Basic Concepts of Income Tax – I

November 24, 2009

SavvY Income Tax chartered accountancy , Income tax for IPCC, Income tax for PCC, Income tax law for Ca, students 6 Comments

Taxation, on of the most interesting and tricky subjects in the syllabus of Chartered Accountancy is actually more about the concepts than the learning. Like all other subjects, if it is studied with an easy and happy approach, its going to be as simple as water. But the students mainly go wrong while starting the subject. The directly move to the ‘Heads of Income’ before studying the basic concepts of taxation. As a result their foundation in this particular subject remains weak and they become prone to making mistakes during exam. Sincerely the first few days should be given to basic concepts about taxation (though I must say that there won’t be any direct question from theses parts in the examination).

What is Tax?

Tax is that part of our income which the Government of India takes from us for providing us numerous facilities like, water and drainage system, protection against internal and external enemies, developing infrastructure.

In simple words Tax is a source of revenue for the Government. There are two types of taxes –

1. Direct Tax

2. Indirect Tax

Classification Of Taxes, Their Advantages And Disadvantages

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Basically, tax can be classified into two broad categories:

1. Direct Tax

2. Indirect Tax

1. Direct Tax

A direct tax is a tax paid by a person on whom it is legally imposed. In direct tax,

the person paying and bearing tax is the same. It is the tax on income and

property. Examples of direct taxes are:

* Income Tax

* Vehicle Tax

* Expenditure Tax

* property Tax

* Interest Tax

* Gift Tax etc.

Advantages Of Direct Tax

* Direct tax is equitable as it is imposed on person as per the property or income.

* Time, procedure and amount of tax paid to be paid is known with certainty.

* Direct tax is elastic. The government can change tax rate with the change in the

level of property or income.

* Direct tax enhances the consciousness of the citizens. Taxpayers feel burden

of tax and so they can insist the government to spend their contributions for the

welfare of the community.

Disadvantages Of Direct Tax

* Direct tax gives mental pinch to the taxpayers as they have to curtail their

income to pay to the government.

* Taxpayers feel inconvenience as the government impose tax progressively.

* Tendency to evade tax may increase to avoid tax burden.

* It is expensive for the government to collect tax individually.

2. Indirect Tax

An indirect tax is a tax imposed on one person but partly or wholly paid by

another. In indirect tax, the person paying and bearing tax is different. It is the tax

on consumption or expenditures. Examples of indirect taxes are:

* VAT

*Entertainment Tax

* Excise Duty

* Sales Tax

* Hotel Tax

* Import And Export Duty etc.

Advantages Of Indirect Tax

* Indirect tax is convenient as the taxpayer does not have to pay a lump sum

amount for tax.

* There is mass participation. Each and every person getting goods or services

has to pay tax.

* There is a less chance of tax evasion as the taxpayers pay the tax collected

from consumers.

* The government can check on the consumption of harmful goods by imposing

higher taxes.

Disadvantages Of Indirect Tax

* Indirect tax is uncertain. As demand fluctuates, tax will also fluctuate.

* It is regretful as the tax burden to the rich and poor is same.

* Indirect tax has bad effect on consumption, production and employment. Higher

taxes will reduce all of them.

* Most of the taxes are included in the price of goods or services. As result,

taxpayers do not know how much tax they are paying to the government.

Advantages and Disadvantages of Direct Taxes

Nitesh Mundra

Ranked #9 in Tax & Taxes

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Advantages and disadvantages of Direct Taxes Advantages of Direct Taxes Direct and indirect taxes have

advantages of their own. Direct taxes have some merits and so have the indirect taxes. Direct taxes have the

following advantages in their favor: — 1. Equitable. The burden of direct taxes cannot be shifted. Hence, equality of

sacrifice can be attained through progression. Of course, the very low incomes can be exempted.

Advantages and disadvantages of Direct Taxes

Advantages of Direct Taxes

Direct and indirect taxes have advantages of their own. Direct taxes have some merits and so have the indirect taxes.

Direct taxes have the following advantages in their favor: —

1. Equitable. The burden of direct taxes cannot be shifted. Hence, equality of sacrifice can be attained through

progression. Of course, the very low incomes can be exempted. This cannot be achieved by taxes on commodities

which fall with equal force on the rich and the poor. The tax raises the price of the commodity and the price of a

commodity is the same for every person, rich or poor.

2. Economical. Their cost of collection is low. They are mostly collected "at the source". For instance, the income tax

is deducted from an officer's pay every month. This saves expense. The employer acts as an honorary tax collector.

This means great economy.

3. Certain. In the case of a direct tax, the payers know how much is due from them and when. The authorities also

know the amount of revenue they can expect. There is certainty on both sides. Certainty minimizes corruption on the

part of the collecting officials.

4. Elastic. If the State suddenly stands in need of more funds in an emergency, direct taxes can well serve the

purpose. The yield from income tax or death duties can be easily increased by raising their rate. People cannot stop

dying for fear of paying death duties.

5. Productive. Another virtue of direct taxes is that they are very productive. As a community grows in numbers and

prosperity, the return from direct taxes expands automatically. The direct taxes yield large revenue to the State.

6. A Means of Developing Civic Sense. In the case of a direct tax, a person knows that he is paying a tax; he feels

conscious of his rights. He claims the right to know how the Government uses his money and approves or criticizes it.

Civic sense is thus developed. He behaves as a responsible citizen.

Disadvantages of Direct Taxes

1 .Inconvenient. The great disadvantage of a direct tax is that it pinches the payer. He 'squeaks' when a lump sum is

taken out of his pocket. The direct taxes are thus very inconvenient to pay. Nobody can help feeling the pinch.

2. Evadable. The assessee can submit a false return of income and thus evade the tax. That is why a direct tax is "a

tax on honesty". There is a lot of evasion. Many of those who should be paying taxes go scot-free by concealing their

incomes.

3.Arbitrary. If taxes are progressive, the rate of progression has to be fixed arbitrarily; and if proportional, 4hey fall

more heavily on the poor. Thus, both are bad. The rate of taxes depends upon the whim of the Finance Minister. This

is arbitrary.

4. If the taxes are too heavy, they discourage saving and investment. In that, case the country will suffer

economically.

Advantages and Disadvantages of Indirect Taxes

Nitesh Mundra

Ranked #9 in Tax & Taxes

FOLLOW

Advantages and disadvantages of Indirect Taxes Advantages of Indirect Taxes Indirect taxes have advantages of

their own. Briefly speaking they are as under:— 1. They are the only means of reaching the poor. It is a sound

principle that every individual should pay something, however little, to the State. The poor are always exempted from

paying direct taxes. They can be reached only through indirect taxation.

Advantages and disadvantages of Indirect Taxes

Advantages of Indirect Taxes

Indirect taxes have advantages of their own. Briefly speaking they are as under:—

1. They are the only means of reaching the poor. It is a sound principle that every individual should pay something,

however little, to the State. The poor are always exempted from paying direct taxes. They can be reached only

through indirect taxation.

2. They are convenient to both the tax-payer and the State. The tax-payers do not feel the burden much, partly

because an indirect tax is paid in small amounts and partly because it is paid only when making purchases. But the

convenience is even greater due to the fact that the tax is "price-coated". It is wrapped in price. It is like a sugar-

coated quinine pill. Thus, a tobacco tax is not fell when it is included in the price of every cigarette bought. It is

convenient to the State as well which can collect the tax at the ports or at the factory. A dealer collects the tax when

he charges a price. He is a honorary tax collector.

3. Indirect taxes can be spread over a wide range. Very heavy direct taxation at just one point may produce harmful

effects on social and economic life. As indirect taxes can be spread widely, they are more beneficial and suitable.

4. They are easy to collect. Collection takes place automatically when goods are bought and sold.

1. They cannot be evaded, as they are a part of the price. They can be evaded only when the taxed article is

not consumed, and this may not always be possible.

6. They are very elastic in yield, if imposed on necessaries of life which have an inelastic demand. Indirect taxes on

necessaries yield large revenue, because people must buy these things.

7. When imposed on luxuries or goods consumed by the rich, they are equitable. In such cases only the well-to-do

will pay the tax.

8. They check consumption of harmful commodities. That is why tobacco, wine and other intoxicants are taxed.

Disadvantages of Indirect Taxes

Indirect taxes have some disadvantages too, which are as follows:—

1. They are regressive. Indirect taxes are not equitable. For instance, salt tax in India fell more heavily on the poor

than on the rich, as it had to be paid at the same rate by all. Whether a rich man buys a commodity or a poor man,

the price in the market is the same for all. The tax is wrapped in the price. Hence, rich and poor pay the same

amount, which is obviously unfair.

They are uncertain in yield unless necessaries are taxed. In the case of goods with an elastic demand, the tax might

not bring in much revenue. The tax will raise the price and contract the demand. When the thing is not purchased, the

question of the tax payment does not arise.

2. They cause the price of an article to rise by more than the tax. A fraction of the money unit cannot be calculated,

so every middleman tends to charge more than the tax. The process is cumulative.

They are uneconomical. The cost of collection is quite heavy. Every source of production has to be guarded. Large

administrative staff is required to administer such taxes. This turns out to be a costly affair. 4. They do not develop

civic- consciousness, because often the tax-payer does not even know that he is paying a tax. The tax is concealed

in the price.

5. They discourage industries if raw materials are taxed.

Let us discuss these in brief:

Direct tax is the tax which can’t be shifted to others. Income tax is a direct tax (and we all try to save it to the best possible limit!) Now while talking about tax saving, three relevant concepts are tax planning, tax omission & tax evasion that we will discuss later.

Indirect Tax on the other hand is a tax that causes rise in the price of goods and is ultimately borne by the customer. That means, if I and Mr. Ambani enjoy Parle- G with the morning tea, both of us are bearing the same amount of tax (that’s soo unfair, isn’t it!). But still we don’t crib about it because the amount of indirect tax can’t be seen by us, the customers. And this is one of the reasons why, Indirect tax is the main source of revenue for the Government.

What are Tax Planning, Avoidance and Evasion?

The Government has given us some provisions to reduce the tax on our income. Proper use of those tools for reducing the tax is called Tax Planning.

The CAs try to find out the loopholes within the provisions of Income Tax Act, and work within those loopholes to save taxes for their clients while the Income Tax department just keeps on staring. It is tax avoidance.

When you compute your income tax returns according to your own whims giving no care whatsoever to the Income Tax laws, its called Tax Evasion and is an offence.

Who are liable to pay Taxes?

“Every PERSON is liable to pay TAX”

We have already briefly discussed the TAX part of the above statement. Now we will discuss about PERSONS liable to pay tax.

Generally we use the words ‘person’ and ‘individual’ in the same way interchangeably but this is not the case in Income Tax. In Income Tax Act, the following are all persons

1. Individual

Ram, Tariq, John, you, me are individuals. We all know about ourselves so we are not discussing it here.

2. Hindu United Family (HUF)

Hindu United Family is not defined in the Income Tax Act. The concept comes from Hindu Law. The three generation of descendents from a common ancestor, with their wives, unmarried daughters and daughter in laws form a Hindu United Family. All in the family are the members of the family though only the male members in the family may be coparceners. Coparceners are those members who have the right to partition of the property.

There are two schools of HUF –

Dayabhaga, where the decision of Karta (i.e., the head of the HUF) is ultimate. Here Karta of the family can distribute property to any person of his choice (male or female) and other members of the family can have no say on his decision. This school is applicable in West Bengal & Assam.

Mitakshara is the school which is applicable in the rest of India. Here the male member of the family has the right to partition in property from his birth.

3. Body of Individuals

When two or more Individuals join hands for common actions with different objectives.

4. Association of Persons (AOP)

When two or more Persons join hands for common actions with common objectives.

5. Firms

AOP with a registered Partnership Deed is called a Firm.

6. Company

Any person is called company if

a) registered under the Indian Companies Act, 1956 or,

b) declared by CBDT by a general or special order as a a company.

7. Every artificial judicial person and Local Authority

Idol of Gods, Goddesses are examples of Artificial Judicial Person where as Loacl Municipality or Corporation is example of Local Authority.

What are Tax Slabs for students appearing examination in May, 2010?

For Individuals

Tax Rate (%) Male (below 65) Female (below 65) Senior CitizensNIL Upto 1,60,000/- Upto 1,90,000/- Upto 2,40,000/-10 1,60,000/- – 3,00,000/- 1,90,000/- – 3,00,000/- 2,40,000/- – 3,00,000/-20 3,00,000/- – 5,00,000/- 3,00,000/- – 5,00,000/- 3,00,000/- – 5,00,000/-30 Above 5,00,000/- Above 5,00,000/- Above 5,00,000/-

BASIC CONCEPTS OF INCOME TAX

An assesses may get income from different sources, eg:- salaries-house property income-profits

and gains of business or profession - capital gains income from other sources like interest on

securities , lottery winnings, races etc.

Income from each of these sources calculated first to find out the gross total income, and then

permissible deduction allowed arriving in total income according to sec 80 c to 80 u. Every

person whose taxable income in the previous year exceeds the minimum taxable limit is liable to

pay income tax during the current financial year at the rates applicable to the current financial

year.

ASSESSMENT YEAR SEC 2(9)

Assessment year means the period of 12 months commencing on the first day of April every

year and ending on 31st march of the next year. The current assessment year is 2007 -

008(1.4.2007 to 31.03.2008).

An Assessee is liable to pay tax on the income of the previous year during the next following

assessment year. Eg: - during the Assessment year 2007-08 income earned during 2006-07 is

taxed.

PREVIOUS YEAR SEC 3

Previous year means the financial year immediately preceding the assessment year. The

previous year relevant to the Assessment year 2007-08 is 2006-07(1.4.06 to 31.03.07).ie the

year in which income is earned is known as previous year.

PERSONS SEC 2(34)

1. Individual

2. Hindu undivided family

3. Company

4. Firm

5. Association of persons or body of individual

6. Local authority

7. Artificial juridical person

ASSESSEE SEC 2(7)

Assessee is a person, who has liability to pay tax or any other sum of money under Income Tax

act of 1961, so the afore said persons include in the category of Assessee. Every Assessee

whose taxable income in the previous year exceeds the minimum taxable limit is liable to pay

income tax during the current financial year at the rates applicable to the current financial year.

EXCEPTIONS TO THE GENERAL RULE

Generally income earned in the previous year is taxed in the assessment year. But there are

certain exceptions to the general rule. Ie the previous year and assignment year are same; the

Assessee is liable to be assessed in the same year in which he earns the income in the

following case,

1. Income from non resident shipping company

2. Income of person leaving India

3. Income of person likely to transfer assets to avoid tax

4. Income from discontinued business.

GROSS TOTAL INCOME

It is the aggregate taxable income under the different heads of income such as income from

salary, income from house property, income from profits or gains of business, capital gains and

income from other sources. Ie total income computed in accordance with the provision of the act

before making any deductions under Sec 80 C to 80 U

TOTAL INCOME SEC 2(45)

Total income is arrived after making various deductions from gross total income under section

80 C to 80 U. It is computed on the basis of residential status of an Assessee

RESIDENTIAL STATUS

Income tax is charged on total income earned by an Assessee during the previous year, but at

the rate applicable to the assessment year. It shall be determined on the basis of the residential

status of the Assessee. Sec.6 of the act divides the Assessee into 3 categories’

*Resident

*Non resident

*Not ordinary resident

There is basic and additional condition for determining the residential status of different

assessee.

Basic condition

1. If he has been India in that previous year for a period or periods amounting in all to 182 days

or more

2.if he has been India for a period or periods amounting in all to 365 days or more, during the 4

years preceding the relevant previous year and has been in India for a period or periods

amounting in all to 60 days or more in that previous year.

Additional conditions

1.An individual who has been in India at least 2 out of 10 previous years preceding the relevant

previous year.

2.The individual has been India for at least 730 days in all during the 7 previous year preceding

the relevant previous year.

RESIDENT AND ORDINARY RESIDENT

Persons who are resident in India is popularly known as ordinary resident. An individual, to

become an ordinary resident in India in any previous year should also satisfy the two additional

conditions along with basic conditions.

NOT ORDINARILY RESIDENT INDIVIDUAL- SEC.6 (6)

If an individual fulfills any one of the basic conditions (specified in the case of resident) but

doesn’t satisfy both additional conditions, he becomes a ‘not ordinary resident’

NON RESIDENT INDIVIDUAL

As per section 2(30) of the income tax act, if an Assessee doesn’t fulfill any of the two basic

conditions or tests will be treated as non resident Assessee during the relevant previous year.

RATE OF INCOME TAX PAYABLE (ASSESSMENT YEAR 2008-09)

*Normal rate of tax

Up to Rs.1, 10,000 nil

Next RS 40,000 10%

Next Rs 1, 00,000 20%

Above Rs.2, 50,000 30%

*For a woman below 65 years of age

Up to Rs.1, 45,000 nil

Next Rs.5000 10%

Next Rs.1, 00,000 20%

Above Rs.2, 50,000 30%

*Senior citizens at the age of 65 year or more

Up to Rs.1,95,000 nil

Next Rs.55, 000 20%

Next Rs.2, 50,000 30%

*Surcharge- In the case of individual and HUF, there is no surcharge if income is less than 10

lakhs. If it exceeds 10 lakhs then surcharge is 10%. But, the surcharge is 2.5% in the case of

company, firm. Local authorities etc.

*Educational Cess: - 3% on amount payable as Tax

tax planning

Tax Planning is aimed at minimizing the amount of federal income tax a given business is required to pay to the government. It also includes ensuring that there are no mistakes in the taxing process, such as a missed payment, missed filing deadline, inappropriate deductions, or incomplete financial records.

Definition of 'Tax Planning'

Logical analysis of a financial situation or plan from a tax perspective, to align financial goals with tax

efficiency planning. The purpose of tax planning is to discover how to accomplish all of the other

elements of a financial plan in the most tax-efficient manner possible. Tax planning thus allows the

other elements of a financial plan to interact more effectively by minimizing tax liability.

Investopedia explains 'Tax Planning'

Tax planning encompasses many different aspects, including the timing of both income and purchases

and other expenditures, selection of investments and types of retirement plans, as well as filing status

and common deductions. However, while tax planning is an important element in any financial plan, it

is important to not let the "tax" tail wag the financial "dog." This can ultimately be counterproductive,

as virtually all courses of financial action will have some tax consequences, and they should not be

avoided solely on this basis.

Read more: http://www.investopedia.com/terms/t/tax-planning.asp#ixzz2HaxERGVW

Tax planning is a process individuals, businesses, and organizations use to evaluate their financial profile, with the aim of minimizing the amount of taxes paid on personal income or business profit. Effective tax planning

entails analyzing investment instruments, expenditures, and other factors such as filing status for their tax liability impact. Accounting, finance,

banking, and insurance firms all emphasize slightly different aspects of tax planning in accordance with the types of services they provide and the laws governing their industries. For example, the tax planning advice banks give clients might revolve around choosing investments that provide the most

favorable return for the lowest tax liability, while an insurer's approach to tax planning might include using cash value life insurance for its tax-deferral features. Estate planning is a form of tax planning, in that its intent is to

minimize estate taxes after death. A number of retail income tax software packages provide tax planning tips along with step-by-step guidance on tax

preparation, and tax planning advice is also available online from the IRS and other sites.

Tax Planning is all about putting your hard earned money to YOUR good use instead of all going to

the government. It doesn't mean not paying your taxes, it just means being smart about where your

placing your money to acquire maximum benefits to you and your future livelihood.

If you're a business owner, even more attention needs to be paid to tax planning with the below points

being included in your planning.

• Entity Structure Planning - Create the optimal entity structure for your business and you personally to

maximize your tax benefits and legal asset protection benefits.

• Compensation and Benefit Planning - Develop strategies that meet your personal and business short

and long goals and objectives. Its really about minimizing taxes and out of pocket expenses paid with

after tax dollars. The goal is maximize your income and the amount available to the business by

minimizing your taxes across the board.

• Maximize Advanced Retirement Planning and Income Deferral Opportunities - Business owners must

annually capitalize on techniques to maximize monies and continued income streams available for life

after the business.

• Utilize Succession, Exit Strategy, and Estate Planning Opportunities - Remember, when you exit your

business, it will be a taxable event. Develop a plan to minimize taxes on the transfer to ensure you walk

away with as much money as possible.

• Avoid or Eliminate Questionable or "Grey Area" Tax Planning Strategies to reduce Audit Risk - All your

tax planning strategies should be supported by the black and white language of the IRS Tax Code and

Regulations. For the informed business owner many opportunities exist.

Examples of tax planning are:

Asset swap. Selling an asset that generates nontaxable income and using the funds to buy another asset that

generates taxable income.

Asset sale. Selling an asset that has appreciated, and for which the tax base has not been adjusted to reflect the

appreciation. A variation on this approach is sale and leaseback transactions.

Deduction deferral. Delaying the recognition of some deductions from taxable profit that can be deferred.

Recognition basis. Electing to recognize interest income for the calculation of taxable profit on either a received

or receivable basis.

Understand How Tax Planning Can Help You Attain

Your Personal Goals

Tax planning is important because taxes are the largest single annual expense for most families. The

average American spends more on taxes than on food, clothing, and medical care combined; he or she must

work for more than three months just to earn enough to pay taxes. In 2009, Americans needed to work 103

days to cover the costs of their federal, state, and local taxes. The day on which taxes were covered, called

Tax Freedom Day, fell on April 13 in 2009—close to the date that it fell on in 1967. (See Figure 1)

The statistics in Figure 1 illustrate why tax planning and tax strategies should be critical parts of your

financial life. The less you have to pay Uncle Sam, the more you can save for your personal and financial

goals.

Figure 1: Tax Freedom Day, 1980–2006

‹ Understand What Our Leaders Have Said Regarding Taxes up

Tax PlanningRelated Terms: Accounting Methods; Capital Structure; Financial Planning; Organizational

Structure

Tax planning involves conceiving of and implementing various strategies in order to

minimize the amount of taxes paid for a given period. For a small business, minimizing the

tax liability can provide more money for expenses, investment, or growth. In this way, tax

planning can be a source of working capital. Two basic rules apply to tax planning. First, a

small business should never incur additional expenses only to gain a tax deduction. While

purchasing necessary equipment prior to the end of the tax year can be a valuable tax

planning strategy, making unnecessary purchases is not recommended. Second, a small

business should always attempt to defer taxes when possible. Deferring taxes enables the

business to use that money interest-free, and sometimes even earn interest on it, until the

next time taxes are due.

Experts recommend that entrepreneurs and small business owners conduct formal tax

planning sessions in the middle of each tax year. This approach will give them time to apply

their strategies to the current year as well as allow them to get a jump on the following

year. It is important for small business owners to maintain a personal awareness of tax

planning issues in order to save money. Even if they employ a professional bookkeeper or

accountant, small business owners should keep careful tabs on their own tax preparation in

order to take advantage of all possible opportunities for deductions and tax savings.

Whether or not an entrepreneur enlists the aid of an outside expert, he or she should

understand the basic provisions of the tax code.

GENERAL AREAS OF TAX PLANNING

There are several general areas of tax planning that apply to all sorts of small businesses.

These areas include the choice of accounting and inventory-valuation methods, the timing

of equipment purchases, the spreading of business income among family members, and the

selection of tax-favored benefit plans and investments. There are also some areas of tax

planning that are specific to certain business forms—i.e., sole proprietorships,

partnerships, C corporations, and S corporations. Some of the general tax planning

strategies are described below:

Accounting Methods Accounting methods refer to the basic rules and guidelines under

which businesses keep their financial records and prepare their financial reports. There are

two main accounting methods used for recordkeeping: the cash basis and the accrual basis.

Small business owners must decide which method to use depending on the legal form of

the business, its sales volume, whether it extends credit to customers, and the tax

requirements set forth by the Internal Revenue Service (IRS). The choice of accounting

method is an issue in tax planning, as it can affect the amount of taxes owed by a small

business in a given year.

Accounting records prepared using the cash basis recognize income and expenses

according to real-time cash flow. Income is recorded upon receipt of funds, rather than

based upon when it is actually earned, and expenses are recorded as they are paid, rather

than as they are actually incurred. Under this accounting method, therefore, it is possible

to defer taxable income by delaying billing so that payment is not received in the current

year. Likewise, it is possible to accelerate expenses by paying them as soon as the bills are

received, in advance of the due date. The cash method is simpler than the accrual method,

it provides a more accurate picture of cash flow, and income is not subject to taxation until

the money is actually received.

In contrast, the accrual basis makes a greater effort to recognize income and expenses in

the period to which they apply, regardless of whether or not money has changed hands.

Under this system, revenue is recorded when it is earned, rather than when payment is

received, and expenses recorded when they are incurred, rather than when payment is

made. The main advantage of the accrual method is that it provides a more accurate

picture of how a business is performing over the long-term than the cash method. The main

disadvantages are that it is more complex than the cash basis, and that income taxes may

be owed on revenue before payment is actually received. However, the accrual basis may

yield favorable tax results for companies that have few receivables and large current

liabilities.

Under generally accepted accounting principles (GAAP), the accrual basis of accounting is

required for all businesses that handle inventory, from small retailers to large

manufacturers. It is also required for corporations and partnerships that have gross sales

over $5 million per year, though there are exceptions for farming businesses and qualified

personal service corporations—such as doctors, lawyers, accountants, and consultants.

Other businesses generally can decide which accounting method to use based on the

relative tax savings it provides.

Inventory Valuation Methods The method a small business chooses for inventory

valuation can also lead to substantial tax savings. Inventory valuation is important because

businesses are required to reduce the amount they deduct for inventory purchases over the

course of a year by the amount remaining in inventory at the end of the year. For example,

a business that purchased $10,000 in inventory during the year but had $6,000 remaining

in inventory at the end of the year could only count $4,000 as an expense for inventory

purchases, even though the actual cash outlay was much larger. Valuing the remaining

inventory differently could increase the amount deducted from income and thus reduce the

amount of tax owed by the business. The tax law provides two possible methods for

inventory valuation: the first-in, first-out method (FIFO); and the last-in, first-out method

(LIFO). As the names suggest, these inventory methods differ in the assumption they make

about the way items are sold from inventory. FIFO assumes that the items purchased the

earliest are the first to be removed from inventory, while LIFO assumes that the items

purchased most recently are the first to be removed from inventory. In this way, FIFO

values the remaining inventory at the most current cost, while LIFO values the remaining

inventory at the earliest cost paid that year.

LIFO is generally the preferred inventory valuation method during times of rising costs. It

places a lower value on the remaining inventory and a higher value on the cost of goods

sold, thus reducing income and taxes. On the other hand, FIFO is generally preferred

during periods of deflation or in industries where inventory can tend to lose its value

rapidly, such as high technology. Companies are allowed to file IRS Form 970 and switch

from FIFO to LIFO at any time to take advantage of tax savings. However, they must then

either wait ten years or get permission from the IRS to switch back to FIFO.

Equipment Purchases Under Section 179 of the Internal Revenue Code, businesses are

allowed to deduct a total of $18,000 in equipment purchases during the year in which the

purchases are made. Any purchases above this amount must be depreciated over several

future tax periods. It is often advantageous for small businesses to use this tax incentive to

increase their deductions for business expenses, thus reducing their taxable income and

their tax liability. Necessary equipment purchases up to the limit can be timed at year end

and still be fully deductible for the year. This tax incentive also applies to personal property

put into service for business use, with the exception of automobiles and real estate.

Wages Paid to Family Members Self-employed persons can also reduce their tax burden

by paying wages to a spouse or to dependent children. Wages paid to children under the

age of 18 are not subject to FICA (Social Security and Medicare) taxes. Under normal

circumstances, employers are required to withhold 7.65 percent of the first $94,200 of an

employee's income for FICA taxes. Employers are also required to match the 7.65 percent

contributed by every employee, so that the total FICA contribution is 15.3 percent. Self-

employed persons are required to pay both the employer and employee portions of the

FICA tax.

But the FICA taxes are waived when the employee is a dependent child of the small

business owner, saving the child and the parent 7.65 percent each. In addition, the child's

wages are still considered a tax deductible business expense for the parent—thus reducing

the parent's taxable income. Although the child must pay normal income taxes on the

wages he or she receives, it is likely to be at a lower tax rate than the parent pays. Some

business owners are able to further reduce their tax burden by paying wages to their

spouse. If these wages bring the business owner's net income below $94,200—the

threshold for FICA taxes—then they may reduce the self-employment tax owed by business

owner. It is important to note, however, that the child or spouse must actually work for the

business and that the wages must be reasonable for the work performed.

Benefits Plans and Investments Tax planning also applies to various types of employee

benefits that can provide a business with tax deductions, such as contributions to life

insurance, health insurance, or retirement plans. As an added bonus, many such benefit

programs are not considered taxable income for employees. Finally, tax planning applies to

various types of investments that can shift tax liability to future periods, such as treasury

bills, bank certificates, savings bonds, and deferred annuities. Companies can avoid paying

taxes during the current period for income that is reinvested in such tax-deferred

instruments.

TAX PLANNING FOR DIFFERENT BUSINESS FORMS

Selection of the form of organization that one uses for a company has a considerable

impact on the rate at which tax liabilities accrue. Many aspects of tax planning are specific

to certain business forms; some of these are discussed below:

Sole Proprietorships and Partnerships Tax planning for sole proprietorships and

partnerships is in many ways similar to tax planning for individuals. This is because the

owners of businesses organized as sole proprietors and partnerships pay personal income

tax rather than business income tax. These small business owners file an informational

return for their business with the IRS, and then report any income taken from the business

for personal use on their own personal tax return. No special taxes are imposed except for

the self-employment tax, which requires all self-employed persons to pay both the employer

and employee portions of the FICA tax, for a total of 15.3 percent.

Since they do not receive an ordinary salary, the owners of sole proprietorships and

partnerships are not required to withhold income taxes for themselves. Instead, they are

required to estimate their total tax liability and remit it to the IRS in quarterly installments,

using Form 1040 ES. It is important that the amount of tax paid in quarterly installments

equal either the total amount owed during the previous year or 90 percent of their total

current tax liability. Otherwise, the IRS may charge interest and impose a stiff penalty for

underpayment of estimated taxes.

Since the IRS calculates the amount owed quarterly, a large lump-sum payment in the

fourth quarter will not enable a taxpayer to escape penalties. On the other hand, a

significant increase in withholding in the fourth quarter may help, because tax that is

withheld by an employer is considered to be paid evenly throughout the year no matter

when it was withheld. This leads to a possible tax planning strategy for a self-employed

person who falls behind in his or her estimated tax payments. By having an employed

spouse increase his or her withholding, the self-employed person can make up for the

deficiency and avoid a penalty. The IRS has also been known to waive underpayment

penalties for people in special circumstances. For example, they might waive the penalty

for newly self-employed taxpayers who underpay their income taxes because they are

making estimated tax payments for the first time. Another possible tax planning strategy

applies to partnerships that anticipate a loss. At the end of each tax year, partnerships file

the informational Form 1065 (Partnership Statement of Income) with the IRS, and then

report the amount of income that accrued to each partner on Schedule K1. This income can

be divided in any number of ways, depending on the nature of the partnership agreement.

In this way, it is possible to pass all of a partnership's early losses to one partner in order

to maximize his or her tax advantages.

C Corporations Tax planning strategies for C corporations are different from those used

for sole proprietorships and partnerships. This is because profits earned by C corporations

accrue to the corporation rather than to the individual owners, or shareholders. A

corporation is a separate, taxable entity under the law, and different corporate tax rates

apply based on the amount of net income received. As of 2005, the corporate tax rates were

15 percent on income up to $50,000, 25 percent on income between $50,001 and $75,000,

34 percent on income between $75,001 and $100,000, 39 percent on income between

$100,001 and $335,000, 34 percent on income between $335,001 and $10 million, 35

percent on income between $10 million and $15 million, 38 percent on income between

$15 million and $18,333,333, and 35 percent on all income over $18,333,334. Businesses

involved in manufacturing are charged a top tax rate of 32 percent. Personal service

corporations, like medical and law practices, pay a flat rate of 35 percent. In addition to the

basic corporate tax, corporations may be subject to several special taxes.

Corporations must prepare an annual corporate tax return on either a calendar-year basis

(the tax year ends December 31, and taxes must be filed by March 15) or a fiscal-year basis

(the tax year ends whenever the officers determine). Most Subchapter S corporations, as

well as C corporations that derive most of their income from the personal services of

shareholders, are required to use the calendar-year basis for tax purposes. Most other

corporations can choose whichever basis provides them with the most tax benefits. Using a

fiscal-year basis to stagger the corporate tax year and the personal one can provide several

advantages. For example, many corporations choose to end their fiscal year on January 31

and give their shareholder/employees bonuses at that time. The bonuses are still tax

deductible for the corporation, while the individual shareholders enjoy use of that money

without owing taxes on it until April 15 of the following year.

Both the owners and employees of C corporations receive salaries for their work, and the

corporation must withhold taxes on the wages paid. All such salaries are tax deductible for

the corporations, as are fringe benefits supplied to employees. Many smaller corporations

can arrange to pay out all corporate income in salaries and benefits, leaving no income

subject to the corporate income tax. Of course, the individual shareholder/employees are

required to pay personal income taxes. Still, corporations can use tax planning strategies to

defer or accrue income between the corporation and individuals in order to pay taxes in the

lowest possible tax bracket. The one major disadvantage to corporate taxation is that

corporate income is subject to corporate taxes, and then income distributions to

shareholders in the form of dividends are also taxable for the shareholders. This situation is

known as "double taxation."

S Corporations Subchapter S corporations avoid the problem of double taxation by

passing their earnings (or losses) through directly to shareholders, without having to pay

dividends. Experts note that it is often preferable for tax planning purposes to begin a new

business as an S corporation rather than a C corporation. Many businesses show a loss for

a year or more when they first begin operations. At the same time, individual owners often

cash out investments and sell assets in order to accumulate the funds needed to start the

business. The owners would have to pay tax on this income unless the corporate losses

were passed through to offset it.

Another tax planning strategy available to shareholder/employees of S corporations

involves keeping FICA taxes low by setting modest salaries for themselves, below the

Social Security base. S corporation shareholder/employees are only required to pay FICA

taxes on the income that they receive as salaries, not on income that they receive as

dividends or on earnings that are retained in the corporation. It is important to note,

however, that unreasonably low salaries may be challenged by the IRS.

Tax management systemupdated Dec 4, 2008 5:00 pm | 3,410 views

A tax management system is used to help set and manage tax processing and meet the tax requirements. Many software systems now provide "wizards" which walk the user through the process as efficiently and accurately as possible.

Tax evasion

What is tax evasion?

Tax evasion generally occurs when people don't report all of their income, or they overstate their deductions. People do this to reduce the amount of tax they need to pay.

Tax evasion is an activity commonly associated with businesses that use cash transactions, which gives them the opportunity not to declare it and pay tax on it.

People who deliberately avoid paying their fair share of tax cheat the community and disadvantage Australians who do the right thing.

Examples of tax evasion

Failing to: report all income report cash wages forward tax withheld from employee's wages to the ATO withhold tax from a worker's wages - for example, paying cash in hand pay employee super entitlements lodge tax returns, in an attempt to avoid payment lodge a tax return in order to avoid child support or other obligations

Claiming: deductions for expenses not incurred or legally deductible input credits for goods or services that GST has not been paid on.

More examples of tax evasion

For more information on specific tax evasion topics, refer to:

What are some other examples of tax evasion? Cash economy Guide to superannuation for employers Guide to contractors .

Why is tax evasion a problem?

Australians value their tax and superannuation systems as community assets.

Tax evasion is a serious threat to the integrity of your tax system and to the revenue used to provide services to the community.

It also means some people have an unfair advantage over those doing the right thing. By telling us about suspected tax evasion, you are making it fairer for everyone.

How to report suspected tax evasion

If you think a person or a business is not playing fair, you can confidentially report suspected tax evasion:

phone us on 1800 060 062 begin_of_the_skype_highlighting FREE 1800 060 062 end_of_the_skype_highlighting (free call), 8.00am till 6.00pm weekdays (except public holidays)

fill in an online form - start online tax evasion reporting form fax us on 1800 804 544 (free call) - mark all information 'in confidence' write to us - mark all letters 'in confidence' and post to:

Australian Taxation OfficeTax EvasionLocked Bag 6050DANDENONG VIC 3175

Information we need from you

All tax evasion information we receive from the community helps to protect Australia's tax and superannuation systems.

Any information that relates to a person or a business could be helpful, such as:

their full name, home address, tax file number (TFN), work address, employer (if employed), phone numbers, date of birth, bank account details, spouse's name, tax agent

name of business, Australian business number (ABN), business bank account details, number of employees, director's names and addresses

the details of the tax evasion taking place - for example:

if they are receiving cash in hand, any assets that indicate they have a higher income than they are declaring

when they pay cash wages, and to whom when they accept or demand cash

types of transactions that are not recorded if they offer discounts for cash payments with no receipt or tax invoice approximate length of time the tax evasion has been occurring, and any

documentary evidence confirming the tax evasion.

The more information you report, the better we can assess whether a person or business is doing the right thing.

Last Modified: Thursday, 20 December 2012

From Wikipedia, the free encyclopedia

Jump to: navigation, search

Tax evasion is the general term for efforts by individuals, corporations, trusts and other entities to evade taxes by illegal means. Tax evasion usually entails taxpayers deliberately misrepresenting or concealing the true state of their affairs to the tax authorities to reduce their tax liability and includes in particular dishonest tax reporting, such as declaring less income, profits or gains than actually earned or overstating deductions.

Tax evasion is an activity commonly associated with the informal economy and one measure of the extent of tax evasion is the amount of unreported income, namely the difference between the amount of income that should legally be reported to the tax authorities and the actual amount reported, which is also sometimes referred to as the tax gap.

Tax avoidance, on the other hand, is the legal utilization of the tax regime to one's own advantage to reduce the amount of tax that is payable by means that are within the law. Both tax evasion and avoidance can be viewed as forms of tax noncompliance, as they describe a range of activities that are unfavorable to a state's tax system.[1]

Differences between Tax Avoidance and Tax Evasion

Tax avoidance is generally the legal exploitation of the tax regime to one's own advantage,

to attempt to reduce the amount of tax that is payable by means that are within the law

whilst making a full disclosure of the material information to the tax authorities. Examples of

tax avoidance involve using tax deductions, changing one's business structure through

incorporation or establishing an offshore company in a tax haven.

By contrast tax evasion is the general term for efforts by individuals, firms, trusts and other

entities to evade the payment of taxes by illegal means. Tax evasion usually entails

taxpayers deliberately misrepresenting or concealing the true state of their affairs to the tax

authorities to reduce their tax liability, and includes, in particular, dishonest tax reporting

(such as underdeclaring income, profits or gains; or overstating deductions).

Tax avoidance may be considered as either the amoral dodging of one's duties to society,

part of a strategy of not supporting violent government activities or just the right of every

citizen to find all the legal ways to avoid paying too much tax. Tax evasion, on the other

hand, is a crime in almost all countries and subjects the guilty party to fines or even

imprisonment. Switzerland is one notable exception: tax fraud (forging documents, for

example) is considered a crime, tax evasion (like underdeclaring assets) is not.

Some tax evaders see their efforts to evade taxation as based upon novel legal theories:

these individuals and groups are sometimes called tax protesters. U.S. tax protesters are an

example of this kind of approach to tax evasion that has generally ended in failure for those

making such claims.

Tax resistance is the refusal to pay the tax for conscientious reasons (because they do not

want to support the government or some of its activities), sometimes breaking the law to do

so. Some donate their unpaid taxes to charity, while others (at least in the US) take creative

"deductions" such as not paying a percentage of tax equal to the defense budget. In either

case, they typically do not take the position that the tax laws are themselves illegal or do

not apply to them (as tax protesters do) and they are more concerned with not paying for

what they oppose than they are motivated by the desire to keep more of their money (as

tax evaders typically are). Some have suggested the term tax avoision for people who adopt

the techniques of tax avoidance in the service of tax resistance, thereby doing tax

resistance legally.

In the UK, there is no General Anti-Avoidance Rule (GAAR), but certain provisions of the tax

legislation (known as "anti-avoidance" provisions) apply to prevent tax avoidance where the

main object (or purpose), or one of the main objects (or purposes), of a transaction is to

enable tax advantages to be obtained. Judicial doctrines, relying on a purposive construction

of tax legislation, are being evolved to prevent tax avoidance involving circular, self-

cancelling transactions (IRC v. Ramsey), or where steps with no commercial purpose other

than the avoidance of tax are inserted into a transaction (Furniss v. Dawson).

Controversially, in the 2004 Budget, it was announced that 'promoters' and users of certain

tax avoidance schemes would be required to disclose details of the schemes to the Inland

Revenue.

The UK authorities use the term tax mitigation to refer to acceptable tax planning,

minimising tax liabilities in ways expressly endorsed by Parliament. As set out above, on this

view tax avoidance flouts the spirit of the law while following the letter and is therefore

thought by some to be unacceptable, albeit not criminal in the way that evasion is.

Upholding a difference between mitigation and avoidance relies on a purposive reading of

legislation, and commentators disagree as to the extent to which this is permissible.

In the United States, thieves are required to report their stolen money as income when they

file for taxes, but they usually do not do so, because doing so would serve as a confession of

theft. For this reason, suspected thieves are sometimes charged with tax evasion when

there is insufficient evidence to try them for theft.

Meaning of VATValue Added Tax (VAT) is a general consumption tax assessed on the value added to goods and services.

It is a general tax that applies, in principle, to all commercial activities involving the production and distribution of goods and the

provision of services. It is a consumption tax because it is borne ultimately by the final consumer.

It is not a charge on companies. It is charged as a percentage of price, which means that the actual tax burden is visible at each

stage in the production and distribution chain.

It is collected fractionally, via a system of deductions whereby taxable persons can deduct from their VAT liability the amount of tax

they have paid to other taxable persons on purchases for their business activities. This mechanism ensures that the tax is neutral

regardless of how many transactions are involved.

In other words, it is a multi-stage tax, lavied only on value added at each stage in the chain of production of goods and services with

the provision of a set-off for the tax paid at earlier stages in the chain. The objective is to avoid 'cascading', which can have a

snowballing effect on prices. It is assumed that due to cross-checking in a multi-staged tax, tax evasion will be checked, resulting in

higher revenues to the government.

Over 130 countries worldwide have introduced VAT over the past three decades and India is amongst the last few to introduce it.

India already has a system of sales tax collection wherein the tax is collected at one point (first/last) from the transactions involving

the sale of goods. VAT would, however, be collected in stages (instalments) from one stage to another.

The mechanism of VAT is such that, for goods that are imported and consumed in a particular state, the first seller pays the first

point tax, and the next seller pays tax only on the value-addition done - leading to a total tax burden exactly equal to the last point

tax.

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India, particularly the trading community, has believed in accepting and adopting loopholes in any system administered by the state

or the Centre. If a well-administered system comes in, it will close avenues for traders and businessmen to evade paying taxes.

They will also be compelled to keep proper records of their sales and purchases.

Many sections hold the view that the trading community has been amongst the biggest offenders when it comes to evading taxes.

Under the VAT system, no exemptions will be given and a tax will be levied at each stage of manufacture of a product. At each

stage of value-addition, the tax levied on the inputs can be claimed back from the tax authorities.

At a macro level, there are two issues, which make the introduction of VAT critical for India.

Industry watchers say that the VAT system, if enforced properly, forms part of the fiscal consolidation strategy for the country. It

could, in fact, help address the fiscal deficit problem and the revenues estimated to be collected could actually mean lowering of the

fiscal deficit burden for the government.

The International Monetary Fund (IMF), in its semi-annual World Economic Outlook released on April 9, expressed its concern over

India's large fiscal deficit - at 10 per cent of the GDP.

Further any globally accepted tax administrative system, will only help India integrate better in the World Trade Organisation regime.

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Since ages always a reform is made for the benefit in the process of development. It was Chanakya who first wrote that a

government should tax its people like a shepherd shears his flock or a bee gets nectar from a flower. But apparently that fiscal

wisdom died with him. Let us not experience the same with VAT in India. It has a baggage full of benefits. Few advantages of VAT

in India are mentioned below.

It will be a virtual crime not to look to the other side of the coin of the Indian VAT system. Disadvantages will always give birth to

amendments to the existing policy so that traders can ride jerk free on it adding value to the existing Indian taxation system. We

have also discussed upon the friction of VAT below.

Advantages of VAT

In the advantages part we will first look after the broad coverage of VAT in the Indian market. Then we will consider the level of

security the Indian VAT is having on our revenues. Obviously the selection of items to be covered by VAT in India will be given a

bullet to think upon and at last we will check out the co-ordination VAT in India will be having with our existing direct tax system.

1) Coverage

If the tax is carried through the retail level, it offers all the economic advantages of a tax that includes the entire retail price within its

scope, at the same time the direct payment of the tax is spread out and over a large number of firms instead of being concentrated

on particular groups, such as wholesalers or retailers.

If retailers do evade, tax will be lost only on their margins because customers that are registered firms gain nothing if their suppliers

fail to collect tax, except delay in payment; they will pay more to the government themselves. Under other forms of sales tax, both

seller and customer gain by evading tax. One particular advantage is that of the widening of the tax base by bringing all transactions

into the tax net. Specifically, VAT gives the new government the opportunity to bring back into the tax system all those persons and

entities who were given tax exemptions in one form or another by the previous regime.

2) Revenue security

VAT represents an important instrument against tax evasion and is superior to a business tax or a sales tax from the point of view of

revenue security for three reasons.

In the first place, under VAT it is only buyers at the final stage who have an interest in undervaluing their purchases, since the

deduction system ensures that buyers at earlier stages will be refunded the taxes on their purchases. Therefore, tax losses due to

undervaluation should be limited to the value added at the last stage. Under a retail sales tax, on the other hand, retailer and

consumer have a mutual interest in underdeclaring the actual purchase price.

Secondly, under VAT, if payment of tax is successfully avoided at one stage nothing will be lost if it is picked up at a later stage; and

even if it is not picked up subsequently, the government will at least have collected the VAT paid at stages previous to that at which

the tax was avoided; while if evasion takes place at the final stage the state will lose only the tax on the value added at that point.

If evasion takes place under a sales tax, on the other hand, all the taxes due on the product are lost to the government.

A significant advantage of the value added form in any country is the cross-audit feature. Tax charged by one firm is reported as a

deduction by the firms buying from it. Only on the final sale to the consumer is there no possibility of cross audit.

Cross audit is possible with any form of sales tax, but the tax-credit feature emphasises and simplifies it and is likely to make firms

more careful not to evade because they know of the possibility of cross check.

3) Selectivity

VAT may be selectively applied to specific goods or business entities. We have already addressed essential goods and small

business. In addition the VAT does not burden capital goods because the consumption-type VAT provides a full credit for the tax

included in purchases of capital goods. The credit does not subsidize the purchase of capital goods; it simply eliminates the tax that

has been imposed on them.

4) Co-ordination of VAT with direct taxation

Most taxpayers cheat on their sales not to evade VAT but to evade personal and corporate income taxes. The operation of a VAT

resembles that of the income tax more than that of other taxes, and an effective VAT greatly aids income tax administration and

revenue collection. It is interesting to note that when Trinidad and Tobago set out to introduce VAT it chose one of its top income tax

administrators as the VAT Commissioner.

It must be stressed once again that if properly implemented VAT can ultimately lead to a reduction in overall rates of tax.

Revenues will not be sacrificed but would in fact be enhanced as a consequence of the broadened tax base. This does not seem to

be a bad idea at all.

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The main disadvantages which have been identified in connection with the Value Added Tax are:

1) VAT is regressive

It is claimed that the tax is regressive, ie its burden falls disproportionately on the poor since the poor are likely to spend more of

their income than the relatively rich person. There is merit in this argument, particularly if it attempts to replace direct or indirect

taxes with steep, progressive rates. However, observation from around the world and even Guyana has shown that steep tax rates

lead to evasion, and in the case of income tax act as a disincentive to effort.

Further, there is now a tendency in most countries to reduce this progressivity of taxes as has been done in Guyana where a flat

rate of income tax has been introduced. In any case VAT recognises and makes room for progressivity by applying no or low rates

of tax on essential items such as food, clothes and medicine. In addition it allows for steep rates of tax on luxury items, although this

can create problems for administration and open opportunities for evasion by way of deliberate misclassification, a problem

incidentally not peculiar to VAT, and which takes place extensively in the area of customs duties.

2) VAT is too difficult to operate from the position of both the administration and business.

(a) The administration

It is often argued that VAT places a special burden on tax administration. However, it is worth noting that wherever VAT was

introduced one of its effects was the rationalisation and simplification of the previous indirect tax system and its administration. Each

of the previous indirect taxes such as customs duties, purchase tax and excise duties replaced by VAT had its own rate structure as

well as a different tax base and separate administrative procedure. The consolidation and incorporation of numerous indirect taxes

into the VAT would simplify the rate structure, tax base, and administration of the indirect tax system, thereby eliminating the

overlapping auditing practices that had plagued those systems.

In addition, the abolition of a number of alternative indirect taxes releases experienced personnel to focus on a single tax. It also

means reduction in the number of forms used, legislation to be applied and returns and accounts with which the business person

has to contend.

(b) Business

It is true that the VAT is collected from a larger number of firms than under any form of income tax or single state sales tax; to the

typical smaller firms the complexities of the tax and the need for more extensive records (for example, to justify deductions) are

likely to prove serious.

However, it is often overlooked that businesses already function with considerable administrative responsibility for a number of laws

including the National Insurance Act and the Income Tax Act.

Under the Income Tax (Accounts and Records) Regulations of 1980 every person, without exception is required to maintain detailed

and extensive records of all its transactions. Compliance with this will certainly ensure compliance with VAT regulations, and since

there is an actual benefit to be derived from accounting for VAT paid on input there is an incentive for proper record-keeping.

As we have noted before, VAT also allows for the exemption of small businesses from the system.

Under any form of sales taxation, small businesses have to be granted special treatment because of their inability to cope with the

requirements of keeping adequate records which larger enterprises can handle at a reasonable cost. The intent of the special

treatment is to reduce the administrative burden on small enterprises, but not the taxes that normally would be charged on the

goods and services they supply. The revenue loss at the final link in the commercial cycle is limited only to the value added at that

stage ,whereas in the case of income tax or sales tax the entire tax is lost. To recover the loss from exemptions, a flat tax on

turnover may be applied.

In the larger businesses with proper staff and computers, the task is really one of double entry book-keeping and any additional

work is hardly ever noticed.

3. VAT is inflationary

Some businessmen seize almost any opportunity to raise prices, and the introduction of VAT certainly offers such an opportunity.

However, temporary price controls, a careful setting of the rate of VAT and the significance of the taxes they replace should

generally ensure that there is no increase if any in the cost of living. To the extent that they lead to a reduction in income tax, any

price increases may be offset by increases in take-home pay.

In any case, any price consequence is one time only and prices should stabilise thereafter.

4. VAT favours the capital intensive firm

It is also argued that VAT places a heavy direct impact of tax on the labour-intensive firm compared to the capital- intensive

competitor, since the ratio of value added to selling price is greater for the former. This is a real problem for labour-intensive

economies and industries.

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550 items covered 270 items of basic needs, like medicine,

drugs, agro & industrial inputs, capital &

declared goods 4% VAT

Rest 12.5% VAT. Gold & silver jewellery -

1%

Tea-producing states options either

percentage VAT

Petrol, diesel, liquor, lottery not included * Sugar, textile & tobacco excluded for one

year

Traders with turnover of less than 500,000 rupees are exempt from the new tax.

Note : * Some states like Delhi have imposed VAT on diesel at 20%, which is higher than the 12% sales tax charged earlier.

Similarly, Delhi imposed VAT on LPG at 12.5%, which is also higher than the previous sales tax rate of 8 percent.

All business transactions carried on within a State by individuals, partnerships, companies etc. will be covered by VAT.

"More than 550 items would be covered under the new Indian VAT regime of which 46 natural and unprocessed local products

would be exempt from VAT", a PTI report quoted West Bengal Finance Minister and VAT panel chairman Asim Dasgupta as saying.

About 270 items including drugs and medicines, all agricultural and industrial inputs, capital goods and declared goods would attract

four per cent VAT in India.

The remaining items would attract 12.5 per cent VAT. Precious metals like gold and bullion would be taxed at one per cent.

Considering the difficulties faced by the tea industry, it was decided that tea-producing states would be given an option to levy 12.5

per cent or four per cent subject to review in 2006.

Petrol and diesel would be kept out of VAT regime in India, which covers only marketable items.

Dasgupta was quoted as saying that the panel was yet to take a view on CNG.

Following opposition from some of the states, it was decided that states would have option to either levy four per cent or totally

exempt food grains but it would be reviewed after one year.

Three items - sugar, textile and tobacco - covered under Additional Excise Duties, will not be under VAT regime for one year but the

existing arrangement would continue.

The Indian VAT panel relaxed the threshold limit for traders coming under VAT regime from Rs 5-50 lakh of turnover from the

previous stance of Rs 5-40 lakh.

Traders within this limit can pay a composite VAT rate of one per cent but would not be entitled to input tax credit

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VAT is most certainly a more transparent and accurate system of taxation. The existing sales tax structure allows for double taxation thereby cascading the tax burden. For example, before a commodity is produced, inputs are first taxed, the produced commodity is then taxed and finally at the time of sale, the entire commodity is taxed once again. By taxing the commodity multiple times, it has in effect increased the cost of the goods and therefore the price the end consumer will pay for it.

The transaction chain under VAT assuming that a profit of Rs 10 is retained during each sale.

SALE 'A' OF CHENNAI

@ Rs. 100/-

»»

'B' OF

BANGALORE

»»

SALE

@ Rs. 114/-

»»

'C' OF

BANGALORE

»»

SALE

@ Rs. 124/-

»»

'D' OF

BANGALORE

»»

SALE

@ Rs. 134/-

»»

CONSUMER

IN

BANGALORE

Tax implication under Value Added Tax ActSelle

r

Buyer Selling Price (Excluding

Tax)

Tax Rate Invoice value (Incl

Tax)

Tax

Payable

Tax

Credit

Net

TaxOutflow

A B 100 4% CST 104 4 0 4.00

B C 114 12.5%

VAT

128.25 14.25 0* 14.25

C D 124 12.5%

VAT

139.50 15.50 14.25 1.25

D Consume

r

134 12.5%

VAT

150.75 16.75 15.50 1.25

Total to Govt. VAT CST 16.75

4.00

*Note: CST Paid cannot be claimed for credit. CST is assumed to remain the same though it could to be reduced to 2% when VAT is introduced and eventually phased out.

VAT can be considered as a multi-point sales tax with set-off for tax paid on purchases (inputs) and

capital goods. What this means is that dealers can actually deduct the amount of tax paid by him for purchase from the tax collected on sales, thereby paying just the balance amount to the Government.