Broadly speaking, tax planning is not a one day show; rather it is a gradual arrangement of one’s financial affairs in such a way that there are no violations of the legal provisions of the Income Tax Act. Though, it is a legal obligation of every citizen to pay the taxes honestly under the law, the taxpayer is legitimately entitled to plan his taxes in such a manner that his tax liability is reduced to a minimum.
Tax planning is needed for :-
Minimizing litigation between the taxpayer and the tax administrators;
Healthy growth of economy; and
Employment generation.
Concepts used in Tax Planning:-
Tax Evasion
Tax Evasion means not paying taxes as per the provisions of the law or minimizing tax by illegitimate and hence illegal means. Tax Evasion can be achieved by concealment of income or inflation of expenses or falsification of accounts or by conscious deliberate violation of law.
Tax Evasion is an act executed knowingly willfully, with the intent to deceive so that the tax reported by the taxpayer is less than the tax payable under the law. Example:- Mr. A, having rendered service to another person Mr. B, is entitled to receive a sum of say Rs. 50,000/- from Mr. B. A tells B to pay him Rs. 50,000/- in cash and thus does not account for it as his income. Mr. A has resorted to Tax Evasion.
Tax Avoidance
Tax Avoidance is the art of dodging tax without breaking the law. While remaining well within the four corners of the law, a citizen so arranges his affairs that he walks out of the clutches of the law and pays no tax or pays minimum tax. Tax avoidance is therefore legal and frequently resorted to. In any tax avoidance exercise, the attempt is always to exploit a loophole in the law. A transaction is artificially made to appear as falling squarely in the loophole and thereby minimize the tax. In India, loopholes in the law, when detected by the tax authorities, tend to be plugged by an amendment in the law, too often retrospectively. Hence tax avoidance though legal, is not long lasting. It lasts till the law is amended.
Example:- Mr. A, having rendered service to another person Mr. B, is entitled to receive a sum of say Rs. 50,000/- from Mr. B. Mr. A other income is Rs. 200,000/-. Mr. A tells Mr. B to pay cheque of Rs. 50,000/- in the name of Mr. C instead of in the name of Mr. A. Mr. C deposits the cheque in his bank account and account for it as his income. But Mr. C has no other income and therefore pays no tax on that income of Rs. 50,000/-. By diverting the income to Mr. C, Mr. A has resorted to Tax Avoidance.
Tax Planning
Tax Planning has been described as a refined form of tax avoidance and implies arrangement of a person’s financial affairs in such a way that it reduces the tax liability. This is achieved by taking full advantage of all the tax exemptions, deductions, concessions, rebates, reliefs, allowances and other benefits granted by the tax laws so that the incidence of tax is reduced. Exercise in tax planning is based on the law itself and is therefore legal and permanent.
Example:- Mr. A having other income of Rs. 200,000/- receives income of Rs. 50,000/- from Mr. B. Mr. A to save tax deposits Rs. 60,000/- in his PPF account and saves the tax of Rs. 12,000/- and thereby pays no tax on income of Rs. 50,000.
Tax Management
Tax Management is an expression which implies actual implementation of tax planning ideas. While that tax planning is only an idea, a plan, a scheme, an arrangement, tax management is the actual action, implementation, the reality, the final result.
Example:- Â Action of Mr. A depositing Rs. 60,000 in his PPF account and saving tax of Rs. 12,000/- is Tax Management. Actual action on Tax Planning provision is Tax Management.
To sum up all these four expressions, we may say that:
Tax Evasion is fraudulent and hence illegal. It violates the spirit and the letter of the law.
Tax Avoidance, being based on a loophole in the law is legal since it violates only the spirit of the law but not the letter of the law.
Tax Planning does not violate the spirit nor the letter of the law since it is entirely based on the specific provision of the law itself.
Tax Management is actual implementation of a tax planning provision. The net result of tax reduction by taking action of fulfilling the conditions of law is tax management.
Quick Look:-
Investing in a senior citizen's name can result for the higher tax exemption one enjoys.
Certain investments offers higher return to senior citizens.
Through gifts made to a senior citizen, investment can be made.
Tax-free investments can be made in the name of any family member.
A self-occupied house should be bought in the name of the member in the highest tax bracket.
A salary earner can reduce his tax by paying rent to the family member owning the house.
There are different considerations while planning of family investments. They are as follows:
Choosing the right member's fund for investments.
Availability of the concessions on the initial investment and the returns.
The tax liability of such earnings.
Taxability of sums received on maturity.
Capital generation needs of each member.
The age of the investor.
Investment made in the name of Senior Citizens
Higher basic exemption limit and increased rate of return.
Certain investment schemes offer higher rates of return or are open for senior citizens. Investing in these increases the earnings of the family.
Funds for a senior citizen can be generated by gifts from a high net worth member. It would not suffer tax.
The earnings are reinvested to increase income in the subsequent years.
Note:- A donor legally divests the title to the property in favour of the recipient by the way of gift, so he/she cannot have any claim to the property thereafter.
Tax-exempt Investment
It can be made in the name of any member but one should keep in mind to make it through such member whose chance of falling in the highest tax bracket is the least in the long run. It can be made in the name of minor so that parents does not have to pay the tax even after clubbing.
Concessional Tax Treatment
Certain investments attract tax concessions, like short-term capital gains on the transfer of shares through recognised stock exchanges. It is taxed only at 10% flat. Investment on shares can be made in any members name as it do not result in any differential tax outflow.
Investment on Business Premises
An investment can be made in office/ business premises in the name of a member who is not the proprietor of the business. Take an example, a person carrying a retail business can buy a shop in the name of another member and then take it on rent. The rent paid is tax-deductible. The rent earned by the member of the family paying lesser or negligible tax suffers lesser tax than the tax paid by the owner of the business. Salary Earners and HRA
A salary earner can reduce tax liability by paying rent to a member of his family who owns his house in which the former resides, provided the member falls in lower tax bracket. But before practising this one must take into consideration the place where the house is located, the local laws on letting out property on rent, like stamp duty, registration charges, leave and license agreements. The rent should be perfectly paid by cheque and on regular basis through the year to prove authenticity of the transaction.
Joint Ownership of a Residential House
In case of joint ownership where the shares are in an agreed ratio, each co-owner's share of the income from the property will be included in his/her total income while filing returns. While taking loans, the co-owner can take in any ratio, irrespective of the sharing ratio. Hence, it is beneficial for the person in higher tax bracket to borrow more. It helps him/her to save more tax on interest deductions.
Owning House Property
A self-occupied house should always be bought by the person with highest tax bracket. This will not fetch any return and the fall in his investible surplus will reduce his future income and future tax liability. Investment made in the name of Senior Citizens :-
Higher basic exemption limit and increased rate of return.
Certain investment schemes offer higher rates of return or are open for senior citizens. Investing in these increases the earnings of the family.
Funds for a senior citizen can be generated by gifts from a high net worth member. It would not suffer tax.
The earnings are reinvested to increase income in the subsequent years.
Note:- A donor legally divests the title to the property in favour of the recipient by the way of gift, so he/she cannot have any claim to the property thereafter.
Tax-exempt Investment
It can be made in the name of any member but one should keep in mind to make it through such member whose chance of falling in the highest tax bracket is the least in the long run. It can be made in the name of minor so that parents does not have to pay the tax even after clubbing.
