TAX PLANNING AND FINANCIAL MANAGEMENT WITH REFERENCE TO WORKING CAPITAL

TAX PLANNING Tax planning is known as arrangement of financial and economic affairs of an assessee by taking into account all benefits under reductions, assuptions,allowances,rebates so that incident of tax liabilities is minimized. 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 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. FINANCIAL MANAGEMENT Financial management is that managerial activity which is concerned with the planning and controlling of the firms financial resources According to Howard &Upton: Financial management is the application of the planning and controlling function to the finance function. Thus financial management means manage the financial activity of the company. There are different approaches regarding financial management. Traditional Approach: Under this approach financial management refers to r aising of funds through various sources according to current needs of the company. Transactional Approach: Under this approach financial management refers to inflow and outflow of cash in operating activity. Operating activity means purchase and sale of material. Modern Approach: M od e rn ap pr o ac h i s ri si n g o f fun ds t hr o u gh di f f e re nt s ou r ce s an d ut i l i z i n g t he m effectively. Capital budgeting and cost of capital must be kept in mind while raising the funds. Capital budgeting means the investment in capital goods in such a way so that we can get back our invested money easily and quickly. Cost of capital means what is the cost of raising capital.

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WORKING CAPITAL MANAGEMENT In the words of Shubin, working capital is the amount of funds necessary to cover the cost of operating the enterprise. Ac c ordi ng t o Genestenberg C i rcu l at i ng ca pi t a l m ea ns cu rr ent ass et s of a company that are changed in ordinary course of business from one form to another as for example, from cash to inventories, inventories to receivables, receivables into cash. There are two concepts of working capital: 1. The term Gross working capital, also referred to as working capital, means the total current assets. 2. The term Net working can be defined as the difference between current assets and current liabilities. The first appropriation out of profits is payment or provision of tax. The amount of taxes to be paid is determined by the prevailing tax regulations. Very often the taxes have to be paid in advance on the basis of profit of preceding year (Advance tax). Tax liability in short is a short-term liability payable in cash. An adequate provision for tax payments is an important aspect of working capital management. If tax liability increases it leads to an increase in the requirement of working capital and vice versa. A companys main objective is to earn profits which are taxable under income tax act 1961 as stated before. Working capital is one of the components which enable the company to achieve its objective of profit earning. It is very important for companies to maintain an adequate (2:1) ratio between current asset and liabilities. Funding of WCM can be done through: Internal sources include retained earnings (accumulated profits) and depreciation (which increases the working capital by an amount provided through provision as long as they are not used for payment of long term liabilities.) External sources include loans and shares which are more certain than internal sources. Small companies use the time lapse between provision of taxes and payment of taxes as a means of short term working capital which has now diminished due to the quarterly advance payments of tax. The scale of business; namely microenterprises, small scale, medium scale, and large scale come with different provisions as per the priority given by the Government so sometimes it is better to open few small scale operations rather than keep one large operation. Also large scale business require higher amount of working capital. SECTION 28: Profits and gains of business or profession: Under this section any profit or gains from a business profession is taxable under income tax act 1961. A major portion of working capital is a portion of profits earned by the company

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and is called retained earnings. This section includes any compensations and payments received as well as income derived from trade which require high amounts of working capital. Another method of financing working capital is through loans from banks and financial institutions. The interest paid to these modes can be used as deductions from the taxable amount which the company is liable for. As working capital deals with short term assets. It is also limited by SECTION 48: capital gains which requires the computation, [Full value (cost of transfer + acquisition+improverment)] and any sum exempted under sections 54, 54B, 54EC, 54F. (For individuals) SECTION 36(1)(iii): Interest paid on borrowed capital for the purpose of business or profession Loan may be borrowed from Bank, Financial institutions, Government, Public friends or relatives. Such borrowed money should be used for the purpose of business or profession. Interest to bank or financial institute must be paid before filing of return. Under this section any interest accrued before commencement of operations, or before the use of the asset cannot be claimed as deduction. These have to be capitalised and added to the actual cost of fixed asset acquired out of borrowed capital. Where the interest is paid outside India without deduction of tax at source is not allowed as deduction. Interest other than interest on borrowing is allowed as deduction under section 37 (General deductions) and not under this clause. E.g. Interest on late payment of sales tax etc. SECTION 36(1)(vii): Bad debts A deduction will be allowed in respect of any bad debts which are written off as unrecoverable in the account of the assessee for the previous year. Advance made for the purchase of raw materials if forfeited not allowed as deduction since advance payed is not part of income. However, deduction can be claimed under section 37. Provision for bad debt is not allowed deduction. Recovery of bad debt: Where a deduction has been allowed in respect of a bad debt or part of debt, then, if the recovered amount is greater than the difference between the debt or part of debt and the amount, the remaining will be considered as profits and gains of business or professionals and chargeable to income tax. SECTION 37: General deductions Some other deductions which may affect the working capital are:

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1. Any legal fees for drafting contract with debtors and creditors 2. Interest paid for overdraft facilities Revenue expenditure vs. capital expenditure: 1. Purchase of capital assets used for the purpose of business(depreciation can be claimed under section 32) 2. Expenditure on raising loans for the purpose of business is allowed as deduction, since treated as expenditure. As stated before tax is a liability payable in cash which makes the provisions under advance payment of tax very important. This includes SECTION 207 to 219 of the Income tax Act: SECTION 211 deals with calculation of advance tax. All companies are liable to pay in four instalments during each financial year and the due date of each instalment is mentioned. Companies: First instalment must not be less than 15% of advance tax liable to assessee and is required to be submitted by 15th June. Second instalment must not be less than 45% (reduced by amount paid earlier) and is required to be submitted by 15th September. Third instalment must not be less than 75 %( reduced by amount paid earlier) and is required to be submitted by 15th December. Fourth instalment must be the whole amount as reduced by amount paid earlier and is required to be submitted by 15th March. Other than companies: First instalment must not be less than 30% of advance tax liable to assessee and is required to be submitted by 15th September. Second instalment must not be less than 60 %( reduced by amount paid earlier) and is required to be submitted by 15th December. Third instalment must be the whole amount as reduced by amount paid earlier and is required to be submitted by 15th March. WAIVE OFF: Due to various reasons such as stiff global competition, new inventions and global recession, the financial position of many companies has deteriorated and, as a result, their accounts with financial institutions or banks have become non-performing assets (NPA). With such a condition present a one-time settlement with banks or financial institutions by paying a stipulated amount against the loan amount is formulated, while the balance is waived-off. According to the act this waive off is taxable under the Profit and Gains of Business or Profession provision, because the loan was taken for the purpose of business, and a one-time settlement was an integral part of the business, but waiver of working capital loan cannot be termed a trading transaction, and it cannot also be seen as flowing out the income (revenue) stream of transactions during the course of business. Hence, the waiver of working capital loan by the bank cannot be taxed under Section 28(i) of the Income-tax Act, 1961.

Abhay Gupta, UM8401