Direct Tax Laws and International Taxation · Different Aspects of Tax Planning

Tax Planning for Specific Management Decisions: Make or Buy, Lease, Replace

Updated 11 October 2026 · Fact-checked

Tax planning for specific management decisions means choosing between alternatives (make or buy, own or lease, repair or replace, export or domestic, shut down or continue) on after-tax cash flows, not pre-tax profit. Compute the tax effect of each option, compare net cash cost or benefit, discount if the horizon is long, and recommend.

Understand Tax Planning for Specific Management Decisions

A management decision is usually judged on cost or profit. A tax-planning view adds one question: what does each option do to my tax bill? Interest, rent, repairs and depreciation reduce taxable business income. Sale proceeds, subsidies and incentives may increase it. So the real cost of an expense is the cost after tax saving.

The core idea is simple. After-tax cost of a deductible expense = expense × (1 − tax rate). After-tax value of a taxable receipt = receipt × (1 − tax rate). Depreciation is not a cash flow, but it saves tax, so it adds a cash benefit equal to depreciation × tax rate.

Tax planning is legal arrangement of affairs within the law. It is different from avoidance and evasion. Your recommendation must rest on a real business reason. Do not choose an option only because it saves tax.

In the exam, each decision type has a small twist. In make or buy, only relevant (avoidable) costs count. In own or lease, you compare the net cost of buying (price less the present value of the depreciation tax shield, less after-tax salvage) with the net cost of leasing (after-tax rentals). Count the interest tax shield separately only if the discount rate is not already the after-tax cost of debt. Otherwise it is double-counted. In repair or replace, a repair is generally a revenue expense deductible in the year, while a replacement is capital and gives depreciation. In export or domestic sale, you compare net realisation after taxes, incentives and extra costs. In shutdown or continue, you compare the contribution lost with the avoidable fixed costs saved. The tax effect of any loss depends on the set-off and carry-forward rules, so state your assumption.

Under the Income-tax Act, 2025, business income is charged under section 26. Note that section 26(2)(e) brings export incentives, such as duty drawback or other export incentive received or receivable, into business income. So an export incentive is taxable and must be taken net of tax in an export comparison. Section 26(2)(k) also matters: where an asset whose whole cost was allowed as a deduction under section 46 is sold, discarded or destroyed, the sum received is business income.

Key rules to remember

After-tax cost of a deductible expense: Net cost = Expense × (1 − t); t is the effective tax rate as a decimal. Use for rent, repairs, interest, wages.
After-tax value of a taxable receipt: Net receipt = Receipt × (1 − t); Applies to sale proceeds and taxable export incentives (section 26(2)(e)).
Tax shield on depreciation: Tax saving = Depreciation × t; Depreciation is non-cash. Only the tax saving is a cash flow.
Net cash cost of buying: Purchase price − PV of (Depreciation × t) − PV of after-tax salvage; Compare with the present value of after-tax lease rentals. Choose the lower. Add the interest tax shield only if the discount rate is not already the after-tax cost of debt; otherwise do not count interest again.
Net cash cost of leasing: PV of Lease rental × (1 − t); Discount at the after-tax cost of borrowing if not stated.
Shutdown test: Continue if Contribution > Avoidable fixed costs; The test is contribution against avoidable fixed costs. Applying the same (1 − t) to both sides gives the same answer after tax. Unavoidable fixed costs are ignored. Tax on any loss depends on the set-off and carry-forward rules.

How to solve Tax Planning for Specific Management Decisions questions

Use the same frame for every decision question. It keeps your working clean and earns method marks.

1List the alternatives and the time horizon. Note the tax rate given (use the rate in the question).
2Separate relevant cash flows from sunk or unavoidable items. Drop them.
3Classify each item: deductible expense, taxable receipt, capital item with depreciation, or non-taxable.
4Apply the tax effect to each item: multiply by (1 − t), or compute the depreciation tax shield.
5Discount to present value if cash flows fall in different years. Use the rate given.
6Total the net cost or net benefit for each alternative.
7Compare, then write a clear recommendation in one or two lines.
8Add non-tax factors in a short note: quality, control, liquidity, risk, and that the choice must have a business purpose.

Quickest way: One-line after-tax comparison

When to use it: Use when the horizon is one year or when the question tells you to ignore time value. If a discount rate is given, discount the cash flows.

Write each option as a column with pre-tax cost or benefit.
Multiply every deductible cost and taxable receipt by (1 − t).
Add depreciation × t as a saving for owned assets.
Subtract salvage value after tax, if any.
Pick the option with the lowest net cost or highest net benefit and state it.

Common mistakes in Tax Planning for Specific Management Decisions

Treating depreciation as a cash outflow, or ignoring its tax shield.
Depreciation appears in the profit statement, so students deduct it from cash.
Fix: Add it back as non-cash and include only Depreciation × t as a cash saving.
Comparing pre-tax figures when tax rates or tax treatment differ between options.
Students rush to the contribution comparison.
Fix: Convert every item to after-tax before comparing, and say so in the answer.
Including sunk or unavoidable fixed costs in make or buy and shutdown decisions.
Total cost looks more complete.
Fix: Include only costs that change with the decision. State the costs you excluded.
Forgetting that export incentives and sale proceeds of fully written-off assets are taxable.
Incentive is seen as a pure bonus.
Fix: Tax the incentive as business income under section 26(2)(e), and check section 26(2)(k) for assets whose whole cost was allowed under section 46.
Giving no recommendation, or ignoring non-tax factors.
Students stop after the numbers.
Fix: End with a one-line decision and a short note on non-tax factors and business purpose.

Worked examples

Example 1

Arjun Industries Ltd needs a machine for 3 years. Buy: cost ₹6,00,000, depreciation ₹2,00,000 a year for 3 years, salvage nil. Lease: rental ₹2,40,000 a year, paid at each year end. Tax rate 30%. Ignore interest and time value. Which option is cheaper?

Show the solution

Buy: cash outlay = ₹6,00,000.
Depreciation tax shield = ₹2,00,000 × 30% = ₹60,000 a year. For 3 years = ₹1,80,000.
Net cost of buying = ₹6,00,000 − ₹1,80,000 = ₹4,20,000.
Lease: after-tax rental = ₹2,40,000 × (1 − 0.30) = ₹1,68,000 a year.
Net cost of leasing for 3 years = ₹1,68,000 × 3 = ₹5,04,000.
Compare: ₹4,20,000 against ₹5,04,000.

Answer: Buying costs ₹4,20,000 against ₹5,04,000 for leasing, so buying is cheaper by ₹84,000 on this simplified basis. With discounting, the gap could change, because the purchase outlay is paid up front while the tax shields and rentals fall later. Recompute at the given rate before concluding.

Example 2

Meera Exports Ltd can sell 10,000 units either in India at ₹500 a unit, or abroad at ₹540 a unit. Export costs (freight and packing) are ₹30 a unit. Export incentive is ₹20 a unit and is taxable. Variable cost is ₹350 a unit in both markets. Tax rate 25%. Which market is better?

Show the solution

Domestic: contribution per unit = ₹500 − ₹350 = ₹150.
Domestic after tax = ₹150 × (1 − 0.25) = ₹112.50 per unit.
Export: sale ₹540 + incentive ₹20 = ₹560. The incentive is business income under section 26(2)(e), so it is taxed with the rest.
Export contribution = ₹560 − ₹350 − ₹30 = ₹180 per unit.
Export after tax = ₹180 × 0.75 = ₹135 per unit.
Total for 10,000 units: domestic ₹11,25,000; export ₹13,50,000.

Answer: Export gives ₹13,50,000 after tax against ₹11,25,000 domestically, a gain of ₹2,25,000. Recommend exporting, subject to payment risk, currency movement and availability of the incentive.

Exam tips

Always state the tax rate and the assumptions you used. Examiners give marks for stated assumptions.
Show the tax shield on depreciation as a separate line. It is a common scoring item.
Finish with a decision sentence and one non-tax factor. Do not leave the answer as numbers only.
In MCQs, check whether the question asks for pre-tax or after-tax cost before you calculate.
Link planning to law: business income is under section 26. Do not recommend arrangements that have no business purpose.

Practice questions from Different Aspects of Tax Planning

Tax Planning for Specific Management Decisions in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Tax Planning for Specific Management Decisions: frequently asked questions

What is the main rule in tax planning for make or buy decisions?

Compare only relevant, avoidable costs after tax. Tax saved on deductible costs reduces the real cost of each option. Choose the option with the lower after-tax relevant cost, then check non-tax factors such as quality and supply risk.

How do I decide between own and lease?

Work out the net cash cost of buying: the purchase price less the present value of the depreciation tax shield and the after-tax salvage value. Add the interest tax shield only if your discount rate is not already the after-tax cost of debt. Work out the present value of after-tax lease rentals. Compare them and choose the lower.

Is repair deductible and replacement not?

In general, a repair that only keeps an asset running is a revenue expense deductible in the year. A replacement is capital spending and gives depreciation over time. Check the facts given in the question before classifying.

Are export incentives taxable?

Yes. Section 26(2)(e) of the Income-tax Act, 2025 includes export incentives, duty drawback and similar receipts in business income. So take them net of tax in an export versus domestic comparison.