on disposal of shares of Amalgamated Company 3. Explain the meaning of amalgamation and demerger in the context of income-tax Act, 1961. 139 CU IDOL SELF LEARNING MATERIAL (SLM)

4. Elaborately discuss about the tax relief available to the amalgamated company. 5. Discuss in detail about the conditions to be satisfied to call it as a demerger u/s 2(19AA) of the Income Tax Act, 1961. A. Multiple choice Questions 1. In the case of a demerger, the accumulated loss and the allowance for unabsorbed depreciation of the demerged company shall be ,where such loss or unabsorbed depreciation is not directly relatable to the undertakings transferred to the resulting company a. Be allowed to be carried forward and set off in the hands of the resulting company. b. Be apportioned between the demerged company and the resulting company c. Both a and b d. None of these 2. \"Computer software\" means— a. any computer programme recorded on any disc, tape, perforated media or other information storage device b. any customized electronic data or any product or service of similar nature as may be notified by the Board c. Both (a) and (b) d. None of these 3. _______________ are those two or more companies which willingly unite to carry on their business activities jointly. a. Amalgamated Company b. Demerged Company c. Amalgamating company d. None of these 4. Under section 47(via), in case of amalgamation of foreign companies, transfer of shares held in Indian Company by amalgamating foreign company to amalgamated foreign company is exempt from tax if: a. Atleast 25% of the shareholders of the amalgamating company continue to remain shareholders of the amalgamated foreign company b. Such transfer does not attract tax on capital gains in the country, in which the amalgamating company is incorporated. c. Both (a) and (b) d. None of these 140 CU IDOL SELF LEARNING MATERIAL (SLM)

5. Under mercantile system, the expenditure is claimed as deduction when a. It is incurred b. It is paid c. In the subsequent year d. None of these Answers 1-b, 2-c, 3-c, 4-c, 5-a 9.11 REFERENCES  V.K. Singhania,DirectTaxes,Taxman Publication (P)Ltd.,Delhi,Latestedition.  Lakhotia R.N., Income Tax Planning Handbook, Vision Books, New Delhi, Latestedition.  H.C. Mehrotra–IncomeTaxLaw&Practice.  Bhagwati Prasad: LawandPracticeofIncomeTaxinIndia  H.P.Ranina:CorporateTaxation: AHandBook(Taxmann).  V.S.Datey:IndirectTaxes– LawandPractice(TaxmannPublicationsLimited).V.S.Datey:IndirectTaxes– LawandPractice(TaxmannPublicationsLimited). 141 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT 10: TAX PLANNING WITH REGARD TO SPECIFIC MANAGEMENT DECISIONS STRUCTURE 10.0 Learning Objectives 10.1 Introduction 10.2 Make or buy decision 10.3 Own or Lease Decision 10.4 Lease Rent Paid 10.5 Retain or Replace Decision 10.6 Summary 10.7 Keywords 10.8 Learning Activity 10.9 Unit End Questions 10.10 References 10.0LEARNING OBJECTIVES After studying this unit students will be able to:  Understand the tax implications on maker or buy decisions  Learn the tax implications on own or lease transactions  Understand the tax implications in replace are retained decisions 10.1 INTRODUCTION Though management/ investment decisions are not based on the tax factor alone, yet it has become imperative to consider tax factors before adopting any course of action because the effect of this factor is not only significant, but it may also differ from one alternative to another. 10.2 MAKE OR BUY DECISION In making ‘make or buy’ decisions, the variable cost of making the product or part/component of product is compared with its purchase price in the market. The article is brought if the former is greater than the latter. Alternatively, if the decision to make involves 142 CU IDOL SELF LEARNING MATERIAL (SLM)

establishment of a separate industrial unit for this purpose, a decision may be taken on the basis of total cost rather than variable cost. In such an event, the assessee would also be in a position to get the tax benefits arising from allowances such as depreciation, tax holiday benefit and deduction in respect of profits from new industrial undertakings, wherever they are applicable. Many other costing and non-costing considerations are taken into account while making a decision, such as capacity utilisation, supply position of the item to be purchased, purchasing terms, and so on. The criterion for deciding whether to make or buy should be the amount of money saved after taxes. After subtracting the income tax due on the amount saved from the gross savings, the net saving may be calculated.The long-term advantages arising out of a decision to make should also be given due weightage in arriving at a decision. At the time of ascertaining variable cost of the product (for taking make or buy decision) all taxes such as GST, customs duty etc., payable in the process of manufacture should be taken into account and in determining purchase price of the product. All taxes to be borne by the purchaser should be added for the purpose of comparison and cost of purchasing. 10.3 OWN OR LEASE DECISION Another important area of decision making is whether to own or lease (or sale and lease back). There are advantages as well as disadvantages in leasing. Leasing avoids ownership and with it, the accompanying risks of obsolescence and terminal value losses. In leasing, immediate payment of capital costs is avoided but fixed rental obligation arises. There are many factors which are required to be considered before making ‘own or lease’ decision such as cost of asset to be owned, rent of the asset to be taken on lease, source of financing the asset, risk involved in the alternatives, impact of tax concessions such as depreciation, tax holiday benefit, etc. Leasing can also offer significant tax benefits. The entire rental payment can be deducted for income tax purposes if the asset is leased. If the tax rate is 30%, the effective rent obligation is decreased by that percentage. Another tax benefit of leasing is that the lease term might be shorter than the depreciable life that would otherwise be allowed if the assessee purchased the item. Thus, there is a delay in paying taxes and in effect an interest free loan by the Government to the extent of the delay in taxes. There is one more tax advantage arising out of lease which arises from the opportunity to depreciate otherwise non-depreciable assets. The principal asset of this type is land. The lease rental covers the cost of the land which thus becomes deductible. This arrangement may prove particularly attractive where the land value constitutes a high percentage of the total value of the real estate or where the building is already fully depreciated. Leasing is becoming popular in India. For purpose of decision making in a lease or own situation, for comparison purpose the lease rentals for each separate year should be converted into present value of today’s cost. 143 CU IDOL SELF LEARNING MATERIAL (SLM)

Wherever possible or appropriate, the concept of sale and lease back can also be made use of as a tool for tax planning with its attendant advantages. 10.4 LEASE RENT PAID In terms of lease consideration, the lessor may receive two types of receipts: a receipt on capital account referred to as \"premium\" or \"salami\" for the transfer of rights, and a receipt on revenue account referred to as \"rent\" for the right or liberty to use the property for a period of years. The lease rental paid is chargeable to revenue every year. The lease rental may be split into three components—the recovery of principal, cost, the interest chargeable and an element of profit. It is generally believed that the interest rate in-built into the rent would be more than the going market interest rate for term loans for purchase of equipment. Since the entire lease rental is chargeable to revenue the lessee could claim tax benefits on even the principal investment in the equipment. In such instances, the tax advantage is said to be greater in a leasing transaction than in a similar loaning arrangement. 10.5 RETAIN OR REPLACE DECISION One of the important decisions which involves alternative choice is whether or not to buy new capital equipment. Both have their own merits and demerits. Generally, replacement offers cost saving which results in increase in profit. However, replacement requires investment of large funds resulting in extra cost. The choice is made based on relative profitability as well as other financial and non-financial factors. In this case, tax implications should also be considered. Some of the important considerations from the tax angle to which attention will have to be paid relate to the allowance of depreciation, as also the allowance on account of expenditure on scientific research. The applicability of the provisions for allowances should be considered and their impact ascertained before any decision is taken. 10.6SUMMARY  An important area of decision making is whether to own or lease.  Important decisions which involve alternatives whether to buy new capital equipment. Such decision is called Retain or Replace Decision.  The variable cost of manufacturing a product or a part/component of a product is contrasted to its market purchase price when making \"make or buy\" decisions.  If the decision to make involves establishment of a separate industrial unit for this purpose, a decision may be taken based on total cost rather than variable cost.  There may be two types of receipts in the hands of the lessor for the lease: receipts on capital account referred to as \"premium\" or \"salami\" for the transfer of rights and receipts on income account referred to as \"rent\" for the right. 144 CU IDOL SELF LEARNING MATERIAL (SLM)

10.7KEYWORDS  Variable cost- Cost which varies with output  Sale and lease back- Sale and Leaseback is a simple financial transaction which allows a person to lease an asset to himself after selling it 10.8LEARNING ACTIVITY 1.Know the difference between operating Lease and Finance lease and its Tax implications ___________________________________________________________________________ ___________________________________________________________________________ 2.Learn about Sale and lease back transactions and its tax implications. ___________________________________________________________________________ __________________________________________________________________________ 10.9UNIT END QUESTIONS A.Descriptive Questions Short Questions 1. Explain briefly about Own or lease decision and its Tax implications 2. G Ltd. intended to purchase machinery to produce a component for its assembly operations rather than purchasing it on the market, in order to take advantage of the tax benefits associated with depreciation on machinery. Is G Limited's decision, correct? Explain. 3. Explain the Tax implications of Make or buy decisions. 4. Write short notes on lease rent paid. 5. Briefly explain about retain or replace decision. Long Questions 1. R Ltd., a manufacturing firm, requires a generator to carry out its operations. The price is Rs. 1,00,000. Upon further investigation, it is discovered that the company has two possibilities. 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 : 145 CU IDOL SELF LEARNING MATERIAL (SLM)

 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 2.An assessee, who carries on a business, acquires amachinery costing Rs.1,00,000. This machinery has a life of 5years. 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 3. Discuss in detail about the various management decisions. 4. Elaborate about the tax implications of retain or replace decision. 5. Discuss why management decisions are directly have an impact on tax planning. B. Multiple Choice Questions 1. When a Machinery is purchased instead of leasing which of the following gives a tax benefit a. Depreciation b. Interest paid on loan to purchase machinery c. Repairs and renewals d. All of these 2. When is Machinery leased instead of purchase which of the following gives a tax benefit? a. Depreciation b. Interest paid on loan to lease machinery c. Lease rentals d. All of these 3. When is a machinery replaced instead of retaining which of the following is a general benefit available? 146 CU IDOL SELF LEARNING MATERIAL (SLM)

a. Depreciation b. Interest paid on loan to lease machinery c. Reduced repair cost d. All of these 4. Lease rental may be split into a. 2 Components b. 3 Components c. 4 Components d. None of these 5. What is the benefit of replacing an old machine instead of retaining it? a. Results in cost saving b. Saving of capital outflow c. Inflow of scrap value d. None of these Answers 1-d 2-c 3-c 4-b 5-a 10.10 REFERENCES  V.K. Singhania,DirectTaxes,Taxman Publication (P)Ltd.,Delhi,Latestedition.  Lakhotia R.N., Income Tax Planning Handbook, Vision Books, New Delhi, Latestedition.  H.C. Mehrotra–IncomeTaxLaw&Practice.  Bhagwati Prasad: LawandPracticeofIncomeTaxinIndia  H.P.Ranina:CorporateTaxation: AHandBook(Taxmann).  V.S.Datey:IndirectTaxes– LawandPractice(TaxmannPublicationsLimited).V.S.Datey:IndirectTaxes– LawandPractice(TaxmannPublicationsLimited). 147 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT 11: ACCOUNTING SYSTEMS AND TAXATION STRUCTURE 11.0 Learning Objectives 11.1 Introduction 11.2 Systems of Accounting 11.3 Basis of Accounting 11.4 Tax planning for salary income 11.5 Summary 11.6 Keywords 11.7 Learning Activity 11.8 Unit End Questions 11.9 References 11.0 LEARNING OBJECTIVES After studying this unit students will be able to  State the different systems of accounting  Discuss the tax planning considerations in case of salary income  Explain the various deductions which are available from salary income 11.1 INTRODUCTION Accounting is not as one-dimensional as it may appear to the untrained eye. It also provides a variety of systems and types, allowing the accountant to select the method that is best for his company. We'll look at two accounting systems: single entry and double entry. We'll also study about the two accounting principles of cash basis and accrual basis. 11.2 SYSTEMS OF ACCOUNTING The two methods of recording financial transactions in the books of accounts are referred to as accounting systems. The single entrance method and the double or dual entry system are the two options. Let's take a quick look at both. Single Entry System Pure entry is another name for this approach. It deviates from the standard dual-recording format. Instead, only a Cash Book will be kept in a single-entry system. The Cash Book will keep track of all cash transactions. There is no room for any other ledgers in this system. All personal transactions are simply recorded in a rough book. 148 CU IDOL SELF LEARNING MATERIAL (SLM)

This procedure, as you can see, is not very scientific. As a result, it is hardly used nowadays.We only use the single-entry technique to prepare final accounts from partial records for whatever reason. Other notable elements of the single-entry system include: Personal and business transactions will be recorded simultaneously because just one cash book is kept. This approach will disregard both real and nominal accounts. We can calculate profit or loss, but we can't reflect the company's financial situation. Because there is no trial balance, the arithmetical accuracy of the accounts cannot be confirmed. Double Entry System This is the more traditional and usual method of recording financial accounting transactions. This is a scientific procedure that must adhere to certain laws and principles. The double entry method is based on the idea that every transaction affects two accounts. The debit and credit rule states that for every credit entry, there must be a corresponding debit entry. In the accounting world, the double entry system is the most extensively used and acknowledged. The following are some of the system's most notable features: This system keeps track of all three sorts of accounts: real, nominal, and personal. The trial balance is used to verify the arithmetic accuracy of the financial records. There aren't many changes to the system. It enables the creation of a balance sheet that reflects the organization's financial situation. This double entry approach makes it simple to detect frauds and errors. 11.3 BASIS OF ACCOUNTING This is concerned with the timing of revenue recognition, or when revenue should be recorded in the books of accounts. The cash basis of accounting and the accrual basis of accounting are two approaches to this conundrum. Let's take a quick look at both of them. Cash Basis of Accounting This is the more straightforward method. An income will only be recorded when it comes in under the cash accounting system. As a result, an income will be produced after the organisation receives payment in cash. Similarly, expenses will only be recorded once they have been incurred. Take, for example, a company that pays its employees' salaries for the month of June on July 3rd. Although the expense is for the month of June, this salary item will be recorded in July. 149 CU IDOL SELF LEARNING MATERIAL (SLM)

Assume the organisation made a credit sale on August 5th. The payment was received on October 11th;thus, this sale will be reported on that date. Accrual Basis of Accounting The accrual basis of accounting is the most logical and scientific method of accounting. Most businesses choose this strategy because it provides a more accurate picture of the company's financial situation. Revenues and expenses are recorded in the accrual system in the time period in which they occur, not when the money is received. So, regardless of whether or not the payment has arrived, the income will be reported if it is earned. And, regardless of whether the expense has been paid, it is recorded when it becomes due. All incomes and expenses, both cash and non-cash (such as prepaid/outstanding expenses and accrued/advance income) will be taken into account in an accrual system. Finally, the final accounts will accurately reflect the organization's financial situation. 11.4 TAX PLANNING CONSIDERATIONS IN RESPECT OF SALARY INCOME Employees have a limited amount of flexibility when it comes to tax preparation. Salary is a broad term that encompasses not just monetary compensation but also non-monetary rewards and perks. The standard deduction up to $50,000, the deduction for entertainment allowance, and the deduction for professional tax are the only deductions allowed for salary income. As a result, tax planning opportunities for salary income are severely limited. However, in terms of salary income, the following are some tax planning suggestions. (1) Salary Structure:The wage structure should be planned with the deductions and exemptions allowed under the Act in mind. If a salary is paid in one lump sum without any breaks, the amount of the salary, after a standard deduction of 50,000, becomes taxable without any further exemptions or deductions. As a result, the company should split it and pay it as a basic salary plus different allowances and perquisites in order to lower the employee's tax burden. For example, the employer may provide allowances as part of the employee's wage structure for which Rule 2BB exemption can be claimed, such as children's education allowance, hostel allowance, and house rent allowance. When calculating the profits and gains of a business or profession, the employer will get a deduction for all of the following sums paid. Depending on the employee's posting, the company may also provide allowances such as special compensatory allowance, border area allowance, distant area allowance, difficult area allowance, or disturbed area allowance. There are some exemptions available for these allowances. Rule 2BB provides the exempt allowances in this regard. The employer must 150 CU IDOL SELF LEARNING MATERIAL (SLM)