Session 01 Introduction

Chapter
1
Introduction
Key Words / Outline
Slide 1-2
Corporate Tax Planning

The term corporate tax planning consists of three words:
Slide 1-3

Corporate - Corporate means of a corporation, where a corporation (or company) is a legal entity formed under the Companies Act having a continued existence, paid-in capital represented by transferable shares, limited liability for the shareholders and a divorce between management and ownership.
Slide 1-4

Tax - Tax is a contribution exacted by the state Chambers English Dictionary (New Delhi: Allide Publishers Ltd., 1992). The term taxes is confined to compulsory, unrequited payments to general government Organization for Economic Cooperation and Development (OECD) (1988).
Slide 1-5

Planning Planning is the process of determining in advance the factors necessary to achieve a set of goals; designing an effective means of achieving some future goals (ends) Kohlers Dictionary for Accountants (1984).
Slide 1-6

Thus, corporate tax planning means dealing with the tax matters of a corporation or company with a view to maximizing the after-tax rate of return on investments after ensuring voluntary tax compliance. For this purpose, each corporate entity has to
1. 2. 3. 4. 5. ensure that it keeps proper records; deduct tax at source where it is necessary; pay advance tax in time, if applicable; file returns in time; comply with notices received from the tax authorities; and 6. be aware of legal remedies where it does not have its rights under the law recognized.
Slide 1-7
Corporate Tax Functions

Tax function activities are those activities which are concerned with fiscal issues. These functions are of two types: 1. Tax compliance activities 2. Tax planning activities
Slide 1-8
Corporate Tax Functions

Tax Compliance Activities: Tax compliance activities are those activities which include the functions or obligations according to the provisions of various fiscal statutes. Tax Planning Activities: Tax planning means dealing with the tax matters of a taxpayer with a view to maximizing the after-tax rate of return on investments after ensuring voluntary tax compliance.
Slide 1-9
Tax Evasion, Avoidance & Planning

Tax Evasion:
Evasion is illegal. It can involve acts of commission or omission (Webley et al. 1991). Noncompliance is a more neutral term than evasion since it does not assume that an inaccurate tax return is necessarily the result of an intention to defraud the authorities and it recognizes that inaccuracy may actually result in overpayment of taxes (Webley et al. 1991).
Slide 1-10

Tax Evasion: contd
Tax cheating describes deliberate acts of noncompliance and does not entail the difficulty of legal proof of tax evasion (Webley et al. 1991). In evading tax one is knowingly breaking the law. This has social and psychological consequences such as stigma and guilt and involves confronting different costs since there is a risk of being caught and fined or sent to prison (Webley et al. 1991).
Slide 1-11

Tax Evasion: contd
The expression Tax evasion means illegally hiding income or concealing the particulars of income or concealing the particular source or sources of income or in manipulating the accounts so as to inflate the expenditure and other outgoings with a view to illegally reduce the burden of taxation. Hence, tax evasion is illegal and unethical (Lakhotia and Lakhotia 1998).
Slide 1-12

Tax Avoidance:
According to Justice Jagadisan J., Avoidance of tax is not tax evasion and it carries no ignominy with it, for, it is sound law and, certainly, not bad morality, for anybody to so arrange his affairs as to reduce the brunt of taxation to a minimum mentioned in the verdict of Aruna Group of Estate v. State of Madras (1965) case (Palkhivala and Palkhivala 1976).
Slide 1-13

Tax Avoidance: contd
Avoidance involves every attempt by legal means to prevent or reduce tax liability which would otherwise be incurred, by taking advantage of some provision or lack of provision in the law it presupposes the existence of alternatives, one of which would result in less tax than the other (Report of the Royal Commission of Taxation 1966, 538; vide Webley et al. 1991).
Slide 1-14

Tax avoidance is the art of dodging taxes without breaking the law. tax avoidance means of traveling within the framework of the law or acting as per the language of the law only in form, but murdering the very spirit of the law and thus acting against the intention of the law and defeating the purpose of the particular legal enactment (Lakhotia and Lakhotia 1998).
Slide 1-15

Perhaps the most celebrated statement made in defense of tax avoidance came from the pen of Judge Learned Hand. In a dissenting opinion, in Commissioner v. Newman (1947), he once said:
Over and over again courts have said that there is nothing sinister in so arranging ones affairs as to keep taxes as low as possible. Everybody does so, rich or poor, and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere cant.
Slide 1-16

Tax Planning:
Tax planning takes maximum advantage of the exemptions, deductions, rebates, reliefs and other tax concessions allowed by taxation statutes, leading to the reduction of the tax liability of the tax payer (Lakhotia and Lakhotia 1998).
Slide 1-17

Tax Planning: contd
According to Shuklendra and Gurha (1992), the prime objectives of tax planning are to achieve the following results: (i) Reduction of tax liability, (ii) Minimization of litigation, (iii) Productive investment, (iv) Healthy growth of economy, and (v) Economic stability.
Slide 1-18

Tax Planning: contd
According to Scholes and Wolfson (1992), Traditional approaches to tax planning fail to recognize that effective tax planning and tax minimization are very different things. The reason is that in a world of costly contracting, implementation of tax-minimizing strategies may introduce significant costs along nontax dimensions. Therefore, the tax-minimization strategy may be undesirable. After all, a particular easy way to avoid paying taxes is to avoid investing in profitable ventures. Thus, effective tax planning means not to minimize tax, but to maximize aftertax rates of return on assets.
Slide 1-19

Tax Planning: contd
According to Lakhotia and Lakhotia (1998), the various objectives of corporate tax planning can be grouped under four different heads: (a) Having maximum taxpayer units; (b) Taking maximum advantage of the exemptions, deductions, rebates, reliefs, and other tax concessions; (c) Legally avoiding unwarranted additions to the income; and (d) Avoidance of tax worries and tensions through voluntary tax compliance and tax management.
Slide 1-20

Legal
Tax Evasion Tax Avoidance Tax Planning
Ethical
Desirable
May or May not be1
May or May not be2
When used as an art of dodging taxes without breaking the law or acting as per the language of the law only in form, but murdering the very spirit of the law and thus unethical from the viewpoint of policymakers
1
When acting against the intention of the law & every attempt by legal means to prevent or reduce tax liability and thus avoiding profitable venture also.
2
Slide 1-21
Tax Formula & Traditional Tax Planning

Tax Planning Formula Aggregate Income Exclusions = Gross Income Allowable Deductions = Taxable Income Tax Rate = Gross Tax Tax Credit & Tax Rebate = Tax Payable
Tax Planning Action
Maximize
Maximize
Minimize
Maximize
Slide 1-22
TRADITIONAL TAX PLANNING TECHNIQUES

..contd
Traditional Tax Planning Techniques based on Tax Formula Traditional tax planning is based on maximizing the tax-favored status and minimizing the tax-disfavored status. Since the ultimate objective of traditional tax planning is the minimization of the bottom line (i.e., the minimization of the net tax payable), the rules of simple arithmetic suggest that tax planning must necessarily involve: Maximization of tax credits/rebates/reliefs, Minimization of the applicable tax rate(s), and Maximization of deductions and/or exclusions. In other words, the items on all even-numbered lines in the above formula constitute the critical variables in tax planning.
Slide 1-23

..contd
1. Maximization of Exclusions:
Exclusions are the incomes which are not included in the tax-base of the income tax [total income as defined u/s 2(65), the scope of which is outlined u/s 17 and computed u/s 43 according to the heads of income u/s 20, but to be reported under the heads mentioned in the Form of Return of Income (Form IT-GA for non-company assessees and Form IT-GHA for companies) u/r 24]. Under section 44(1), any income or class of income or the income of any person or class of persons specified in Part A, Sixth Schedule shall be exempt from the tax, and shall be excluded from the computation of total income. Along with this list under Part A, Sixth Schedule, Government has issued a number of S.R.O. u/s 44(4) of the ITO to extend this exclusion list. 6 (six) SROs issued u/s 60(1) of the Income-tax Act 1922 are still in force for similar exclusion purpose. The business entities which have been allowed tax holiday u/s 46A or under any SRO are able to exclude their income enjoying tax holiday.
Slide 1-24

..contd
2. Maximization of Deductions:
Except Salaries head u/s 21, all other statutory heads of income have provisions of deductions: Sec. 23 for deductions from Interest on securities, Sec. 25 for deductions from Income from house property, Sec. 27 for deductions from Agricultural income, Sec. 29 for deductions from Income from business or profession [along with section 30 for inadmissible expenses from Income from business or profession], Sec. 32(1) for deductions from Capital gains [along with section 32(12) for restricted deductions from Capital gains], and Sec. 34 for deductions from Income from other sources. All these deductions are subject to limits, and conditions and subject to evidential proofs. So a business entity must be careful about these conditions, limits and authenticity of the transactions and thereby, disallowances may be avoided and deductions can be maximized.
Slide 1-25

..contd
2. Maximization of Deductions:
Loss as a Deduction:
..contd
Under section 37, in the year of loss, losses under any head other than two losses loss in speculation business and capital loss can be set-off against other head(s) except against speculation business income and capital gain. But one speculation business loss can be set off against other speculation business income only and one capital loss can be set off against other capital gain only. From AY 2007-08, loss from business or profession is restricted to set off against income from house property. Under other provisions of sections 38-42, set-off of losses can be done in future six successive income years only against the concerned head of income and applicable only for following incomes: Speculation business income (u/s 39), Capital gains (u/s 40), and Other business income (u/s 38), Agricultural income (u/s 41) But in case of capital loss, carry-forward can be done after deduction of Taka 5,000 [u/s 40(3)]. Loss will be calculated for carry-forward after deducting any cash subsidy from the Government [second proviso to section 37]. Loss due to depreciation can be carried forward for unlimited period [u/s 42]. In case of loss, how to maximize the setting-off of the loss in the year concerned should be given special attention and in case of unset-off losses, special tax planning regarding accounting method can help to set off those losses before the expiry of the time limits.
Slide 1-26

..contd
3. Minimization of Tax Rate(s):

Marginal tax rate (MTR) is the relevant tax rate for any business decision. As stated by Sommerfeld et al. (1980), the marginal tax rate is to business affairs what the law of gravity is to physics. Just as water seeks its lowest level (due to the laws of gravity), so also taxable income seeks its lowest marginal tax rate. The tax planning objective is achieved, of course, when the marginal tax rate is minimized. Final emphasis for tax planning is to be given to maximize tax credits, tax rebates and tax reliefs. Again these are subject to conditions, limits and special applicability.
4. Maximization of Credits/Rebates/Relief :

Slide 1-27

..contd
Alternative View of Tax Planning Opportunities

An alternative way of viewing tax-planning opportunities is to observe that income tax is constrained by: Time, Entity, and Accounting method.
Since income tax rates start over with each new tax year and because very few taxpayers have a constant level of taxable income in each year, there tend to be high-tax years and low-tax years. The tax value of a deduction is directly dependent on the marginal tax bracket of the party reporting it. Obviously, therefore, taxpayers tend to recognize losses and other deductions in high-tax years and to defer the recognition of taxable income to low-tax years. To the extent that a taxpayer can control tax timing, s/he should do so only after giving full considerations to the time value of money. Sometimes the financial cost of deferral is greater than the tax benefit.
Slide 1-28

..contd

Method of Accounting in ITO: All income classifiable under the head: Agricultural income [u/s 26 & 27], Income from business or profession [u/s 28-30, 30A] or Income from other sources [u/s 33, 34, 36 & 43]
..contd
shall be computed in accordance with the method of accounting regularly employed by the business entity [sec. 35(1)].
However, every public or private company as defined in the Companies Act, 1913 or 1994 shall, with the return of income required to be filed under the ITO for any income year, furnish a copy of the trading account, P&L account and the balance sheet in respect of that income year certified by a CA [sec. 35(3)]. Where no method of accounting has been regularly employed, or if the method employed is such that, in the opinion of the DCT, the income of the assessee cannot be properly deduced therefrom; or where a company fails to furnish financial statements certified by a CA with its return, the income of the entity shall be computed on such basis & in such manner as the DCT may think fit [sec. 35(4)].
Slide 1-29

..contd

Method of Accounting in ITO: The method of accounting may be:
..contd
Mercantile system (or accrual basis) or Cash system (or cash basis) or Hybrid system (i.e., mixture of these two for separate heads of income). However, in the income tax laws, few incomes must be computed under a specific accounting method. For instance, Dividend is taxable under cash system [u/s 19(7)], Income from house property is taxable under cash system [S.R.O. No. 454-L/80 dt. 31.12.80], and Advance salary income are taxable under cash system [u/s 21(1) (b)] subject to a relief u/s 172.
Slide 1-30

..contd
..contd
Owner/Operator (O/O) of a Company: Shareholder Director of a Private Company :

The time constraint may also be important in case of working with a closely held private company as a shareholder director, i.e., the owner/operator (O/O). The salaries with arrangement of TDS of the director are an allowable deduction with some other limits u/s 30 in case of determining the total income of the company. The salaries are taxable in the hand of the director subject to the exclusions under rules 33 and 33A-33J and Part A, Sixth Schedule. The method of accounting followed by the company may be mercantile system, but the accounting method followed by the director may be cash system. Depending on this entity level advantage (as O/O of the company), a year-end bonus to the director may be shown as a deduction under accrual basis but the O/O is not required to show it as an income until the time of receipt. Even income year might be different from the entity to its O/O. Such accounting legerdemain is a common practice for tax planning purpose.
TAX PLANNING under the SCHOLES-WOLFSON PARADIGM
Slide 1-31
Scholes-Wolfson Paradigm jointly developed in 1992 by:

Myron S. Scholes, the 1997 Nobel Winner in Economics as the co-originator of the Black-Scholes option pricing model and a partner of Oak Hill Capital Management and Mark A. Wolfson, a managing partner of Oak Hill Capital Management, through their book titled Taxes and Business Strategy: A Planning Approach. The focus of Scholes-Wolfson Paradigm is:
Effective Tax Planning.
Slide 1-32
Effective Tax Planning

Effective Tax Planning vs. Tax Avoidance

Objective
Tax Avoidance
Maximizing after tax Legal tax avoidance to minimize tax return May be undesirable in some cases
Not considered and hence those costs may be introduced significantly
Desir-ability Always desirable Non-tax cost Considered
Slide 1-33

Effective Tax Planning vs. Tax Avoidance contd

Consideration of tax implication of all parties involved
Tax Avoidance
Usually not considered
May be done by adopting easy way to avoid paying tax
Yes considered
Possible avoidance of Not done investment in profitable ventures
Tax cost
May be high along with higher after tax return
Minimum
TAX PLANNING under the SCHOLES-WOLFSON PARADIGM
Slide 1-34
Scholes-Wolfson have adopted a contractual perspective for their paradigm & suggested 3 key aspects of tax planning globally: 1. Multilateral Approach: All contracting parties must be taken into account in tax planning, which allows a global or multilateral, rather than a unilateral, approach. 2. Importance of Hidden Taxes: All taxes (both implicit tax and explicit tax) must be taken into account considering the global measures of taxes. Implicit tax is the decrease in return due to availing tax favored investment and explicit tax is the tax deposited in the treasury. 3. Importance of Nontax Costs: All costs of business must be considered, not just taxes. Thus, the paradigm is based on consideration of
ALL PARTIES, ALL TAXES, ALL COSTS. These are also prerequisites of Effective Tax Planning.
Slide 1-35
Why Study Corporate Tax Planning?

Taxpayers or Tax Professionals Perspective: Preparing to be a Tax Professional Developing the tax assessment and tax auditing skill Understanding the tax notices issued by the tax authority and preparing the responses to tax queries Selecting a new Tax Professional or changing the existing Tax Professional Selecting the services to be sought from a Tax Professional tax compliance or tax planning services
Slide 1-36
Why Study Corporate Tax Planning?

Tax Authoritys Perspective: Preparing to be a Tax Executive Developing the tax assessment and tax auditing skill Preparing the tax notices to be issued and understanding the responses to tax queries Selecting a Tax Professional in case of a decision of outsourcing Selecting the services to be sought from a Tax Professional tax compliance or tax planning services
Slide 1-37
Taxing Authority
Taxing Authority as an uninvited party to all contracts:
Brings to each of its forced ventures with taxpayers a set of contractual terms (tax rules) Does not negotiate the contractual terms separately for each venture Announces a standard set of the above terms taxpayers must accept Claims a partnership interest in taxpayers profit Does not exercise any voting rights
Slide 1-38
Taxing Authority
Taxing Authority as an uninvited party to all contracts: . contd Does not directly monitor taxpayers performance to determine whether taxpayers are violating the contractual terms But does conducts audits Being a partner in all firms enable the taxing authority to determine when taxpayers are reporting result far out of line with what other taxpayers are reporting in similar situations (information that is used to select return for audit)
Slide 1-39

Traditional tax planning is equivalent to tax avoidance with the main purpose of legal reduction of tax liability.
Tax Planning Principles:

Taxes decrease if income earned by entity is subject to a low rate. Taxes decrease if payment can be deferred to a later year, because tax deferred is tax reduced. Taxes decrease if income is generated in a low rate jurisdiction. Taxes decrease if income is taxed at a preferential rate.
Relevant Tax Rate:

For planning purposes only relevant rate is rate at which the transaction will be taxed, i.e., marginal tax rate (MTR) rate at which next Taka of income will be taxed. The MTR may change as follows: (a) higher bracket due to more income, or (b) law may be changed and a new rate is prescribed.
Slide 1-40

..contd
Factors Affecting Tax Planning:

Choice of Entity: Which entity undertakes the transaction? Different entities have different tax rates. Pass-through entities (sole-proprietorship) allow shifting income to owner and one level of tax. Non-pass-through entities (companies) are subject to double taxation, once at corporate level and then again at the shareholder level. Period of Transaction: Over what period does transaction take place? Tax deferred is tax saved based upon time value of money. Common techniques are to accelerate deductions (e.g., following accelerated depreciation) and to defer income (e.g., through installment sale). A taxpayer has to consider when taxes are actually paid (e.g., quarterly estimates versus end of year computation). Tax Jurisdictions: In which jurisdiction does the transaction take place? Tax liability depends whether the income will be accrued in foreign country (subject to exemption or tax relief) or Bangladesh or whether the income will be earned by establishing the entity in a low tax zone or a high tax zone. Character of Income: What is the character of the income? Depending on the income character, certain types of income are exempted fully or partially. Certain types of income are taxed at preferential rates (e.g., capital gain on transfer of stocks and shares of non-listed private limited company taxed @ 15%, dividend income from shares taxed to companies @ 15%).
Slide 1-41

..contd
Tax is a Function of 3 Variables:

A final tax liability is a function of three (3) variables: the law, the facts, and the administrative (and sometimes judicial) process. If any taxpayer is not satisfied with either the law or the administrative and judicial processes, there is relatively little that s/he can do (unless, of course, s/he has enough money and clout to get a tax law change). The facts, however, are generally amenable to modification. If a taxpayer is wise enough to understand when and how to modify them, s/he may very well reduce her/his tax liability significantly. The most highly qualified professional tax experts earn most of their lucrative fees by giving advice on alternative ways of arranging facts. In other words, most professional tax planning is little more than the prearrangement of facts in the most tax-favored way.
Slide 1-42

..contd
Tax Planning Opportunities under IAS 12 :

IAS 12, Income Taxes has suggested exploiting tax planning opportunities through changing the accounting method or arranging the facts. Under paragraph 30 of IAS 12, tax planning opportunities are actions that the enterprise would take in order to create or increase taxable income in a particular period before the expiry of a tax loss or tax credit carryforward. IAS 12 has mentioned following few examples how, in some jurisdictions, taxable profit may be created or increased:
(a) by electing to have interest income taxed on either a received or receivable basis; (b) by deferring the claim for certain deductions from taxable profit; (c) by selling, and perhaps leasing back, assets that have appreciated but for which the tax base has not been adjusted to reflect such appreciation; and (d) by selling an asset that generates non-taxable income (such as, in some jurisdictions, a government bond) in order to purchase another investment that generates taxable income.
Where tax planning opportunities advance taxable profit from a later period to an earlier period, the utilisation of a tax loss or tax credit carryforward still depends on the existence of future taxable profit from sources other than future originating temporary differences.
Slide 1-43

..contd
Special Provisions Relating to Avoidance of Tax in Chapter-XI of ITO:

Section 104: Avoidance of tax through transactions with non-residents Section 105: Avoidance of tax through transfer of assets Section 106: Avoidance of tax by transactions in securities Section 107: Tax clearance certificate required for persons leaving Bangladesh.
Appendix-I delineates the Special Provisions Relating to Avoidance of Tax under Chapter-XI of the Income Tax Ordinance, 1984.
Appendix-I
Slide 1-44
Why Tax Planning Arises?

Contractual terms that taxing authority imposes on its joint venture --Tax Rules
Tax Rules result from a variety of

socioeconomic forces:* Finance Public Projects * Redistribute Wealth * Encourage Economic Activities
Slide 1-45

Government ensures objectives of Tax Rules by
Designing to discriminate among different economic activities This has been done through two things: Progressive Taxation (for redistributing wealth) Subsidy (for encouraging economic activities) Tax Rules provides also to arrange taxpayers affairs to keep the tax bite as painless as possible
Slide 1-46

Progressive Taxation, Subsidy and Provision to arrange taxpayers affairs to minimize tax-bite
Gives rise to marginal tax rate (MTR) that widely varies
From one contracting party to the next
For a given contracting party over time
For a given contracting party over different economic activities
Slide 1-47
Types of Tax Planning

All changes in tax regimes involve turning two types of dials: * Levels of tax rates * Relative tax rates varying --- Across different tax paying units -- Across different tax periods for the same taxpayer -- Across different economic activities for the same taxpayer and same time period
Slide 1-48

Thus, types of income tax planning activities are: Attempts to have income converted from one type to another (ordinary income vs. capital gain, regular income vs. windfall income, domestic income vs. foreign income, set-off of loss under any head); Attempts to have income shifted from one pocket to another (taxable vs. tax-exempt sources); and Attempts to have income shifted from one time period to another (delaying recognition of income, if tax rates are constant or declining over time, instant salary vs. deferred compensation)
Slide 1-49

In short, the types of income tax planning activities are: Shifting income from one pocket to another Shifting income from one time period to another Converting income from one type to another
Slide 1-50
Tax vs. Financial Management Decisions

Financial Management Decisions Investment Decisions decision regarding acquisition of fixed assets Financing Decisions capital structure decision Dividend Decisions decision regarding distribution and/or retention of earnings
Slide 1-51

Why do Tax Rules influence Investment Decisions? Tax rules affect the before-tax rates of return on assets. Some firms select investments with high before-tax rates of return while others select assets with low before-tax rates of return even when both types of investments are available to all firms. Before-tax rate of return means the rate of return earned from investing in an asset before any taxes are paid to domestic and foreign, central and local taxing authorities.
Slide 1-52

Why do Tax Rules influence Investment Decisions? .. contd
The before-tax rates of return differ because:
the returns to different types of assets are taxed differently, the returns to similar assets are taxed differently if they are located in different tax jurisdictions, the returns to similar assets located in the same tax jurisdiction are taxed differently if they are held through different legal organizational forms (such as a corporation versus a sole proprietorship), and
Slide 1-53

Why do Tax Rules influence Investment Decisions? .. contd
The before-tax rates of return differ because: .. contd the returns to similar assets located in the same tax jurisdiction and held through same legal organizational form are taxed differently depending upon such factors as: the operating history of the organization, the returns to other assets held by the organization, and the particular characteristics of the individual owners of the organization.
Slide 1-54

Why do Tax Rules influence Financing Decisions? Tax rules influence the financing decisions of firms through their effect on the cost of financing the firms activities. The cost of issuing a capital structure instrument depends on the tax treatment it is accorded (i.e., whether the cost is tax deductible or not), which, in turn, depends on whether the instrument
is debt, equity, or a hybrid, is issued to an employee, a customer, a related party, a bank, or any one of a number of other special classes of suppliers of capital, and is issued by a corporation, a partnership, or some other legal organizational form.
Slide 1-55

Why do Tax Rules influence Dividend Decisions?
If investment by individual investor is deemed to be tax-advantageous relative to corporations, it is important to determine whether existing corporations should liquidate (so individual investors can reinvest the funds in ways that result in single-level taxation) or whether retained earnings should be reinvested at the corporate level, if there exist projects that generate returns above the competitive rate.
Slide 1-56

Why do Tax Rules influence Dividend Decisions?
. contd
Say, a company distributes Tk. 1 as a dividend today, shareholders pay taxes at their own personal tax rates, and reinvest the after-tax income on their own account for n periods at an after tax rate of return per period. If the company retains the Tk. 1 of after-tax corporate income, on the other hand, and invests it on corporate account, it returns at corporate rate per period after tax until it finally distributes the accumulated amount of retained earnings. At that time, shareholders pay tax on the distribution at his personal tax rate then. So we can compare the two alternatives as follows:
Liquidate and invest on personal account for n periods Retain and invest on corporate account for n periods before liquidating
Slide 1-57

Why do Tax Rules influence Dividend Decisions? . contd
The best strategy depends upon two factors:
the investors marginal tax rate today, versus the investors marginal tax rate in the future, (a decreasing tax rate, or an ability to convert dividend income into a capital gain taxed at a reduced rate, favors dividend deferral), and the corporate versus investor tax rate (a higher corporate rate favors current payout)
Slide 1-58
Tax Planning as a Tax-Favored Activity

Tax Planning itself is a tax-favored activity because-
Money spent thereon is tax deductible Tax savings arising from tax planning is effectively tax exempt because they reduce taxes payable & hence, more tax-favored than tax-exemption
When PTROR (pre-tax rate of return) is equal to ATROR (after-tax rate of return), then it is called tax exemption (a situation in which an asset escapes explicit taxation).
PTROR=Pre-tax Return/Pre-tax Investment ATROR=After-tax Return/After-tax Investment
Slide 1-59
Tax Planning as a Tax-Favored Activity

Tax Planning itself, a tax-favored activity Example Two alternatives with marginal tax rate (MTR) of 15%:
Alternative-1: Invest Tk. 10,000 in fully taxable corporate bonds for one year with a yield of 10% p.a. before taxes. Alternative-2: Invest Tk. 10,000 in tax planning services to save Tk. 11,000 in taxes in one year. PTROR (pre-tax rate of return) for Alternative-1: (Tk. 10,000x10%)/Tk. 10,000=10% PTROR (pre-tax rate of return) for Alternative-2: (Tk. 11,000 Tk. 10,000)/Tk. 10,000=10% ATROR (after-tax rate of return) for Alternative-1: [(Tk. 10,000x10%)(1 15%)]/Tk. 10,000=8.50% ATROR (after-tax rate of return) for Alternative-2: [(Tk. 11,000 Tk. 10,000) (1 0%)]/[Tk. 10,000(1 15%)]=11.76% Thus, Alternative-2 yields higher ATROR & hence, tax-favored.
Slide 1-60
Important Concepts for Tax Planning

Explicit Tax money taxes paid directly to tax authorities. Implicit Tax arises because the pre-tax investment returns available on tax-favored assets are less than those available on tax-disfavored assets. Taxpayers wishing to obtain the tax-favored treatment offered by the investment bid up the price of the investment lowering the pre-tax return. Implicit Tax Rate the difference in pretax returns on a given asset, and the benchmark asset (usually, fully taxable bonds taken as benchmark asset). Say, pretax return on fully taxable bond = 10%, and fully tax-exempted return on government security = 7%, then implicit tax rate on government security = (10% 7%)/10% = 30%. Thus, paying tax at a rate of 30% on fully taxable bond would result in a return of 7%, the same as the pretax return on tax-exempt government security.
Slide 1-61

Marginal Investor: Taxpayers who are indifferent between purchasing two equally risky assets, the returns to which are taxed differently, are called the marginal investors. Tax Clientele (inframarginal investor): Taxpayers that prefer one investment over another are referred to as the tax clientele for the preferred investment. Unless investors correctly identify their proper tax clientele, they will not maximize their after-tax rates of return.
Slide 1-62

Friction transaction costs incurred by taxpayers in the marketplace that make certain tax-planning strategies costly. Restriction restraints imposed by the tax authority that prevent taxpayers from using certain tax arbitrage techniques to reduce taxes in socially undesirable ways. It is these frictions and tax-rule restrictions that make potential returns to tax planning so high.
Slide 1-63

Tax Arbitrage the purchase of one asset (a long position) and the sale of another (a short position) to create a sure profit despite a zero level of net investment.
Strategic Corporate Tax Planning:

The SAVANT Framework
Key Words / Outline
Source of the SAVANT Framework

Book: Strategic Corporate Tax Planning Published by: John Wiley & Sons, Inc., Hoboken, New Jersey in 2002 Authored by: John E. Karayan, J.D. Ph.D., a tax attorney and former Director of Taxes for a New York Stock Exchange-listed high tech multinational, Charles Swenson, Ph.D., professor of taxation and the Elaine & Kenneth Leventhal Research Fellow at the Leventhal School of Accounting of the University of Southern California, and Joseph W. Neff, J.D., a partner in the Los Angeles office of PricewaterhouseCoopers.
65
Approaches to Strategic Corporate Tax Planning Approaches to Strategic Corporate Tax Planning

Taxes are important to know, but hard to learn. The devil is in the details. But managers and investors do not need to know the details. They just need to be aware of the fundamental principles of taxation and how to apply them when making decisions. Even this is no simple task.
66
Approaches to Strategic Corporate Tax Planning Approaches to Strategic Corporate Tax Planning
This has been tried to do in two steps.
contd
First, an innovative analytic framework called SAVANT has been explained and illustrated. (A savant is an exceptionally knowledgeable person.) The framework organizes tax principles and their applications and this framework helps nontax specialists see tax savings opportunities and also helps managers to apply tax principles to make better decisions. SAVANT is an acronym for how tax planning fits into business decisions: through Strategy, Anticipation, Value-Adding, Negotiating, and Transforming. Second, it has been shown how managers can apply this SAVANT framework to typical business transactions.
67
Applying SAVANT to Maximize Shareholder Value Applying SAVANT to Maximize Shareholder Value
SAVANT is used to show nontax specialists how to critically analyze situations to generate tax-savings opportunities. SAVANT works as follows: To add maximum value to each transaction, decision mak-ers need to stay focused on the firms strategic plan, anticipating tax impacts across time for all parties affected by the transaction. Managers add value by considering these impacts when negotiating the most advantageous arrangement, thereby transforming the tax treatment of items to the most favorable status. Expert managers (and consultants) use these concepts, derived from economic policy and tax law, to maximize shareholder value.
68
Why Managers Need to Know the Why Managers Need to Know the Principles of Tax Planning Principles of Tax Planning
Reducing taxes is beneficial, but why should managers learn the basics of tax planning? It may seem obvious at first glance, especially to the ownermanager or corporate entrepreneur. But this is an important question, which can be answered differently at different times, in different organizations, and for operations in different countries. Managers need to learn about taxes because optimizing a ventures total tax burden is important to its success, and managers are the main decision makers in an organization.
69
contd
Knowing the fundamentals of taxation and how to apply them allows managers to make better decisions and thus be more effective in their jobs. Managers who are able to identify tax issues can also make more effective use of tax consultants, because these managers can recognize a problem when it arises and advise consultants of the trade-offs involved.
70
contd
Taxes impact success because operational decisions are generally based on the risk-adjusted net present value of expected after-tax cash flows. In addition, income taxes, payroll, sales (e.g., value-added, goods and services, or gross receipts), and property taxes often add up to one of the largest expense items of an organization. Furthermore, tax payments typically have a high legal priority claim on an organizations cash flow. That is, not only can taxes be a big expense, but they also must be paid, and paid quickly.
71
contd
Furthermore, multinational businesses that are publicly traded in capital markets can be especially sensitive to tax expense. This is because earnings (which usually have a major impact on stock prices) must be reported on an after-tax basis. Indeed, not only must earnings be reduced by taxes paid in the current year, but earnings must also be reduced by any expected future income taxes generated by such earnings. Because senior managers compensation is often tied to earnings via stock prices (e.g., through stock options), key decision makers in multinational organizations often have a high personal stake in optimizing taxes.
72
SAVANT Balances the Benefits with the SAVANT Balances the Benefits with the Costs of Tax Planning Costs of Tax Planning
contd
All in all, there are many factors that combine to motivate managers of organizations to seek to reduce taxes, provided the cost of doing so is not too high. This is because tax planning requires making changes, and doing so is not cost free, nor are the rewards certain. First, the details of taxation are hideously complex. Second, the cost of complying with tax rules (e.g., preparing tax returns and providing details requested by tax auditors) can be significant. Not only can it be costly to figure out how much to pay but also who to pay and when to pay.
73
Such costs can be particularly high for cross-border activities, which can involve a multitude of different tax jurisdictions imposing different taxes. In addition, similar taxes are often imposed by different jurisdictions using similar but different basic definitions. This raises the specter of multiple taxation (e.g., the same income effectively being taxed at rates exceeding 100%), although governments typically try to avoid this situation through tax treaties and special adjustments, such as the foreign tax credit.
contd
74
contd
Finally, although income and payroll taxes may be the province of headquarters staff, and thus savings may not directly affect a divisional managers annual performance bonus, other taxes almost always do. This is because these taxes are normally charged to strategic business units and thus reduce their individual bottom lines. Not every idea that saves taxes is a good one. The SAVANT framework helps managers make better decisions because it balances the benefits of tax planning with the costs of doing so.
75
Goals of Tax Planning Goals of Tax Planning

Most people think that minimizing taxes should be the goal of tax planning. This is short-sighted, because taxes are only one factor, albeit a major one, in the mix of costs and other factors that generate the amounts most often taxed: profits and wealth. Put simply, one can avoid many taxes by neither earning a living nor owning property, but most people do not aspire to a life of poverty, however tax free it is. Furthermore, strategies that reduce taxes are rarely cost free. If nothing else, when focusing on saving taxes, managers are not focusing on increasing sales, improving product quality, or producing goods and services more efficiently. The SAVANT framework recognizes this by striving toward optimizing taxes, rather than minimizing them. The goal is to balance the benefits against the risks and costs.
76
77
contd Tax strategies are also risky: Changing operations to save taxes (e.g., by operating through multiple corporations) often results in an increase in long-term administrative costs and generates uncertain returns because tax laws can change (change can occur dramatically, rapidly, and unpredictably), and tax rules themselves are all too often obscure at best. In cross-border transactions, the interactions of multiple taxes imposed by different jurisdictions also must be appreciated. Also, tax-savings strategies can be intrusive. Why is it, for example, that profitable businesses in the Los Angeles area, a relatively high-tax location, do not all move to Las Vegas, a very-low tax location? One reason is that it is costly to move. Another is that nontax factors dominate the decision: Many business owners simply want to live in southern California rather than southern Nevada. Yet another reason is that skilled labor, qualified subcontractors, and competitive suppliers are plentiful in southern California, as are (perhaps more importantly) customers.
Goals of Tax Planning Goals of Tax Planning
SAVANT: The Generic Tax Planning SAVANT: The Generic Tax Planning Strategies Strategies
Thus, even though total elimination of taxes is not a goal, people and organizations often invest significant amounts of time and resources in implementing tax-reducing strategies. The ultimate goal is to reduce taxes while not excessively intruding on the organizations overall operations. SAVANT explicitly recognizes this. SAVANT also illustrates that tax strategies are usually based on taking advantage of either the time value of money (e.g., paying taxes later) or differences in tax rates (i.e., tax-rate arbitrage). Tax arbitrage is typically behind artificial transfer pricing schemes, that is, using accounting entries to shift profits to jurisdictions that impose the lowest net taxes (i.e., the lowest tax costs relative to the benefits received by operating in a particular jurisdictione.g., free medical care for all people, including a firms employees.)
78
Tax Saving Strategies Tax Saving Strategies

Tax savings strategies usually fall into one of four types: (1) creation, (2) conversion, (3) shifting, and (4) splitting. CREATION: Creation involves plans that take advantage of tax subsidies, such as moving an operation to a jurisdiction that imposes lower taxes. For example, during the past 25 years many engineering and entertainment firms have fled the city of Los Angeles, which imposes a gross receipts tax, and moved to the relatively tax-free city of Pasadena, which is located just a few miles away.
79
contd
CONVERSION: Conversion entails changing operations so that more tax-favored categories of income or assets are produced. For example, advertising in order to sell inventory results in ordinary income, which is usually taxed immediately and at the highest rates. However, equally successful image advertising generates an increase in a firms goodwill, which is not taxed until the goodwill is sold, if at all, and then would likely be taxed at lower cap-ital gains rates. SHIFTING: Shifting involves techniques that move amounts being taxed (also called the tax base) to more favorable tax-accounting periods. A good example is accelerated depreciation, which allows more of an assets cost to be a tax-deductible expense in early years, thus deferring the payment of taxes until later. Another example is an individual retirement account (IRA).
80
SPLITTING: Splitting techniques entail spreading the tax base among two or more taxpayers to take advantage of differing tax rates. For example, the top U.S. income tax rate on individuals is nearly 40%, but the standard tax rate on the first $50,000 of corporate income is only 15%. Incorporating a sole proprietorship generating $200,000 in profits, and paying a $150,000 salary (provided it is reasonable) to the proprietors, is a splitting strategy that saves $12,500 (i.e., 25% of $50,000 split off and moved into the corporate tax return) of income taxes each year. Taxes can also be avoided through fraud, which is fairly widespread throughout the world outside of the United States, but relatively small for noncriminal activities within the United States. Those favoring fraud as a strategy generally need not read books like this.
81
contd
SAVANT: The Transactions Approach to SAVANT: The Transactions Approach to Maximize Firm Value Maximize Firm Value
To increase firm value, managers engage in transactions. Of course, firm value can increase for other reasons. For example, the value of the firms assets simply can appreciate due to market factors beyond the control of managers. However, transactions must have occurred when firms acquire such assets, and it takes transactions to convert such assets into cash flow. Managers do things like buy, sell, rent, lease, and recapitalize. If managers structure transactions such that each is valuemaximizing, then by year-end the sum of such transactions will have maximized firm value. However, note that each transaction has an uninvited third party: the government. In strategic tax management, when a firm chooses transactions, it keeps tax management in mind. This transactions approach is the SAVANT framework.
82
SAVANT Framework: SAVANT Framework: The Transactions Approach to Tax Management The Transactions Approach to Tax Management
Strategy Anticipation
ValueAdding Negotiating Transforming
83
Strategy The firm looks to engage in transactions that maximize end-of-period value.
contd
It can chose from a constellation of entities or transactions, and the choice then is put through the lens of the firms strategic objectives. If the transaction (including tax effects) is consistent with the firms strategic objectives, it may accept the transaction. Otherwise, even if the transaction is highly tax-advantaged, the firm should consider rejecting the transaction. Similarly, the tax aspects of the transaction can be managed in a strategic manner.
84
Anticipation
contd
Next, the firm anticipates its future tax status and chooses the timing this year or a future yearof the transaction.
Because the effects of transactions often span more than one year, the firm projects tax effects into the future, using current and expected future tax rates and rules, and factors in managements expectations as to the future tax status of the firm. If there is tax advantage to adjusting the timing of a transaction, the firm should do so provided that the nontax economics still make sense.
85
Negotiating
contd
Taxes are also negotiated between the firm and the other entity.
The firm seeks to shift more of the tax burden away from itself (and potentially, onto the other entity) by negotiating the terms of the transaction. The firm attempts to minimize tax costs by Transforming transforming transactions being considered into ones with more favorable tax treatment. For example, managers can work to restructure transactions that might generate nondeductible costs into ones where costs are deductible ones, or work to transform what would have been ordinary income into capital gain income. .
86
ValueAdding
contd
What is left, after taxes, is value-added to the firm. Like taxes, value-added often inures to the firm over time. Because it is a fundamental principle that cash inflows are more valuable now than later, tax management takes into account the time value of a transaction as well.
87
The time value of a transaction, after taxes and transaction costs, is what increases firm value in the future. One aspect of a transaction that affects value-added comprises transaction costs, such as sales commissions or attorney fees. Transaction costs reduce the net change is inconsistent with its strategy. For example, if a firm wants to acquire another business that is unrelated to its core competency, to obtain tax benefits [e.g., NOL (net operating loss) carryovers], it should not do so unless it is clear that the pretax economics make sense. Second, a firms competitive strategy may be shaped, in part, by its tax status. Put simply, if a firm is structured so that it has a more favorable tax status than that of its competitors, this can give the firm an overall cost advantage over its competitors. Effective tax management is an important tool in obtaining this kind of competitive edge.
Slide 1-88
End of the Chapter
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Session 01 Introduction

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Chapter

Key Words / Outline

Corporate Tax Planning

Corporate Tax Planning

Corporate Tax Planning

Corporate Tax Planning

Corporate Tax Planning

Corporate Tax Functions

Corporate Tax Functions

Tax Evasion, Avoidance & Planning

Tax Evasion, Avoidance & Planning

Tax Evasion, Avoidance & Planning

Tax Evasion, Avoidance & Planning

Tax Evasion, Avoidance & Planning

Tax Evasion, Avoidance & Planning

Tax Evasion, Avoidance & Planning

Tax Evasion, Avoidance & Planning

Tax Evasion, Avoidance & Planning

Tax Evasion, Avoidance & Planning

Tax Evasion, Avoidance & Planning

Tax Evasion, Avoidance & Planning

May or May not be1

May or May not be2

Tax Formula & Traditional Tax Planning

TRADITIONAL TAX PLANNING TECHNIQUES

TRADITIONAL TAX PLANNING TECHNIQUES

TRADITIONAL TAX PLANNING TECHNIQUES

TRADITIONAL TAX PLANNING TECHNIQUES

TRADITIONAL TAX PLANNING TECHNIQUES

3. Minimization of Tax Rate(s):

TRADITIONAL TAX PLANNING TECHNIQUES

Alternative View of Tax Planning Opportunities

TRADITIONAL TAX PLANNING TECHNIQUES

Alternative View of Tax Planning Opportunities

TRADITIONAL TAX PLANNING TECHNIQUES

Alternative View of Tax Planning Opportunities

TRADITIONAL TAX PLANNING TECHNIQUES

Alternative View of Tax Planning Opportunities

Owner/Operator (O/O) of a Company: Shareholder Director of a Private Company :

TAX PLANNING under the SCHOLES-WOLFSON PARADIGM

Scholes-Wolfson Paradigm jointly developed in 1992 by:

Effective Tax Planning.

Effective Tax Planning

Effective Tax Planning

Desir-ability Always desirable Non-tax cost Considered

Effective Tax Planning

Effective Tax Planning

Possible avoidance of Not done investment in profitable ventures

May be high along with higher after tax return

TAX PLANNING under the SCHOLES-WOLFSON PARADIGM

Why Study Corporate Tax Planning?

Why Study Corporate Tax Planning?

TRADITIONAL TAX PLANNING TECHNIQUES

Tax Planning Principles:

Relevant Tax Rate:

TRADITIONAL TAX PLANNING TECHNIQUES

Factors Affecting Tax Planning:

TRADITIONAL TAX PLANNING TECHNIQUES

Tax is a Function of 3 Variables:

TRADITIONAL TAX PLANNING TECHNIQUES

Tax Planning Opportunities under IAS 12 :

TRADITIONAL TAX PLANNING TECHNIQUES

Special Provisions Relating to Avoidance of Tax in Chapter-XI of ITO: