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Wednesday, March 22, 2017

Tax Planning

Unit – 4: Tax planning
Concept of Tax Planning, Tax Avoidance, Tax evasion and Tax mitigation
Tax Planning: In an organized society, tax is unavoidable because it is the price paid for administrative and political stability by the public to the Government. It is the duty of each citizen to pay due taxes in time and not to resort to any device to evade the payment of taxes. An effective tax strategy is vital for successful financial planning since payment of taxes reduces the disposable income of the tax payers. To solve the problem of tax burden, the concept of tax planning has been introduced in the Income Tax Act. Tax planning may be defined as an arrangement of one’s financial affairs in such a way that without violating in any way the legal provisions, full advantage is taken of all tax exemptions, rebates, allowances and other reliefs or benefits permitted under the Act. This will reduce the burden of taxation on the assessee as far as possible. Tax planning may be regarded as a method of intelligent application of expert knowledge of planning one’s economic affairs with a view to securing the consciously provided tax benefits on the basis of national priorities in keeping with the legislative and judicial opinion. But it does not imply taking undue advantage of loopholes in tax laws or evading tax liability. Hence tax planning is defined as the methods used by a tax payer to reduce his burden of taxes in a legal manner. Tax planning may be legitimate provided it is with in the frame work of tax laws. Hence tax evasion and tax avoidance must be understood as distinct from tax planning.
The methods adopted to reduce the tax liability can be broadly put into four categories: "Tax Evasion";”Tax Avoidance” and "Tax Mitigation”.  The difference between these three methods sometimes become blurred owing to the perception of the tax authorities and / or tax payer.

Tax Evasion: Tax Evasion term is usually used to mean 'illegal arrangements where liability to tax is hidden or ignored i.e. the tax payer pays less than he is legally obligated to pay or by hiding income or information from tax authority.   Thus, here the tax liability is reduced by "illegal and fraudulent"  means. For example: understatement of income.
Tax Avoidance: Tax Avoidance refers to the legal means so as to avoid or reduce tax liability, which would be otherwise incurred, by taking advantage of some provision or lack of provision in the law.   Thus, in this case tax payer tries to reduce his tax liability but here the arrangement will be legal, but may not be as per intent of the law.   Thus, in this case, tax payer does not hide the key facts but is still able to avoid or reduce tax liability on account of some loopholes or otherwise. For example: misinterpreting the provisions of the IT Act.
Tax Mitigation: "Tax Mitigation" is a situation where the taxpayer takes advantage of a fiscal incentive afforded to him by the tax legislation by actually submitting to the conditions and economic consequences that the particular tax legislation entails.  A good example of tax mitigation is the setting up of a business undertaking by a tax payer in a specified area such as Special Economic Zone (SEZ).
“Tax evasion is illegal but tax avoidance is in no way a crime. “It has been said very rightly and to understand the meaning of this statement we have to understand the meaning of evasion and avoidance. The latest trend and judgements do not subscribe to this view. The burden of tax is so heavy that even the honest citizen will also like to save tax. To save the incidence of tax, a person may adopt legal or illegal methods.
These methods are (a) Tax avoidance and (b) Tax evasion.
The Direct Taxes Enquiry Committee (Wanchoo Committee) has tried to draw a distinction between the two items in the following words. “The distinction between ‘evasion’ and ‘avoidance’, therefore, is largely dependent on the difference in methods of escape resorted to. Some are instances of merely availing, strictly in accordance with law, the tax exemptions or tax privileges offered by the government. Others are maneuvers involving an element of deceit, misrepresentation of facts, falsification of accounting calculations or downright fraud. The first represents what is truly tax planning, the latter tax evasion. However, between these two extremes, there lies a vast domain for selecting a variety of methods which, though technically satisfying the requirements of law, in fact circumvent it with a view to eliminate or reduce tax burden. It is these methods which constitute “tax avoidance”.
Differences amongst tax planning, tax avoidance and tax evasion:
TAX PLANNING
TAX AVOIDANCE
TAX EVASION
Legal
Legal
Illegal
Ethical
Unethical
Unethical
No intention to defeat legal spirit
Intention to defeat legal spirit
Intention to defeat legal spirit
By taking legitimate benefits of Income tax law
By taking benefit of loopholes of law
Misstatement and falsification of accounts, incomes and expenses
No Litigation in courts
Leads to litigation in courts
Leads to litigation in courts
No Penalty/ Prosecution
No Penalty/ Prosecution
Attracts penalty/prosecution
Good for National Development/ Society and it creates employment etc
It is evil for Nation/Society
It is evil for Nation/Society
Promotes professionalism and strengthens economic and political situation.
Encourages bribery and weakens economic and political situation
Encourages bribery and weakens economic and political situation.
Planning before tax liability arises
Planning for avoidance before tax liability arises
Tax evasion involves avoidance of payment of tax after the liability of tax has arisen.

Points to be taken into consideration before tax planning
Tax Planning should be done by keeping in mine following factors:
a)      The Planning should be done before the accrual of income. Any planning done after the accrual income is known as Application of Income and it may lead to a conclusion of that there is a fraud.
b)      Tax Planning should be resorted at the source of income.
c)       The Choice of an organization, i.e. Taxable Entity. Business may be done through a Proprietorship concern or Firm or through a Company.
d)      The choice of location of business , undertaking, or division also plays a very important role.
e)      Residential Status of a person. Therefore, a person should arrange his stay in India such a way that he is treated as NR in India.
f)       Choice to Buy or Lease the Assets. Where the assets are bought, depreciation is allowed and when asset is leased, lease rental is allowed as deduction.
g)      Capital Structure decision also plays a major role. Mixture of debt and equity fund should be balanced, to maximize the return on capital and minimize the tax liability. Interest on debt is allowed as deduction whereas dividend on equity fund is not allowed as deduction.
Methods of Tax Planning
Various methods of Tax Planning may be classified as follows:
1. Short Term Tax Planning: Short range Tax Planning means the planning thought of and executed at the end of the income year to reduce taxable income in a legal way. 
Example: Suppose, at the end of the income year, an assessee finds his taxes have been too high in comparison with last year and he intends to reduce it. Now, he may do that, to a great extent by making proper arrangements to get the maximum tax rebate u/s 88. Such plan does not involve any long term commitment, yet it results in substantial savings in tax.
2. Long Term Tax Planning: Long range tax planning means a plan started at the beginning or the income year to be followed around the year. This type of planning does not help immediately as in the case of short range planning but is likely to help in the long run; e.g. If an assessee transferred shares held by him to his minor son or spouse, though the income from such transferred shares will be clubbed with his income u/s 64, yet is the income is invested by the son or spouse, then the income from such investment will be treaded as income of the son or spouse.  Moreover, if the company issues any bonus shards for the shares transferred, that will also be treated as income in the hands of the son or spouse.
3. Permissive Tax Planning: Permissive Tax Planning means making plans which are permissible under different provisions of the law, such as planning of earning income covered by Sec.10,especially by Sec. 10(1), Planning of taking advantage of different incentives and deductions, planning for availing different tax concessions etc.
4. Purposive Tax Planning: It means making plans with specific purpose to ensure the availability of maximum benefits to the assessee through correct selection of investment, making suitable programme for replacement of assets, varying the residential status and diversifying business activities and income etc.
Requisites of a successful tax planner i.e. requisites of successful tax planning
1.       Thorough knowledge of present law: A layman who does not know the various provisions of taxation laws of the country cannot think of filing his own tax return and he can never think of tax planning. The process of tax planning starts with every individual whose income is in tax bracket. He starts gathering knowledge about his income and various ways and means by which he can save tax. This shows that to be a successful tax planner the knowledge of all the provisions of Income Tax Act 1961, rules framed there under the notifications and circulars issued by the Central Board of Direct Taxes. The person who is not well conversant with the latest position of law cannot be successful tax planner.
2.       Preparedness for retrospective amendments: in our country amendments are made by the Finance Act passed annually along with budget. Some times amendments are made by Taxation laws Amendment Acts. The certain modifications are made by circulars and notification is sued from time to time. Generally these amendments are prospective and one can make plans but occasionally the amendments are made retrospectively also and here all the planning comes to an end. In such a situation a planner must be able to absorb the shock of such retrospective amendments.
3.       Knowledge of other allied laws: The person who wants to plan his tax liability is supposed to have the knowledge of other allied laws also. There are:
a)      Wealth Tax Act.
b)      Central Sales Tax Act.
c)       State Sales Tax Act.
d)      Interest Act.
e)      Expenditure Tax Act.
f)       Transfer of Property Act.
g)      Foreign Exchange Management Act. Etc.
                A working knowledge of these laws shall certainly help the planner to make effective and realistic plans.
4.       Knowledge of methods of tax planning: The various methods of tax planning have to be understood and mastered by a successful tax planner. These methods are:
a)      Determination of residential status: The residential status plays a very important role for those persons who have foreign income. A resident has to pay tax on income earned and received any where in the world whereas a non-resident has to pay tax on only those incomes which are earned and received in India only.
b)      Selection of suitable form of organisation: While starting a new business or when a business is at such a stage that it has to change its form of organisation, the amount of tax advantage weights large while selecting the form of organisation. The tax incentives, rates of tax, ease of formation, legal obligations etc. are some of the factors which have to be considered.
c)       Capital structure decisions-whether to have loaned capital or owned capital. What should be the optimum combination of these two forms of capital has its bearing on the successful tax planning.
d)      Diversification of business activity i.e. to add or drop a product, to produce or to purchase certain parts etc.
e)      Replacing old assets to obtain maximum advantage of rules regarding depreciation or take assets on lease.
f)       Optimum claim of expenses to reduce the tax liability. The effort should be made to claim such expenses which are allowed to be debited under Income Tax Act.
Limitations of tax planning
1.       Tax planning has its own scope beyond which an assessee cannot go. All decisions regarding tax planning should be taken in such a manner hat they do not hurt others.
2.       Taxation laws are most dynamic laws and they keep changing very frequently. There is not stability in the applicability of these laws. The government can change them at any time it likes. As a result tax planning can be done only for a very short period i.e. only for one to two previous years. Long terms tax planning is not possible.
3.       The law gives several benefits to an assessee and to claim them certain preconditions are imposed. It is essential that those preconditions must be fulfilled to claim that benefit. A blind person must get a certificate from the medical authorities about his blindness to claim deduction u/s 80U. The procedure to claim this certificate is very complicated and as such the blind person is in difficulty. As such tax planning becomes limited to the extent of fulfillment of these conditions.
4.       Indian tax laws are among the most complicated laws of the world. Understanding its intricacies is a very difficult job. This act as a limitation for successful tax planning.
5.       Tax planning does not mean infringement of different provisions of law. It means reducing the tax liability while lawfully implementing the different provisions of law. Thorough knowledge of Income Tax Act, Wealth Tax Act, Interest Tax Act, Expenditure Tax Act, Money Laundering Act, Foreign Exchange Management Act etc. is very necessary to be a successful tax planner.
6.       It is not only the knowledge of tax and other laws are necessary it is also essential for good tax planning to be an expert in the field of accountancy. The little knowledge of accountancy can caused bad tax planning.
7.       As the income increases, the tax liability increases. The increase in profitability of business is good for the economy. But when the profits increase the financial managers become busy in finding ways and means to reduce the tax burden. The time, which they should devote towards more profitability, is devoted towards tax planning.
Tax Management
Tax planning is a wider term and it includes tax management also. Tax management is an important aspect of tax planning. Planning which leads to filing of various returns in time, compliance of the applicable provisions of law and avoiding of levy of interest and penalties can be termed as efficient tax management. It is an exercise by which defaults are avoided and legal compliance is secured. The filing of returns with all proper documentary evidence for the various claims, rebates, reliefs, deductions and computation of income and tax liability would come under the purview of tax management. The assessee is exposed to certain unpleasant consequences if obligations cast under the tax laws are not duly discharged. Such consequences take shape of levy of interest, penalty, prosecutions, forfeiture of certain rights etc. Therefore any effort in tax planning is incomplete unless proper discharge of responsibilities is made. Tax management includes:
1)      Compiling and preserving data and supporting documents evidencing transactions, claims etc.
2)      Making timely payment of taxes.
3)      TDS and TCS compliance.
4)      Following procedural requirements.
5)      Timely filing of returns.
6)      Responding to notices received from the authorities.
7)      Preserving record for the prescribed number of years.
8)      Mentioning PAN, TAN etc. at appropriate places.
THE DIFFERENCE BETWEEN ‘TAX PLANNING’ AND ‘TAX MANAGEMENT’:
Tax Planning
Tax Management
The Objective of Tax Planning is to minimize the tax liability
The objective of Tax Management is to comply with the provisions of Income Tax Law and its allied rules.
Tax Planning also includes Tax Management
Tax Management deals with filing of Return in time, getting the accounts audited, deducting tax at source etc.
Tax Planning relates to future.
Tax Management relates to Past ,. Present, Future.
Past – Assessment Proceedings, Appeals, Revisions etc.
Present – Filing of Return, payment of advance tax etc.
Future – To take corrective action
Tax Planning helps in minimizing Tax Liability in Short-Term and in Long Term.
Tax Management helps in avoiding  payment of interest, penalty, prosecution etc.
Tax Planning is optional.
Tax Management is essential for every assessee.

Tax Planning of Salaried Assessee
In the matter of taxation of salaries, the law of income tax has recently been made comprehensive. Almost every type of salary, or remuneration of every kind of employee, government or private, is covered under it. Therefore, it becomes very important for an employee; however high or low placed he may be, to understand at least those fundamental principles of income - tax law which directly or indirectly affect him, before he is caught unaware in the net of taxation. Employees, next to the business community, constitute the biggest sector of income tax paying public and contribute the most to the income tax in the country. Since income from salary has been accounted correctly and there is less or no scope for evasion, this class of tax payers is considered as the most honest in the records of Income Tax Department. However, in a period of ever growing inflation resulting in higher prices, it is the fixed income earners who suffer the most.
In view of this, tax planning is of great importance to every employee because it leaves the maximum possible amount of salary after payment of taxes with them. This could be achieved only by availing maximum amount of tax exemptions, deductions and relief. Therefore, tax planning is the scientific planning made by the employees to attract minimum liability to tax and or postponement of the tax liability for the subsequent period by availing of various incentives, concessions, allowances, rebates and relief provided, in the context of existing tax laws.
While planning for salary income, the following hints will be of much use to the employees in getting maximum benefits of tax planning.
1)         Tax on salaries can be reduced to minimum if salary is divided in to different allowances (which are not taxable or which are partially exempt from tax) and perquisites.
2)         It should be ensured that, under the terms of employment, dearness allowance and dearness pay form part of basic salary. This will minimise tax incidence on house rent allowance, entertainment allowance, gratuity and commuted pension.
3)         A tax-payer should properly assess the incidence of tax and choose between going in for house rent allowance or rent free furnished or unfurnished accommodation. House rent allowance is exempt under section 10 (13A) of the Income Tax Act within the limits prescribed by Rule 2A of the Income Tax Rules, 1962.
4)         There are several employees’ welfare schemes such as recognised provident fund, approved superannuation fund, gratuity fund etc. Payments received from such funds by the employees are totally exempt or exempt up to significant amounts.
5)         Employees should go in for free medical facilities instead of a fixed medical allowance, since medical allowance is taxable.
6)         Reimbursement of expenditure on medical treatment of the employee or his family members is exempted up to ` 15000.
7)         Travel concession should be claimed to the maximum possible extent without attracting any incidence of tax.
8)         Avail deductions under Section 80C of the Income Tax Act to the maximum possible extent.
9)         Encashment of earned leave on retirement of employees is exempted fully/partially, as the case may be. Leave encashment while in service is treated as part of salary.
10)      Leave Travel Concession (LTC) or Leave Travel Allowance (LTA) is allowed twice in a block of four years. The allowance is exempt subject to amount of expenses actually incurred by the employee for such travel.
11)      An employee should take the benefit available under section 89(1) of the Income Tax Act when salary is received in arrear or advance.
12)      As uncommuted pension is always taxable, employees should get their pension commuted. Commuted pension is fully exempt from tax in the case of Government employees and partially exempt from tax in the case of non-govt. employees who can claim relief u/s 89 (1) of the Income Tax Act.
13)      Since incidence of tax on retirement benefits like gratuity, commuted pension, accumulated balance of unrecognised provident fund is lower if they are paid in the beginning of the financial year, employers and employees should mutually plan their affairs in such a way that retirement, termination or resignation, as the case may be, takes place in the beginning of the financial year.
14)      VRS is exempt up to five lakh rupees if VRS is as per prescribed conditions.
Tax Planning for Senior Citizens 
The age limit for a senior citizen is 60 years or more for A.Y. 2016-17 & 2015-16. The age limit for very senior citizens is 80 years or more for A.Y. 2016-17 & 2015.16. The category of senior citizens has been under the purview of income tax from a very long time. However, there has been certain relief that has been provided to them when it comes to imposing taxes on their income. A person is regarded as a senior citizen if the person is above the age of 60 years. Some of the tax planning tips for senior citizens is as follows:
1)      Basic Exemption Limit: When it comes to determining the basic limit for computing tax liability, the senior citizen section enjoys a freedom upto Rs. 3,00,000 per year (A.Y.2016-17) and same for A.Y. 2015-16. Any income which is within the prescribed limit shall necessarily be exempted from the purview of taxation. A very senior citizens can claim up to Rs. 5,00,000. Senior citizens (60 years or above) not having any income from business or profession shall not be liable to pay advance tax.
2)      Permissible Deductions:
Investments: Deduction in respect of life insurance premium, provident funds, repayment of housing loan etc. up to a maximum of Rs.1,50,000/-[Sec. 80C].
Additional deduction of Rs. 50,000 (maximum) for contribution to notified Pension Scheme.
Investment in health policies: Just like the benefits which accrue to the ordinary residents, even senior citizens are entitled to receive a deduction of Rs. 30, 000 (only for senior citizens) (A.Y.2016-17)/ Rs.20,000 (A.Y.2015-16). When they invest in medical policies under the section 80D. 
One more deduction related to mediclaim added from A.Y.2016-17 i.e. expenditure on medical treatment of resident very senior citizen (80 years or above) not having medical insurance cover, shall also be deductible within the aforesaid limit of Rs.30,000.
Deduction under Sec. 80C
Section 80C provides deduction in respect of specified qualifying amounts paid deposited by the assessee in the previous year. The following are the main provisions of the Section 80C:
a)      Under Section 80C , deduction would be available from Gross Total Income.
b)      Deduction under section 80C is available only to individual or HUF.
c)       Deduction is available on the basis of specified qualifying investments / contributions / deposits / payments made by the taxpayer during the previous year.
d)      The maximum amount deduction under section 80C , 80CCC, and 80CCD can not exceed  Rs.1.50 lakh.
The Deduction is calculated as per the following steps
Step-1  : Gross qualifying Amount which is the aggregate of the following:
a)      Life Insurance Premium
b)      Payment in respect of non-commutable deferred annuity.
c)       Any sum deducted form salary payable to Govt. employee for the purpose of securing him a deferred annuity.
d)      Contribution towards Statutory Provident Fund and Recognised Provident Fund.
e)      Contribution towards 15-year Public Provident Fund
f)       Contribution towards an Approved Superannuation Fund.
g)      Subscription to National Saving Certificates, VIII Issue.
h)      Contribution for participating in the Unit-linked Insurance Plan (ULIP) of UTI.
i)        Contribution for participating in the Unit-linked Insurance Plan (ULIP) of LIC Mutual Fund.
j)        Payment to notified annuity plan of LIC
k)      Subscription towards notified Units of Mutual Fund or UTI.
l)        Contribution to notified Pension Fund set up by Mutual Fund or UTI.
m)    Any sum paid as subscription to Home Loan Account Scheme of the National Housing Bank.
n)      Any sum paid as Tuition Fees for full time education of any 2 children of an individual.
o)      Any payment towards the cost of purchase / construction of a residential Property.
p)      Amount invested in approved Debenture of , and equity shares in, public company engaged in infrastructure.
q)      Amount deposited in as Term Deposit for a period of 5 years or more in accordance with a scheme framed by the Government.
r)       Subscription to any notified Bonds of National Bank for Agriculture and Rural Development ( NABARD)
s)       Amount deposited under Senior Citizens Saving Scheme.
t)       Amount deposited in 5 Year Time Deposit in Post Office.
Step-2: Net Qualifying Amount : Deduction u/s 80C is available on the basis of Net Qualifying Amount which is determined as under:
Gross Qualifying Amount or Rs. 1,50,000 Whichever is LESS.
Step-3 : Amount of Deduction : Amount Deduction u/s 80C is computed as under :
Net Qualifying Amount or Rs. 1,50,000 Whichever is LESS. The aggregate deduction u/s 80C, 80CCC, and 80 CCD can not exceed Rs. 1,50,000.
Deductions under Section 80G
Contributions made to certain relief funds and charitable institutions can be claimed as a deduction under Section 80G of the Income Tax Act. All donations are not eligible for deduction under section 80G. Only donations made to prescribed funds qualify as a deduction.
Deduction allowed to all types of tax payers: This deduction can be claimed by any tax payer -individuals, company, firm or any other person.
Mode of Payment: This deduction can only be claimed when the contribution has been made via cheque or draft or in cash. But deduction is not allowed for donations made in cash exceeding Rs 10,000. In-kind contributions such as food material, clothes, medicines etc do not qualify for deduction under section 80G.
Amount of Donation: The various donations specified in section 80G are eligible for deduction up to either 100% or 50% with or without restriction as provided in section 80G.
How to claim the deduction: To be able to claim this deduction the following details have to be submitted in Income Tax Return:
1. Name of the Donee
2. PAN of the Donee
3. Address of the Donee
4. and the amount contributed
Donations with 100% deduction without any qualifying limit:
a)      National Defence Fund set up by the Central Government
b)      Prime Minister's National Relief Fund
c)       National Foundation for Communal Harmony
d)      National Sports Fund
e)      National Cultural Fund
f)       National Children's Fund
g)      Chief Minister's Earthquake Relief Fund, Maharashtra
h)      Swachh Bharat Kosh (applicable from FY 2014-15)
i)        Clean Ganga Fund (applicable from FY 2014-15)
j)        National Fund for Control of Drug Abuse (applicable from FY 2015-16)
Donations with 50% deduction without any qualifying limit:
a)      Jawaharlal Nehru Memorial Fund
b)      Prime Minister's Drought Relief Fund
c)       Indira Gandhi Memorial Trust
d)      Rajiv Gandhi Foundation
Donations to the following are eligible for 100% deduction subject to 10% of adjusted gross total income:
Government or any approved local authority, institution or association to be utilised for the purpose of promoting family planning. Donation by a Company to the Indian Olympic Association or to any other notified association or institution established in India for the development of infrastructure for sports and games in India or the sponsorship of sports and games in India.
Donations to the following are eligible for 50% deduction subject to 10% of adjusted gross total income:
Any other fund or any institution which satisfies conditions mentioned in Section 80G(5)
Government or any local authority to be utilised for any charitable purpose other than the purpose of promoting family planning
Any authority constituted in India for the purpose of dealing with and satisfying the need for housing accommodation or for the purpose of planning, development or improvement of cities, towns, villages or both
Any corporation referred in Section 10(26BB) for promoting interest of minority community
For repairs or renovation of any notified temple, mosque, gurudwara, church or other place.
Adjusted total income: Adjusted gross total income is the gross total income (sum of income under all heads) less the following:
Amount deductible under Sections 80CCC to 80U (but not Section 80G)
Exempt income
Long-term capital gains
Income referred to in Sections 115A, 115AB, 115AC, 115AD and 115D, relating to non-residents and foreign companies.