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TAX PLANNING WITH REFERENCE TO

NEW BUSINESS FORM OF


ORGANISATION
Roll No Name
4 Bhatt Harshil Kiritkumar
6 Brahmbhatt Harsh Nareshkumar
7 Chauhan Manish
8 Desai Shreel Rakesh
9 Desai Tejas Maheshbhai
11 Doshi Vikrant Harishchandra
Introduction
Business:
An organization or economic system where goods and
services are exchanged for one another or for money.
Every business requires some form of investment and
enough customers to whom its output can be sold on a
consistent basis in order to make a profit.
Factors Influencing Form of
Company
Requirement of finance
Requirement of resources
Personal liability of owner
Level of operation
Quantum of profit
Specified requirement of technical expertise
Tax incentives

One can take a decision while comparing tax liability under


different organization forms.
Form of Business Organization
under Tax Planning
The choice of the appropriate form of business organization will have to be thought of and decided
by the person who intends to carry on business or profession at the beginning itself, because a change
in the form of business organization after the commencement of the business, may attract liability to
tax.

A new business can be organized under any of the following forms:


1. Sole proprietorship
2. Hindu undivided family
3. Association of persons or Body of Individuals
4. Partnership firm/LLP
5. Company
6. Co-operative society
Sole Proprietorship
In the case of a sole proprietorship concern, one of the important tax
disadvantages would be that no allowance or relief would be available to the
tax payer in computing his income from business in respect of even a reasonable
amount of remuneration attributable to the services rendered by him for carrying
on the business. As a result, the taxable income arrived at would be a larger
amount than what it would have been if it had been the case of, say, a private
company in which the individual himself is the Managing Director.

Under sole proprietorship, the entire income of a business unit gets assessed in
the hands of the same person along with other income, while the entire loss and
other allowances shall be available for set off in his hands against other income.
This may have some advantage in the initial years, after which the possibility of
converting it into company/firm may be considered; on such conversion, the
questions of possible capital gains tax, etc., will have to be considered.
Advantages & Disadvantages of Proprietorship
Advantages of a Sole Proprietorship
Easiest and least expensive form of ownership to organize.
Sole proprietors are in complete control, and within the parameters of the law, may make
decisions as they see fit.
Sole proprietors receive all income generated by the business to keep or reinvest.
Profits from the business flow-through directly to the owners personal tax return.
The business is easy to dissolve, if desired.

Disadvantages of a Sole Proprietorship


Sole proprietors have unlimited liability and are legally responsible for all debts against the
business. Their business and personal assets are at risk.
May be at a disadvantage in raising funds and are often limited to using funds from personal
savings or consumer loans.
May have a hard time attracting high-caliber employees, or those that are motivated by the
opportunity to own a part of the business.
Some employee benefits such as owners medical insurance premiums are not directly
deductible from business income (only partially deductible as an adjustment to income).
Partnership Firm

There will be no initial exemption and the entire income will be


taxed. In computing the taxable income of a firm, certain
prescribed deductions in respect of interest and
remuneration have to be allowed. The share income of a firm in
the hands of the partners of the firm is fully exempt.
Advantages & Disadvantages of Partnership Firm
Advantages of a Partnership Firm
Partnerships are relatively easy to establish; however time should be invested in developing the
partnership agreement.

With more than one owner, the ability to raise funds may be increased.

The profits from the business flow directly through to the partners personal tax returns.

Prospective employees may be attracted to the business if given the incentive to become a
partner.

The business usually will benefit from partners who have complementary skills.

Disadvantages of a Partnership Firm


Partners are jointly and individually liable for the actions of the other partners.
Profits must be shared with others.
Since decisions are shared, disagreements can occur.
Some employee benefits are not deductible from business income on tax returns.
The partnership may have a limited life; it may end upon the withdrawal or death of a partner.
Limited Liability Partnership (LLP)
LLP is limited to his agreed contribution. There is no personal
liability of a partner except in the case of a fraud.
Under the income-tax act, the LLP is taxed like a traditional
partnership firm
LLP pays tax on its taxable income at the rate of 30.9%.
Interest on capital is deductible at the maximum rate of 12 %
per annum.
Remuneration to partners is deductible, if such remuneration
is payable to working partners according to the provision of
partnership deed.
Limited Liability Partnership (LLP)
(Contd)
The aggregate remuneration payable to all working partners
cannot exceed 90% of first Rs. 3 lakh of book profit and 60%
of balance of book profit.
Share of profit of partners in LLP is not taxable in the hands of
partners.
However, remuneration and interest are taxable under sec 28
under the head Profit & Gains of business or profession in
the hands of partners to the extent these are allowed as
deduction in the hands of LLP.
Company
On the basis of the ownership and control, a company can either be organized
as a widely held company, i.e. a company in which the public are
substantially interested within the meaning of section 2(18) of the Income-tax
Act, 1961. Alternatively, it can be organized as a closely held company.
Depending upon the choice of the form of organization of the company, the
following important tax consequences would have to be considered from the
view point of tax planning:
The applicability of provisions of section 2(22)(e) regarding deemed dividend
in respect of advances or loans to shareholders would also depend on the fact
whether or not it is a company in which the public are substantially
interested.
The provisions of section 79 regarding restrictions on carry forward of losses
in the event of substantial change in the shareholding of the company also
become applicable if the company is one in which the public are not
substantially interested.
It is significant to note that domestic companies have to pay 17.304 %
(surcharge plus cess on dividend declared, distributed or paid except dividend
under section 2(22)(e).
Aggregate amount of tax liability on firm and partners is generally higher than
that of the case when the same amount of income is generated through sole
proprietorship. One should, therefore, consider the possibility of converting
firms into sole proprietorships. The same is evident from the case studies
given below:
Case Study

Particular Case 1 Case 2 Case 3


Number of partners 3 4 8
Profit-sharing ratio Equal Equal Equal

Total capital contribution of partners (each


contributing identical amount) 10,00,000 15,00,000 80,00,000
Profit of the previous year 2016-17 6,00,000 12,00,000 60,00,000
Tax on firm
Income 6,00,000 12,00,000 60,00,000
Less: salary 3,78,000 7,02,000 31,14,000
LESS: INTEREST @12% 1,20,000 1,80,000 9,60,000
NET INCOME 1,02,000 3,18,000 19,26,000
TAX @ 30.9% 31,518 98,262 5,95,134
Tax liability of each partner 10,506 24,566 74,392
TAX INCIDENCE ON PARTNERSHIP FIRM
100% 80,000
90% 70,000
80%
60,000
70%
60% 50,000

50% 40,000
40% 30,000
30%
20,000
20%
10% 10,000

0% 0
3 4 8
Net Taxable Income 102,000 318,000 1,926,000
Interest 120,000 180,000 960,000
Salary 378,000 702,000 3,114,000
Tax on Partners 10,506 24,566 74,392
Tax on partner : Firm
Particular Case 1 Case 2 Case 3
Number of partners 3 4 8
Salary 126,000 175,500 389,250
Interest 40,000 60,000 320,000
Income 166,000 235,500 709,250
Income after 80C DEDUCTIONS 16,000 85,500 559,250
Tax on net income 0 0 37960

Total tax 10,506 24,566 112,352

Tax on partner : Sole Proprietor


Particular Case 1 Case 2 Case 3
No of Partners 3 4 8
Profit of the previous year 2016-17 600,000 1,200,000 6,000,000
Income by each individual 200,000 300,000 750,000
Net Income after 80C deductions 50,000 150,000 600,000
Taxable Income 0 0 46,350
TAX LIABILITY: PARTNERSHIP FIRM V/S PROPRIETORSHIP FIRM
120,000

100,000

80,000
TAX LIABILITY

60,000

40,000

20,000

0
3 4 8
Partnership Firm 10,506 24,566 112,352
proprietorship Firm 0 0 46,350

To avoid high tax incidence on firms, firms may be converted into sole proprietorship.
Partnership firm
The following basic assumptions have been made
1. There are two partners X and Y with an equal share of profit.
2. They want to draw the maximum permissible amount as salary. Both the
partners will draw equal salary.
3. Income is from business (not from profession)
4. They are entitled to simple interest at the rate of 12 per cent on the capital
contribution of RS.10,00,000.
5. Partners do not have any income.
Taxable
Taxable
income Total tax as
Interest on income of
before Salary payable Tax liability of Tax liability of percentage of
capital to firm after
deduction of to X and Y the firm the partners income (5+6)
partners salary and
salary and as % of (1)
interest
interest

1 2 3 4 5 6 7

Rs. Rs. Rs. Rs. Rs. Rs.

5,00,000 1,20,000 3,18,000 62,000 19,160 0 3.83%

10,00,000 1,20,000 6,18,000 2,62,000 80,960 14,210 9.52%

15,00,000 1,20,000 9,18,000 4,62,000 1,42,760 59,320 13.47%

20,00,000 1,20,000 12,18,000 6,62,000 2,04,560 1,21,120 16.28%

25,00,000 1,20,000 15,18,000 8,62,000 2,66,360 1,82,920 17.97%

30,00,000 1,20,000 18,18,000 10,62,000 3,28,160 2,44,720 19.10%


TAX INCIDENCE ON PARTNERSHIP FIRM AND PARTNERS
100% 350,000

90%
300,000
80%

70% 250,000

60%
200,000
50%
150,000
40%

30% 100,000
20%
50,000
10%

0% 0
500,000 1,000,000 1,500,000 2,000,000 2,500,000 3,000,000
Interest Salary taxable Income Firm Tax Liablity Partner Tax Liablilty
Private limited company
On the same data tax incidence is computed in the case of private limited
company, the following assumptions have been made:
1. X and Y will be the two shareholder and directors of the company.
2. they will draw salary, as there is no maximum limit under the income tax
act. They will draw salary @ 90% of profit up to Rs. 3,00,000 of profit and
60% of balance it is assumed that provision of section 40A(2) are not
attracted.
Taxable
income before Salary to Taxable Total tax of
Tax liability of Taxable Tax liability of
payment of directors X income of the the company
the company income of X X
salary to and Y company X and Y
directors

1 2 3 4 5 6 7
Rs. Rs. Rs. Rs. Rs. Rs. Rs.
5,00,000 3,90,000 1,10,000 33,990 1,95,000 0 33,990
10,00,000 6,90,000 3,10,000 95,790 3,45,000 4,640 1,05,070
15,00,000 9,90,000 5,10,000 1,57,590 4,95,000 20,090 1,97,790
20,00,000 12,90,000 7,10,000 2,19,390 6,45,000 55,620 3,30,630
25,00,000 15,90,000 9,10,000 2,81,190 7,95,000 86,520 4,54,230
30,00,000 18,90,000 11,10,000 3,42,990 9,45,000 1,17,420 5,77,830
TAX INCIDENCE ON PRIVATE LIMITED COMPANY AND
DIRECTORS
100% 400,000
90% 350,000
80%
300,000
70%
60% 250,000

50% 200,000
40% 150,000
30%
100,000
20%
10% 50,000

0% 0
500,000 1,000,000 1,500,000 2,000,000 2,500,000 3,000,000
SALARY COMPANY TAXABLE INCOME
TAX BY COMPANY TAX BY DIRECTOR
FIRM V/S COMPANY
25.00%

20.00%
Total Tax as % of income

15.00%

10.00%

5.00%

0.00%
500,000 1,000,000 1,500,000 2,000,000 2,500,000 3,000,000
Firm 3.83% 9.52% 13.47% 16.28% 17.97% 19.10%
Company 6.80% 10.51% 13.19% 16.53% 18.17% 19.26%
HOW TO REDUCE TAX INCIDENCE
ON COMPANY
firm Private limited company
Partners are increased to five Directors are increased to five
Total salary payable to partner Total salary payable to directors
remains the same (maximum is increased to 90 per cent of
permissible) total income of the company.
(there is no maximum limit on
remuneration payable to
directors)
Tax incidence on Firm and Partners
Taxable Interest Salary Taxable Tax liability Tax liability Total tax as
income on capital payable to income of of the firm of the percentage of
before to 5 Partners firm after partners income (5+6)
deduction partners salary and as % of (1)
of salary interest
and interest

(1) Rs. (2) Rs. (3) Rs. (4) Rs. (5) Rs. (6) Rs. (7) Rs.

5,00,000 1,20,000 3,18,000 62,000 19,160 0 3.83%

10,00,000 1,20,000 6,18,000 2,62,000 80,960 0 8.10%

15,00,000 1,20,000 9,18,000 4,62,000 1,42,760 0 9.52%

20,00,000 1,20,000 12,18,000 6,62,000 2,04,560 0 10.23%

25,00,000 1,20,000 15,18,000 8,62,000 2,66,360 14,200 11.22%

30,00,000 1,20,000 18,18,000 10,62,000 3,28,160 45,100 12.44%


TAX INCIDENCE ON FIRM AND FIVE PARTNERS
100% 350,000

90%
300,000
80%

70% 250,000

60%
200,000
50%
150,000
40%

30% 100,000
20%
50,000
10%

0% 0
500,000 1,000,000 1,500,000 2,000,000 2,500,000 3,000,000
Interest Salary taxable Income Firm Tax Liablity Partner Tax Liablilty
Tax incidence on company and five directors
Taxable
Total tax of
income Salary Taxable Taxable Taxable
Tax of the (7)
before to five income of liability of income
one company as%
payment of director the the of one
director and five of (1)
salary to s company company director
directors
directors

(1) Rs. (2) Rs. (3) Rs. (4) Rs. (5) Rs. (6) Rs. (7) Rs. (8) Rs.

5,00,000 4,50,000 50,000 15,450 90,000 0 15,450 3.09%

10,00,000 9,00,000 1,00,000 30,900 1,80,000 0 30,900 3.09%

15,00,000 13,50,000 1,50,000 46,350 2,70,000 0 46,350 3.09%

20,00,000 18,00,000 2,00,000 61,800 3,60,000 6,180 92,700 4.64%

25,00,000 22,50,000 2,50,000 77,250 4,50,000 15,450 1,54,500 6.18%

30,00,000 27,00,000 3,00,000 92,700 5,40,000 33,990 2,62,650 8.76%


TAX INCIDENCE ON PRIVATE LIMITED COMPANY AND FIVE DIRECTORS
100% 100,000

90% 90,000

80% 80,000

70% 70,000

60% 60,000

50% 50,000

40% 40,000

30% 30,000

20% 20,000

10% 10,000

0% 0
500,000 1,000,000 1,500,000 2,000,000 2,500,000 3,000,000
SALARY COMPANY TAXABLE INCOME TAX BY COMPANY TAX BY DIRECTOR
Firm V/s Company
14.00%

12.00%

10.00%
Total Tax as % of income

8.00%

6.00%

4.00%

2.00%

0.00%
500,000 1,000,000 1,500,000 2,000,000 2,500,000 3,000,000
Firm 3.83% 8.10% 9.52% 10.23% 11.22% 12.44%
Company 3.09% 3.09% 3.09% 4.64% 6.18% 8.76%
The aforesaid proposition is examined
in the following case study:
Firm Private Company

Number of partners : 4 Number of partners : 4

Taxable income before interest\remuneration: Taxable income before interest\remuneration:


Rs. 14,00,000 Rs. 14,00,000

Interest on capital to partners on total capital Remuneration payable to directors :


contribution of Rs. 15,00,000 @ 12% : Rs. Rs.12,00,000 salary to each being Rs. 3,00,000
1,80,000 payable in cash.

Remuneration payable to partners at the


maximum level : Rs. 8,22,000 (salary to each
partner being Rs.2,02,500 payable in cash / kind)
FIRM
Basic pay 1,20,000
Education allowance 2,400
Free residential house at Delhi ( rent paid by employer is Rs. 1,68,000) 158,000
Transport allowance 19,200

Firm income 14,00,000


Less: Interest on capital 1,80,000
book profit 12,20,000
Less : remuneration to partners 8,22,000
Net income of firm 3,98,000
Tax liability of firm (rounded off) 1,22,980

Partner salary 2,05,500


Interest 45,000
Net income 2,50,500
Tax (rounded off) Nil
Tax liability of firm and four partners 1,22,980
Tax incidence as percentage of income 8.78%
Private Limited Company
Income 14,00,000
Less: salary and perquisites to four directors 12,00,000
Net Income 2,00,000
Tax @ 30.9% (rounded off) 61,800
Director
Basic salary 1,20,000
Education allowance (not taxable under section 10 (14) NIL

Valuation of rent free house at Delhi (as per rule 3) 18,000

Gross salary 1,38,000


Less: Standard deduction Nil
Salaries 1,38,000
Net income 1,38,000
Tax on net income Nil
Tax Liability of company and four directors 61,800
Tax incidence as percentage of income 4.41%
Tax Benefits to Firm , LLP & Company
Firm LLP Company
Tax rates 34.608% 34.608% 34.608%

Minimum Alternate Minimum Alternate Minimum Applicable, if normal


alternate tax tax is applicable, if tax is applicable, if tax liability is less than
normal tax liability is normal tax liability is 18.5%(SC+EC+SHEC) of
less than less than book profit
18.5%(SC+EC+SHEC) 18.5%(SC+EC+SHEC)
of adjusted total of adjusted total
income income

Dividend tax Not applicable Not applicable Dividend declared,


distributed or paid is
liable for dividend tax
at the rate of 20.36%.
However, deemed
dividend under section
2(22)(e) is an
exception.
Firm LLP Company

Tax treatment in the Share of profit in firm Share of profit in firm Dividend in the hands
hands of shareholders is not taxable in the is not taxable in the of shareholders is not
or partners hands of partners. hands of partners. taxable. However,
deemed dividend
under section 2(22)(e)
is an exception

Interest on capital to Deductible if Deductible if Shareholder cannot


partners or permitted by the permitted by the be paid interest on
shareholders partnership deed and partnership deed and share capital.
rate of interest does rate of interest does Shareholders get
not exceed 12% not exceed 12% dividend on shares,
conditions of section conditions of section dividend payment is
184 should be 184 should be not a deductible
satisfied. satisfied. expenditure.
Firm LLP Company

Remuneration to Deductible if Deductible if Shareholders can join


partners or shareholders conditions of sec. conditions of sec. the company as
40(b) and 184 are 40(b) and 184 are employees.
satisfied. Aggregate satisfied. Aggregate Remuneration can be
amount deductible amount deductible paid. There is no
cannot, however, cannot, however, maximum ceiling .
exceed 90% of first exceed 90% of first Rs. However, section 40A(2)
Rs. 3 lakh of book 3 lakh of book profit is applicable.
profit and 60% of the and 60% of the
balance. balance.

Applicability of sections Section 78 is Section 78 is Section 79 is applicable,


78 and 79 in case there is applicable applicable if the company is a
a change in constitution company in which the
of the firm or change in public are not
the list of shareholders of substantially interested
a company
Firm LLP company

Loan to partners/ Not taxable as Not taxable as Treated as deemed


shareholders income income dividend in the hands
of shareholders
under section
2(22)(e), if a few
conditions are
satisfied and the
company is a
company in which
the public are not
substantially
interested.

Applicability of Applicable Not Applicable Not Applicable


presumptive tax
schemes under
section 44AD
Firm LLP Company

Whether expenditure Cannot be claimed as Cannot be claimed as Cannot be claimed as


for family planning for deduction under deduction under deduction under
the benefit of section 36(1)(ix). section 36(1)(ix). section 36(1)(ix).
employee is However, deduction However, deduction
deductible under can be claimed under can be claimed under
section 36(1)(ix) section 32 and 37 section 32 and 37
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