[FAQs] on Personal Tax Planning

To understand the meaning of tax planning, tax avoidance and tax evasion, one can go through the following cases –

Case 1 – X is an individual. For the assessment year 2023-24, his gross total income is Rs. 12,90,000. Tax on Rs. 12,90,000 is Rs. 2,07,480. To reduce his tax liability, he deposits Rs. 1,50,000 in public provident fund account. Consequently, his taxable income and tax liability thereof will be reduced to Rs. 11,40,000 and Rs. 1,60,680 respectively.

As the tax liability has been reduced within the legal framework, it is tax planning.

Case 2 – X Ltd. is a chemical manufacturing company. It has a factory in Haryana near Delhi border. Within the factory campus a piece of land of 2000 square metre is lying unutilized. The company wants to start a new unit to manufacture computer components. If this manufacturing unit is started in the existing factory campus, deduction under section 80-IE is not available. However, if the new unit is started in Assam, the company can claim deduction under section 80-IE. To get the benefit of deduction under section 80-IE, the company starts the new unit in Assam.

The company has two options. Under one of the options, deduction under section 80-IE is not available. However, this deduction is available under the other option. To get the benefit of deduction under section 80-IE, the new unit has been started in Assam. As the tax liability has been reduced to get the benefit of deduction available under the income-tax, it is tax planning.

Case 3 – Suppose in Case 2, the process of manufacturing actually takes place in Haryana. To get the benefit of deduction under section 80-IE, the company takes a factory building on rent in Assam and only on paper it is shown that the new manufacturing unit is situated in Assam.

As the company wants to reduce the tax liability by making incorrect statement about the location of manufacturing process, it is tax evasion.

Case 4 – If Rs. 50,000 is gifted by a husband to his wife, income generated therefrom is taxable in the hands of husband under the clubbing provisions of section 64(1). Section 64(1) is not applicable if gift is made by the same person out of the funds of his Hindu undivided family in capacity as karta of the family.

If gift is made by karta of the family to his wife, clubbing provisions can be avoided and ultimate tax liability will be reduced. However, the tax liability will be reduced by taking the help of a loophole in the law but within the legal framework. It is tax avoidance.

Tax planning can be defined as an arrangement of one’s financial and economic affairs by taking complete legitimate benefit of all deductions, exemptions, allowances and rebates so that tax liability reduces to minimum. Essential features of tax planning are as under –

• It comprises arrangements by which tax laws are fully complied.
• All legal obligations and transactions (both individually and as a whole) are met.
• Transactions do not take the form of colourable devices (i.e., those devices where statute is followed in strict words but actually spirit behind the statute is marred would be termed as colourable devices).
• There is no intention to deceit the legal spirit behind the tax law.

The line of demarcation between tax planning and tax avoidance is very thin and blurred. The English courts about nine decades ago recognized the right of a taxpayer to resort to the legal method of tax avoidance. It is well settled that it is unconstitutional for the Government to attempt tax collection without the authority of law or legal basis. Similarly, a taxpayer cannot escape tax payment outside the legal framework, as he renders himself liable for prosecution as a tax evader.

Tax avoidance is reducing or negating tax liability in legally permissible ways and has legal sanction. Essential features of tax avoidance are as under –

• Legitimate arrangement of affairs in such a way so as to minimize tax liability.
• Avoidance of tax is not tax evasion and carries no public disgrace with it.
• An act valid in law cannot be treated as fictitious merely on the basis of some underlying motive supposedly resulting in lower payment of tax to authorities.
• There is no element of mala fide motive involved in tax avoidance.

Over and over again, the courts have said that there is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible. Tax avoidance is sound law and certainly not bad morality for any body to so arrange his affairs in such a way that the brunt of taxation is the minimum. This can be done within the legal framework even by taking help of loopholes in the law. If on account of a lacuna in the law or otherwise, the assessee is able to avoid payment of tax within the letter of law, it cannot be said that the action is void because it is intended to save payment of tax. So long as the law exists in its present form, the taxpayer is entitled to take its advantage.

The above meaning of tax avoidance has also now acquired the judicial blessings of the Supreme Court of India in Union of India v. Azadi Bachao Andolan [2003] 263 ITR 706/132 Taxman 373, which reversed the findings in its earlier judgment in McDowell & Co. Ltd. v. CTO [1985] 154 ITR 148/122 Taxman 11 as legally incorrect.

All methods by which tax liability is illegally avoided are termed as tax evasion. An assessee guilty of tax evasion may be punished under the relevant laws. Tax evasion may involve stating an untrue statement knowingly, submitting misleading documents, suppression of facts, not maintaining proper accounts of income earned (if required under law), omission of material facts on assessment. All such procedures and methods are required by the statute to be abided with but the assessee who dishonestly claims the benefit under the statute before complying with the said abidance by making false statements, would be within the ambit of tax evasion.

The following are the broad areas of distinction between the two:

Tax management involves the procedures of compliance with the statutory provisions of law. The following are the broad areas of distinction between tax planning and tax management.

Income-tax is an annual tax on income. Before one can embark on a study of the law of income-tax, it is absolutely vital to understand the following expressions found under the Income-tax Act, 1961 –

• Assessment year
• Previous year
• Person
• Assessee
• Income
• Gross total income
• Total Income
• Exemption and deduction

Tax liability of an assessee depends upon his residential status. Suppose an individual generates some income outside India. He is an Indian citizen. To find out whether his foreign income is taxable in India, one has to determine his “residential status” under the provisions of Income-tax Act. Likewise, whether an income earned by a foreign national in India (or outside India) is taxable in India, depends on the residential status of the individual, rather than on his citizenship.

• Provisions regulating residential status and its impact on computation of taxable income

For the purpose of tax planning the following broad propositions should be borne in mind. However, these propositions would hold good only in the context in which they have been made-

• In order to enjoy non-resident status, individuals who are visiting India on a business trip or in some other connection, should not stay in India for more than 181 days during one previous year and their total stay in India during any four previous years preceding the relevant previous year should in no case exceed 364 days.
• If individuals having been in India for more than 365 days during the four years preceding the relevant previous year, wish to stay in India for more than 60 days, they should plan their visit to India in such a manner that their total stay in India falls under two previous years. To illustrate, such persons can come to India any time in the first week of February and stay up to May 29 without incurring any risk of losing their non-resident status.
• An Indian citizen or a person of Indian origin (whether rendering service outside India or not) can stay for a maximum of 119 days on a visit to India without losing his non-resident status. If, however, such persons wish to stay in India for more than 119 days, they should plan their visit in such a manner that their maximum stay of 238 days comes under two previous years, stay in each previous year being not more than 119 days.
• An Indian citizen, leaving India for the purpose of employment, will not be treated as a resident in India, unless he has been in India in that year for 182 days or more. In other words, Indian citizens going abroad for the purpose of employment can stay in India for 181 days without becoming resident in that year, even if they were in India for more than 365 days during the four preceding years. This concession is available only to those who want to leave the country for the purpose of employment. However, the term “employment” is not defined in the Act. One has, therefore, to depend upon judicial pronouncements. It would be useful to quote, Denman and Vaisey, JJ. in this context-

-Per Denman, J. –

“I do not think that employment means only where one is set to work by others to earn money; a man may employ himself so as to earn profits in many ways”

-Partridge v. Mallandine [1886] 18 QBD 276 (DC).

-Per Vaisey, J. –

“The word ’employment’ is one of very wide significance. But the words ’employer’ and the ’employee’ are much more restricted in their meanings. Thus, I may be said to ’employ’ my time or my talents without being in any proper sense an employer, and I may also be said to be employed in some pursuit or activity without being an ’employee’ “

-Westall Richardson Ltd. v. Roulson [1954] 2 AER 448.

Applying the aforesaid ratios, there is no reason why a professional who expects to set up an independent practice in, or a businessman who wants to shift his activities to, a foreign country should be denied the benefit of this concession. A similar ruling is given by the Karnataka High Court in the case of CIT v. O. Abdul Razak [2011] 198 Taxman 1.

• A non-resident can escape tax liability in respect of income earned out of India if he first receives it out of India and then remits the whole or a part of it to India, even though the business is controlled from India.
• A person who is not ordinarily resident, earning income outside India from a business controlled outside India, can avoid tax liability if he first receives such income in a foreign country and then remits the whole or a part of it to India, either in the same year or in the following year(s).
• Not ordinarily resident persons can claim set off of losses sustained in a business controlled from outside India against their income taxable in India provided they shift the control of the business to India.

By virtue of section 10(1) agricultural income is exempt from tax. “Agricultural income” is defined by section 2(1A).

Before discussing tax planning hints pertaining to salary income, it is advisable to understand the following –

• What is salary income?
• What is basis of charge of salary income?
• How to calculate taxable salary?
• How to calculate taxable allowances?
• How to calculate taxable prerequisites?
• What are deductions from salary income?
• How retirement benefits are taxed?
• What is alternative tax regime?

1. Remuneration planning – Making a selection between different possible remuneration plans keeping in view the following broad objectives is remuneration planning-

1. Whatever is paid by employer is deductible in the hands of the employer while calculating business income of the employer.
2. In the hands of the employee it is not chargeable to tax or it is subject to lower tax incidence.

1.1 Broad Hints – Remuneration should be paid in the form of basic salary, different allowances and different perquisites. Tax bill of employees can be reduced substantially if salary is divided into different allowances (which are not taxable or which are partially exempt from tax) and perquisites (which are taxable at concessional rate). The optimum combination of allowances and perquisites depends upon individual requirement of each employee taking into consideration present take home pay and future benefits of different items in salary structure.

• Salary – In case of new appointment, basic salary may be taken at 25 to 30 per cent of total pay package. There is no hard and fast rule. However, tax liability can be reduced if basic salary is reduced and the expenditure by the employer on allowance and perquisites is increased.
• Allowances – The following allowances can be given-
  1. Education allowance for two children may be given wherever it is possible.
  2. Uniform allowance may be given if the employer has uniform code in the organization.
  3. Helper allowance may be given for engaging a helper at residence to complete office work after office hours.
  4. Research allowance can be given for conducting a research on behalf of employer.
• Perquisites – A rent-free house may be given if the employee is interested in employer’s accommodation. If the employee owns a house which he has occupied for his own residence, the house may be taken by the employer on self lease and the same house may be allotted to the employee as rent-free perquisite.Besides, the following perquisites may be given to employees (in the same order of priority) as given below as far as possible-

1. Tea, coffee, snacks, lunch/dinner in factory or office.
2. Conference participation fees.
3. Computer or laptop for office and private use.
4. LTC twice in a block of four years.
5. Medi-claim insurance premium for employee and his family members.
6. Motor car for office and private use along with driver.
7. Telephone at residence along with mobile phone.
8. Staff welfare expenses.
9. Free holiday home.
10. Gift in kind.
11. Club including health club.
12. Scholarship to children.

1.2 Other Points – For the purpose of tax planning under the head “Salaries”, the following propositions should also be kept in view-

• It should be ensured that, under the terms of employment, dearness allowance and dearness pay form part of basic salary. This will minimise tax incidence on house rent allowance, gratuity and commuted pension. Likewise, incidence of tax on employer’s contribution to recognised provident fund will be lesser if dearness allowance forms a part of basic salary.
• The Supreme Court has held in Gestetner Duplicators (P.) Ltd. v. CIT [1979] 1 Taxman 1/117 ITR 1 that commission, payable as per terms of contract of employment at a fixed percentage of turnover achieved by an employee, falls within the expression “salary” as defined in rule 2(h) of Part A of the Fourth Schedule. Consequently, tax incidence on house rent allowance, gratuity and commuted pension will be lesser if commission is paid at a fixed percentage of turnover achieved by the employee.
• As uncommuted pension is always taxable, employees should get their pension commuted. Commuted pension is fully exempt from tax in the case of Government employees and partly exempt from tax in the case of non-Government employees who can claim relief under section 89.
• An employee, being a member of a recognised provident fund, who resigns before completing five years of continuous service, should ensure that he joins a firm which maintains a recognised provident fund for the simple reason that the accumulated balance of the provident fund with the former employer will be exempt from tax, provided the same is transferred to the new employer, who also maintains a recognised provident fund.
• Since employer’s contribution towards recognised provident fund is exempt from tax up to 12 per cent of salary, employer may give extra benefit to their employees by raising their contribution to 12 per cent of salary without increasing any tax liability.
• While medical allowance payable in cash is taxable, provision of medical facilities made available in a few hospitals is not taxable (subject to some conditions). Therefore, employees should go in for free medical facilities instead of fixed medical allowance.
• Since incidence of tax on retirement benefits like gratuity, commuted pension, accumulated balance of unrecognised provident fund is lower if they are paid in the beginning of the financial year, employer and employees should mutually plan their affairs in such a way that retirement, termination or resignation, as the case may be, takes place in the beginning of a financial year.
• An employee should take the benefit of relief available under section 89 wherever possible. Relief can be claimed even in the case of a sum received from unrecognised provident fund so far as it is attributable to employer’s contribution and interest thereon. Although gratuity received during employment is not exempt from tax under section 10(10), relief under section 89 can be claimed. It should, however, be ensured that the relief is claimed only when it is beneficial.
• Pension received in India by a non-resident assessee from abroad is taxable in India. If, however, such pension is first received by or on behalf of the employee in a foreign country and later on remitted to India, it will be exempt from tax.
• As the perquisite in respect of leave travel concession is not taxable in the hands of employees if certain conditions are satisfied, it should be ensured that the travel concession should be claimed to the maximum possible extent without attracting any incidence of tax.
• As the perquisite in respect of free refreshments during office hours, free residential telephone, providing use of computer/laptop, gift of movable assets (other than computer, electronic items, car) by employer after using for 10 years or more are not taxable, employees can claim these benefits without adding to their tax bill.
• Since the term “salary” includes basic salary, bonus, commission, fees and all other taxable allowances for the purpose of valuation of perquisite in respect of rent free house, it would be advantageous if an employee goes in for perquisites rather than for taxable allowances. This will reduce valuation of rent-free house.

For the purpose of tax planning regarding income from house property, the following broad propositions should be borne in mind. However, these propositions would hold good in the context in which they have been made:

• If a person has occupied more than two houses for his own residence, only two houses of his own choice are treated as self-occupied and all the other houses are deemed to be let out. The tax exemption applies only in the case of two self-occupied houses and not in the case of deemed to be let out properties. Care should, therefore, be taken while selecting two houses to be treated as self-occupied to minimise tax liability.
• As interest payable out of India is not deductible if tax is not deducted at source (and in respect of which there is no person who may be treated as an agent under section 163), care should be taken to deduct tax at source in order to avail exemption under section 24(b).
• As amount of municipal tax is deductible on “payment” basis and not on “due” or “accrual” basis, it should be ensured that municipal tax is actually paid during the previous year if the assessee wants to claim deduction.
• As a member of a co-operative society to whom a building or part thereof is allotted or leased under a house building scheme is the deemed owner of the property, it should be ensured that interest payable (even if not paid) by the assessee, on outstanding instalments of the cost of the building, is claimed as a deduction under section 24.
• If an individual makes a cash gift to his wife who purchases a house property with the gifted money, the individual will not be deemed as fictional owner of the property under section 27(i) – K.D. Thakar v. CIT [1979] 120 ITR 190 (Guj.). Taxable income of the wife from the property is, however, includible in the income of individual in terms of section 64(1)(iv). Such income is to be computed under section 23(2) if she uses the house property for her own residential purposes. It can, therefore, be advised that if an individual transfers an asset, other than house property, even without adequate consideration, he can escape the deeming provision of section 27(i) and the consequent hardship.
• Under section 27(i), if a person transfers a house property without consideration to his/her spouse (not being a transfer in connection with an agreement to live apart), or to his minor child (not being a married daughter), the transferor is deemed to be the owner of the house property. This deeming provision was found necessary in order to bring this situation in line with the provision of section 64. But when the scope of section 64 was extended to cover transfer of assets without adequate consideration to son’s wife or minor grandchild by the Taxation Laws (Amendment) Act, 1975, with effect from the assessment year 1976-77 onwards, the scope of section 27(i) was not similarly extended. Consequently, if a person transfers house property to his son’s wife without adequate consideration, he will not be deemed to be owner of the property under section 27(i), but income earned from the property by the transferee will be included in the income of the transferor under section 64 – see CIT v. H.L. Gulati [1982] 11 Taxman 167 (All.). For the purpose of sections 22 to 27, the transferee will, thus, be treated as an owner of the house property and income computed in his/her hands is included in the income of the transferor under section 64. Such income is to be computed under section 23(2) if the transferee uses that property for self-occupation. Therefore, in some cases, it is beneficial to transfer the house property without adequate consideration to son’s wife or son’s minor child.

For the purpose of tax planning regarding income under the head “Capital gains”, the following propositions should be borne in mind. However, these propositions would hold good in the context in which they have been made –

• Since long-term capital gains bear lower tax, taxpayers should so plan as to transfer their capital assets normally only 36 months (24 months/12 months in a few cases) after acquisition. It is pertinent to note that if the capital asset is one which became the property of the taxpayer in any of the manner specified in section 49(1), the period for which it was held by the previous owner is also to be counted in computing 36 months (24 months/12 months in a few cases).
• The assessee should take advantage of exemption under section 54 by investing the capital gain arising from the sale of residential house property in the purchase of another house within the specified period. It may be noted that for claiming exemption for the assessment year 2015-16 (or any subsequent year), the new house property should be situated in India.
• In order to claim advantage of exemption under sections 54B, 54D, 54EC and 54EE it should be ensured that the investment in new asset is made only after effecting transfer of capital assets.
• In order to take advantage of exemption under sections 54, 54B, 54D, 54EC, 54F, 54G and 54GA the taxpayer should ensure that the newly acquired asset is not transferred within three years from the date of acquisition. In this context, it is interesting to note that the transfer of a newly acquired asset according to the modes mentioned section 47 is not regarded as “transfer” even for this purpose. Consequently, newly acquired assets may be transferred even within 3 years of their acquisition according to the modes mentioned in section 47 without attracting capital gains tax liability. Alternatively, it will be advisable that instead of selling or converting assets acquired under sections 54, 54B, 54D, 54F, 54G and 54GA into money, the taxpayer should obtain loan against the security of such asset (even by pledge) to meet the exigency.
• In two cases, surplus arising on sale or transfer of capital assets is chargeable to tax as short-term capital gain by virtue of section 50. These cases are:

(a) when written down value of a block of assets is reduced to nil, though all the assets falling in that block are not transferred,

(b) when a block of assets ceases to exist.

Tax on short-term capital gain can be avoided if –

a. another capital asset, falling in that block of assets, is acquired at any time during the previous year; or

b. benefit of section 54G/54GA is claimed.

Taxpayers desiring to avoid tax on short-term capital gains under section 50 on sale or transfer of capital asset, can acquire another capital asset, falling in that block of assets, at any time during the previous year.