What is Tax Planning? Features, Need, Limitations, Management

What is Tax Planning?

Tax planning is an arrangement of one’s financial affairs in such away that the burden of taxation on the assessee is reduced to the minimum without violating in any way the legal provisions. 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 Planning’.

In tax planning, maximum advantage is taken of all tax exemptions, deductions, concessions, rebates, allowances other reliefs or benefits permitted under the Act. It is an act of prudence and farsightedness on the part of an assessee to reduce the burden of his tax liability to maximum possible extent by remaining in the four corners of the law.

Tax planning is a legitimate right of the tax payer. However, it is not an inherent right of the tax payer. It can be exercised only if it is provided under the taxation law. In other words, Tax planning can be done only if the tax laws contain provisions in this respect. The concept of tax planning has originated from the very existence of certain exemptions, deductions etc. provided under the tax laws.

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Features of tax planning

• Tax Planning is an exercise aimed at reducing tax liability by availing maximum benefits of various deductions, exemptions, rebates, reliefs etc. provided under tax laws.
  
  
• It comprises of arrangements completely within the framework of law. In other words, tax-reduction strategies involve full compliance to law.
  
  
• Transactions do not take the form of colourable devices (i.e., those devices where the statute is followed in strict words but the actual spirit behind the statute is marred).
  
  
• There is no intention to deceit the legal spirit behind the taxation laws.
  
  
• It is legal and accepted by judiciary.
  
  
• It is based on principle of disclosure.
  
  
• It is a deliberate creation of law for wealth generation through encouraged savings and investment.
  
  
• It leads to more resources with the tax payer without any fear of being eroded later on rather used for productive purposes.
  
  
• It leads to sound sleeps for the tax payer i.e. stress-less device.
  
  
• Tax planning is an honest effort of the tax payer to benefit himself and economy as a whole.

Tax planning strategies deal with how to optimise after tax income and capital flows after considering transaction cost, the management structure and business risk. It is a systematic and scientific exercise with due respect to the letter and spirit of the prevalent tax laws. It is a process of looking at various tax option in order to determine whether, when and how to conduct business/personal transaction so that the taxes are either eliminated or reduced. Tax planning should not be done with an intention to defraud the revenue and should be in correct form and substance of law.

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 Westminster 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.”

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Business Transactions and Tax Planning

Every business transaction has tax consequence or consequences, Whether that transaction is a day-to-day transaction like purchase, sale, routine expense, etc or certain special transactions like purchase of fixed assets, raising of capital etc.

So, while taking any business decisions, its tax effects must be analysed before hand. If not always but in certain cases, tax consequences guide in carrying out a particular business transaction. Thus, tax planning aids business owners in making tax conscious business decisions. It involves revenue planning, expense planning, investment planning and finance planning.

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Tax Management

Tax management, a 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:

• Past: At the end of financial year filing of various returns, issuing certificates, payment of tax etc.
  
  
• Present: During the course of financial year payment of tax at appropriate time, deduction of tax at source, its payment etc.
  
  
• 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 organization from payment of interest, penalties and prosecutions and as such has nothing to do with tax avoidance or tax evasion rather it deals with compliance with tax rules and regulations. It involves compliance with legal formalities to avail of various incentives available under Income Tax Act. Tax management is essential because often tax deductions/Exemptions/Incentives provided under IT Act are conditional.

In other words, deductions/exemptions are available only if assessee fulfills certain specified conditions prescribed under I.T Act. Thus, it becomes imperative to fulfill the conditions and to comply with statutory requirements to get a reduction in tax liability.

For example, Sec 10A of Income Tax Act 1961 provides, a deduction to certain types of undertakings in respect of profit from export of articles or things or computer software. A number of conditions have been prescribed under that section to enjoy the deduction. Thus, an attempt to comply with those conditions is called Tax management. Tax management, now-a-days has become a complex exercise involving high time and labour.

This is so because of the following two reasons:

• Economic uncertainity under which corporations/companies/business houses operate, and
  
  
• Ever growing regulatory flameworks being introduced by the legislature.

A well developed system and set procedures are required to be employed to deal effectively and efficiently with company’s tax obligations. Tax management system may be manual or mechanical. However, under present times mechanical system (i.e. computer) are increasingly being used for tax management.

Thus, Tax management can be described as a ‘road’ that leads to the destination of tax planning.

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Need for Tax Planning

Tax Planning strategies deal with how to optimise after tax income and capital flows after considering transaction cost, the management structure and business risk.

The main need of tax planning are as follows:

Reduction in tax liability

The first and foremost purpose of tax planning is reduction in tax liability and tax planning helps the tax payer to reduce his tax liability by enabling him to claim the various exemptions, deductions, rebates or reliefs etc.

These exemptions or deductions are deliberately provided by the law makers. Non-planning of tax may cast a heavy burden of tax on the shoulders of the tax payer. Since, tax constitutes cash outflows, therefore, tax planning helps a tax payer to make savings and to feel a lesser pinch of taxation.

Minimisation of litigation

Taxation laws being so complicated and cumbersome, have always been a cause of litigation. Tax litigation occurs due to the conflicting objectives of the tax officials and tax payers. Tax officials make every effort to collect more and more tax revenue whereas tax payers try to pay lesser and lesser tax. In this context, sometimes, tax officials derive such interpretations of the tax laws which cause increased tax burden on the assessee.

Considering such tax demand as unjustified, the aggrieved assessee often approaches the various appellate authorities as provided under the law. Similarly, quite often, tax payers, in a bid to reduce tax liability, interpret the law as causing either no tax liability or reduced tax liability (by fabricating artificial transactions as real ones) for them.

As and when such a case comes to the knowledge of the tax officials, they serve a demand notice to such an assessee (treating it as a case of tax avoidance or tax evasion) which is often challenged by the assessee in the court of law.

Healthy growth of nation

As we know that tax revenues constitute a major source of revenue to the government. Any effort, by the government to provide deduction, exemption etc. to tax payer, leads to fall in the revenue of the government. But inspite of this, government deliberately provides such exemptions and deductions to the tax payers.

As most of the times, these exemptions, deductions are for the socio-economic development of the country. For example, the deduction u/s 80IA is provided to build up a strong infrastructure base in the economy. Similarly, certain exemptions/ deductions etc. are available to undertakings set up in industrially backward areas.

Helps in Capital Formation

Savings and investment decide the level and pace of economic development of a nation. Tax planning helps a lot in the process of capital formation. Most of the times, tax laws encourage tax payer to invest money in government instruments. Many tax benefits/concessions can be availed by investing money in government owned undertakings or by depositing money in state sponsored saving schemes.

For example, section 80C of Indian Income Tax Act, 1961, provides deduction for investment in NSCs etc. which helps the government to garner the idle money or money saved through tax planning of the assessees. The money so generated gives a big push up to the economy in its development phase.

A Source of Working Capital

As we know Cash/Bank Balance is the main constituent of working Capital and is regarded as life blood of business. It is required for meeting day to day expenses, purchasing assets, payment to creditors and payment of dividend to shareholders etc. Effective tax planning helps in conserving this important constituent of working capital. In the absence of proper tax planning, much of the cash will go out of business, thus leaving lesser cash for other important purposes.

Other implications

Apart from these major ones, there are some derived implications also such as, boost to capital market, cost effectiveness, employment generation and economic stability etc.

These very implications of tax planning explain that tax planning is not only the necessity of tax payer but also beneficial for him.

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Does tax planning reduce governmental revenue?

As we know, tax planning aims at reducing the tax outflows of the taxpayer which leads to reduction in the revenue of the government. Therefore, some experts are of the opinion to do away with provisions involving tax concessions, exemptions etc. But, by and large, it has been accepted that although these concessional provisions reduce the inflow of government yet it offsets the fall in revenue by channelising savings and investment in the growth of economy.

The savings through tax planning are pumped into the economy by the individual & corporate tax payers and not by government. Thus, the ultimate purpose of socio-economic development is fulfilled.

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Limitations of Tax Planning

• 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.
  
  
• Taxation laws are most dynamic laws and they keep ch‘nging 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.
  
  
• 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.
  
  
• 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.
  
  
• 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.
  
  
• It is not only the knowledge of tax and other laws is necessary it is also essential for good tax planning to be an expert in the field of accountancy. The little knowledge of accountancy can cause bad tax planning.
  
  
• 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.

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