CU-MCOM-SEM-IV-Tax Planning and Procedure-Second Draft

["derived by the owner from the house property. Similarly, where the assessee has only one residential house but it cannot be occupied by the owner by reason of his employment, business or profession carried out on at any other place, he has to reside at that other place in a building not belonging to him, the annual value of such house shall be taken to be nil if the house is not actually let and no other benefit is derived by the owner from such house. However, if the self-occupied is let out during the previous year, or the owner derives some other benefit from it, then the annual value of such a house cannot be taken as \u2018nil\u2019. In such a case, the annual value of the property must be calculated for the whole year and the proportionate annual value of the period for which the house was in the occupation of the owner for his own residence is deducted from the gross annual value. Where the assessee occupies more than one house for his residence the above exemption is applicable only to one such house at the option of the assessee. The annual value of the other house or houses shall be computed as if the house or houses are let. Where the house property is self-occupied and its annual value is taken as nil, no deductions are allowed, except interest payable on funds borrowed in relation to the house property. Ownership of the Property For income being charged to tax under the head \u2018income from house property\u2019, the property must belong to the assessee. The tax under this head is in respect of ownership and not the occupation or possession of the house. Deductions from Income from House Property Income chargeable under the head income from house property is computed after making the following deductions, namely: (a) flat deduction; (b) interest on borrowed funds, generally; (c) interest on borrowed funds in relation to self-occupied property; (d) subsequent receipt of unrealized rent; (e) receipt of arrears of rent; and (f) property owned by co-owners. \uf0b7 A flat deduction equal to 30 per cent of the annual value is allowed as a deduction from the annual value. \uf0b7 Where the property has been acquired, constructed, repaired, renewed, or reconstructed with borrowed capital, the amount of any interest payable on such capital is allowed to be deducted. \uf0b7 In case of self-occupied property whose annual value is taken as nil, any interest is payable on funds borrowed for the purpose of acquiring, constructing, repairing, renewing, or reconstructing a self-occupied house property is allowed as a deduction. \uf0b7 Where the assessee cannot realize rent from a property let to a tenant and subsequently the assessee has realized any amount in respect of such rent, the amount so realized shall be deemed to be income chargeable under the head Income from house property and accordingly charged to income-tax as the income of that previous 101 CU IDOL SELF LEARNING MATERIAL (SLM)","year in which such rent is realized whether the assessee is the owner of that property in that previous year. \uf0b7 Where the assessee (a) is the owner of any property consisting of any buildings or lands appurtenant thereto which has been let to a tenant; and (b) has received any amount, by way of arrears of rent from such property, not charged to income-tax for any previous year, the amount so received, after deducting a sum equal to 30 per cent of such amount, shall be deemed to be the income chargeable under the head Income from house property and accordingly charged to income-tax as the income of that previous year in which such rent is received, whether the assessee is the owner of that property in that year or not. \uf0b7 Where any house property is owned by two or more persons and their respective shares are definite and ascertainable, in such a case, the share of each such person in the income from the property is to be separately included in his total income. \uf0b7 Any loss from house property, whether let out or self-occupied, is allowed to be set off against any other head of income in the same assessment year. Where the loss under the head \u2018income from house property\u2019 cannot be set off against any other head of income in the same assessment year, it is allowed to be carried forward and set off against \u2018income from house property\u2019 of immediately succeeding eight assessment years. The computation of income under the head income from house property is computed using the following format: Sr# Particulars Amount A Annual Value of House Property XXX B Deductions from Annual Value of House Property XXX 1 Flat deduction XXX 2 Interest on borrowed funds, generally 3 Interest on borrowed funds in relation to self-occupied property 4 Subsequent receipt of unrealized rent 5 Receipt of arrears of rent 6 Property owned by co-owners Total Deduction C Net Income from House Property (A-B) 102 CU IDOL SELF LEARNING MATERIAL (SLM)","7.3.3 Profits and Gains from Business and Profession The income chargeable under the head profits and gains from business or profession is net income or profits. Profits should be computed after deducting the losses and expenses incurred for the purpose of the business, profession, or vocation. Profits may be realized in money or in money\u2019s worth, in cash or in kind. Income Chargeable under the Head Profits and Gains The following incomes are chargeable to income-tax under the head profits and gains of business or profession: \uf0b7 The profits and gains of any business or profession that was carried on by the assessee at any time during the previous year. \uf0b7 Compensation for Termination of Office \uf0b7 Income of Trade Associations \uf0b7 Profits on Sale of Import Licenses \uf0b7 Export Incentives \uf0b7 Business Perquisites \uf0b7 Remuneration of a Partner \uf0b7 Compensation for Non-Compete Agreements Deduction of Expenses from Gross Profits and Gains The profits or gains from business or profession are taxed on a net basis, that is, after deducting all the expenses from the gross income. However, all expenses are not allowed to be deducted, and some expenses are allowed to be deducted to a limited extent. The following is the scheme of deductions from this head of income: \uf0b7 Deduction allowed, generally \uf0b7 Deductions that are not allowed, generally \uf0b7 Deduction that are not allowed in certain circumstances \uf0b7 Deductions not allowed in certain circumstances \uf0b7 Deductions Explicitly Allowed Presumptive Taxation In some types of businesses, it is difficult to accurately compute the profit or gains from business and profession. To address this problem ITA has introduced a concept of presumptive taxation for certain business, such as the business of civil contracting, retailing and that of plying, hiring, or leasing carriages. 7.3.4 Capital Gains Income includes gains derived on transfer of a capital asset. When a person sells (or transfers) a capital asset, the difference between the sale price and the cost of its acquisition, plus the 103 CU IDOL SELF LEARNING MATERIAL (SLM)","cost of any improvement and the cost of effectuating the transfer, is either a capital gain or a capital loss. Thus, capital gain is the profit or gain arising from the transfer of a capital asset during the previous year. Since these gains are not routine accruals, they are treated on a different footing for taxation purpose. There are two types of capital assets, namely: long term and short term. Long-Term Capital Asset Ordinarily, a capital asset that was held for more than 36 months before its transfer is called a long-term capital asset. However, in case of certain assets, such as shares of a company, the units of Unit Trust of India or any specified mutual fund or any security traded in a recognised Indian stock exchange, the holding period for being considered as long-term capital asset is more than 12 months. The capital gains on the transfer of the long-term capital asset are termed long term capital gains. Short-Term Capital Asset Ordinarily, a capital asset that was held for 36 months or less before its transfer is called a short-term capital asset. However, in case of certain assets, such as shares of a company, the units of Unit Trust of India or any specified mutual fund or any security traded in a recognised Indian stock exchange, the holding period for being considered as long-term capital asset is 12 months or less. The capital gain on the transfer of short-term capital asset is termed short term capital gains. Short-term capital gains are included in the total income of an assessee and charged to tax along with the other incomes at the normal rates in force. Mode of Computation of Capital Gains The income chargeable under the head capital gains is calculated by reducing the full value of the consideration received (or accruing) because of the transfer of the capital asset by the sum of: (i) the cost of acquisition of the capital asset; (ii) the cost of improving the asset; and (iii) the expenditure incurred wholly and exclusively in connection with the transfer. Thus, any capital gains arising out of transfer of a capital asset is computed using a four-step process. Step 1: Determine the expenditure incurred wholly and exclusively in connection with the transfer. Step 2: Determine the cost of acquisition of the asset. Step 3: Determine the cost of improvement to the capital asset incurred before its transfer. Step 4: Subtract the sum of amounts determined in steps 1, 2, and 3 from the full value of consideration received (or accruing) because of transfer of the capital asset. Where a capital gain arises due to transfer of a long-term capital asset then instead of the \u2018cost of acquisition\u2019 and \u2018cost of improvement\u2019, the indexed cost of acquisition and the 104 CU IDOL SELF LEARNING MATERIAL (SLM)","indexed cost of improvement should be subtracted from the full value of the consideration. In this case, the resultant capital gain is called long term capital gain. 7.3.5 Income from Other Sources Income from other sources is the residual 'head of income' covering any item of taxable income which does not specifically fall under the heads of 'Profits and Gains of Business or Profession', 'Capital Gains', 'House Property', or 'Salary'. However, certain incomes are necessarily to be charged under this head as per the law. Income Chargeable Under the Head Income from Other Sources Any winnings from lotteries, crossword puzzles, races including horse races, card games and other games of any sort or from gambling or betting of any form or nature. Certain incomes are also chargeable to tax under this head only if the same are not otherwise chargeable to tax under the head 'salaries' or \u2018profits and gains of business or profession', for example income from machinery, plant or furniture belonging to the assessee and let on hire, and income from letting on hire machinery, plant or furniture belonging to the assessee along with buildings if the letting of the building is inseparable from the letting of the said machinery, plant or furniture. Certain incomes falling under this head of income include salaries received by a person who cannot be termed an employee, annuities which are not provided by the employers, debenture interests, interest on bank deposits and all other interest incomes if it is not chargeable to tax under the head Profits and Gains of Business or profession, Rental incomes from properties which are not owned by the assessee, for example, in cases of subletting or in respect of sub lease of properties etc., interest on fixed deposits and other deposits before the commencement of business, and family pensions. Deductions from Income from Other Sources The law permits deduction of expenditure laid out wholly and exclusively for the purpose of making or earning the Incomes from Other Sources as long as the expenditure is not of a capital nature. Besides certain specific deductions are also permitted from the income from other sources include any reasonable sum paid by way of commission or remuneration to a banker or any other person for the purpose of realising such dividend or interest on behalf of the assessee. Amounts Not Deductible from Other Sources There are certain amounts which are not allowed as a deduction from the income from other sources. Such expenses include: (a) personal expenses of the assessee; (b) interest chargeable under the Income Tax Act, 1961 which is payable outside India but on which no tax was deducted at source; (c) any payment which is chargeable under the head 'salaries' if it is payable outside India but on which no tax was deducted at source. 105 CU IDOL SELF LEARNING MATERIAL (SLM)","The law prohibits any deduction in respect of any expenditure or allowance in connection with winnings from lotteries, crossword puzzles, races including Horse races, card games, and other games of any sort or from gambling or betting of any form or nature. The 'horse race' means a horse race upon which wagering, or betting may be lawfully made. However, this prohibition does not apply to an assessee who is the owner of horses maintained by him for running in horse races when he earns income from other sources from the activity of owning and maintaining such horses. 7.4SET OFF AND CARRY FORWARD OF LOSSES An assessee may have earned income from multiple sources during the previous year. It is possible that within each head of income listed above, the assessee may have earned income from multiple sub sources. For example, an assessee may have earned, or received, income from more than one employer, or may have earned income from multiple house properties, or may have earned profits or gains from multiple businesses. Further, an assessee may have capital gains from multiple transactions. 7.4.1 Intra-Head Set Off of Losses When an assessee earns income from multiple sub-sources within a single head of income, it is possible that there may be a positive income from some sub-sources and losses in some other sub-sources. The Income tax law allows an assessee to set off a loss in one or more sub- sources against the positive income in other sub-sources within a single head of income in the same previous year. This is called as intra-head set off of losses (Cruz, Deschamps, Niswander, Prendergast, & Schisler, 2018). 7.4.2 Inter-Head Set Off of Losses When intra-head set off of losses is not possible, the law allows setting off of losses from one head against the income of another head. This is called as inter-head set off of losses. Thus, inter-head adjustments mean the setting off of losses from one head of income against income from other heads of income.For example, an assessee may have a loss under the head of house property. This loss may be set off against the profits under another head, such as income from salaries.Such inter-head adjustments are allowed subject to certain restrictions. 7.4.3 Carry Forward of Losses It may be possible that the loss incurred by an assessee are so big that it cannot be fully absorbed both, within the head of income, and across the heads of income. In such a scenario, the assessee may be allowed to carry forward the loss to subsequent assessment years. This topic of set off and carry forward of losses is discussed in more detail in Unit 4 of this course. 106 CU IDOL SELF LEARNING MATERIAL (SLM)","7.5 DEDUCTIONS OUT OF GROSS TOTAL INCOME For arriving at the taxable income, the taxpayer is allowed several deductions. The deductions allowed by the Income Tax Act, 1961 can be classified in two categories: (a) deductions specific to a head of income; and (b) deductions allowed from total income. The deductions allowed by the Income Tax Act, 1961 are for two purposes: (a) deductions allowed providing relief to taxpayer from tax payables. Examples of such deductions include standard deductions from salary income and income from house property; and (b) deductions allowed to encourage certain behaviour and actions. Examples of such deductions include encourage to provide for one\u2019s retirement, setting up industries in backward areas, etc. The deductions allowed from gross total income are numerous and to make sense may be classified in the following categories: \uf0b7 Insurance Premium \uf0b7 Retirement Planning \uf0b7 Deposit Schemes \uf0b7 Child Development \uf0b7 Housing \uf0b7 Investments in Securities \uf0b7 Disability \uf0b7 Donations \uf0b7 Environment Protection \uf0b7 Royalty and Interest Income This topic of deductions out of gross total income is discussed in more detail in Unit 5 of this course. 7.6 RATES OF TAX The rates of income tax are not contained in the Income Tax Act, 1961. The rates are contained and prescribed by the Finance Act. The Finance Act is passed every year during the budget session of the parliament every year. The government proposals for the levy of new taxes, alterations in the present tax structure or continuance of the current tax structure beyond the approved period. The Parliament approves the Finance Bill for a period of one year at a time, which becomes the Finance Act. There is a legal reason too for the preparation and presentation of the budget. Every rupee earned by the government is deposited in the Consolidated Fund of India. This is one big reservoir where the government pools all its funds together. The fund includes all government revenues, loans raised. and recoveries of loans granted. No money can be withdrawn from the 107 CU IDOL SELF LEARNING MATERIAL (SLM)","Consolidated Fund without the sanction of the Parliament. This sanction is given by the Parliament by passing the Appropriation Bill. The basic tax rates applicable to a resident individual will depend on the age of the individual. However, in case of a non-resident individual the tax rates will be same irrespective of his age. For the purpose of ascertainment of the applicable tax slab, an individual can be classified as follows: (a) resident individual below the age of 60 years; (b) resident individual of the age of 60 years or above at any time during the year but below the age of 80 years; (c) resident individual of the age of 80 years or above at any time during the year; and (d) non-resident individual irrespective of the age. 7.6.1 Basic Rates of Taxation for Individuals Net Income Range Rate of Income Tax AY 2021-22 AY 2022-23 Nil Up to Rs. 250,000 Nil 5% Rs. 250,000 to Rs. 500,000 5% 20% Rs. 500,000 to Rs. 1,000,000 20% 30% Above Rs. 500,000 30% 7.6.2 Basic Rates of Taxation for Senior Citizens Net Income Range Rate of Income Tax AY 2021-22 AY 2022-23 Nil Up to Rs. 300,000 Nil 5% Rs. 300,000 to Rs. 500,000 5% 20% Rs. 500,000 to Rs. 1,000,000 20% 30% Above Rs. 500,000 30% 7.6.3 Basic Rates of Taxation for Super Senior Citizens Net Income Range Rate of Income Tax AY 2022-23 AY 2021-22 108 CU IDOL SELF LEARNING MATERIAL (SLM)","Up to Rs. 500,000 Nil Nil Rs. 500,000 to Rs. 1,000,000 20% 20% Above Rs. 500,000 30% 30% 7.6.4 Surcharge and Health and Education Cess Surcharge is levied on the amount of income-tax at following rates if total income of an assessee exceeds specified limits. Surcharge: Assessment Year 2021-22 | 2022-23 Rs. 50 Lakhs and Rs. 1 Crore and Rs. 2 Crores and Rs. 5 Crores and Rs. 10 Less than Rs. 1 Less than Rs. 2 Less than Rs. 5 Less than Rs. 10 Crores and Crore Crores Crores Crores More 10% 15% 25% 37% 37% Health and Education Cess is levied at the rate of 4 per cent on the amount of income-tax plus surcharge. 7.7 SUMMARY \uf0b7 Generally, the entire income person earned by a taxpayer is chargeable to tax. However, in order to provide relief to some taxpayers and to encourage some activities and businesses, the government exempts some income from being included in the taxable income of a taxpayer. Some income is fully exempt, whereas some other incomes are partially exempt. \uf0b7 Companies are by far the most common vehicles used to carry on business activity both in India and around the world. They have become so because governments have legislated to provide companies with various incentives, rights, and privileges. Governments have successfully used the law to create a legal framework favourable to form various types of companies. \uf0b7 For the purpose of Income Tax, the following types of companies have been distinguished: \uf0b7 Indian company, domestic company, foreign company, widely held company, closely held company, and infrastructure Capital Company. \uf0b7 The government has reduced the rate of income tax applicable to certain domestic companies to as low as 15 per cent, provided they do not claim any deduction which they were earlier eligible to claim. While introducing this scheme, the government 109 CU IDOL SELF LEARNING MATERIAL (SLM)","also recognised that some domestic companies may wish to continue with the old system. Therefore, while introducing the new scheme the government has given an option to domestic companies to either choose the new scheme or to continue with the traditional system. \uf0b7 The dividend distribution tax has been rescinded from assessment year 2020-21. Now, when a shareholder received dividend from a domestic company, he has to pay tax and not the company. \uf0b7 Ordinarily, issue of shares at premium by listed companiesis not considered as income. However, in case of un-listed companies, premium can be considered as income in case the price charged at the time of issue of share is more than face value (that is at premium) and is also higher than fair market value. 7.8 KEYWORDS \uf0b7 Closely Held Company.A company in which the public is not substantially interested is known as a closely held company. \uf0b7 Dividend. As applied to a company that is a going concern, dividend ordinarily means the portion of the profits of the company which is allocated to the holders of shares in the company. In the case of winding up, dividend means a division of the realized assets among creditors and contributories according to their respective rights. \uf0b7 Domestic Company. Domestic company is an Indian company or (a) any other company which, in respect of its income liable to tax under the Income Tax Act; (b) has made the prescribed arrangements for the declaration and payment within India, of the dividends payable out of such income. \uf0b7 Indian Company. An Indian company is one that is formed and registered under the Companies Act, 2013 and includes (a) a company formed and registered under any law relating to companies formerly in force in any part of India; (b) any corporation established by or under a central, state or provincial act; (c) any institution, association or body which is declared by the CBDT to be a company; and (d) in the case of any of the union territories of a company formed and registered under any law for the time being in force in that union territory. \uf0b7 Intercorporate Dividend. An intercorporate dividend is dividend received by a company from investments in equity and preference shares held by it in other companies. \uf0b7 Interim Dividend. An interim dividend is a dividend declared by the board of directors of a company before a company's annual general meeting (AGM) and the release of final financial statements. \uf0b7 Share Buyback. A share buyback refers to the process by which a company repurchases its own shares from its shareholders by paying them cash. 110 CU IDOL SELF LEARNING MATERIAL (SLM)","\uf0b7 Share Premium. Share premium is the amount payable for shares in a company and issued by the company itself in excess of their nominal value. \uf0b7 Widely Held Company. A widely held company is defined as a company in which the public are substantially interested. 7.9LEARNING ACTIVITY Based on the learning from this unit (1) identify the 30 companies which are part of the S&P BSE SENSEX; (2) find out which of the companies are issued shares at a premium in the last five years; (3) find out how much intercorporate dividends was earned by these companies (4) read the notes to accounts section and find details of the above. ___________________________________________________________________________ ___________________________________________________________________________ 7.10UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Explain the concept of interoperate dividends in brief. 2. Explain the concept of share premium in brief. 3. Explain the concept of widely held company in brief. 4. Explain the concept of closely held company in brief. 5. Explain the concept of share buyback in brief. Long Questions 1. Discuss the current position of taxation of dividends distributed by a domestic company. 2. Discuss the current position of taxation of shares bought back by a domestic company. 3. Discuss the current position of income distributed by a mutual fund to its unit holders. 4. Discuss the current position of premium received by a company on issue of equity shares. 5. Explain the rationale for the new optional tax system for domestic company. B. Multiple Choice Questions 1. Under which of the following circumstances would a non-Indian company be considered as a domestic company? a. The company makes prescribed arrangements for the declaration and payment of dividends in India on which tax is deductible at source. 111 CU IDOL SELF LEARNING MATERIAL (SLM)","b. The company earns more than 50 per cent of its revenue from its operations in India. c. The majority of directors on the company's board of directors are either citizens of India or persons of Indian origin. d. The control and management of the company is located in India. 2. A not-for-profit company registered under Section 8 of the Companies Act, 2013 is considered as which of the following under the Income Tax Act, 1961? a. Closely held company. b. Thinly capitalised company. c. Widely held company. d. Under-capitalised company. 3. Under the Income Tax Act, 1961 a company is considered as a closely held company in which of the following circumstances? a. The public is substantially interested in the company. b. The public is NOT substantially interested in the company. c. The market capitalisation of the company is less than Rs. 100 crores. d. The majority of directors on the company's board of directors belong to one family. 4. Where a company in which the public are substantially interested, issues shares at a premium, the difference between any consideration for issue of shares and the face value of such shares, is chargeable to tax under which of the following heads of income? a. Profits and gains from business and profession. b. The share premium is not an income and hence not chargeable to tax. c. Capital gains. d. Income from other sources. 5. Where a domestic company receives dividend from a foreign company, in which such domestic company has 26 per cent or more equity shareholding, is taxable at which of the following rate on a gross basis without allowing deduction for any expenditure? a. 15 per cent b. 30 per cent c. 25 per cent 112 CU IDOL SELF LEARNING MATERIAL (SLM)","d. 10 per cent Answer 1-a, 2-c, 3-b, 4-d, 5-a 7.11 REFERENCES Reference Books \uf0b7 Cruz, A., Deschamps, M., Niswander, F., Prendergast, D., & Schisler, D. (2018). Fundamentals of Taxation. New York: McGraw-Hill Education. \uf0b7 Martin, E. A. (2003). The Dictionary of Law. Oxford: Oxford University Press. \uf0b7 Singhania, V., & Singhania, K. (2021). Direct Taxes Law & Practice. New Delhi: Taxmann. Website: \uf0b7 Income Tax Department. (2021, 4 1). Set Off and Carry Forward of Losses Under the Income Tax Act. Retrieved from Tutorials: https:\/\/www.incometaxindia.gov.in\/Tutorials\/21- %20MCQ%20set%20off%20and%20carry%20frwrd.pdf \uf0b7 Institute of Chartered Accountants of India. (2019, February 1). Set off and Carry forward, of Losses. Retrieved from Western India Regional Council: https:\/\/www.wirc-icai.org\/images\/material\/Key-Aspects-Carry-Forward-Set- Losses.pdf \uf0b7 Sirwalla, P. (2012, January 31). Income Tax Deductions That You Should Not Miss. Business Today. Retrieved from https:\/\/www.businesstoday.in\/magazine\/tax\/story\/income-tax-deductions-24273- 2011-12-28 \uf0b7 Directorate of Income Tax. (2021). Salary Income and Tax Implications for AY 2020- 21. New Delhi. Retrieved from https:\/\/www.incometaxindia.gov.in\/booklets%20%20pamphlets\/salary-income-tax- implications-ay-20-21.pdf \uf0b7 KPMG. (2020, January 30). India: Income Tax. Retrieved from Taxation of International Executives: https:\/\/home.kpmg\/xx\/en\/home\/insights\/2011\/12\/india- income-tax.html 113 CU IDOL SELF LEARNING MATERIAL (SLM)","UNIT- 8COMPUTATION OF BOOK PROFIT AND MAT CREDIT STRUCTURE 114 8.0 Learning Objectives 8.1 Computation of Tax Liability 8.2 Minimum Alternate Tax (MAT) 8.2.1 Rational for Minimum Alternate Tax (MAT) 8.2.2 Impact of Minimum Alternate Tax (MAT) 8.2.3 Basic Provisions of Minimum Alternate Tax (MAT) 8.2.4 Applicability of Minimum Alternate Tax (MAT) 8.2.5 Meaning of Book Profits 8.2.6 MAT Credit 8.3 Tax Deduction at Source 8.3.1 Rationale for Deduction of Tax at Source 8.3.2 Applicability of TDS 8.3.3 Tax Deduction Account Number (TAN) 8.3.4 Responsibility of the Deductor 8.4 Payment of Advance Tax 8.4.1 Liability to Pay Advance Tax 8.4.2 Due Dates for Payment of Advance Tax 8.4.3 Interest of Excess Payment of Advance Tax 8.5 Summary 8.6 Keywords 8.7 Learning Activity 8.8 Unit End Questions 8.9 References 8.0 LEARNING OBJECTIVES After studying this unit, you will be able to: CU IDOL SELF LEARNING MATERIAL (SLM)","\uf0b7 State the tax rationale, impact, applicability, and the basic provisions of minimum alternative tax. \uf0b7 Explain the rationale, applicability, and provisions of the scheme for deduction of tax at source, and advance tax. 8.1COMPUTATION OF CORPORATE TAX LIABILITY The procedure for computation of corporate tax liability of a company is similar to that of any other assessee. The following are the steps involved in computing the taxable income and amount of tax payable by companies. Step #1 Determine the type of company The scope of income and the rate of income tax depend upon the type of company. In this regard companies are classified into a domestic company and a foreign company. A domestic company is one that is incorporated under the Indian company law. However, even if a company not incorporated under the company law in India if its place of effective management is located in India. A foreign company is one which is not incorporated under the company law in India and its place of effective management is located outside India. Step #2 Choice of Tax Policy Even when a company is a domestic company, the management has to consider whether they are better off claiming all the allowable deduction and be liable to tax at a higher rate or choose not to claim all the available deduction and pay tax at a lower rate. Domestic companies that decide to avail all the deductions are liable to pay tax at the rate of 30 per cent, wheredomestic companies that decide to forego all the deductionsare liable to pay tax at the rate of 22 per cent. Step #3 Compute Taxable Incomesunder Each Head of Passing The company then computes its taxable income from each of the following head of passing: income from house property, profits and gains of business, capital gains, and income from other sources. The total of taxable income under the above head is called gross taxable income. Step #4 Compute Deductions under Chapter VI A Where the company has decided to go for the traditional system of taxation, it would claim all the allowable deduction from the gross taxable income and the resulting figure would be the net taxable income. On the other hand, if the company has opted for the optional system of taxation, it would not claim all the deductions. Step #5 Apply the Rate of Taxation to Net Taxable Income 115 CU IDOL SELF LEARNING MATERIAL (SLM)","The applicable rate of income is applied to the net taxable income and determines the amount of tax payable. The surcharge and health and education cess is then calculated on the amount of tax. A domestic company is liable to tax at the rate of 25 per cent if its turnover or gross receipt does not exceed Rs. 400 crores in the previous year 2019-20. The rate of tax is 30 per cent otherwise. 8.2 MINIMUM ALTERNATE TAX (MAT) Many companies with significant accounting income substantially reduce their taxableincome by the judicious use of allowable deductions and income exemptions. Toensure that most companies pay some taxes, the government instituted a second paralleltax system aptly named theminimum alternative tax (MAT), which applies to all companies, except those that are exempt. To determine the minimum alternative tax, the regular income tax base is broadened by a series of positive and negative adjustments and positive preference items to arrive at the MAT. Next the company deducts an exemption amount (subject to limitation) to determine its MAT base, to which it then applies the flat alternative minimum tax rate of 20 percent to calculate gross MAT. 8.2.1 Rationale for Minimum Alternative Tax In India, we come across several companies who report substantial net profit in the financial statements they issue to their shareholders and the public, but the profits suddenly disappear in the tax returns, and they pay either no tax or very small amount of tax. This discrepancy in the profits reported in the financial statements and the income tax return may not be illegal. Companies achieves this result by doing aggressive tax planning by utilising every incentive and concession available in the tax laws to minimise their tax liability to almost zero. Ideally, the government should let the company enjoy its zero-tax status unless the company has violated any provision of the tax laws or has used any colourable devices to avoid taxes. However, in order to \u2018catch\u2019 these zero-tax companies, the government may have to make aggressive amendments to the tax laws. These amendments would make the tax laws even more complicated than what they are at present. This additional complications in the tax laws may help the government is \u2018catching\u2019 these zero-tax companies but in the process make life difficult for all taxpayers. It is for this reason that government has introduced an alternative system of tax whereby companies are required to pay at least \u2018some\u2019 tax based on the profits reported in the financial statements even though the taxable profit reported in the income tax return in zero (Income Tax Department, 2021). 8.2.2 Impact of Minimum Alternative Tax (MAT) on Companies 116 CU IDOL SELF LEARNING MATERIAL (SLM)","Minimum Alternative Tax (MAT) can affect a company\u2019s tax liability in two ways. First, MAT directly affects the company as it imposes an additional tax that that exceeds the company\u2019s regular tax liability. Secondly, MAT indirectly affects the company, by reducing the amount of certain tax credits allowable underthe regular income tax. After calculating their taxes under the regularincome tax, many taxpayers must complete a series of calculations to compute their liability under Minimum Alternative Tax. 8.2.3 Basic Provisions of Minimum Alternative Tax (MAT) Under the alternative system of taxation of MAT, the tax liability of a company is higher of the following: \uf0b7 Tax liability of the company computed as per the normal provisions of the income tax law by computing the taxable income and applying the tax rate applicable to the company. This is called as the normal tax liability. \uf0b7 Tax computed at the rate of 15 per cent (plus surcharge and cess as applicable) on book profits of the company. This is called as the Minimum Alternative Tax (MAT) liability. Minimum Alternative Tax (MAT) is levied at the rate of 9 per cent (plus surcharge and cess as applicable) in case of a unit of an International Financial Services Centre which derives its income solely in convertible foreign exchange. Illustration #1 Airoli Aviation Company, a domestic company, has a taxable income of Rs. 10 lakhs as per the normal provisions of Income-tax Act. Book profit of the company computed as per the provisions of Minimum Alternative Tax (MAT) is Rs. 20 lakhs. The turnover of the company is less than Rs. 400 crores. What will be the tax liability of Airoli Aviation Companyfor the previous year 2019-20? Solution: As per the normal provisions of Income-tax Act, the normal tax liability is at the rate of 25 per cent. Thus, (a) the normal tax liability of the company is (1,000,000 * 0.25) = Rs. 250,000 and (b) the MAT liability of the company is (2,000,000 * 0.15) = Rs. 300,000. Finally, the company is liable to pay the higher of (a) and (b), that is, Rs. 300,000. Illustration #2 Boisar Bauxite Company, a domestic company, has a taxable income of Rs. 13 lakhs as per the normal provisions of Income-tax Act. Book profit of the company computed as per the provisions of Minimum Alternative Tax (MAT) is Rs. 20 lakhs. The turnover of the company is less than Rs. 400 crores. What will be the tax liability of Boisar Bauxite Companyfor the previous year 2019-20? 117 CU IDOL SELF LEARNING MATERIAL (SLM)","Solution: As per the normal provisions of Income-tax Act, the normal tax liability is at the rate of 25 per cent. Thus, (a) the normal tax liability of the company is (1,300,000 * 0.25) = Rs. 325,000 and (b) the MAT liability of the company is (2,000,000 * 0.15) = Rs. 300,000. Finally, the company is liable to pay the higher of (a) and (b), that is, Rs. 325,000. 8.2.4 Applicability of Minimum Alternative Tax (MAT) Every company is liable to pay Minimum Alternative Tax (MAT) if its normal tax liability. is less than 15 per cent of its book-profit. However, the provisions of MAT are not applicable to the following entities. \uf0b7 Domestic companies that have opted for the optional system of taxation. \uf0b7 Any income accruing or arising to a company from the life insurance business. \uf0b7 A shipping company whose income is subject to tonnage taxation. \uf0b7 A foreign company which is a resident of a country with whom India has entered into a double taxation avoidance agreement (DTAA). \uf0b7 A foreign company which is a resident of a country with whom India has not entered into a double taxation avoidance agreement (DTAA) and the entity is not required to register as a company. \uf0b7 An entity to which the provision of presumptive taxation is applicable. 8.2.5 Meaning of Book Profits In the context of Minimum Alternative Tax (MAT), book profit means net profit as shown in the profit and loss account as per the law prepared in accordance with the law as increased and decreased by certain items prescribed by the Income Tax Act. The IndAS accounting standards are now applicable to all companies in India. As such, \u2018book profits\u2019 in the case of such entities is as follows: \uf0b7 The book profits as increased by (a) all amounts credited to other comprehensive income (OCI) in the profit and loss account that will not be re- classified to profit or loss; and (b) aggregate of amounts debited to the profit and loss account on distribution of non-cash assets to shareholders in a demerger of companies. \uf0b7 The book profits as decreased by (a) all amounts debited to other comprehensive income (OCI) in the profit and loss account that will not be re- classified to profit or loss; and (b) aggregate of amounts credited to the profit and loss account on distribution of non-cash assets to shareholders in a demerger of companies. 8.2.6 MAT Credit Minimum Alternate Tax (MAT) requires a company has to pay higher of normal tax liability or liability as per MAT provisions. If in any year the company pays tax as per MAT, then it is 118 CU IDOL SELF LEARNING MATERIAL (SLM)","entitled to claim credit of MAT paid over and above the normal tax liability in the subsequent year(s). A company is entitled to claim MAT credit, that is, excess of MAT paid over the normal tax liability. The credit of MAT can be utilised by the company in the subsequent year(s). The credit can be adjusted in the year in which the normal tax liability of the company is more than the MAT liability. The MAT credit can be carried forward for a maximum period of 15 years. No interest is payable to the company for the amount of MAT credit. Illustration #3 Chimbai Crystal Company\u2019s normal taxable liability for the financial year 2019-20 is Rs. 250,000 and its MAT liability of the company is Rs. 300,000. What is the tax liability of the companyfor the previous year and how much credit is available to the company for subsequent year(s)? Solution: A company\u2019s tax liability is the higher of (a) the normal tax liability of the company, that is, Rs. 250,000; and (b) MAT liability of the company, that is, Rs. 300,000. Thus, the company is liable to pay the higher of (a) and (b), that is, Rs. 300,000. However, credit is available to the company for subsequent year(s) to the extent of the excess of (b) over (a), which is Rs. 300,000 less Rs. 250,000 = Rs. 50,000. Illustration #4 Dahisar Daisy Company\u2019s normal taxable liability for the financial year 2020-21 is Rs. 250,000 and its MAT liability of the company is Rs. 200,000. The company has brought forward MAT credit of Rs. 60,000. What is the tax liability of the company for the previous year and how much of the opening balance of MAT credit can the company adjust this year? Solution: A company\u2019s tax liability is the higher of (a) the normal tax liability of the company, that is, Rs. 250,000; and (b) MAT liability of the company, that is, Rs. 200,000. The, the company is liable to pay the higher of (a) and (b), that is, Rs. 250,000. However, as the amount of normal tax liability is higher than the MAT liability, the company can use the opening balance of its MAT credit to the extent of the difference between the two, that is Rs. 50,000. Thus, the company may utilise Rs. 50,000 out of the MAT credit available to it this year and preserve the balance of Rs. 10,000 for adjustment in the subsequent years. 8.3 TAX DEDUCTION AT SOURCE Tax deduction at source is a provision in income tax law which requires the payers of money to withhold tax from the money payable and only pay the net amount to the payee. This amount that was withheld is required to be remitted to the treasury within seven days of the end of the month in which tax was deducted. 119 CU IDOL SELF LEARNING MATERIAL (SLM)","The payee is allowed to adjust the withheld tax against the tax payable by him. In case the amount of tax withheld is greater than the tax payable by the payee, he is eligible to get a refund from the tax authorities. In India, this system of tax collection is known as \u2018tax deducted at source\u2019 or TDS, whereas the world over it is called as the system of withholding of tax. 8.3.1 Rationale for Deduction of Tax at Source There are three reasons for the provisions regarding deduction of tax at source. \uf0b7 Deduction of tax at source provides the taxpayer a convenient manner to meet his probable income tax liability. \uf0b7 Deduction of tax at source ensures that tax is collected right at the source and thus reduces the risk of the assessee not reporting the income and evading the tax. \uf0b7 Deduction of tax at source improves the government\u2019s cash flow as tax is collected right when the assessee earns income. Thus, deduction of tax at source results in administrative efficiency, prompt and efficient collection of taxes, prevention of tax evasion, and reduction of governmental effort to collect taxes(KPMG, 2020). 8.3.2 Applicability of TDS Tax is required to deducted from the following incomes: \uf0b7 Salaries \uf0b7 Interest on securities \uf0b7 Interest other than interest on securities \uf0b7 Dividends \uf0b7 Winnings from lottery or crossword puzzleand horse races \uf0b7 Payments to contractors and sub-contractors \uf0b7 Insurance commission \uf0b7 Payments to non-resident sportsmen or sports associations \uf0b7 Payments in respect of deposits under National Savings Scheme \uf0b7 Payments on account of repurchase of units by Mutual Fund or UTI \uf0b7 Income payable units of a certain Mutual Fund or UTI \uf0b7 Commission on the sale of lottery tickets \uf0b7 Commission on brokerage \uf0b7 Payment of rent by a non-individual \uf0b7 Fees for professional or technical services \uf0b7 Payment of compensation on acquisition of capital asset or certain immovable property 120 CU IDOL SELF LEARNING MATERIAL (SLM)","\uf0b7 Payment to non-resident non-corporate entities and to foreign companies 8.3.3 Tax Deduction Account Number (TAN) Every person liable to deduct tax at source or collect tax at source is required to obtain Tax Deduction Account Number (TAN). The Tax Deduction Account Number (TAN) is a 10- digit alphanumeric code issued by the income tax authorities. This number is required to be quoted by the \u2018deductor\u2019 while remitting the money to the treasure and filing a TDS statement. A penalty of Rs. 10,000 is applicable on a person who being required to obtain the TAN does not obtain it and on a person who does not quote the correct TAN where required to be quoted (Income Tax Department, 2021). 8.3.4 Responsibility of the Deductor The person who have deducted tax at source are required to remit the tax deducted to the credit of the government within the prescribed time, issue a certificate to the payee, and file a return with the government. \uf0b7 The deductor is required to issue a certificate to the person from whose income tax was deducted. The certificate is required to be issued on quarterly basis. \uf0b7 Where tax deducted during the months of April to February, the deductor is required to remit the tax deducted, to the credit of the Government within seven days from the end of the month in which the tax is deducted. Where tax deducted during the months of March, the deductor is required to remit the tax deducted to the credit of the Government on or before April 30. \uf0b7 Provide details of tax deducted at source to the government on a quarterly basis. 8.4 PAYMENT OF ADVANCE TAX The law requires that taxpayers should estimate their annual tax liability and pay the tax at periodic intervals through the year. The rationale for payment of advance tax is that the taxpayers earn income throughout the year, and it is only fair that they pay tax accordingly. The provision for advance tax also spread the government cash flow over the financial year (Income Tax Department, 2021). 8.4.1 Liability to Pay Advance Tax Every taxpayer whose estimated annual tax liability is more than Rs. 10,000 is required to pay advance tax. However, resident senior citizens who do not have any income from business or profession are exempted from this requirement. 8.4.2 Due Dates for Payment of Advance Tax Advance tax is required to be paid at periodic intervals by all assessees as per the following schedule: 121 CU IDOL SELF LEARNING MATERIAL (SLM)","\uf0b7 Minimum 15 per cent of advance tax by June 15. \uf0b7 Minimum 45 per cent of advance tax by September 15. \uf0b7 Minimum 75 per cent of advance tax by December 15. \uf0b7 Minimum 100 per cent of advance tax by March 15. An assessee who defaults in payment of advance tax is liable to pay a penal interest at the rate of 15 per cent per annum. The above schedule of advance tax is not applicable to assessees who have opted for the presumptive system of taxation. Illustration #5 Ernakulam Electronics Company\u2019s estimated annual taxable liability for the financial year 2021-22 is Rs. 250,000. The company is ineligible for the system of presumptive taxation. What is the minimum amount of first instalment of advance tax payable by the company and what is the due date? Solution. Every assessee, except those who are eligible for, and have opted for, presumptive taxation, are required to pay at least 15 per cent of the estimated annual taxable liability. Thus, minimum amount of first instalment of advance tax payable by the company is (250,000 * 0.15) = 37,500. The amount is required to be paid latest by June 15, 2021. Illustration #6 F Electronics Company\u2019s estimated annual taxable liability for the financial year 2021-22 is Rs. 250,000. The company is ineligible for the system of presumptive taxation. What is the minimum amount of first instalment of advance tax payable by the company and what is the due date? Solution. Every assessee, except those who are eligible for, and have opted for, presumptive taxation, are required to pay at least 15 per cent of the estimated annual taxable liability. Thus, minimum amount of first instalment of advance tax payable by the company is (250,000 * 0.15) = 37,500. The amount is required to be paid latest by June 15, 2021. 8.4.3 Interest of Excess Payment of Advance Tax As advance tax is paid on estimated annual tax liability, it is possible that the estimate is proven wrong. In such a case, the assessee may have paid advance tax more than what he should have. This excess advance tax payment is of course refundable but at the same time the assessee is entitled to receive interest from the government at the rate of 15 per cent per annum. 8.5 SUMMARY \uf0b7 The procedure for computation of corporate tax liability of a company is similar to that of any other assessee. The steps involved in computing the taxable income and amount of tax payable by companies are determine the type of company, choice of tax 122 CU IDOL SELF LEARNING MATERIAL (SLM)","policy, compute taxable income under each head of passing, compute deductions under Chapter VI-A, and apply the rate of taxation to net taxable income. \uf0b7 In India, we come across several companies who report substantial net profit in the financial statements they issue to their shareholders and the public, but the profits suddenly disappear in the tax returns, and they pay either no tax or very small amount of tax. This discrepancy in the profits reported in the financial statements and the income tax return may not be illegal. Companies achieve this result by doing aggressive tax planning by utilising every incentive and concession available in the tax laws to minimise their tax liability to almost zero. It is for this reason that government has introduced an alternative system of tax whereby companies are required to pay at least \u2018some\u2019 tax based on the profits reported in the financial statements even though the taxable profit reported in the income tax return in zero. \uf0b7 Tax deduction at source is a provision in income tax law which requires the payers of money to withhold tax from the money payable and only pay the net amount to the payee. This amount that was withheld is required to be remitted to the treasury within seven days of the end of the month in which tax was deducted. \uf0b7 The law requires that taxpayers should estimate their annual tax liability and pay the tax at periodic intervals through the year. The rationale for payment of advance tax is that the taxpayers earn income throughout the year, and it is only fair that they pay tax accordingly. The provision for advance tax also spread the government cash flow over the financial year. 8.6 KEYWORDS \uf0b7 Advance Tax. Advance tax refers to the legal requirement that taxpayers should estimate their annual tax liability and pay the tax at periodic intervals through the year. The rationale for payment of advance tax is that the taxpayers earn income throughout the year, and it is only fair that they pay tax accordingly. \uf0b7 Book Profits. In the context of Minimum Alternative Tax (MAT), book profit means net profit as shown in the profit and loss account as per IndAS as increased and decreased by certain items prescribed by the Income Tax Act. \uf0b7 MAT. The Minimum Alternate Tax is a tax system through which companies, who have a low taxable income but have reported a substantial profits in their financial statement, are required to a per cent of the book profits as an alternative tax. \uf0b7 TDS. Tax deduction at source is a provision in income tax law which requires the payers of money to withhold tax from the money payable and only pay the net amount to the payee. This amount that was withheld is required to be remitted to the treasury within seven days of the end of the month in which tax was deducted. 123 CU IDOL SELF LEARNING MATERIAL (SLM)","\uf0b7 Withholding Tax. Withholding tax refers to tax deducted at source from payments made to non-resident assessees. 8.7 LEARNING ACTIVITY 1. Explain the responsibilities of a person liable to deduct income tax at source ___________________________________________________________________________ _____________________________________________________________________. 2. Discuss the entities that are liable to make advance payment of income tax and the penalties for not honouring this liability. ___________________________________________________________________________ _____________________________________________________________________ 8.8 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Explain the concept of minimum alternative tax (MAT) in brief. 2. Explain the concept of TDS in brief. 3. Explain the concept of advance payment of tax in brief. 4. Explain the concept of withholding tax in brief. 5. Explain the concept of book profits in brief. Long Questions 1. Enumerate the steps involved in computing tax liability. 2. Explain the rationale of the following: 3. Minimum alternative tax. 4. Deduction of tax at source. 5. Advance payment of tax. 3. Discuss the basic provisions of scheme of minimum alternative tax and enumerate the entities on which this scheme is applicable. 4. Discuss the concept of book profit in the scheme of minimum alternative tax. 5. Discuss the concept of minimum alternative tax (MAT) credit. B. Multiple Choice Questions 124 CU IDOL SELF LEARNING MATERIAL (SLM)","1. Aqsa Aviation Company\u2019s normal taxable liability for the financial year 2019-20 is Rs. 250,000 and its MAT liability of the company is Rs. 300,000. What is the tax liability of the company for the previous year? a. Rs. 250,000 b. Rs. 300,000 c. Rs. 50,000 d. Nil 2. Bela Bauxite Company\u2019s normal taxable liability for the financial year 2019-20 is Rs. 350,000 and its MAT liability of the company is Rs. 300,000. What is the tax liability of the company for the previous year? a. Rs. 250,000 b. Rs. 300,000 c. Rs. 350,000 d. Rs. 50,000 3. Cleo Chemical Company is an assessee who is liable to pay advance tax, what is the minimum amount of advance tax payable by June 15? a. Minimum 15 per cent of advance tax. b. Minimum 45 per cent of advance tax. c. Minimum 10 per cent of advance tax. d. Minimum 5 per cent of advance tax. 4. Dino Diamond Company is an assessee who is liable to pay advance tax, what is the minimum amount of advance tax payable by December 15? a. Minimum 15 per cent of advance tax. b. Minimum 45 per cent of advance tax. c. Minimum 75 per cent of advance tax. d. Minimum 5 per cent of advance tax. 5. What is the amount of penalty applicable on a person who being required to obtain the TAN does not obtain it and on a person who does not quote the correct TAN where required to be quoted? a. Rs. 50,000 b. Rs. 75,000 125 CU IDOL SELF LEARNING MATERIAL (SLM)","c. Rs. 5,000 d. Rs. 10,000 Answer 1-b, 2-c, 3-A, 4-c, 5-d 8.9 REFERENCES Reference Books \uf0b7 Cruz, A., Deschamps, M., Niswander, F., Prendergast, D., & Schisler, D. (2018). Fundamentals of Taxation. New York: McGraw-Hill Education. \uf0b7 Martin, E. A. (2003). The Dictionary of Law. Oxford: Oxford University Press. \uf0b7 Singhania, V., & Singhania, K. (2021). Direct Taxes Law & Practice. New Delhi: Taxmann. Website \uf0b7 Income Tax Department. (2021, 4 1). Set Off and Carry Forward of Losses Under the Income Tax Act. Retrieved from Tutorials: https:\/\/www.incometaxindia.gov.in\/Tutorials\/21- %20MCQ%20set%20off%20and%20carry%20frwrd.pdf \uf0b7 Institute of Chartered Accountants of India. (2019, February 1). Set off and Carry forward, of Losses. Retrieved from Western India Regional Council: https:\/\/www.wirc-icai.org\/images\/material\/Key-Aspects-Carry-Forward-Set- Losses.pdf \uf0b7 Sirwalla, P. (2012, January 31). Income Tax Deductions That You Should Not Miss. Business Today. Retrieved from https:\/\/www.businesstoday.in\/magazine\/tax\/story\/income-tax-deductions-24273- 2011-12-28 126 CU IDOL SELF LEARNING MATERIAL (SLM)","UNIT- 9TAX PLANNING AND MANAGEMENT 127 STRUCTURE 9.0 Learning Objectives 9.1 Introduction 9.2 Tax Planning Relating to Ownership Pattern 9.2.1 Choice of Entity: Tax Planning 9.2.2 Choice of Entity: Relevant Questions 9.2.3 Flow-Through Entities 9.2.4 Sole Proprietorships 9.2.5 Partnership Firms 9.2.6 Companies 9.3 Tax Planning Relating to Location of Business 9.3.1 North-Eastern States 9.3.2 Special Category States 9.3.3 Specified Area 9.3.4 Backward Areas 9.4 Tax Planning Relating to Nature of Business 9.4.1 Start-Up Business 9.4.2 Housing Projects 9.4.3 Environment-Friendly Business 9.4.4 Finance Sector Business 9.4.5 Development of Special Economic Zone 9.4.6 Presumptive Taxation Scheme for Small Business 9.4.7 Specified Business 9.5 Summary 9.6 Keywords 9.7 Learning Activity 9.8 Unit End Questions 9.9 References CU IDOL SELF LEARNING MATERIAL (SLM)","9.0 LEARNING OBJECTIVES After studying this unit, you will be able to: \uf0b7 State the tax implications of choice of a legal form of business as well as the tax implications of location of business. \uf0b7 Explain the various tax benefits available to different types of businesses. 9.1 INTRODUCTION The process of arranging one\u2019s financial affairs to minimize one\u2019s overall tax liability, while complying with both, the letter of the law and the intent of the law, is often referred to as tax planning. There is nothing wrong with tax planning to avoid tax, provided legal methods are used. Judge Learned Hand best stated the doctrine of tax planning in 1947 when he wrote: \u201cover and over again, courts have said there is nothing sinister in so arranging one\u2019s affairs as to keep taxes as low as possible. Everybody does so, rich, or poor, and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced extractions, not voluntary contributions\u201d. Tax planning is defined as follows: Tax planning is the process of evaluating the tax consequences associated with a transaction and making recommendations that will achieve the desired objective at a minimal tax cost. When illegal methods are used to reduce tax liability, the process can no longer be considered tax planning, but instead becomes tax evasion. Tax evasion can subject the taxpayer and tax practitioner to fines, penalties, or incarceration. Illegal acts are outside the realm of tax- planning services offered by a professional tax practitioner. Tax planning covers two basic categories of transactions, the \u2018\u2018open\u2019\u2019 transaction and the \u2018\u2018closed\u2019\u2019 transaction. In an open transaction, all the events have not yet been completed; therefore, the taxpayer has some degree of control over the tax consequences. In a closed transaction, all material parts of the transaction have been completed. As a result, tax planning involving a closed transaction is limited to presentation of the facts to the tax authorities in the most favourable, legally acceptable manner possible. 9.2 TAX PLANNING RELATING TO OWNERSHIP PATTERN 9.2.1 Choice of Entity: Tax Planning The choice of entity type, in which to operate a business is one of the most important decisions owners of businesses can make. Owners generally can form: \uf0b7 A sole proprietorship. \uf0b7 A partnership firm. \uf0b7 A Company. 128 CU IDOL SELF LEARNING MATERIAL (SLM)","There are tax consequences of the type of entity chosen by the owner. Therefore, it is extremely important to consider the day-to-day operations of the business and any applicable legal or tax restrictions on a particular business form. 9.2.2 Choice of Entity: Relevant Questions No one entity generally satisfies all characteristics that owners desire. Selecting the entity usually involves determining a priority for the desirable characteristics and selecting the form that satisfies the most important characteristics. To make these compromises, it is necessary to understand an entity\u2019s characteristics from formation through dissolution. The relevant questions are: \uf0b7 What are permissible tax permissible methods of accounting? \uf0b7 How will its income be taxed? \uf0b7 How will the business be able to raise additional capital if it is to grow? \uf0b7 Who bears the liability if the business fails? \uf0b7 How will owners be compensated? \uf0b7 Can an owner easily divest himself or herself of the ownership interest? \uf0b7 How easily are new owners able to join the business? \uf0b7 What are the tax consequences to the business and its owners if the business ceases operations? 9.2.3 Flow-Through Entities A flow-through business entity is an operating business whose net profits passes directly to the owners of the business, who then pay taxes on this net profits along with their other taxable items. A variety of flow-through business forms are available from which to choose, each with its own individual characteristics, from both legal and tax standpoints. The two most common forms of flow-through business entities are sole proprietorships, and partnership firms. For example, a person who is a 50 percent partner in a partnership that reports Rs. 10,000 of net profit would report Rs. 5,000 of net profit on her individual income tax return. This single level of tax has great appeal to many taxpayers. 9.2.4 Sole Proprietorships The simplest flow-through business is the sole proprietorship. It is a business that has only one individual as the owner. Although it may have a name different from that of the sole proprietor, the sole proprietorship has no identity separate from that of the owner for income tax purposes. The owner (sole proprietor) has unlimited liability for the business operations; that is, the owner\u2019s personal assets are all at risk for the liabilities of the business. Despite this, there are many sole proprietorships due to the ease with which they are formed. Legal requirements for 129 CU IDOL SELF LEARNING MATERIAL (SLM)","formation are minimal. Although usually small, a sole proprietorship is not limited in size. It simply must be an unincorporated business owned by one individual. Deductibility of Expenses A sole proprietorship is formed whenever an individual starts a business with him or herself as the sole owner and chooses no other business form in which to operate. The sole proprietorship cannot be separated from the business, The results of the business operations are included with the sole proprietor\u2019s income tax return along with his or her other tax- related personal items. The taxpayer may use either the cash or accrual method of accounting for the business. Many sole proprietors use a part of their home as an office from which to operate their business. To take a deduction for space allotted to the home office, the area must be used exclusively and on a regular basis as an office. Expenses allocated to the qualifying home office space qualify as business expenses, but this deduction is limited to the taxable income from the business after deducting all other business expenses. Thus, expenses of a home office cannot be used to create or increase a loss. If the taxpayer has assets such as a computer within the home office space, the computer must be dedicated solely to the business. Using the computer for non-business use will negate the solely business use for that portion of the home. To take a deduction for any of the computer use, the taxpayer should keep a written record of the time spent on the computer for business versus personal use. Because the proprietor and the sole proprietorship are a single taxable entity, the proprietor cannot be an employee of the business. As a result, the proprietor cannot receive a salary or perquisites and the business cannot take a deduction for such payments made on behalf of the owner. Paying a salary or the proprietor\u2019s personal expenses is viewed as a cash withdrawal by the owner. It simply moves cash from the owner\u2019s business account to the owner\u2019s personal account and has no tax consequences to either the owner or the business. 9.2.5 Partnership Firms Partnerships are one of the more common business forms, partly because of this ease of entry and their flexibility. The India Partnership Act defines partnership as follows: A partnership is the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all. From this definition, the following points emerge: \uf0b7 That partnership is an association of two or more persons. \uf0b7 There must be an agreement entered into by all persons. \uf0b7 The agreement is to carry on some business. 130 CU IDOL SELF LEARNING MATERIAL (SLM)","\uf0b7 The business to be carried on by all or by any one of them acting on behalf of all and for the benefit of all. \uf0b7 The agreement is to share the profits and losses of business. Taxability of Partnership Firms A partnership firm in the first assessment year is assessed as a firm if the following conditions are satisfied: \uf0b7 The partnership is evidenced by a partnership deed which is to be in writing containing necessary clauses. \uf0b7 The individual shares of the partners as specified in the deed (including how the loss will be borne by major partners in case of a minor admitted for benefits only). \uf0b7 A copy of the partnership deed certified by all the partners or their duly authorized agents, in writing (other than the minors) is submitted along with the return of income in respect of which assessment as a firm is first sought. When a firm is assessed as such for any assessment year, it shall be assessed in the same capacity for every subsequent year if there is no change in the constitution of the firm or in the shares of partners as evidenced by the partnership deed on the basis of which assessment as a firm was first sought. Partnership Firms: Tax Rate A partnership firm is not a separate entity distinct from the partners, but for tax purposes a partnership is taxed as a separate entity and therefore total income will be computed under various heads of income. A partnership firm is also entitled for deductions for expenditures incurred. However, for payment of remuneration to partners and interest on capital are allowed subject to certain conditions.The tax rate applicable to partnership firms is as follows: \uf0b7 In the case of a firm which is assessable as such, tax is chargeable on its total income at the rate of 30 per cent. \uf0b7 Surcharge of 12 per cent is applicable where the total income exceeds Rs. 1 crore. \uf0b7 Health and Education cess is added at 4 per cent of tax plus surcharge. \uf0b7 The firm and LLP are subject to alternate minimum tax. Deductibility of Remuneration to Partners Payment of salary, bonus, commission, or remuneration by whatever name called to a non- working partner is not allowed as deduction. Such payments are allowed only to working partners if it is authorised by the partnership deed and are in accordance with partnership deed. Also, such payments should pertain to the period after the partnership deed. 131 CU IDOL SELF LEARNING MATERIAL (SLM)","The maximum remuneration payable to partners is as follows: \uf0b7 On the first Rs. 300,000 of the book-profit or in case of a loss, maximum remuneration deductible is Rs. 1,50,000 or 90 per cent of the book-profit, whichever is more. \uf0b7 On book-profit beyond Rs. 300,000, the maximum remuneration payable is 60 per cent of the book profits. Deductibility of Interest to Partners Payment of interest can be made to both working and non-working partner.Payment of interest must be authorized by the partnership deed, and it should be related to the period of the partnership deed. If there is another partnership deed for another period, then such deed\u2019s provisions will be considered for that period.The rate of interest should not exceed 12 per cent. If the amount of interest exceeds 12 per cent of the capital, then such excess amount is disallowed as deduction. Deductibility of Salary and Interest to Partners In the following circumstances a firm is not eligible for deduction on account of interest, salary, bonus, etc. paid to the partners: \uf0b7 Fails to make the income tax return \uf0b7 Fails to comply with all the terms of a notice issued by the Income Tax Department \uf0b7 Fails to comply with a direction issued the Income Tax Department \uf0b7 Having made a return, fails to comply with all the terms of a notice issued by the Income Tax Department \uf0b7 The partnership is evidenced by a partnership deed which is to be in writing containing necessary clauses. \uf0b7 The individual shares of the partners as specified in the deed (including how the loss will be borne by major partners in case of a minor admitted for benefits only). \uf0b7 A copy of the partnership deed certified by all the partners or their duly authorized agents, in writing (other than the minors) is submitted along with the return of income in respect of which assessment as a firm is first sought. 9.2.6 Companies For the purpose of income tax, the following types of companies have been distinguished into the following categories Indian company, domestic company, foreign company, widely held company, closely held company, and infrastructure capital company. The issues relation to taxation of companies is discussed in Unit VII and Unit VIII. 132 CU IDOL SELF LEARNING MATERIAL (SLM)","9.3 TAX PLANNING RELATING TO LOCATION OF BUSINESS The different regions in the country are not equally developed in an economic sense. Some regions are highly developed whereas other regions are highly underdeveloped. This imbalance in economic development of different regions creates several economic and social problems such as urbanisation, and crime. With a view to bring about balanced economic development, the government used income tax incentives for encouraging businesses to set their facilities in certain regions of the country. For this purpose, the focus regions are classified in four categories:(a) North-Eastern States; (b) Special Category States; (c) Specified Area; and (d) Backward Areas. The income tax benefits offered to taxpayers in these regions is discussed below. 9.3.1 North-Eastern States Hundred per cent of the gross income derived by any business located in the North-Eastern States, that includes the states of Arunachal Pradesh, Assam, Manipur, Meghalaya, Mizoram, Nagaland, Sikkim, and Tripura is allowed as a deduction for ten years beginning the year of commencement of business. This benefit is available subject to several conditions such the business should be a greenfield project, that is, it should not be set up by splitting up, or the reconstruction, of an existing business. Further, the business should have commenced between the period from April 1. 2007 and March 31, 2017. 9.3.2 Special Category States Businesses engaged in manufacture or production of eligible articles in special category states are allowed a deduction of 100 per cent of their gross income for a period of ten years or five years depending on the location and nature of business. Even after the expiry of this tax-free period the entities are allowed a deduction of 25 per cent of their gross income. This rate is 35 per cent for corporate assessees. The special category states include the states of Sikkim, Himachal Pradesh,and State of Uttaranchal. This benefit is on its way out as it is applicable only to entities who commenced business up to March 31, 2012. 9.3.3 Specified Area Entities engaged in the business of hotels and running convention certain centres in certain specified areas were allowed a deduction of 100 per cent of their gross income for a period of five years from the commencement of business. A total of 22 areas having World Heritage site were specified, including Kamrup, Goalpara, and Nagaon in Assam, and Agra in Uttar Pradesh. However, this incentive lapsed on March 31, 2018, and is no longer available. 9.3.4 Backward Areas Twenty per cent of the gross income of an entity engaged in the business of an industrial undertaking, or of the hotel, allowed if the business is located in a backward. Several areas 133 CU IDOL SELF LEARNING MATERIAL (SLM)","are notified as backward areas, including the districts of Garo Hills, Jaintia Hills and Khasi Hills and whole of the states of Meghalaya and Nagaland.This benefit too is on its way out as it is applicable only to entities who commenced up to March 31, 1990. 9.4 TAX PLANNING RELATING TO NATURE OF BUSINESS Several tax incentives are offered by the government to encourage certain types of businesses. The business who are eligible for these tax breaks include startups, business of housing projects, environment friendly business, entities in the finance sector, development of special economic zones. Further, recognising the difficulty faced by small business in maintaining books of accounts and getting them audited, a scheme of presumptive taxation has been introduced by the government. This scheme of presumptive taxation is applicable entities engaged in retail business, civil construction business, business of plying, hiring or leasing carriages, and business of exploration of mineral oils. 9.4.1 Start-Up Business A tax holiday is available to any start-up, established on or after April 1, 2016, is engaged in innovation, development or improvement of products or processes or services or a scalable business model with a high potential of employment generation or wealth creation. The entire income of such entity under the head profits and gains is exempt for three consecutive assessment yearsout of tenyears beginning from the year in which the entity is incorporated. This benefit is available subject to several conditions such the business should be a Greenfield project, that is, it should not be set up by splitting up, or the reconstruction, of an existing business. 9.4.2 Housing Projects Rapid urbanisation and migration to cities have caused severe urban housing shortages in India. The Government and the Reserve Bank of India have undertaken a number of initiatives to boost affordable housing. One such initiative is the tax incentives for the housing sector (Reserve Bank of India, 2018). The entire income of an assessee under the head profits and gains derived from the business of developing and building rental housing project is exempt from income tax, subject to certain conditions. The condition is that the project is approved by the competent authority between June 1, 2016, and March 31, 2021. Further, the project is completed within a period of five years from the date of approval by the competent authority. 9.4.3 Environment-Friendly Business There has been a sharp increase in environment consciousness in our society and there is a large potential for environment-friendly products. However, these environment-friendly products are often perceived to be expensive. This is also due to premium image attached to such products resulting in apathy of the common people (Putri & Setianan, 2020). With a 134 CU IDOL SELF LEARNING MATERIAL (SLM)","view to encourage environment-friendly business the following two incentives are offered as a start. We expect more such incentives in the near future. Purchase of Electric Car Where an individual obtains a loan from a financial institution for the purchase of an electric car, he would be allowed a deduction up to Rs. 150,000 towards interest paid on the loan. This deduction is available from the assessment year commencing on or after April 1, 2020, and subject to the condition that the loan is sanction during a period between April 1, 2019 and March 31, 2023. Business of Collecting and Processing of Bio-Degradable Waste The entire income of an entity that has income under the head profits and gains from the business of collecting and processing or treating of bio-degradable waste for generating power or producing bio-fertilizers, bio-pesticides, or other biological agents or for producing biogas or making pellets or briquettes for fuel or organic manure, is exempt for a period of five consecutive assessment years from the year in which the business commenced. 9.4.4 Finance Sector Business Mutual Funds A mutual fund is a collective investment scheme that collects funds from small investors and invests these funds in various assets. The entire income of SEBI-registered mutual funds and those operated by a public sector bank, or a public financial institution or a mutual fund authorised by RBI is exempt from income tax. Venture Capital Fund A venture capital funds is a pooled investment scheme that collects funds from large investors and invests these funds in startups and other portfolio companies with strong growth potential. The entire income of a venture capital fund and a venture capital company from investment in a venture capital undertaking is exempt from income tax. Certain entities are excluded from this benefit. Investment Fund An investment fund is a pool of capital that a number of individual investors pay into, which is used to collectively invest in stocks, bonds, and other financial and alternate investments the entire income of a SEBI-registered investment fund, other than the income chargeable under the head profits and gains of business or profession, is exempt from income tax. Real Estate Investment Trust (REIT) A real estate investment trust (REIT) is a SEBI-registered company that owns, operates, or finances income-producing commercial real estate properties. REITs generate a steady income stream for investors but offer little in the way of capital appreciation. The type of 135 CU IDOL SELF LEARNING MATERIAL (SLM)","business is in its infancy in India and needs tax and regulatory policy interventions by the government help the sector grow (Deloitte, 2019). As a part of this initiative, the government has made the entire income of a real estate investment trust, by way of renting or leasing or letting out any real estate asset owned directly by it is exempt from income tax. Infrastructure Debt Fund A debt fund is a pool of investment that holds a portfolio of fixed-income instruments such as bonds or debentures. An Infrastructure Debt Fund is a NBFC (Non-Banking Financial Company) which is a non-deposit accepting financial institutions that manages a debt fund dedicated to the infrastructure sector. The entire income of a notified infrastructure debt fund is exempt from income tax. Financial Institutions The entire income of an institution established by an Act of Parliament, for financing infrastructure and development is exempt for a period of ten years from the year of its establishment. Development Financial Institution A development financial institution is a financial institution that provides long-termloans to companies in private and the public sector on a non-commercial basis. The entire income of an RBI-licensed development financial institution is exempt for a period of five years from the year or its establishment. This five-year tax holiday may be extended by the Central Government for a further period five years. Offshore Banking Units Offshore banking units (OBUs) are bank branches located outside of its home country, and handling transactions made in foreign currency.The income of an offshore banking unit (OBU) operating in a Special Economic Zone and run by a scheduled bank, or a bank incorporated by or under the laws of a country outside India, is exempt to the extent of 100 of the income earned in the first five years from the year it obtained permission to start operations, and 50 per cent of the income earned in the subsequent five years. 9.4.5 Development of Special Economic Zone The entire income from profits and gains of a developer from any business of developing a notified-Special Economic Zone (SEZ)is exempt for a period of ten years from the year of its establishment. However, this exemption is only available for developers who commenced the development work on or before April 1, 2017. 9.4.6 Presumptive Taxation Scheme for Small Business In some types of businesses, it is difficult to accurately compute the profit or gains from business and profession. To address this problem government has introduced a concept of 136 CU IDOL SELF LEARNING MATERIAL (SLM)","presumptive taxation for certain business, such as the business of civil contracting, retailing and that of plying, hiring, or leasing carriages (Income Tax Department, 2021). Retail Business Where an assessee in engaged in retailing goods or merchandise, and the total turnover in a year is up to Rs 40 lakhs, a flat sum of five per cent of the total turnover can be taken to be \u2018profits and gains chargeable to tax\u2019. Of course, an assessee is free to declare higher profits and gains and pay tax thereon. If the assessee declares a profit of 5 per cent or more of her total turnover, he will not be required to maintain books of accounts. If, however, the assessee declares a profit of less than five per cent of her turnover, she will have to maintain books of accounts, and get the accounts audited by a chartered accountant. Civil Construction Business Where an assessee is engaged in the business of civil construction or the business of erection of plant or machinery or testing or commissioning thereof, in connection with a turnkey power project, ten per cent of the gross receipts can be taken to be the gains from the business. Again, an assessee is free to declare higher profits and gains and pay tax thereon. If the assessee declares a profit of ten per cent or more of her gross receipts, he will not be required to maintain books of accounts. If, however, he declares a profit of less than eight per cent, he will have to maintain books of accounts and get the accounts audited by a chartered accountant. Business of Plying, Hiring or Leasing Carriages If a person in the business of plying, hiring, or leasing carriages does not own more than ten carriages, the gains, on each carriage is to be computed as Rs 3500 per month in the case of each vehicle. The assessee is free to declare higher profits and gains and pay tax thereon. If, however, the assessee declares a profit that is lower than Rs 3500 a month per vehicle, he will have to maintain books of accounts and get the accounts audited by a chartered accountant. Business of Exploration of Mineral Oils Where an assessee is engaged in the business of business of providing services or facilities in connection with, or supplying plant and machinery on hire used, or to be used, in the prospecting for, or extraction or production of, mineral oils, ten per cent of the gross receipts can be taken to be as the gains from the business. Again, an assessee is free to declare higher profits and gains and pay tax thereon. If the assessee declares a profit of ten per cent or more of her gross receipts, he will not be required to maintain books of accounts. If, however, he declares a profit of less than ten per cent, he will have to maintain books of accounts and get the accounts audited by a chartered accountant. 9.4.7 Specified Business 137 CU IDOL SELF LEARNING MATERIAL (SLM)","The law has recognised some business as specified business to whom is given the facility of claiming 100 per cent deduction of the amount of capital expenditure incurred by them in the year in which such expenditure is incurred. Some of the business identified as specified business include: \uf0b7 Setting up and operating a cold chain facility. \uf0b7 Setting up and operating a warehousing facility for storage of agricultural produce. \uf0b7 Laying and operating a cross-country natural gas or crude or petroleum oil pipeline network for distribution, including storage facilities being an integral part of such network. \uf0b7 Building and operating, anywhere in India, a hotel of two-star or above. \uf0b7 Building and operating, anywhere in India, a hospital with at least 100 beds for patients. \uf0b7 Developing and building a housing project under a scheme for affordable housing. 9.5 SUMMARY \uf0b7 Tax planning is the process of evaluating the tax consequences associated with a transaction and making recommendations that will achieve the desired objective at a minimal tax cost. \uf0b7 There are tax consequences of the type of entity chosen by the owner. Therefore, it is extremely important to consider the day-to-day operations of the business and any applicable legal or tax restrictions on a particular business form. \uf0b7 With a view to bring about balanced economic development, the government used income tax incentives for encouraging businesses to set their facilities in certain regions of the country. For this purpose, the focus regions are classified in four categories: (a) North-Eastern States; (b) Special Category States; (c) Specified Area; and (d) Backward Areas. \uf0b7 Several tax incentives are offered by the government to encourage certain types of businesses. The business who are eligible for these tax breaks include startups, business of housing projects, environment friendly business, entities in the finance sector, development of special economic zones. Further, recognising the difficulty faced by small business in maintaining books of accounts and getting them audited, a scheme of presumptive taxation has been introduced by the government. This scheme of presumptive taxation is applicable entities engaged in retail business, civil construction business, business of plying, hiring, or leasing carriages, and business of exploration of mineral oils (Directorate of Income Tax, 2021). 138 CU IDOL SELF LEARNING MATERIAL (SLM)","9.6 KEYWORDS \uf0b7 Debt Fund. A debt fund is a pool of investment that holds a portfolio of fixed-income instruments such as bonds or debentures. \uf0b7 Development Financial Institution. A development financial institution is a financial institution that provides long-term loans to companies in private and the public sector on a non-commercial basis. \uf0b7 Flow-Through Entities. A flow-through business entity is an operating business whose net profits passes directly to the owners of the business, who then pay taxes on this net profits along with their other taxable items. \uf0b7 Infrastructure Debt Fund. An infrastructure debt fund is a NBFC (Non-Banking Financial Company) which is a non-deposit accepting financial institutions that manages a debt fund dedicated to the infrastructure sector. \uf0b7 Investment Fund. An investment fund is a pool of capital that a number of individual investors pay into, which is used to collectively invest in stocks, bonds, and other financial and alternate investments. \uf0b7 Mutual Fund. A mutual fund is a collective investment scheme that collects funds from small investors and invests these funds in various assets. \uf0b7 Offshore Banking Units. Offshore banking units (OBUs) are bank branches located outside of its home country, and handling transactions made in foreign currency. \uf0b7 Presumptive Taxation. Presumptive taxation involves the use of indirect methods to calculate tax liability, which differ from the usual rules based on the taxpayer\u2019s accounts. \uf0b7 REIT. A real estate investment trust (REIT) is a company that owns, operates, or finances income-producing commercial real estate properties. REITs generate a steady income stream for investors but offer little in the way of capital appreciation. \uf0b7 Venture Capital Fund. A venture capital funds is a pooled investment scheme that collects funds from large investors and invests these funds in startups and other portfolio companies with strong growth potential. 9.7 LEARNING ACTIVITY 1. Business of plying, hiring, or leasing carriages. ___________________________________________________________________________ _____________________________________________________________________ 2. Business of exploration of mineral oils. ___________________________________________________________________________ _____________________________________________________________________ 139 CU IDOL SELF LEARNING MATERIAL (SLM)","9.8 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Explain the concept of a debt fund in brief. 2. Explain the concept of a development financial institution in brief. 3. Explain the concept of a flow-through entities in brief. 4. Explain the concept of an infrastructure debt fund in brief. 5. Explain the concept of an investment fund in brief. 6. Explain the concept of a mutual fund in brief. 7. Explain the concept of an offshore banking units in brief. 8. Explain the concept of presumptive taxation in brief. 9. Explain the concept of a real estate investment trust (REIT) in brief. 10. Explain the concept of a venture capital fund in brief. Long Questions 1. Discuss the tax implications of a business owner choosing to be a sole proprietor. 2. Discuss the tax implications of a business owner choosing to be a partnership firm. 3. Explain the rationale for presumptive system of taxation for certain business. 4. Discuss the tax benefits available to entities engaged within the finance sector. 5. Discuss the tax benefits available to business entities engaged environment-friendly activities. 6. Discuss the scheme of presumptive taxation as applicable to entities engaged in the following businesses: 7. Retail business. 8. Civil construction business. B. Multiple Choice Questions (MCQs) 1. Which of the following an operating business whose net profits passes directly to the owners of the business, who then pay taxes on this net profits along with their other taxable items? a. Partnership firm. b. A flow-through business entity. c. Offshore company. d. Sole proprietorship. 140 CU IDOL SELF LEARNING MATERIAL (SLM)","2. From income tax perspective what is the treatment of payment of salary to the owner? a. The salary payment is a deductible expense under income tax law. b. The salary payment is NOT a deductible expense under income tax law as it is viewed as a cash withdrawal by owner. c. The salary payment is a deductible expense under income tax law only if the owner is a resident person in India. d. The salary payment is a partially deductible expense under income tax law if the owner can prove that he worked full time for the furtherance of the business. 3. Ms. Emma Eknath is a working partner in a partnership firm. As per the provisions of the partnership deed she received a salary of Rs. 9 lakhs for the previous year. The book profit of the partnership firm was 12 lakhs for the previous year? How much of the salary paid to Ms. Emma Eknath is deductible as an expense for calculating the profit and gains from business and profession of the partnership firm? a. Rs. 270,000 b. Rs. 540,000 c. Rs. 810,000 d. Rs. 900,000 4. Ms. Gina Goswami is a non-working partner in a partnership firm. As per the provisions of the partnership deed she received an interest on capital of Rs. 9 lakhs for the previous year. The capital contribution of Ms. Gina Goswami is Rs. 50 lakhs. The book profit of the partnership firm was 12 lakhs for the previous year? How much of the interest paid to Ms. Gina Goswami is deductible as an expense for calculating the profit and gains from business and profession of the partnership firm? a. Rs. 108,000 b. Rs. 900,000 c. Rs. 810,000 d. Rs. 600,000 5. What benefit is available under income tax to an entity that has income under the head profits and gains from the business of collecting and processing or treating of bio-degradable waste for generating power or producing bio-fertilizers, bio-pesticides, or other biological agents or for producing biogas or making pellets or briquettes for fuel or organic manure? a. No benefit is available under income tax. 141 CU IDOL SELF LEARNING MATERIAL (SLM)","b. 100 per cent of the income is exempt for a period of five consecutive assessment years from the year in which the business commenced. c. 50 per cent of the income is exempt for a period of five consecutive assessment years from the year in which the business commenced. d. 75 per cent of the income is exempt for a period of five consecutive assessment years from the year in which the business commenced. Answer 1-b, 2-b, 3-c, 4-d, 5-b 9.9 REFERENCES Reference Books \uf0b7 Cruz, A., Deschamps, M., Niswander, F., Prendergast, D., & Schisler, D. (2018). Fundamentals of Taxation. New York: McGraw-Hill Education. \uf0b7 Martin, E. A. (2003). The Dictionary of Law. Oxford: Oxford University Press. \uf0b7 Singhania, V., & Singhania, K. (2021). Direct Taxes Law & Practice. New Delhi: Taxmann. Website \uf0b7 Income Tax Department. (2021, 4 1). Set Off and Carry Forward of Losses Under the Income Tax Act. Retrieved from Tutorials: https:\/\/www.incometaxindia.gov.in\/Tutorials\/21- %20MCQ%20set%20off%20and%20carry%20frwrd.pdf \uf0b7 Institute of Chartered Accountants of India. (2019, February 1). Set off and Carry forward, of Losses. Retrieved from Western India Regional Council: https:\/\/www.wirc-icai.org\/images\/material\/Key-Aspects-Carry-Forward-Set- Losses.pdf \uf0b7 Sirwalla, P. (2012, January 31). Income Tax Deductions That You Should Not Miss. Business Today. Retrieved from https:\/\/www.businesstoday.in\/magazine\/tax\/story\/income-tax-deductions-24273- 2011-12-28 \uf0b7 Directorate of Income Tax. (2021). Salary Income and Tax Implications for AY 2020-21. New Delhi. Retrieved from https:\/\/www.incometaxindia.gov.in\/booklets%20%20pamphlets\/salary-income- tax-implications-ay-20-21.pdf \uf0b7 KPMG. (2020, January 30). India: Income Tax. Retrieved from Taxation of International Executives: https:\/\/home.kpmg\/xx\/en\/home\/insights\/2011\/12\/india- income-tax.html 142 CU IDOL SELF LEARNING MATERIAL (SLM)","UNIT- 10DIVIDEND POLICY 143 STRUCTURE 10.0 Learning Objectives 10.1 Introduction 10.1.1 Types of Dividends 10.1.2 Why Companies Pay Dividends? 10.1.3 Theories of Dividend 10.2 Overview of Dividend Policy 10.2.1 Factors Affecting Dividend Policy 10.2.2 Dividend Paying Approaches 10.3 Sources of Dividends 10.3.1 Current Profits 10.3.2 Accumulated Profits 10.3.3 Government Grants 10.4 Tax Implications of Dividends 10.4.1 Current Position 10.4.2 Inter-Corporate Dividend 10.5 Summary 10.6 Keywords 10.7 Learning Activity 10.8 Unit End Questions 10.9 References 10.0LEARNING OBJECTIVES After studying this unit, you will be able to: \uf0b7 Understand the legal, contractual and tax implication of dividends. \uf0b7 expected to apply the various theories of dividend policies \uf0b7 Explain the dividend practices of prominent companies in India. CU IDOL SELF LEARNING MATERIAL (SLM)","10.1 INTRODUCTION Dividends are a major component of the total returns that stocks provide over time to investors. Cash dividends and share buybacks are two ways that firms can payout profits to current shareholders. Dividends are paid from the after-tax profits of a company and are taxed a second time when received by the shareholder. 10.1.1 Types of Dividends The meaning and scope of dividends in income tax law is much broader than in corporate finance and corporate. The income tax law envisages the following six types of dividends (KPMG, 2020). Regular Dividends Ordinarily, dividends are paid out of current profits or out of revenue reserves (accumulated profits) of the company. However, the income tax law extends the meaning of dividends by providing that dividend may also have been paid out of capital reserves, as long as there is a distribution from the company to the shareholders. The company law provides that the dividend should be paid in cash, whereas income tax law provides dividends includes release of assets of the company, whether cash or otherwise. Dividend need not be distributed in terms of money; it may be distributed by delivery of property or right having monetary value. When assets are distributed as dividends, the amount of dividend is taken as the market value of the assets on the date the shareholders become entitled to receive dividends. Dividends in Form of Issue of Debt Instruments Some companies have \u2018paid\u2019 dividends to their shareholders in the form of issue of bonds and debentures to the extent of their accumulated profits. Under income tax law this amounts to dividends. Dividends in Form of Bonus to Preference Shareholders Some companies have issued bonus shares to the holders of the company\u2019s bonus shares. Under income tax law this also amounts to dividends. Dividend in the Form of Reduction of Share Capital The doctrine of capital maintenance requires that the capital of the company should be maintained for the benefit of lenders and creditors and as such cannot be returned to shareholders. However, the company law provides an exception where companies may reduce their share capital by reducing the share capital by obtaining the sanction of the National Company Law Tribunal (NCLT). Ordinarily, this is not considered a dividend, but under the income tax law distribution of assets of a company consequent to reduction of share 144 CU IDOL SELF LEARNING MATERIAL (SLM)","capital is considered as dividend to the extent it represents accumulated profits of the company. Liquidating Dividend A liquidating dividend is a distribution to shareholders during a liquidation. Shareholders are the residual claimants, and as such they will be paid whatever remains after paying out all the other claimants. A liquidating dividend is considered dividend under the income tax law to the extent the distribution represents the accumulated profitsof the company, whether capitalised or not. When distribution in the winding up of a company is out of accumulated profit, it is dividend even though the amount does not exceed the capital subscribed by the shareholder. Loans to Holders of Substantial Shares Some closely held companies distribute loans and advances to a person who beneficially own more than ten per cent of the shares or voting rights. Such pay-outs are also considered as dividend under certain conditions. However, loans or advances made by the company in the ordinary course of business are not considered as dividends (Gupta, Choudhury, & Buaria, 2020). In corporate law a distinction is made between final dividend and interim dividend. Both dividends involve distribution of profits to shareholders. The difference is that the final dividends are recommended by the board of directors and declared by the company in its annual general meeting (AGM). Interim dividends, however, are declared by the board of directors before the annual general meeting. In corporate finance we see authors referring to issue of bonus shares by companies to the holders of their equity shares as stock dividends. Under income tax law however, such issue of bonus shares is not considered as dividends. 10.1.2 Why Companies Pay Dividends? As per corporate law, a company is under no compulsion to pay dividends. The company enjoys absolute freedom what to do with their profits. The decision to recommend payment of dividend is vested with the board of directors of the company. The dividend is ultimately declared by the shareholders of the company in their annual general meeting (AGM). However, the shareholders can declare dividends only to the extent recommended by the board of directors. This raises a question that given that the company is not have a legal obligation to pay dividend, why do they in fact do declare and pay dividends? Two reasons are commonly offered to explain why companies pay dividends: investor preferences and differences in the rate of return expected by the company vis-\u00e0-vis that of the investor. Investor Preferences 145 CU IDOL SELF LEARNING MATERIAL (SLM)","One motivation for a company to pay dividends is that a steadily increasing dividend pay-out is viewed as a strong indication of a company's continuing success. The great thing about dividends is that they can't be faked. They are either paid or not paid, increased or not increased. Corporate Vs Investor Rate of Return By choosing to pay dividends, the company management is essentially conceding that profits from operations are better off being distributed to the shareholders than being put back into the company. In other words, management feels that reinvesting profits to try to achieve further growth will not offer the shareholder as high a return as a distribution in the form of dividends. 10.1.3 Theories of Dividend There are several theories of dividend; the following are the prominent ones:irrelevance of dividend (Modigliani-Miller theory), dividend signalling theory, bird in the hand theory, agency theory of dividend, and the residual theory of dividend (Tanushev, 2016). Irrelevance of Dividend Theory A dividend is typically a cash payment made from a company's profits to its shareholders as a reward for investing in the company. Dividend irrelevance theory holds the belief that dividends don't have any effect on a company's stock price. The theory was proposed by Franco Modigliani and Merton Miller and is also known as the Modigliani-Miller theory. The premise of the theory is that a company's ability to earn a profit and grow its business determines a company's market value and drives the stock price, not dividend payments. Those who believe in the dividend irrelevance theory argue that dividends don't offer any added benefit to investors.Although there are companies that have likely opted to pay dividends instead of boosting their earnings, there are many critics of the dividend irrelevance theory who believe that dividends help a company's stock price to rise. Dividend Signalling Theory Dividend signalling theory suggests that a company's announcement of an increase in dividend pay-outs is an indication of positive prospects.The theory is tied to concepts in game theory. Managers with positive investment potential are more likely to signal, while those without such prospects refrain. Although the concept of dividend signalling has been widely contested, the theory is still followed by some investors. Dividend signalling posits that dividend increases are an indication of positive future results for a firm, and that only managers overseeing positive potential will provide such a signal.Increasing a company's dividend pay-out may predict favourable performance of the company's stock in the future. Bird in Hand Theory 146 CU IDOL SELF LEARNING MATERIAL (SLM)","The bird in hand theory suggests that investors prefer dividends from stock investing compared to potential capital gains because of the inherent uncertainty associated with capital gains. Based on the adage, \\\"a bird in the hand is worth two in the bush,\\\" the bird-in-hand theory states that investors prefer the certainty of dividend payments to the possibility of substantially higher future capital gains.The bird-in-hand theory says investors prefer stock dividends to potential capital gains due to the uncertainty of capital gains. The theory was developed as a counterpoint to the Modigliani-Miller dividend irrelevance theory, which maintains that investors don't care where their returns come from.Capital gains investing represents the \\\"two in the bush\\\" side of the adage \u2018a bird in the hand is worth two in the bush\u2019. Agency Theory of Dividend Agency theory deals with the conflict between the owners of a company, that is the shareholders, and the board of directors who manage the company as agents of the owners.The assumption of a perfect capital market under the dividend irrelevance theory implies that there are no conflicts of interests between managers and shareholders. In practice, however, this assumption is questionable where the owners of the firm are distinct from its management. In these cases, managers are always imperfect agents of shareholders and managers\u2019 interests are not necessarily the same as shareholders\u2019 interests, and therefore they do not always act in the best interest of the shareholders. Shareholders therefore incur (agency) costs associated with monitoring managers\u2019 behaviour, and these agency costs are an implicit cost resulting from the potential conflict of interest among shareholders and corporate managers. The payment of dividends might serve to align the interests and mitigate the agency problems between managers and shareholders, by reducing the discretionary funds available to managers. Residual Theory of Dividend The residual theory holds that dividends paid by firms are residual, after the firm has retained cash for all available and desirable positive net present value (NPV) projects. The essence of this theory is that dividend payment is useless as a proxy in determining the future market value of the firm. As such, the firm should never forego desirable investment projects to pay dividends. Investors who subscribe to this theory therefore do not care whether firms pay dividends or not, what they are concerned with is the prospect of higher future cashflows which might lead to capital appreciation of their stocks and higher dividends pay-outs. The residual theory has been criticized as having no empirical support, but it\u2019s just an illustration of logic which is all too obvious for corporate decision makers. Firms tend to meet the financing needs of their growth strategies before paying anything out to shareholders and hence a theory stating so would simply be stating the obvious. 147 CU IDOL SELF LEARNING MATERIAL (SLM)","10.2 OVERVIEW OF DIVIDEND POLICY A company's dividend pay-out policy is the approach a company follows in determining the amount and timing of dividend payments to shareholders. 10.2.1 Factors Affecting Dividend Policy Where a company has earned profits, it has to decide whether to use the funds for investing in projects for expanding the company\u2019s operations or distribute them to the shareholders as dividends. Six primary factors affect a company's dividend pay-out policy: investment opportunities, expected volatility of future profits, financial flexibility, tax preference of investors, floatation costs, contractual restrictions, and legal restrictions (Panigrahi & Zainuddin, 2015). Investment Opportunities Growth and expansion of operations is one of the prime objectives of most companies. Projects are evaluated on the basis of the net present value (NPV). That is, the difference between the present values of incremental cash flows from the projects and its initial investment. Where, positive NPV investment opportunities are available the company would be inclined to investment in these projects and pay less, or no, dividends to the shareholders. This would be true especially when these investment opportunities need to be captured quickly and not much time is available for raising external capital. Thus, other things being equal, the more profitable investments are available; the low would be the dividend pay-out. Expected Volatility of Future Profits Some mature companies earn stable profits and are able to maintain a stable rate of dividends. However, companies that expect volatility in their profits, tend to keep a dividend pay-out. This is because if the profits are low in a given year and dividend pay-out is lower, the shareholders may not like this, and this may result in lower the stock prices if the company\u2019s shares are traded on the stock exchange. Therefore, companies that expect future profits to be volatile, tend to make lower dividend pay-out. Financial Flexibility Dividends are considered to be sticky. What this means is that once a company follows a dividend policy, the shareholders get used to it and expect the same policy to be followed in the future. In this scenario when a company get higher than average profit, it faces a problem of either paying a high dividend that year or to pay the average dividend and retain the remaining profit in the company although the company may not need it. In such a case many companies prefer to buy-back the shares rather than pay a higher dividend. Tax Preference of Investors 148 CU IDOL SELF LEARNING MATERIAL (SLM)","At present, the company paying dividends do not have to pay any tax; rather the shareholder is liable to pay tax on the dividends received from the company. Some investors, especially old and retired shareholders prefer current dividends as they wish to earn a regular stream of return. On the other hand, many young investors do not prefer getting dividends as they have other means of taking care of their expenses. The younger investors prefer that the company not pay dividends and invest the funds to fuel future growth and expansion. They believe that this growth will result in the rise in the price of the shares, which is also called as capital appreciation. However, whenever they sell the shares, they are taxed on the difference between the price at which the shares were sold and the price at which shares were purchased. This is called as capital gains tax. The capital gains tax if further divided into short term and long-term capital gains tax depending on the period of holding the shares before their sale. If the period is less than 12 months, the capital gain is called short term capital gain otherwise it is called long term capital gain. The rate at which dividends are taxed and the rate at which capital gains are taxed are different. Generally, the tax on dividends and short-term capital gains tend to be similar but that on long-term capital gain is generally significantly lower than that on dividends. This difference leads some investors to not prefer dividends. Thus, the dividend policy of the company is shaped by the nature of its shareholders and their preference for or against dividends. Flotation Costs The process of raising capital by a company is called as floatation. When a company issues new shares, whether to the public or otherwise, it has to take help of investment bankers, lawyers, accountants, etc. All these activities costs money and is called as floatation cost. Flotation costs are incurred by a company when it issues new securities. In case of public issue of shares, the floatation costs are substantial. Floatation costs affect dividend policy because when a company decides to pay dividend and fund the investment opportunities with raising new capital, it has to incur these floatation costs. Thus, the higher the floatation costs, the lower the dividend pay-out, given the need for raising new capital for funding the investment opportunities. Contractual Restrictions When a company obtains fund through loans, either by issuing bonds and debentures, or a loan from a financial institution, it has to agree to several restrictions on its activities. These are called as negative, or restrictive, covenants of the debt contract. The most common restrictive, covenants is to restrict the company freedom to declare and pay dividends. Many covenants require a firm to meet or exceed a certain target for liquidity ratios (e.g., current ratio) and coverage ratios (e.g., interest coverage ratio) before they can pay a dividend. Thus, 149 CU IDOL SELF LEARNING MATERIAL (SLM)","the more loans a company has taken the more restrictive would be the contracts and the company would have less freedom to pursue an independent dividend policy. Legal Restrictions The dividend policy of a company is also affected by the legal restrictions. As we saw in the paragraphs above, the legal constraints include the following: \uf0b7 Dividends should only be paid out of realised profits \uf0b7 There should be compulsory transfer to reserves \uf0b7 Ordinarily, dividends cannot be paid out of capital profits \uf0b7 Common legal and contractual restrictions on dividend These constraints are designed to protect lenders and creditors and dictate things A company must or must not do. 10.2.2 Dividend-Paying Approaches Companies following several dividend paying approaches. Three of the common approaches are residual dividend policy, stable dividend policy, and hybrid dividend policy. Residual Dividend Policy Companies using the residual dividend policy choose to rely on internally generated equity to finance any new projects. As a result, dividend payments can come out of the residual or leftover equity only after all project capital requirements are met. These companies usually attempt to maintain balance in their debt\/equity ratios before making any dividend distributions, which demonstrates that they decide on dividends only if there is enough money left over after all operating and expansion expenses are met. Stabile Dividend Policy The fluctuation of dividends created by the residual policy significantly contrasts with the certainty of the dividend stability policy. The aim of a stable dividend policy is to reduce uncertainty for investors and to provide them with income. Hybrid Dividend Policy The final approach is a combination between the residual and stable dividend policy. In today\u2019s markets, this approach is commonly used by companies that pay dividends. As these companies will generally experience business cycle fluctuations, they will generally have one set dividend, which is set as a relatively small portion of yearly income and can be easily maintained. On top of this set dividend, these companies will offer another extra dividend paid only when income exceeds general levels. 150 CU IDOL SELF LEARNING MATERIAL (SLM)"]