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Goods and Services Tax (GST) and Corporate Tax Planning · Corporate Tax Planning

Tax Planning for Setting Up a New Business: Form, Location and Nature

Updated 11 October 2026 · Fact-checked

Tax planning for a new business means choosing the form of organisation, location, nature of business and capital structure so that you legally pay the lowest tax. You compare the tax cost of each option, check the conditions for any incentive, and document a genuine commercial reason for the choice.

Understand Tax Planning for Setting Up a New Business

Tax planning at the start is the cheapest planning you will ever do. Once the business is running, the form, place and funding are hard to change. So you look at four decisions before you begin: the form of organisation, the location, the nature of business and the capital structure.

Form of organisation. A company is taxed as a separate person. A partnership firm or LLP is taxed as a firm, and the partners are then taxed on what they receive from it. A sole proprietor is taxed on the whole profit at individual rates. You compare the total tax burden of each form, not just the first layer. Also weigh non-tax factors: limited liability, compliance cost, ease of raising funds and continuity. The correct answer is rarely 'the lowest rate'. It is the lowest total tax that still fits the business.

Location. Where you set up decides which incentives you can claim. The Income-tax Act, 2025 contains relief on shifting an industrial undertaking from an urban area to a non-urban area (section 87) or to a Special Economic Zone (section 88). Under both sections, any capital gain not spent on the new asset must be deposited in a specified bank or institution before the return is filed and not later than the due date under section 263(1). Proof of deposit goes with the return. Other location benefits, such as area-based deductions, also matter. Always check the conditions before you recommend a location, since the benefit is lost if a condition fails.

Nature of business. Manufacturing, services, trading, infrastructure and export businesses are treated differently. Some natures attract special deductions, special rates or special schemes. Choose the nature only where it makes commercial sense, because a business cannot be adopted purely for tax.

Capital structure. Interest on borrowing is generally deductible against business income. Dividend on shares is paid out of profit after tax. So debt is usually cheaper in tax terms than equity, but too much debt raises financial risk. You also plan the start-up costs: preliminary expenses under section 44 are spread over five years, subject to a ceiling.

Key rules to remember

Preliminary expenses deduction (section 44)
Annual deduction = 1/5 × eligible expenditure, for 5 successive tax years
Applies to an Indian company or a resident non-company assessee. The first year is the year business commences (pre-commencement) or the year extension completes or new unit starts (post-commencement).
Ceiling on preliminary expenses
Total eligible expenditure ≤ 5% of cost of the project, or 5% of capital employed (company, at its option)
Cost of the project means the actual cost of fixed assets such as land, buildings, leaseholds, plant, machinery, furniture, fittings and railway sidings. Capital employed means issued share capital, debentures and long-term borrowings.
Eligible expenditure for a company
Feasibility and project report, survey, engineering services, legal charges for agreements; plus MoA and AoA drafting and printing, registration fees, and public issue costs
Public issue costs include underwriting commission, brokerage and charges for drafting, typing, printing and advertisement of the prospectus.
Audit condition for non-company assessees
Accounts audited before the specified date, and audit report furnished for the first year of claim
Applies to a person other than a company or co-operative society.
Relief on shifting undertaking (sections 87 and 88)
If cost of new asset < capital gain: taxable gain = capital gain − cost of new asset. If cost of new asset ≥ capital gain: no capital gain is charged.
The new asset must be bought, acquired or constructed within one year before or three years after the transfer. Section 87 covers shifting from an urban area to a non-urban area. Section 88 covers shifting to a Special Economic Zone. Gain not spent on the new asset must be deposited under the notified scheme before the return is filed and not later than the due date under section 263(1). Proof of deposit must be filed with the return.
Cost of new asset on early transfer
Transfer within 3 years of acquisition: cost = nil (if cost of new asset ≥ gain) or cost reduced by the amount of the capital gain (if cost of new asset < gain)
This is the cost adjustment for computing gain when the new asset is transferred within three years. It applies under both sections. The cost cannot go below nil.

How to solve Tax Planning for Setting Up a New Business questions

Use the same four-part frame for any question, whether it asks for advice or a computation.

  1. 1Read the facts and list what is fixed: the promoters, capital needed, products, markets and whether the business is new or an extension.
  2. 2Identify which of the four heads the question tests: form, location, nature or capital structure. Many questions test two.
  3. 3For form of organisation, compute total tax in each form (entity tax plus the owner-level tax) and compare, then add non-tax factors such as liability and compliance.
  4. 4For location or nature, state the relevant provision and test every condition against the facts: who the assessee is, what asset is transferred, where it is shifted and the time limits.
  5. 5For capital structure, compare the after-tax cost of debt and equity and note the limits on the deduction.
  6. 6For start-up costs, check the items against the list in section 44, apply the 5% ceiling and spread over five years.
  7. 7Compute the figure step by step with clear working.
  8. 8Conclude with a recommendation, and add that the plan must be genuine, within the law, and properly documented.

Quickest way: Four-question check for new business planning

When to use it: Use it when time is short and the question gives a scenario with a request to advise.

  1. Form: which structure gives the lowest total tax and still suits liability and funding needs?
  2. Location: is any incentive available, and are all the conditions met?
  3. Nature: does the activity qualify for any special deduction or rate?
  4. Capital: is debt or equity better after tax, and what happens to start-up expenses?
  5. Write one line on each, then one line on legality: planning, not avoidance or evasion.

Common mistakes in Tax Planning for Setting Up a New Business

  • Choosing the form of organisation only on the tax rate of the entity.

    Students stop after the first layer of tax.

    Fix: Add the tax the owners pay on profit or distributions, and then compare total burden. Mention non-tax factors too.

  • Claiming the whole preliminary expenditure in the year it is incurred.

    The expense feels like an ordinary revenue cost.

    Fix: Remember that it is deducted in five equal instalments, starting from the year of commencement or of extension completion, and only up to the 5% ceiling.

  • Ignoring the 5% ceiling or using the wrong base.

    Students forget there are two bases.

    Fix: Use 5% of the cost of the project, or for a company, 5% of capital employed at its option. Include only items listed as cost of the project or capital employed.

  • Applying section 87 or 88 relief without checking the conditions.

    Students remember only the headline of relief on shifting.

    Fix: Check that it is an industrial undertaking in an urban area, that the assets are the listed types, that the new asset is acquired within one year before or three years after, and that unspent gain is deposited by the return due date.

  • Treating the section 87 and section 88 relief as the same.

    The wording is nearly identical.

    Fix: Section 87 applies when shifting to an area other than an urban area. Section 88 applies when shifting to a Special Economic Zone, which can be in an urban or any other area.

  • Recommending a structure with no commercial reason, just to save tax.

    Students think planning means any arrangement that cuts tax.

    Fix: State that the choice must have genuine commercial substance and be within the law.

Worked examples

Example 1

A new Indian company, Kaveri Foods Ltd, starts business in the tax year 2027-28. Its eligible preliminary expenses (feasibility report, MoA and AoA drafting, registration fees) are ₹9,00,000. Cost of the project is ₹1,50,00,000 and capital employed is ₹1,60,00,000. The company opts for the cost of the project as the base. Find the deduction each year.

Show the solution
  1. Ceiling = 5% of cost of the project = 5% × ₹1,50,00,000 = ₹7,50,000.
  2. Actual eligible expenditure is ₹9,00,000. It is more than the ceiling, so only ₹7,50,000 is allowed.
  3. Deduction per year = ₹7,50,000 ÷ 5 = ₹1,50,000.
  4. The five years start with the year in which business commences, so 2027-28 to 2031-32.
  5. The excess of ₹1,50,000 (₹9,00,000 − ₹7,50,000) is not allowed under this section.

Answer: Deduction of ₹1,50,000 each year for five tax years from 2027-28. The excess ₹1,50,000 is disallowed.

Example 2

Anand Engineering Ltd shifts its industrial undertaking from an urban area to a notified non-urban area. It transfers the old factory building and land and earns a capital gain of ₹80,00,000. Within the permitted time it buys new plant and machinery for the undertaking in the new area for ₹65,00,000. Compute the taxable capital gain and state the rule for the cost of the new asset if it is sold after two years.

Show the solution
  1. The conditions are met: industrial undertaking, urban area, shifting to an area other than an urban area, new plant bought within the time limit. So section 87 applies.
  2. Cost of the new asset is ₹65,00,000, which is less than the capital gain of ₹80,00,000.
  3. Taxable gain = ₹80,00,000 − ₹65,00,000 = ₹15,00,000. It is charged as capital gains of the year of transfer.
  4. If the new asset is transferred within three years of purchase, its cost for computing gain is reduced by the amount of the capital gain, because the cost of the new asset is less than the gain (section 87(1)(B)).
  5. Cost of ₹65,00,000 reduced by the capital gain of ₹80,00,000 gives −₹15,00,000. The cost cannot go below zero, so it is taken as nil.

Answer: Taxable capital gain is ₹15,00,000. If the new plant is sold within three years, its cost of ₹65,00,000 is reduced by the capital gain of ₹80,00,000, which gives nil (it cannot go below zero), so the cost is taken as nil for computing gain on that sale.

Exam tips

  • Answer advice questions in the order: provision, analysis of the facts, conclusion. Link every recommendation to the facts.
  • Write the section number only where you are sure. Section 44 for preliminary expenses and sections 87 and 88 for shifting of an industrial undertaking are the ones to remember.
  • For form of organisation, give a short comparison of company, firm and sole proprietor, then recommend one.
  • Show the ceiling calculation for preliminary expenses even if the expense is below it, so the examiner sees you checked.
  • End with a sentence that the plan is legitimate tax planning and not avoidance or evasion.

Practice questions from Corporate Tax Planning

Tax Planning for Setting Up a New Business 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 Setting Up a New Business: frequently asked questions

What are the main areas of tax planning when setting up a new business?

They are the form of organisation, location, nature of business and capital structure. You decide these before you start because they are costly to change later. Each is judged on total tax and on commercial fit.

How are preliminary expenses treated under the Income-tax Act, 2025?

Under section 44, eligible expenses are deducted in five equal yearly instalments. The total is capped at 5% of the cost of the project or, for a company at its option, of the capital employed. The assessee must be an Indian company or a resident non-company.

What is the difference between section 87 and section 88?

Section 87 gives relief when an industrial undertaking shifts from an urban area to an area other than an urban area. Section 88 gives relief when it shifts to a Special Economic Zone, which may be in an urban or other area. The method of computing the relief is the same.

What happens if the capital gain is not used for the new asset before the return is filed?

The unspent amount is deposited in a specified bank or institution before the due date of the return. If it is still unused after three years from the transfer, it is charged as income of the year in which the three years expire. The assessee can withdraw it under the notified scheme.