Rise of American Accounts."Hollywood ".

TAX PLANNING-MEANING AND ITS NEED.

Need for tax planning.

The Income-tax Act provides for certain sections which allow a person to save tax legally by adopting the path shown in the sections. When a person takes shelter behind these sections , provisions and rules and as a result reduces his tax liability , it is called tax avoidance . In this case the assessee manages his financial affairs in such a way that the tax burden is reduced.

Tax planning reduces the inflow of cash resources to the government by way of taxes. As a result the money to be effectively utilised for the benefit of the individual or the business as the case may be in reduced. A good effective tax planning is indispensable for the welfare of the individual in the same manner as economic planning is for the State.

Meaning of tax planning

Tax planning is an arrangement of one's financial affairs in such a way that the burden of taxation on the assessee is reduced to the minimum without violating in any way the legal provisions. Maximum advantage is taken of all tax exemptions , deductions , concessions , rebates , allowances and other relief or benefits permitted under the Act. The tax planning arrangements are required to be natural and must not appear to be artificial.

Tax planning is an arrangement of a person's financial affairs in such a way that , without contravening in any way the legal provisions , full advantage is taken of all tax exemptions , deductions , concessions , rebates , allowances and other reliefs or benefits permitted under the Act to reduce the burden of taxation on the assessee . This statement is based on a judgement given under English law in a case Inland Revenue Commissioner vs. Duke of Westminister 1936 AC.

"Every man is entitled if he can, to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result. then, however unappreciative the Commissioners of Inland Revenue or his fellow taxpayers may be of his ingenuity , he cannot be compelled to pay an increased tax."

"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 judgments 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 distiction between the two items in the following words.

" The distinction between 'evasion' and 'avoidance', therefore , is largely dependent on the difference in metods 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".

TAX AVOIDANCE

Judicial View

Before discussing the relevant observations of the Supreme Court in relation to tax avoidance scheme it will be instructive to have an idea of the development in judicial thinking in England since our own judicial thinking on the subject has been largely derived from English thinking.

The English Scene

In Inland Revenue Commissioner Vs. Duke of Westminster-[ 1936 AC I ] it was held

" Every man is entitled if he can, to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result. then, however unappreciative the Commissioners if Inland revenue or his fellow taxpayers may be of his ingenuity , he cannot be compelled to pay an increased tax ."

Lord Simon in Lattila's case observed as follows:

" There is, of course no doubt that they are within their legal rights but that is no reason why their efforts , or those of the professional gentlemen who assist them in the matter, should be regarded as a commendable exercise of ingenuity or as a discharge of the duties of the good citizenship. On the contrary, one result of such methods , if they succeed , is of course to increase protante the load of tax on the shoulder of the body of good citizens who do not desire or do not know how to adopt these maneuvers."

Indian Scene

While deciding the case CIT Vs. A. Roman & Co. [ I SCR 10] the Supreme Court followed the Westminister's case. It said that avoidance of tax liability by so arranging commercial affairs that charge of tax is shifted is not prohibited. The tax payer may adopt certain measures which may divert the income before it accrues to him. He is not concerned about morality of the transaction rather he depends upon the operation of the Income tax Act.

In a case CIT Vs.Kharwar [ 72 ITR 603 ] same view was observed:

" The taxing authority is entitled and is indeed bound to determine the true legal relation resulting from a transaction, if the parties have chosen to conceal by a device the legal relation , it is open to the taxing authorities to unravel the device and to determine the true character of relationship. But the legal effect of a transaction cannot be displaced by probing into the substance of the transaction."

The Supreme Court in the case of M/s Mc Dowell and Company Ltd. Vs . Commercial Tax Officer [ 1985 ] [ 154 ITR 148 (SC) ] clearly changed its view from its earlier observations and gave its observations in following manner:

(1) There is substantial loss of public revenue required for the economic development of the nation.

(2) It results in creation of black money economy which results in inflation.

(3) It results into lot if litigation which results into huge amount of tax arrears , busy courts and wastage of time and money.

(4) It results into injustice and inequality caused by tax avoidance for the honest tax payers.

(5) It results into an unethical practice of transferring the incidence of tax liability from the tax dodgers to the honest tax payers who have to pay tax at higher rates.

TAX EVASION

It is illegal method of saving tax and it makes the person liable to penalties and prosecution . The methods of tax evasion are :

(1) Not showing income at its real level i.e. under disclosure of income.

(2) Inflating the expenses and thus reducing the real income.

(3) Manipulation of accounts to reduce the income.

(4) Violation of rules and regulations of law with the intention to save tax.

(5) Manipulation of sale and purchase of property i.e. Benami transactions.

The person who adopts these measures cannot have sound sleep. The fear of tax authorities will always be on his head and he cannot enjoy the fruits of his efforts.

The Income-tax Act provides for very stringent penalties which may range from a minimum of an amount equal to tax payable to a maximum of 300% of tax and for certain crimes the amount of penalty has been fixed . Along with the penalty there is provision of prosecution also. There are certain sections of the Act which provide for prosecution and then imprisonment for various terms. As such no body will advise the assessee to go in for tax evasion.

Distinction between tax planning , tax avoidance and tax evasion.

1.Approach. While the tax planning it is the compliance of law and then save tax whereas in tax evasion it is willfull disobedience of law and then save tax. In tax avoidance the approach though legal but it is still unethical.

2. Nature. The tax planning is scientific adoption of different provisions of law so as to save tax whereas the nature of tax evasion is to hide the facts about income or expenses.

3. Result. Though in all the three cases object is to save tax but in tax planning a person does not attract any penalty or punishment whereas in tax evasion/avoidance the person makes himself liable for penalty and punishment.

Requisites of a succesful tax planner i.e. requisites of succesful 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 succesful tax planner the knowledge of all the provisions of Income Tax Act 1961, rules framed there under and 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 succesful 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 notifications 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. These 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 succesful 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 weighs 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 succesful 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 expense 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 that they do not hurt others.

2. Taxation laws are most dynamic laws and they keep changing very frequently. There is no 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 term 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 fulfilment 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 acts 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. 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 is necessary it is also esssential for good tax planning to be an expert in the field of accountancy. The little knowledge of accountancy can cause 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 becomes 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 management part of the tax planning is name given to compliance of tax laws. It deals with the relationship of a person with the tax authorities. It has three facets :

(1) Past. At the end of financial year filing of various returns, issuing certificates, payment of tax etc.

(2) Present. During the course of financial year payment of tax at appropriate time , deduction of tax at source , its payment etc.

(3) Future. Rectification of any mistake committed , going in for appeals etc.

Tax management is that part of the tax planning where the planner saves the organisation from payment of interest , penalties and prosecutions . As such has nothing to do with tax avoidance or tax evasion rather it deals with compliance with tax rules and regulations.

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