Tax Planning and Managerial Decisions: formula sheet

Key formulas

Tax planning

Lawful + genuine commercial purpose + uses benefits the law gives

Done before or while the decision is taken, with full disclosure.

Tax avoidance

Within the letter of law, but against its intent; often artificial steps

Not a crime in itself, but may be denied under anti-avoidance rules.

Tax evasion

Illegal means: concealment, false entries, suppression of income

Attracts penalty and prosecution.

Tax management

Compliance: returns, TDS/TCS, records, assessments, appeals

Aims to avoid penalty and interest, not to reduce the tax base.

Treaty benefit (Section 159(4))

Act applies only to the extent more beneficial to the assessee

Section 159(6) makes Chapter XI apply even if it is not beneficial.

Treaty claim by non-resident (Section 159(8))

Non-resident assessee obtains residency certificate from the Government of the other country or specified territory + provides other prescribed documents and information

Both are conditions for claiming relief under the agreement.

International transaction (Section 163(1))

Transaction between two or more associated enterprises, one necessarily a non-resident

Section 163(2) can deem a transaction with a third party to be one, if a prior agreement exists or terms are set in substance with the associated enterprise.

After-tax cost of a deductible expense

After-tax cost = Pre-tax cost × (1 − t)

t is the tax rate given in the question, as a decimal. Use it only for costs allowed as a deduction.

Tax shield on depreciation

Tax shield = Depreciation × t

Depreciation is not a cash cost. It matters only through the tax saving. Use the depreciation figure the question supplies.

Relevant cost of making

Make cost = Variable cost + Avoidable fixed cost + Opportunity cost (if any)

Leave out unavoidable fixed overheads. They are the same under both options.

Decision rule

Choose the option with the lower after-tax net cost

Compare per unit or in total, but keep the same basis for both options.

Indifference point

Break-even quantity = Extra fixed cost of making ÷ (Buy price − Variable make cost), with both parts on the same tax basis

Use it only when the buy price is higher than the variable cost of making. If it is not, making is never cheaper at any quantity. When that condition holds, making is cheaper above this quantity and buying is cheaper below it. The extra fixed cost of making must include avoidable fixed cost and the cost of any asset, net of the depreciation tax shield. Put the numerator and denominator on the same basis, either both pre-tax or both after-tax. Applies when the fixed cost is incurred only if you make.

Depreciation on block of assets

Depreciation = prescribed rate × written down value of the block

Section 33(3)(a). Use the rate given in the question. WDV falls each year by the depreciation claimed.

Half-rate rule

Depreciation = 50% of the prescribed rate

Section 33(4). Applies if the asset is acquired in the tax year and used for less than 180 days in that year.

Additional depreciation on new plant

20% of actual cost in the year of use; 10% if used for less than 180 days, with 10% more in the next year

Section 33(8) and (9). It needs a manufacturer or power business (generation, transmission or distribution) that acquires and installs new machinery or plant and first puts it to use for business. It is not allowed on plant used by anyone else before, plant installed in office premises or residential accommodation (including a guest house), office appliances, road transport vehicles, or an asset whose whole actual cost is deducted in computing business income.

Depreciation tax shield

Tax shield = depreciation × tax rate

Depreciation is non-cash. The saving is the tax avoided.

After-tax lease rental

After-tax rental = lease rental × (1 − tax rate)

Lease rentals are a deductible business expense. Assumes the lessee has enough profit to absorb the deduction.

Discount rate

After-tax cost of debt = interest rate × (1 − tax rate)

Use it unless the question gives another rate.

Net present cost of owning

NPC (own) = cost − PV of depreciation tax shields − PV of after-tax salvage proceeds

If the asset is bought on a loan and the discount rate is already after-tax, do not also deduct the interest separately.

Net present cost of leasing

NPC (lease) = PV of after-tax lease rentals

Choose the option with the lower NPC.

After-tax cost of an expense

After-tax cost = Expense × (1 − tax rate)

Use for repairs, running costs and renewal costs that are revenue expenses and deductible.

Depreciation tax shield

Tax saving = Depreciation × tax rate

Depreciation is a non-cash item. Only the tax it saves is a cash flow.

Block depreciation

Depreciation = Prescribed rate × Written down value of the block

Section 33(3)(a). Halve the rate if the asset is acquired and used for fewer than 180 days in the year (section 33(4)).

Additional depreciation on new plant

Additional deduction = 20% × actual cost (10% + 10% in next year if used under 180 days)

Section 33(8) and (9). Only for eligible manufacturers or power businesses and eligible new plant. Not available if the plant was used by another person before installation, is installed in office or residential premises, is an office appliance or road transport vehicle, or is an asset whose whole actual cost is allowed as a deduction. These section 33(8)(d) exclusions are drafted for plant other than a ship or an aircraft.

Terminal loss on a discarded tangible asset (power undertakings)

Deduction = WDV − (moneys payable including scrap value), if written off in books

Section 33(10) applies only to assets on which depreciation was claimed and allowed under section 33(2), that is, assets of an undertaking generating or generating and distributing power, where depreciation is on actual cost. Conditions: asset sold, discarded, demolished or destroyed in a year other than the year it is first used, proceeds below WDV, and deficiency written off in books. For ordinary block assets under section 33(3), this provision does not give a separate terminal loss. The sale proceeds reduce the WDV of the block instead.

Net cash outflow of replacement

Cost of new asset − sale proceeds of old asset − tax saving on loss (or + tax on gain) − PV of depreciation shield

Compare with the PV of after-tax costs of retaining. Use the same time horizon.

After-tax cash flow of continuing

Cash flow after tax = Pre-tax cash flow − Tax payable + Tax saved on loss

Tax saved on a loss exists only if the loss can actually be set off or carried forward and used.

Tax saving on a usable loss

Tax saved = Loss set off × Tax rate

Use the rate that applies to the income against which the loss is set off. Add surcharge and cess only if the question gives them.

Avoidable cost test

Continue if Revenue > Avoidable (variable and avoidable fixed) costs

Unavoidable costs are paid in both options, so they do not change the decision before tax.

Ring-fenced losses

Speculation loss → speculation profit only; specified business loss → specified business profit only; race horse activity loss → that activity's income only

Sections 113, 114 and 115. Sections 113 and 115 limit carry forward to four succeeding tax years. Section 114 sets no time limit on carry forward against specified business profit.

Change of shareholding test

Carry forward allowed only if persons holding ≥ 51% of voting power on the last day of the current year also held ≥ 51% of voting power on the last day of the year or years of the loss

Section 119(3)(a), for a company in which the public are not substantially interested. An eligible start-up (section 140) has a separate rule in section 119(3)(b) for losses within ten years of incorporation. Other exceptions are in section 119(4).

After-tax cost of debt

Kd (after tax) = Interest rate × (1 − tax rate)

Use the effective tax rate including surcharge and cess if the question gives it. Applies only if interest is fully deductible and the company has taxable profit.

Tax saving on interest

Tax saved = Deductible interest × tax rate

Interest not deductible, for example interest on funds for an asset not yet put to use under section 32(b)(i), gives no saving.

Cost of equity (dividend based)

Ke = Dividend per share ÷ Market price per share (no growth case)

No tax shield, because dividend is paid out of profit after tax.

Deduction rule for interest

Section 32(b): interest on capital borrowed for business or profession

Excludes interest from the borrowing date until the asset is first put to use, where the capital was borrowed to acquire that asset.

Recharacterisation power

Section 181(3)(a): equity may be treated as debt or vice versa

Applies when an arrangement is declared an impermissible avoidance arrangement.

Net worth in slump sale

Net worth = Aggregate value of total assets − Value of liabilities (as per books)

Revaluation is ignored. Section 77(5)(a). Net worth is deemed the cost of acquisition and cost of improvement for sections 72 and 73 (section 77(3)(a)).

Aggregate value of total assets

Depreciable assets = WDV of block; self-generated goodwill = nil; assets fully allowed under section 46 = nil; other assets = book value

Section 77(5)(b).

Slump sale capital gain

Capital gain = Full value of consideration (FMV of the capital assets on the date of transfer, computed in the prescribed manner) − Net worth

Section 77(3)(b) deems the FMV to be the full value of consideration. Long-term if undertaking held more than 36 months, otherwise short-term. Section 77(1), (2) and (3).

After-tax comparison

After-tax profit = Pre-tax profit − Tax on that profit

Compare each option on this basis, with cash timing.

Business income inclusions

Section 26(2) items: export incentives, keyman insurance receipts, FMV of inventory converted to capital asset, and more

These are taxed as business income, not capital gains.

International transaction

Transaction between associated enterprises, at least one non-resident (section 163(1))

Includes sale of goods, services, lending and cost-sharing; arm's length pricing applies.

Quick revision

• Every decision: list options, find relevant cash flows, adjust for tax, compare, recommend.
• Ignore sunk costs. Only future cash flows that differ between options matter.
• Tax shield on an expense = expense × tax rate.
• Depreciation is a non-cash item. It matters only through the tax it saves.
• Section 33 allows depreciation on tangible assets and listed intangible assets, but not on goodwill, if used wholly and exclusively for business.
• Depreciation on a block of assets is a percentage of written down value, not of original cost.
• Under section 33(4), depreciation is restricted to 50% of the prescribed rate for an asset used for less than 180 days in its first year.
• Unabsorbed depreciation is carried forward under section 33(11) and added to the next year's allowance.
• In own or lease, compare the present value of after-tax costs, not the raw totals.
• In shut down or continue, avoidable fixed costs and contribution decide the answer.
• Interest is deductible. Dividends are paid out of post-tax profit.
• Under section 69, buy-back consideration is compared with cost of acquisition to compute the shareholder's capital gains, and a promoter may bear additional tax as the section provides.
• Write a conclusion that names the better option and gives the reason.

Common mistakes

• Treating tax avoidance as the same as tax evasion. Fix: Evasion is illegal. Avoidance is within the letter of the law but defeats its intent. Say this distinction explicitly.
• Calling tax management a way to reduce tax. Fix: Tax management is about compliance and avoiding penalty and interest. Reduction of liability is planning.
• Including unavoidable fixed overheads in the cost of making Fix: Ask of each cost: does it go away if we buy? If not, leave it out.
• Comparing a pre-tax make cost with an after-tax buy cost Fix: Put both options on an after-tax basis before you compare.
• Discounting at the pre-tax interest rate. Fix: Use interest × (1 − tax rate) unless the question gives a discount rate. Cash flows are after tax, so the rate must be too.
• Ignoring the depreciation tax shield and comparing the cost with pre-tax rentals. Fix: Depreciation is not a cash flow, but it saves tax. Always compute depreciation × tax rate and deduct it from the cost of owning.
• Treating depreciation as a cash outflow or inflow. Fix: Count only the tax saved: depreciation × tax rate.
• Ignoring tax on repairs and running costs. Fix: Multiply every deductible expense by (1 − tax rate) before discounting.
• Counting unavoidable fixed costs as a reason to close. Fix: Include only avoidable costs in the comparison. Unavoidable costs are the same under both options.
• Assuming every loss can be set off against any income. Fix: Check the type of loss first. Speculation, specified business and race horse activity losses are ring-fenced under sections 113, 114 and 115.

Exam tips

• Open any distinction answer with one-line definitions of all four terms, then compare on legality, intent and purpose.
• In case questions, label the facts first, then give the conclusion; markets reward the reasoning chain.
• Quote Section 159 and Section 163 conditions exactly: at least one non-resident, associated enterprises, residency certificate.
• Finish with a practical point: documentation, board approval or disclosure.
• Do not state that avoidance is a crime; say it is within the letter of the law but may be countered.
• Write the tax rate and your assumptions in the first line. Marks follow the steps.
• Show a clear table of relevant costs for each option. A tidy layout helps the examiner follow you.
• Always finish with a recommendation and a line on non-tax factors. The paper is descriptive and case-based.