UNIT 5 – TAX PLANNING

Difference between tax planning, tax evasion, tax avoidance and tax management, Tax planning
with reference to make or buy, own or lease and capital structure.

Tax planning is the prac�ce of organizing one's financial affairs in a way that minimizes tax liability
while adhering to tax laws. It involves taking advantage of legi�mate deduc�ons, exemp�ons, credits,
and other provisions provided by tax authori�es. Tax planning is a legal and ethical approach to
reducing tax burdens and is widely prac�ced by individuals, businesses, and corpora�ons.

Examples:

a) Company: A manufacturing company may set up a research and development unit to avail of tax
deduc�ons for expenses incurred on research ac�vi�es. Addi�onally, it may claim deprecia�on on
assets, deduct employee benefits, and explore other tax incen�ves offered for specific industries or
sectors.

b) Individual: An individual may invest in tax-saving instruments such as Equity Linked Saving Schemes
(ELSS), Public Provident Fund (PPF), or Na�onal Pension System (NPS) to reduce their taxable income.
They may also claim deduc�ons for expenses like home loan interest, educa�on loan interest, medical
insurance premiums, and dona�ons to eligible charitable organiza�ons.

Tax evasion is the inten�onal and illegal prac�ce of misrepresen�ng or concealing informa�on to
reduce tax liability. It involves ac�ons like underrepor�ng income, infla�ng deduc�ons, hiding assets,
or failing to pay taxes altogether. Tax evasion is considered a criminal offense and can result in
penal�es, fines, and even imprisonment.

Examples:

a) Company: A company may understate its sales or overstate its expenses to reduce its taxable income
illegally. It may also engage in prac�ces like maintaining parallel books of accounts, dealing in cash
transac�ons without proper documenta�on, or transferring funds to offshore accounts to conceal
income.

b) Individual: An individual may fail to disclose income from various sources like rental income, capital
gains, or income from side businesses. They may also provide false informa�on, forge documents, or
claim deduc�ons they are not eligible for to evade taxes.

Tax avoidance involves exploi�ng loopholes, ambigui�es, or unintended consequences in tax laws to
minimize tax liability. While tax avoidance is technically legal, it may be deemed unacceptable by tax
authori�es and can be challenged in court. Tax avoidance prac�ces o�en push the boundaries of tax
laws and may be subject to scru�ny or legal challenges.

Examples:

a) Company: A company may set up subsidiaries in low-tax jurisdic�ons, engage in complex transfer
pricing arrangements, or use hybrid financial instruments to shi� profits and reduce its overall tax
burden.

b) Individual: An individual may structure their investments or transac�ons in a way that takes
advantage of tax trea�es, offshore trusts, or tax havens to reduce their tax liability.
Tax management is a comprehensive approach that encompasses tax planning, compliance, and risk
management. It involves a systema�c process of analyzing tax implica�ons, iden�fying opportuni�es
for tax op�miza�on, ensuring compliance with tax laws, maintaining accurate records, filing tax
returns, and monitoring tax risks through effec�ve implementa�on strategies.

Examples:

a) Company: A company may have a dedicated tax management team that oversees tax planning, filing
tax returns, maintaining records, monitoring tax risks, and ensuring compliance with tax laws and
regula�ons across mul�ple jurisdic�ons. They may also engage tax advisors or consultants for
specialized advice and guidance.

b) Individual: An individual may seek professional advice from tax consultants, use tax-planning
so�ware, or atend seminars to understand tax implica�ons and manage their tax affairs effec�vely.
They may also maintain proper documenta�on, file tax returns accurately and on �me, and stay
updated with changes in tax laws and regula�ons.

Difference Table:

Tax
Aspect Tax Planning Tax Evasion Tax Avoidance
Management

Legal (but may

Legality Legal Illegal be challenged by Legal
tax authorities)
Exploits Encompasses tax
Utilizes Conceals or
loopholes or planning,
Approach provisions of tax misrepresents
ambiguities in tax compliance, and
laws information
laws risk management
Ensures
Penalties, fines, compliance,
May face
potential minimizes tax
Reduces tax scrutiny, legal
Consequence imprisonment, risks, optimizes
liability legally challenges, or
and reputational tax position, and
reputational risks
damage protects
reputation
Questionable
Unethical and ethics and Ethical, if done
Ethics Ethical
illegal potential within the law
reputational risks
Optimize tax
Minimize tax
position, ensure
Minimize tax Deliberately liability by
compliance,
Purpose liability while evade tax pushing the
manage tax risks,
adhering to laws obligations boundaries of tax
and maintain
laws
reputation

Proactive and Deceptive and Exploitative and Holistic and

Approach
strategic illegal potentially risky comprehensive
Case Point

Mauri�us has long been a popular tax haven for Indian companies and investors due to the favorable
tax treaty between India and Mauri�us. Under this treaty, capital gains arising from the sale of shares
in an Indian company were taxable only in Mauri�us, which had a low or zero tax rate. To take
advantage of this benefit, Indian companies or individuals would set up a holding or shell company in
Mauri�us. This Mauri�us-based company would then invest in Indian companies or assets. When the
shares of the Indian companies were sold, the capital gains would be booked by the Mauri�us en�ty,
which would be exempt from paying taxes on those gains in India due to the tax treaty.

For example, let's say an Indian company, ABC Ltd., wanted to sell its stake in another Indian company,
XYZ Ltd., for a significant capital gain. Instead of selling the shares directly and paying capital gains tax
in India, ABC Ltd. would first transfer its shares in XYZ Ltd. to a newly created subsidiary in Mauri�us,
called ABC Mauri�us Ltd. ABC Mauri�us Ltd. would then sell the shares of XYZ Ltd., and any capital
gains arising from the sale would be taxable only in Mauri�us, which had a low or zero tax rate. This
way, ABC Ltd. could avoid paying the higher capital gains tax in India on the sale proceeds.

Similarly, foreign investors looking to invest in Indian companies would o�en route their investments
through Mauri�us-based en��es to take advantage of the favorable tax treaty and minimize their tax
liability in India. While the India-Mauri�us tax treaty was amended in 2016 to address such treaty
abuse, the example illustrates how tax havens and offshore structures were historically used for tax
avoidance purposes by Indian companies and individuals. It's important to note that while such
prac�ces were technically legal at the �me, they were considered aggressive tax avoidance strategies
and were eventually targeted by the Indian government through changes in tax laws and trea�es.

Tax planning considera�ons play a significant role in make or buy, own or lease, and capital structure
decisions for companies in India. Here are some examples and key figures/data related to tax planning
in these areas:

Make or Buy:

When deciding whether to manufacture a product in-house (make) or purchase it from a third party
(buy), companies consider the tax implica�ons of each op�on. In India, companies can claim
deprecia�on on assets used for manufacturing purposes, which can provide tax benefits.

Example: Suppose a company needs to acquire a machinery worth ₹10 crore. If the company decides
to buy the machinery, it can claim deprecia�on at the rate of 15% per annum (as per the Income Tax
Act) on the writen-down value method. This would result in a tax deduc�on of ₹1.5 crore in the first
year, reducing the company's taxable income and tax liability.

Own or Lease:

Companies also evaluate the tax implica�ons of owning an asset versus leasing it. In India, lease rentals
paid for acquiring assets on lease are generally tax-deduc�ble expenses, while deprecia�on can be
claimed on owned assets.

Example: Let's consider a company that needs to acquire office space. If the company decides to buy
the property worth ₹5 crore, it can claim deprecia�on at the rate of 10% per annum on the writen-
down value method. This would result in a tax deduc�on of ₹50 lakhs in the first year. Alterna�vely, if
the company opts to lease the office space at a monthly rent of ₹5 lakhs, the en�re lease rental of ₹60
lakhs would be tax-deduc�ble for that year.

Capital Structure:

The choice of capital structure (debt vs. equity) also has tax implica�ons in India. Interest paid on debt
is tax-deduc�ble, while dividends paid on equity are not. However, there are restric�ons on the
deduc�bility of interest expenses under certain circumstances.

Example: A company has a profit before interest and tax (PBIT) of ₹100 crore. If the company has a
debt of ₹100 crore with an interest rate of 10%, the interest expense would be ₹10 crore. At the
corporate tax rate of 25% (plus applicable surcharge and cess), the tax deduc�on on the interest
expense of ₹10 crore would be ₹2.5 crore (assuming a flat 25% tax rate for simplicity).

So, if the company has a PBIT of ₹100 crore and an interest expense of ₹10 crore, its taxable income
would be ₹90 crore (₹100 crore - ₹10 crore). By u�lizing the tax deduc�on on the interest expense of
₹2.5 crore, the company can reduce its tax liability.