Tax Planning with Respects to Specific managerial Decisions

• Capital structure
• Dividend Policy and Bonus Shares
• Make or Buy
• Own Or lease or hire
Tax Considerations in Capital Structure
• Cost of capital and tax treatment
• Floatation cost and tax treatment
• Effect of corporate tax rate
• Tax treatment in the hand of investors
Tax treatment of Interest

• Interest on loan/debt/debentures is 100 percent tax deductible while

calculating business income.
• Accrual Basis
• Payment Basis (Section 43 B)
• The proof of the payment ha to be attached along with the return of income

•
1. X ltd. Borrowed Rs. 5,000,000 from IDBI on April 1, 2015 at 12 %
P A. The company paid the interest of Rs. 600000 for the period
1/4/2015 to 31/03/2016 on November 15, 2016. the company
prepares its accounts as per accrual system of accounting. Discuss
the allowability of interest
2. Nishit Ltd took a loan of 1,000,000 (on 1/10/2015 from a private
company for the purchase of an imported machine for its
manufacturing units. The company got the possession of the
machine on 28/02/2016. however the company started using the
machine w.e.f 01/04/2016. the loan carries 14 percent interest.
Discuss the tax treatment of interest for the A Y 2016-17 and 2017-
18
Example No 3:
D B Ltd. Is an existing company and needs capital for its expansion. It has two
option.
• To have equity capital of Rs. 40,00,000 and loaned capital of Rs. 20,00,000 @ 15
percent P A
• To have equity capital of Rs. 20,00,000 and loaned capital of Rs. 40,00,000 @ 15
percent P A
The expected rate of return is 22 percent and company had been distributing
dividend of 20 percent P A for the last several years. Rate of tax is 30 percent
+surcharge @ 5 percent of tax. Education cess is @3 percent of tax and surcharge.
Suggest the better option assuming that company has decided to retain its entire
profits.
Note: the surcharge is applicable only if the total income of the company exceeds
Rs. 1 crore.
 Choice of Capital structure

Option I Option II
Particulars Rs. Rs.
EBIT (22% of 60,00,000) 13,20,000 13,20,000

Less: Interest on Loan (15% of 20,00,000 and 3,00,000 6,00,000

40,00,000)
EBT 10,20,000 7,20,000

Less: Income Tax 3,15,180 2,22,480

PAT (Return on Equity) 7,04,820 4,97,520
Equity Capital 40,00,000 20,00,000

% Return On Equity Capital 17.60% 24.88%

Example No 4:
Shree Lid requires Rs. 75,00,000 to finance its expansion programmes. It has the
following three options
Option I Option II Option III
Share Capital 75,00,000 30,00,000 15,00,000
9% debenture - 30,00,000 20,00,000
Loan from IDBI - 15,00,000 40,00,000
(12%)
75,00,000 75,00,000 75,00,000
The expected rate of return before interest and tax is 25 percent, for the past few
years the company has been declaring a dividend of 16 percent. The tax rate is 30
percent + surcharge 7 percent and education cess 3 percent. The BOD have decided
not to distribute any dividend.
Note: the surcharge is applicable if the total income of the company exceeds 1 crore
but does not exceed Rs. 10 crore.
Which is the best option for the company?
 Choice of Capital structure
Option I Option II Option II
Particulars Rs. Rs. Rs.
EBIT (25% of 75,00,000) 18,75,000 18,75,000 18,75,000

Less: Interest on Loan (9% debenture and 12% IDBI - 4,50,000 6,60,00
Loan)
EBT 18,75,000 14,25,000 12,15,000

Less: Income Tax 5,78,375 4,40,,325 3,75,435

PAT (Return on Equity) 12,95,625 9,84,675 8,39,565

Equity Capital 75,00,000 30,00,000 15,00,000

% Return On Equity Capital 17.28% 32.82% 55.97%

• From the above calculation, it is clear that option III gives maximum rate of return
on Equity capital, therefore, the company should opt for option III
Example No 5:
A Co. requires Rs 50,00,000 to finance an expansion project. The expected
rate of return before interest and tax is 30 percent on the investment. The
debt can be raised by issuing 11 percent debentures. The company has
following 3 options:
Option I Option II Option III

Equity Share Capital 50,00,000 35,00,000 15,00,000

11% Debenture - 15,00,000 35,00,000

The tax rate applicable to company is 30% plus 7 % surcharge (if total
income exceeds 1 crore ) and 3% Education cess . The company has decided
to distribute the entire earnings as dividend. The rate of corporate dividend
tax on the amount of dividend distributed is 17.64706 plus 12% surcharge
plus 3% education cess.
Suggest the best option out of the three option.