Tax Planning and Nature of Business: formula sheet

Key formulas

Tax planning test

Legal in form + consistent with the purpose of the law + genuine commercial substance = tax planning

If any one element is missing, think avoidance or evasion.

Tax avoidance test

Legal in form + defeats the purpose of the law + main aim is tax benefit = tax avoidance

The arrangement can be struck down or recharacterised; the Income-tax Act, 2025 allows disregarding, combining or recharacterising steps (Section 181(2)(a)).

Tax evasion test

Illegal means: concealment, false statements, false records = tax evasion

Penalty and prosecution follow. Evasion is a wrong, not a choice.

Tax management test

Compliance with law (books, returns, TDS, payment) = tax management

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

Treaty benefit limit

Treaty relief should not create non-taxation or reduced taxation through avoidance, including treaty-shopping (Section 159(3)(b))

Also, a non-resident needs a tax residency certificate from the other country to claim treaty relief (Section 159(8)).

Partner remuneration (Section 26(2)(g))

Business income of partner = Interest, salary, bonus, commission or remuneration received from firm, limited to the amount allowed under section 35(e)

Only the allowed part is taxed in the partner's hands as business income. Check the limit in the exam question.

Firm profit after partner payments

Firm taxable profit = Book profit adjustments − allowed partner payments − other deductions

Allowed payments reduce firm profit and appear in the partner's hands. Do not count them twice.

Investment fund pass-through (Section 224(1))

Unit holder taxed as if investments were made directly by him

Applies to Category I and II AIFs. The fund's business loss is carried forward in the fund and ignored for the unit holder (Section 224(2)(a)). A loss under another head that cannot be set off in the fund is ignored for the unit holder where the unit was held for less than twelve months (Section 224(2)(b)). The section does not expressly ignore such a loss for a unit held for twelve months or longer.

Fund-level tax (Section 224(6))

Fund taxed at Finance Act rates if a company or firm; otherwise at maximum marginal rate

This applies to income of the fund itself, subject to the pass-through rule.

Speculation business (Section 26(3))

Speculation business = distinct and separate from any other business

Compute its profit or loss separately.

After-tax cost of a deductible expense

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

Use for rent, repairs, purchase price of goods bought and interest. Assumes the business has enough taxable profit to use the deduction.

Tax saving on depreciation

Tax saving = Depreciation × tax rate

Depreciation is a non-cash item. Only the tax saving it produces is a cash benefit.

Net present cost of an option

NPC = Σ (after-tax cash outflow ÷ (1 + r)ⁿ) − PV of tax savings − PV of salvage value

Use the after-tax cost of capital for r. Pick the option with the lower net present cost.

Make or buy comparison

Make if after-tax cost of making < after-tax cost of buying

Include only relevant costs. Ignore fixed costs that continue either way.

Lease versus buy

Compare PV of after-tax lease rentals with PV of (purchase cost − depreciation tax shield − interest tax shield − salvage)

Discount at the after-tax cost of borrowing, since lease is a debt-like commitment.

Pass-through rule

Nature and proportion of distributed income in unit holder's hands = Nature and proportion in the trust's hands

Section 223(1). Applies irrespective of anything in other provisions of the Act, except as sub-section (4) says.

Tax on trust's income

Total income of business trust is taxed at the maximum marginal rate

Section 223(2). Subject to sections 196, 197 and 198, which you must check first.

Deemed income of unit holder

Distributed income of the nature in Schedule V (Sl. No. 3 or 4) = income of the unit holder, charged in that tax year

Section 223(3). Check the Schedule V entries in your study material for what they cover.

Exception to pass-through

Section 223(1) does not apply to any sum referred to in section 92(2)(k) received from a business trust

Section 223(4).

Reporting duty

Payer of distributed income gives a statement of nature of income to the unit holder and the prescribed authority

Section 223(5). Time, form and manner are as prescribed.

Quick revision

• Tax planning is legal and uses the law as intended. Tax evasion is illegal and involves concealment or falsehood.
• Tax avoidance follows the letter of the law but defeats its purpose. Always show the contrast with planning.
• Planning must be done before the transaction, with the facts and law in view.
• For make or buy, own or lease and repair or replace, compare after-tax cash flows, not just pre-tax cost.
• Schedule V states income not included in total income of eligible persons, subject to its conditions.
• Sl. No. 1: an investment fund's income, other than income under the head profits and gains of business or profession, is not included.
• Sl. No. 2: in the hands of a unit holder of an investment fund, the section 224 income accruing to, arising to or received by it is not included, but only that proportion which is of the same nature as business or profession income.
• Sl. No. 3: a business trust is covered for interest and dividend from a special purpose vehicle.
• Sl. No. 4: a REIT is covered for rent from real estate assets it owns directly.
• Sl. No. 5: unit holders get no exemption on the part of distributed income that is SPV interest or REIT rental income from real estate assets owned directly. Clause (b), SPV dividend, is omitted w.r.e.f. 1 April 2026, so only these two parts are excluded. Older notes may still list SPV dividend.
• Sl. No. 7 applies only to a specified person, such as a sovereign wealth fund or pension fund that meets the Note 5 conditions. The investment must be made on or after 1 April 2020 and on or before 31 March 2030, and held at least three years.
• For Sl. No. 7, the investment must be in an eligible InvIT, eligible infrastructure entity, eligible Alternate Investment Fund, eligible domestic company or eligible NBFC.
• A special purpose vehicle is an Indian company in which the business trust holds controlling interest.

Common mistakes

• Treating tax avoidance as the same as tax planning. Fix: Add the purpose and substance test. Planning respects the intent of the law; avoidance defeats it.
• Saying tax avoidance is always illegal like evasion. Fix: Say avoidance is not a crime by itself, but the arrangement can be disregarded or recharacterised and the benefit denied.
• Taxing the whole partner remuneration in the partner's hands. Fix: Tax in the partner's hands only the amount allowed as a deduction to the firm under section 35(e).
• Taxing a partner's share of a firm's profit again. Fix: The firm pays tax on its profit. Treat the partner's share of the firm's profit as not taxed again in the partner's hands. Do not extend the section 26(2)(g) rule to an LLP partner unless the question gives that law.
• Comparing pre-tax costs only Fix: Convert every deductible item to after-tax cost using (1 − tax rate) before comparing.
• Treating depreciation as a cash outflow Fix: Count only the tax saving on depreciation (depreciation × tax rate) as a cash inflow.
• Treating all distributions as one type of income, such as a single 'trust distribution'. Fix: Split the distribution by nature. Section 223(1) says the nature and proportion are the same as in the trust's hands.
• Saying the trust pays no tax because income passes through. Fix: Section 223(2) charges the trust's total income at the maximum marginal rate, subject to sections 196, 197 and 198. Pass-through applies to the distributed income in the unit holder's hands.

Exam tips

• Always give the three-way comparison in a table-like point list: meaning, legality, intent, method, consequence.
• Write the facts-based conclusion in case questions. Name the category and the reason.
• Use the exact language of the Act when you cite consequences of avoidance, but cite a section only when sure of it.
• Mention the judicial trend: genuine commercial arrangements are respected, sham or colourable devices are looked through.
• Do not forget tax management as the fourth term when the question asks about differences with planning.
• Quote the exact section for each rule: section 26 for business income, section 224 for investment funds, section 265 for verification.
• Structure answers as provision, facts, conclusion. Add one drafting or compliance point.
• When asked to compare forms, give entity-level tax, owner-level tax and one compliance difference.