Professional Documents
Culture Documents
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Introduction
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Ethical
Desirable
When used as an art of dodging taxes without breaking the law or acting as per the language of the law only in form, but murdering the very spirit of the law and thus unethical from the viewpoint of policymakers
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When acting against the intention of the law & every attempt by legal means to prevent or reduce tax liability and thus avoiding profitable venture also.
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Maximize
Maximize
Minimize
Maximize
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Traditional Tax Planning Techniques based on Tax Formula Traditional tax planning is based on maximizing the tax-favored status and minimizing the tax-disfavored status. Since the ultimate objective of traditional tax planning is the minimization of the bottom line (i.e., the minimization of the net tax payable), the rules of simple arithmetic suggest that tax planning must necessarily involve: Maximization of tax credits/rebates/reliefs, Minimization of the applicable tax rate(s), and Maximization of deductions and/or exclusions. In other words, the items on all even-numbered lines in the above formula constitute the critical variables in tax planning.
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1. Maximization of Exclusions:
Exclusions are the incomes which are not included in the tax-base of the income tax [total income as defined u/s 2(65), the scope of which is outlined u/s 17 and computed u/s 43 according to the heads of income u/s 20, but to be reported under the heads mentioned in the Form of Return of Income (Form IT-GA for non-company assessees and Form IT-GHA for companies) u/r 24]. Under section 44(1), any income or class of income or the income of any person or class of persons specified in Part A, Sixth Schedule shall be exempt from the tax, and shall be excluded from the computation of total income. Along with this list under Part A, Sixth Schedule, Government has issued a number of S.R.O. u/s 44(4) of the ITO to extend this exclusion list. 6 (six) SROs issued u/s 60(1) of the Income-tax Act 1922 are still in force for similar exclusion purpose. The business entities which have been allowed tax holiday u/s 46A or under any SRO are able to exclude their income enjoying tax holiday.
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2. Maximization of Deductions:
Except Salaries head u/s 21, all other statutory heads of income have provisions of deductions: Sec. 23 for deductions from Interest on securities, Sec. 25 for deductions from Income from house property, Sec. 27 for deductions from Agricultural income, Sec. 29 for deductions from Income from business or profession [along with section 30 for inadmissible expenses from Income from business or profession], Sec. 32(1) for deductions from Capital gains [along with section 32(12) for restricted deductions from Capital gains], and Sec. 34 for deductions from Income from other sources. All these deductions are subject to limits, and conditions and subject to evidential proofs. So a business entity must be careful about these conditions, limits and authenticity of the transactions and thereby, disallowances may be avoided and deductions can be maximized.
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2. Maximization of Deductions:
Loss as a Deduction:
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Under section 37, in the year of loss, losses under any head other than two losses loss in speculation business and capital loss can be set-off against other head(s) except against speculation business income and capital gain. But one speculation business loss can be set off against other speculation business income only and one capital loss can be set off against other capital gain only. From AY 2007-08, loss from business or profession is restricted to set off against income from house property. Under other provisions of sections 38-42, set-off of losses can be done in future six successive income years only against the concerned head of income and applicable only for following incomes: Speculation business income (u/s 39), Capital gains (u/s 40), and Other business income (u/s 38), Agricultural income (u/s 41) But in case of capital loss, carry-forward can be done after deduction of Taka 5,000 [u/s 40(3)]. Loss will be calculated for carry-forward after deducting any cash subsidy from the Government [second proviso to section 37]. Loss due to depreciation can be carried forward for unlimited period [u/s 42]. In case of loss, how to maximize the setting-off of the loss in the year concerned should be given special attention and in case of unset-off losses, special tax planning regarding accounting method can help to set off those losses before the expiry of the time limits.
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4. Maximization of Credits/Rebates/Relief :
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shall be computed in accordance with the method of accounting regularly employed by the business entity [sec. 35(1)].
However, every public or private company as defined in the Companies Act, 1913 or 1994 shall, with the return of income required to be filed under the ITO for any income year, furnish a copy of the trading account, P&L account and the balance sheet in respect of that income year certified by a CA [sec. 35(3)]. Where no method of accounting has been regularly employed, or if the method employed is such that, in the opinion of the DCT, the income of the assessee cannot be properly deduced therefrom; or where a company fails to furnish financial statements certified by a CA with its return, the income of the entity shall be computed on such basis & in such manner as the DCT may think fit [sec. 35(4)].
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Mercantile system (or accrual basis) or Cash system (or cash basis) or Hybrid system (i.e., mixture of these two for separate heads of income). However, in the income tax laws, few incomes must be computed under a specific accounting method. For instance, Dividend is taxable under cash system [u/s 19(7)], Income from house property is taxable under cash system [S.R.O. No. 454-L/80 dt. 31.12.80], and Advance salary income are taxable under cash system [u/s 21(1) (b)] subject to a relief u/s 172.
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Tax Avoidance
Maximizing after tax Legal tax avoidance to minimize tax return May be undesirable in some cases
Not considered and hence those costs may be introduced significantly
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Tax Avoidance
Usually not considered
May be done by adopting easy way to avoid paying tax
Yes considered
Tax cost
Minimum
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Scholes-Wolfson have adopted a contractual perspective for their paradigm & suggested 3 key aspects of tax planning globally: 1. Multilateral Approach: All contracting parties must be taken into account in tax planning, which allows a global or multilateral, rather than a unilateral, approach. 2. Importance of Hidden Taxes: All taxes (both implicit tax and explicit tax) must be taken into account considering the global measures of taxes. Implicit tax is the decrease in return due to availing tax favored investment and explicit tax is the tax deposited in the treasury. 3. Importance of Nontax Costs: All costs of business must be considered, not just taxes. Thus, the paradigm is based on consideration of
ALL PARTIES, ALL TAXES, ALL COSTS. These are also prerequisites of Effective Tax Planning.
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Taxing Authority
Taxing Authority as an uninvited party to all contracts:
Brings to each of its forced ventures with taxpayers a set of contractual terms (tax rules) Does not negotiate the contractual terms separately for each venture Announces a standard set of the above terms taxpayers must accept Claims a partnership interest in taxpayers profit Does not exercise any voting rights
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Taxing Authority
Taxing Authority as an uninvited party to all contracts: . contd Does not directly monitor taxpayers performance to determine whether taxpayers are violating the contractual terms But does conducts audits Being a partner in all firms enable the taxing authority to determine when taxpayers are reporting result far out of line with what other taxpayers are reporting in similar situations (information that is used to select return for audit)
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Where tax planning opportunities advance taxable profit from a later period to an earlier period, the utilisation of a tax loss or tax credit carryforward still depends on the existence of future taxable profit from sources other than future originating temporary differences.
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Appendix-I delineates the Special Provisions Relating to Avoidance of Tax under Chapter-XI of the Income Tax Ordinance, 1984.
Appendix-I
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Say, a company distributes Tk. 1 as a dividend today, shareholders pay taxes at their own personal tax rates, and reinvest the after-tax income on their own account for n periods at an after tax rate of return per period. If the company retains the Tk. 1 of after-tax corporate income, on the other hand, and invests it on corporate account, it returns at corporate rate per period after tax until it finally distributes the accumulated amount of retained earnings. At that time, shareholders pay tax on the distribution at his personal tax rate then. So we can compare the two alternatives as follows:
Liquidate and invest on personal account for n periods Retain and invest on corporate account for n periods before liquidating
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Money spent thereon is tax deductible Tax savings arising from tax planning is effectively tax exempt because they reduce taxes payable & hence, more tax-favored than tax-exemption
When PTROR (pre-tax rate of return) is equal to ATROR (after-tax rate of return), then it is called tax exemption (a situation in which an asset escapes explicit taxation).
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Approaches to Strategic Corporate Tax Planning Approaches to Strategic Corporate Tax Planning
Taxes are important to know, but hard to learn. The devil is in the details. But managers and investors do not need to know the details. They just need to be aware of the fundamental principles of taxation and how to apply them when making decisions. Even this is no simple task.
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Approaches to Strategic Corporate Tax Planning Approaches to Strategic Corporate Tax Planning
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First, an innovative analytic framework called SAVANT has been explained and illustrated. (A savant is an exceptionally knowledgeable person.) The framework organizes tax principles and their applications and this framework helps nontax specialists see tax savings opportunities and also helps managers to apply tax principles to make better decisions. SAVANT is an acronym for how tax planning fits into business decisions: through Strategy, Anticipation, Value-Adding, Negotiating, and Transforming. Second, it has been shown how managers can apply this SAVANT framework to typical business transactions.
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Applying SAVANT to Maximize Shareholder Value Applying SAVANT to Maximize Shareholder Value
SAVANT is used to show nontax specialists how to critically analyze situations to generate tax-savings opportunities. SAVANT works as follows: To add maximum value to each transaction, decision mak-ers need to stay focused on the firms strategic plan, anticipating tax impacts across time for all parties affected by the transaction. Managers add value by considering these impacts when negotiating the most advantageous arrangement, thereby transforming the tax treatment of items to the most favorable status. Expert managers (and consultants) use these concepts, derived from economic policy and tax law, to maximize shareholder value.
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Why Managers Need to Know the Why Managers Need to Know the Principles of Tax Planning Principles of Tax Planning
Reducing taxes is beneficial, but why should managers learn the basics of tax planning? It may seem obvious at first glance, especially to the ownermanager or corporate entrepreneur. But this is an important question, which can be answered differently at different times, in different organizations, and for operations in different countries. Managers need to learn about taxes because optimizing a ventures total tax burden is important to its success, and managers are the main decision makers in an organization.
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Why Managers Need to Know the Why Managers Need to Know the Principles of Tax Planning Principles of Tax Planning
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Knowing the fundamentals of taxation and how to apply them allows managers to make better decisions and thus be more effective in their jobs. Managers who are able to identify tax issues can also make more effective use of tax consultants, because these managers can recognize a problem when it arises and advise consultants of the trade-offs involved.
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Why Managers Need to Know the Why Managers Need to Know the Principles of Tax Planning Principles of Tax Planning
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Taxes impact success because operational decisions are generally based on the risk-adjusted net present value of expected after-tax cash flows. In addition, income taxes, payroll, sales (e.g., value-added, goods and services, or gross receipts), and property taxes often add up to one of the largest expense items of an organization. Furthermore, tax payments typically have a high legal priority claim on an organizations cash flow. That is, not only can taxes be a big expense, but they also must be paid, and paid quickly.
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Why Managers Need to Know the Why Managers Need to Know the Principles of Tax Planning Principles of Tax Planning
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Furthermore, multinational businesses that are publicly traded in capital markets can be especially sensitive to tax expense. This is because earnings (which usually have a major impact on stock prices) must be reported on an after-tax basis. Indeed, not only must earnings be reduced by taxes paid in the current year, but earnings must also be reduced by any expected future income taxes generated by such earnings. Because senior managers compensation is often tied to earnings via stock prices (e.g., through stock options), key decision makers in multinational organizations often have a high personal stake in optimizing taxes.
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SAVANT Balances the Benefits with the SAVANT Balances the Benefits with the Costs of Tax Planning Costs of Tax Planning
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All in all, there are many factors that combine to motivate managers of organizations to seek to reduce taxes, provided the cost of doing so is not too high. This is because tax planning requires making changes, and doing so is not cost free, nor are the rewards certain. First, the details of taxation are hideously complex. Second, the cost of complying with tax rules (e.g., preparing tax returns and providing details requested by tax auditors) can be significant. Not only can it be costly to figure out how much to pay but also who to pay and when to pay.
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SAVANT Balances the Benefits with the SAVANT Balances the Benefits with the Costs of Tax Planning Costs of Tax Planning
Such costs can be particularly high for cross-border activities, which can involve a multitude of different tax jurisdictions imposing different taxes. In addition, similar taxes are often imposed by different jurisdictions using similar but different basic definitions. This raises the specter of multiple taxation (e.g., the same income effectively being taxed at rates exceeding 100%), although governments typically try to avoid this situation through tax treaties and special adjustments, such as the foreign tax credit.
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SAVANT Balances the Benefits with the SAVANT Balances the Benefits with the Costs of Tax Planning Costs of Tax Planning
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Finally, although income and payroll taxes may be the province of headquarters staff, and thus savings may not directly affect a divisional managers annual performance bonus, other taxes almost always do. This is because these taxes are normally charged to strategic business units and thus reduce their individual bottom lines. Not every idea that saves taxes is a good one. The SAVANT framework helps managers make better decisions because it balances the benefits of tax planning with the costs of doing so.
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contd Tax strategies are also risky: Changing operations to save taxes (e.g., by operating through multiple corporations) often results in an increase in long-term administrative costs and generates uncertain returns because tax laws can change (change can occur dramatically, rapidly, and unpredictably), and tax rules themselves are all too often obscure at best. In cross-border transactions, the interactions of multiple taxes imposed by different jurisdictions also must be appreciated. Also, tax-savings strategies can be intrusive. Why is it, for example, that profitable businesses in the Los Angeles area, a relatively high-tax location, do not all move to Las Vegas, a very-low tax location? One reason is that it is costly to move. Another is that nontax factors dominate the decision: Many business owners simply want to live in southern California rather than southern Nevada. Yet another reason is that skilled labor, qualified subcontractors, and competitive suppliers are plentiful in southern California, as are (perhaps more importantly) customers.
SAVANT: The Generic Tax Planning SAVANT: The Generic Tax Planning Strategies Strategies
Thus, even though total elimination of taxes is not a goal, people and organizations often invest significant amounts of time and resources in implementing tax-reducing strategies. The ultimate goal is to reduce taxes while not excessively intruding on the organizations overall operations. SAVANT explicitly recognizes this. SAVANT also illustrates that tax strategies are usually based on taking advantage of either the time value of money (e.g., paying taxes later) or differences in tax rates (i.e., tax-rate arbitrage). Tax arbitrage is typically behind artificial transfer pricing schemes, that is, using accounting entries to shift profits to jurisdictions that impose the lowest net taxes (i.e., the lowest tax costs relative to the benefits received by operating in a particular jurisdictione.g., free medical care for all people, including a firms employees.)
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contd
CONVERSION: Conversion entails changing operations so that more tax-favored categories of income or assets are produced. For example, advertising in order to sell inventory results in ordinary income, which is usually taxed immediately and at the highest rates. However, equally successful image advertising generates an increase in a firms goodwill, which is not taxed until the goodwill is sold, if at all, and then would likely be taxed at lower cap-ital gains rates. SHIFTING: Shifting involves techniques that move amounts being taxed (also called the tax base) to more favorable tax-accounting periods. A good example is accelerated depreciation, which allows more of an assets cost to be a tax-deductible expense in early years, thus deferring the payment of taxes until later. Another example is an individual retirement account (IRA).
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SPLITTING: Splitting techniques entail spreading the tax base among two or more taxpayers to take advantage of differing tax rates. For example, the top U.S. income tax rate on individuals is nearly 40%, but the standard tax rate on the first $50,000 of corporate income is only 15%. Incorporating a sole proprietorship generating $200,000 in profits, and paying a $150,000 salary (provided it is reasonable) to the proprietors, is a splitting strategy that saves $12,500 (i.e., 25% of $50,000 split off and moved into the corporate tax return) of income taxes each year. Taxes can also be avoided through fraud, which is fairly widespread throughout the world outside of the United States, but relatively small for noncriminal activities within the United States. Those favoring fraud as a strategy generally need not read books like this.
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SAVANT: The Transactions Approach to SAVANT: The Transactions Approach to Maximize Firm Value Maximize Firm Value
To increase firm value, managers engage in transactions. Of course, firm value can increase for other reasons. For example, the value of the firms assets simply can appreciate due to market factors beyond the control of managers. However, transactions must have occurred when firms acquire such assets, and it takes transactions to convert such assets into cash flow. Managers do things like buy, sell, rent, lease, and recapitalize. If managers structure transactions such that each is valuemaximizing, then by year-end the sum of such transactions will have maximized firm value. However, note that each transaction has an uninvited third party: the government. In strategic tax management, when a firm chooses transactions, it keeps tax management in mind. This transactions approach is the SAVANT framework.
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SAVANT Framework: SAVANT Framework: The Transactions Approach to Tax Management The Transactions Approach to Tax Management
Strategy Anticipation
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SAVANT Framework: SAVANT Framework: The Transactions Approach to Tax Management The Transactions Approach to Tax Management
Strategy The firm looks to engage in transactions that maximize end-of-period value.
contd
It can chose from a constellation of entities or transactions, and the choice then is put through the lens of the firms strategic objectives. If the transaction (including tax effects) is consistent with the firms strategic objectives, it may accept the transaction. Otherwise, even if the transaction is highly tax-advantaged, the firm should consider rejecting the transaction. Similarly, the tax aspects of the transaction can be managed in a strategic manner.
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SAVANT Framework: SAVANT Framework: The Transactions Approach to Tax Management The Transactions Approach to Tax Management
Anticipation
contd
Next, the firm anticipates its future tax status and chooses the timing this year or a future yearof the transaction.
Because the effects of transactions often span more than one year, the firm projects tax effects into the future, using current and expected future tax rates and rules, and factors in managements expectations as to the future tax status of the firm. If there is tax advantage to adjusting the timing of a transaction, the firm should do so provided that the nontax economics still make sense.
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SAVANT Framework: SAVANT Framework: The Transactions Approach to Tax Management The Transactions Approach to Tax Management
Negotiating
contd
Taxes are also negotiated between the firm and the other entity.
The firm seeks to shift more of the tax burden away from itself (and potentially, onto the other entity) by negotiating the terms of the transaction. The firm attempts to minimize tax costs by Transforming transforming transactions being considered into ones with more favorable tax treatment. For example, managers can work to restructure transactions that might generate nondeductible costs into ones where costs are deductible ones, or work to transform what would have been ordinary income into capital gain income. .
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SAVANT Framework: SAVANT Framework: The Transactions Approach to Tax Management The Transactions Approach to Tax Management
ValueAdding
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What is left, after taxes, is value-added to the firm. Like taxes, value-added often inures to the firm over time. Because it is a fundamental principle that cash inflows are more valuable now than later, tax management takes into account the time value of a transaction as well.
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The time value of a transaction, after taxes and transaction costs, is what increases firm value in the future. One aspect of a transaction that affects value-added comprises transaction costs, such as sales commissions or attorney fees. Transaction costs reduce the net change is inconsistent with its strategy. For example, if a firm wants to acquire another business that is unrelated to its core competency, to obtain tax benefits [e.g., NOL (net operating loss) carryovers], it should not do so unless it is clear that the pretax economics make sense. Second, a firms competitive strategy may be shaped, in part, by its tax status. Put simply, if a firm is structured so that it has a more favorable tax status than that of its competitors, this can give the firm an overall cost advantage over its competitors. Effective tax management is an important tool in obtaining this kind of competitive edge.
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Thank you.