PROJECT REPORT ON CORPORATE TAX PLANNING

SUBMITTED TO: SUBMITTED BY:

PROF. NARESH SHAH DEEPIKA PANDEY (28)

NEELAM DARBAR (02)

NEHAL MEHTA (37)

RAHUL PARMAR (14)

RAJESH VAJA (53)

TAX PLANNING

“In this world nothing can be said to be certain, except death and taxes" – Benjamin Franklin

INTRODUCTION

What is Tax Planning?

Tax planning is an essential part of your financial planning. Efficient tax planning enables you to reduce your tax liability to the minimum. This is done by legitimately taking advantage of all tax exemptions, deductions rebates and allowances while ensuring that your investments are in line with your long term goals.

What tax planning is not?

Tax Planning is NOT tax evasion. It involves sensible planning of your income sources and investments. It is not tax evasion which is illegal under Indian laws.

Tax Planning is NOT just putting your money blindly into any 80C investments.

Tax Planning is NOT difficult. Tax Planning is easy. It can be practiced by everyone and with a very little time commitment as long as one is organized with their finances.

Smart ways to save income tax in India in 2012

The time will soon come for filing your income tax returns (ITR form) for 2012 in India. The first three quarters of any year are the most dangerous ones for an investor’s financial planning. I say dangerous because he falls prey to people who sell products in the name of tax planning. This is the time when most investors end up with crap life insurance policies. This is also the month when life insurance policies sales pitches go on a screaming overdrive to sell, sell and sell.

So how does one take the noise out of everything and save income tax in 2012? We list for you some of the avenues available to you today to park your money in to save income tax.

Remember to invest in the below products much before filing your income tax returns (ITR forms). Also keep in mind that Direct Tax Code (DTC) might or might not be implemented but don’t fret about it yet – just invest!

Public Provident Fund (PPF)

Your investment in Public Provident Fund contributes to the Section 80C limit of Rs 1 lakh. From this year, the investment in PPF has been jacked up from Rs 70,000 to Rs 1 lakh. With the kind of guarantee this investment product brings with itself and an 8.6% return that it will now generate, I cannot think of any reason why we would neglect it especially when the income is tax free! Remember that you need to invest a minimum of Rs 500 each year in the PPF and that it locks your money for 15 years. In the fixed income instruments, it’s a shame if one were not to invest in this.

Employee Provident Fund (EPF)

For salaried employees, the EPF is deducted compulsorily from the monthly salary and the employee’s contribution is eligible for tax deduction under Section 80C. Again, the income is tax free and returns are around 8.5% a year.

While the forced saving acts as a great tool for saving money for investors who are not disciplined, the fact that investors withdraw the EPF corpus and waste it away dampens the excitement around this avenue.

Life Insurance Policies

This is one of the most unsuitable, for lack of a better word, ways to save income tax in India. For those who are caught in the investment cum insurance quagmire, this will end up being for the easiest option. However, this is not desirable.

It does not make sense to buy Unit Linked Insurance Plans (ULIPs), endowment plans, money back plans and other types of life insurance policies to save income tax. These products don’t offer you more than inflation (ULIP might if you stay the course of 10- 15 years). Term plans can of course and should be bought as they are the right products for insurance.

While the premium you pay can be used for tax deduction under Section 80C and while the income is tax free, DTC is mum about how this will change. My advice is to avoid putting in money in the first 3 quarters of the year in insurance policies.

Tax saving mutual funds or ELSS

Tax saving mutual funds or Equity Linked Saving Schemes (ELSS) as they are loosely called are a very good way to save income tax for those whose Section 80C limit is not saturated and you cannot park your money in other options available. ELSS has a lock in of 3 years and investing in them is not for the faint hearted as they take an exposure to the stock markets.

Remember to take the systematic investment planning route of ELSS while saving for income tax. I need to caveat the fact that DTC is not very clear about whether the contribution will continue to be accounted for Section 80C benefits. Wait and watch.

Five year Bank Fixed Deposits

Bank deposits for 5 years can be used towards Section 80C tax deduction. Currently, the interest that you can earn is easily a minimum of 9% per annum. Keep in mind the fact that you still need to pay tax on the maturity value that you receive after 5 years, so in that sense, your returns are lower then 9%.

NSC and SCSS

The NSC underwent a change this year. It was shortened to 5 years from 6 years and its interest is now linked to the government yield. There is also a 10 year NSC now on the offing. NSCs will offer you 8.4% this year and the income, like 5 year bank FDs will be taxable after getting added to your income.

Similarly, Senior Citizen Savings Scheme (SCSS) has become market linked and will offer 9% per annum. Senior citizens (those above the age of 60) can invest a maximum Rs 15 lakh in this with a 5 year locking with a payout which happens every quarter. How I wish, this limit was increased.

New Pension Scheme (NPS)

The NPS was meant to create a wave in this country but seems to have died a death with innumerable tries to revive it. Meant as a retirement planning tool, the NPS invests in both equity and debt. The commissions middlemen earn are paltry so no one is selling it at all.

If one wants to use tax planning with retirement planning, then pension plans offered by insurance companies are also available as an option. Then there are pension plans offered by mutual fund houses as well.

The complete list

The above mentioned smart ways to save income tax should be used in alignment with your asset allocation. Depending on how much you want to save for the future and your expectation of return, tax planning should be done by investing in these products. Also note that apart from these, there are other sections that should be used to save income tax.

Here is a quick listing of the various Sections available to save your income tax this year.

80C –

Payment of Life Insurance Premium (For self, spouse & children)

Contribution to Unit Linked Insurance Scheme – ULIP (For self, spouse & children)

Deposit in Public Provident Fund-PPF (For self, spouse & children)

Purchase of National Saving Certificates – NSC (Self)

Contribution to Equity Linked Savings Scheme (Self)

Payment of tuition fees for children to any School, College, University or Educational Institution

Repayment of Principal of housing loan

Fixed Deposit for 5 years with a Scheduled Bank

80CCC - Contribution to Pension Plans (Self)

80CCF - Investment in Infrastructure Bonds

24(2) - Housing Loan – Repayment of Interest (Self Occupied)

80D – Medi Claim Policy Premium (For self, spouse, children & dependent parents)

80E - Payment of interest on loan taken for higher education for a full time course

80DD - Medical treatment of handicapped dependent

80U - Deduction in case of self being totally blind or physically handicapped

Five heads of income in the Indian Income Tax Act

Income is classified under five heads in the Indian Income Tax Act. Each year, you or your qualified chartered accountant is expected to put all your earnings or incomes under these 5 heads of income for calculating tax. Here is a small primer of what these 5 heads of income mean and what all they consist of.

First head of income: Income from salary

Income can be charged under this head only if there is an employer employee relationship between the payer and payee. Salary includes basic salary or wages, any annuity or pension, gratuity, advance of salary, leave encashment, commission, perquisites in lieu of or in addition to salary and retirement benefits. The aggregate of the above incomes, after exemptions available, is known as Gross Salary and this is charged under the head income from salary.

Basic salary along with commissions and bonuses is fully taxable.

Allowances: An allowance is a fixed monetary amount paid by the employer to the employee for expenses related to office work. Allowances are generally included in the salary and taxed unless there are exemptions available.

The following allowances are fully taxable: dearness allowance, city compensatory allowance, overtime allowance, servant allowance and lunch allowance.

Specific exemptions are available for some allowances as shown below.

Conveyance Allowance: Up to Rs 800/- a month is exempt from tax.

House Rent Allowance (HRA): Hop over the House Rent Allowance article to check on calculation and exemptions available.

Leave Travel Allowance (LTA): LTA accounts for expenses for travel when you and your family go on leave. While this is paid to you, it is tax free twice in a block of 4 years.

Medical Allowance: Medical expenses to the extent of Rs 15,000/- per annum are tax free. The bills can be incurred by you or your family.

Perquisites: Perquisites (or personal advantage) are benefits in addition to normal salary to which an employee has a right by way of his employment. Examples of these are rent free accommodation or car loan. There are some perquisites that are taxable in the hands of all categories of employees, some which are taxable when the employee belongs to a specific group and some that are tax free.

Your employer will give you Form 16 which will contain all the earnings, deductions and exemptions available.

Second head of income: Income from house property

Any residential or commercial property that you own will be taxed as well. Even if your piece of real estate is not let out, it will be considered earning rental income and you will need to pay tax on it. The income tax blokes are a bit easy going on this – they tax you on the capacity of the real estate to earn income and not the actual rent. This is called the property’s Annual Value and is the higher of the fair rental value, rent received or municipal rent.

The Annual Value can go through a standard deduction of 30% and if you reduce the interest on borrowed capital, then you get the value which is charged under the head income from house property.

Third head of income: Profits and gains of business or profession

Income earned through your profession or business is charged under the head “profits and gains of business or profession”. The income chargeable to tax is the difference between the credits received on running the business and expenses incurred. The deductions allowed are depreciation of assets used for business; rent for premises; insurance and repairs for machinery and furniture; advertisements; traveling and many more.

Fourth head of income: Capital gains

Any profit or gain arising from transfer of capital asset held as investments are chargeable to tax under the head “capital gains”.

Hop over to the Long Term and Short Term capital gains article to read more about this. Might be worth reading to see how indexation is used in long term capital gains scenario to reduce tax outgo.

Fifth head of income: Income from other sources

Any income that does not fall under the four heads of income above is taxed under the head “income from other sources”. An example is interest income from bank deposits, winning from lottery, any sum of money exceeding Rs. 50,000 received from a person (other than from relative, on marriage, under a will or inheritance).

Here is a snapshot of the above 5 heads of income.

Planning taxes this year

a. You will have certain needs and goals to meet. Understand what those are and then figure out how to maximize tax efficiency in your effort to meet them. Tax planning should be a part of the overall financial planning that you must do.

For instance, you might be getting married and need to buy a house. In this situation you need to get insurance to protect you spouse if they are financially dependant upon you, as well as you need to get a home loan. What should you prioritize and what do you have the capacity to afford? If you blindly put money into an insurance policy, it might not even be sufficient to give you adequate insurance cover. However, if you choose to pay off the principal on your home loan, that could be a better option in this situation.

b. Do not blindly invest money with the first agent that you might come across. You might end up making mistakes. A lot of people end up buying insurance policies with minimal insurance coverage or putting money in instruments where they cannot access the money when they need it.

c. Do not make last minute decisions just because your payroll department has reminded you that the internal deadline for submitting proofs is approaching. Tax planning involves planning in advance to avoid the last minute scramble.

Selecting tax saving investments

You should think about the following criteria, before selecting your tax saving investments for the year:

Liquidity: How quickly will you need the money? Will you need to access the money within the next year or two years or over what duration?

None of the above instruments let you withdraw your money quickly, in fact there is a minimum three year lock in for all tax saving investments.

Risk and Return: How much risk do you want to take? There is a trade off between the two, some instruments are very low risk, but as a result they give low returns which are capped.

Inflation protection: The instruments that give you a low return typically are the worst type of investments regarding inflation. This is important because many of the instruments give you a fixed rate of interest, and lock in your money for a long period. This is not a good protection against inflation.

Tax Exemption: All tax saving investments under Section 80C are alike in one respect that they are tax exempt when they are invested. But they differ with respect to the tax on the income you earn from such an investment as well as the tax on the maturity of the investment.

Five tips to avoid tax bloopers in India or abroad

In March, last year, Karthik Shankar, a doctor and British citizen, got a tax bolt from the blue when the HM Revenue & Customs (HMRC), the UK's tax department, asked him to pay tax on the money he held in India. Under the UK law, Shankar was told, every British citizen had to pay tax on the income earned anywhere in the world.

He had to deposit the amount within three months or face a penalty. The HMRC was aware that Shankar had deposited money in a bank account in India, the amount he had received from selling a house in Chennai in 2008, the same year that he received British citizenship.

Such shockers are not uncommon when one is either working in a different country or holds accounts there. Here are five things you should know before you emigrate or shift temporarily for work.

Global income in your tax return

Governments often demand tax on the global incomes of foreign residents living in their country on a long-term basis. Says Marnix van Rij, partner at Ernst & Young Belastingadviseurs LLP: "This is set to become more commonplace as governments across the globe, strapped for revenue following the economic crisis, are increasingly exchanging information on tax matters. This is a bid to curb evasion and track money kept in low tax jurisdictions."

They are also increasing their focus on high net worth individuals as well as heightening surveillance of accounts held in foreign countries to crack down on financing of terrorism.

Countries such as the US, the UK and Australia now require immigrants who become permanent residents or citizens to report their incomes from all global sources and pay tax accordingly. Temporary residents are not required to declare their global incomes in these countries, but they have to ensure that taxes are paid in the home country. India also requires its residents to pay tax on any income earned overseas, if they ordinarily pay tax in India.

What constitutes global Income?

Global income includes anything earned abroad, from rental income and dividends to interest and capital gains. If you are emigrating from India, make a list of your assets, the cost of acquisition, earnings from these assets and the tax paid on incomes and capital gains. For instance, if you own a house in India that is rented out, it will have to be reported as global income if you become a permanent resident or citizen of another country, but you may not have to pay tax on it. According to the Indian tax laws, you will have to pay tax here on the rental income. You could claim foreign tax credit in the country where you are living.

Permanent residents in the US also have to report inheritances and gifts received in India, though there is no tax liability on such gains either in India or the US.

Conversely, if you are only a temporary resident in these nations, you will have to continue paying taxes in India on the income earned here. You will also have to comply with all the reporting requirements under the Indian tax laws, such as filing the annual information report if a property transaction exceeds Rs 30 lakh. You won't need to declare this income in the country where you are residing temporarily.

Manage tax residency

The residency rules determine if an NRI has to pay tax in a foreign country or India, says van Rij. There is no common rule across the globe. Countries such as the UK and Australia, which follow the common law system, use a residency test to determine whether a person is required to pay tax in that country. India too follows this system.

So, if you have spent more than 182 days in a country, such as India, the UK or Singapore, during a financial year, or more than 729 days in the previous seven financial years, you will have to pay income tax in that country. This means that if you emigrate mid-year, you will pay income tax in India as well as file returns at the end of the year.

In case, you are a temporary resident of a country, say, the UK, you will pay tax only on the income you earn in the UK till you become a permanent resident or citizen, says Kaushik Mukherjee, executive director at PricewaterhouseCoopers. Once you are a citizen, you will be taxed on your global income. In the US, foreign residents are taxed as American citizens if they have either acquired a green card or clear the substantial presence test. This test is far more stringent than the residency rules that apply in India and the UK.

An individual is said to have satisfied it if he stays at least 31 days in a calendar year and 183 days in the current and two preceding years. To avoid confusion about the number of days spent in a country and prevent double taxation, it will be useful to maintain a travel calendar as well as details of entry and exit as

stamped on the passport. Tax authorities could check your passport to determine the residency status.

Credit for taxes paid in India

India has signed double tax avoidance treaty with about 70 countries, including the US, the UK, Australia, Japan, Germany and Switzerland. This ensures that NRIs can claim foreign tax credit if taxes have been paid on incomes and gains made in India.

If, however, taxes paid in India are lower than that required to be paid in the country where the NRI is residing, additional tax will have to be paid. Before you claim foreign tax credit, ensure that you have all the relevant documents as proof.

Residency rules & Direct Taxes Code

The current residency rules in India will change when the Direct Taxes Code is implemented, most probably from 1 April 2012. Sonu Iyer, partner at the India office of E&Y, says, "The residency rules are set to become more stringent. So, taxpayers will have to report and pay taxes in India on their global incomes."

The change will mean that a person will have to pay tax in India if he spends 60 days in the country during a financial year, or 365 days or more in the previous four financial years.

Checklist for an Emigrant

Retain the tax residency certificate from the host country to avoid double taxation.

Maintain the income and tax documents of both countries to claim foreign tax credit.

If you plan to work abroad for a few years and return to India eventually, file income tax returns in India in the case of incomes from property, equity or other securities and bank deposits.

Maintain a travel calendar as it helps to determine residency status for taxation purposes.

Keep your passport handy as tax officials may ask for it to check your residential status.