Key Words / Outline

1. Corporate Tax Management Key Words / Outline

2. Corporate Tax Management • The term ‘corporate tax management’ consists of three words: • Corporate • Tax • Management

3. Corporate Tax Management • ‘Corporate’ - Corporate means “of a corporation”, where a corporation (or company) is a legal entity formed under the Companies Act having a continued existence, paid-in capital represented by transferable shares, limited liability for the shareholders and a divorce between management and ownership.

4. Corporate Tax Management • ‘Tax’ - Tax is “a contribution exacted by the state” – Chambers English Dictionary (New Delhi: Allide Publishers Ltd., 1992). “The term taxes is confined to compulsory, unrequited payments to general government” – Organization for Economic Cooperation and Development (OECD) (1988).

5. Corporate Tax Management • ‘Management’ - “Management is the process of planning, organizing, leading and controlling the work of organization members and of using all available organizational resources to reach stated organizational goals” – J. A. F. Stoner, R. E. Freeman, and D. R. Gilbert (1998), Management (Prentice-Hall). ‘Organizational resources’ include six M’s – men, materials, machine, money, method, and market. According to Henri Fayol, “To manage is to forecast and plan, to organize, to command, to coordinate and to control.”

6. Corporate Tax Management Thus, ‘corporate tax management’ means dealing with the tax matters of a corporation or company with a view to maximizing the after-tax rate of return on investments after ensuring voluntary tax compliance. For this purpose, each corporate entity has to – 1. ensure that it keeps proper records; 2. deduct tax at source where it is necessary; 3. pay advance tax in time, if applicable; 4. file returns in time; 5. comply with notices received from the tax authorities; and 6. be aware of legal remedies where it does not have its rights under the law recognized.

7. Corporate Tax Functions Tax function activities are those activities which are concerned with fiscal issues. These functions are of two types: 1. Tax compliance activities 2. Tax planning activities

8. Corporate Tax Functions Tax Compliance Activities: Tax compliance activities are those activities which include the functions or obligations according to the provisions of various fiscal statutes. Tax Planning Activities: Tax planning means dealing with the tax matters of a taxpayer with a view to maximizing the after-tax rate of return on investments after ensuring voluntary tax compliance.

9. Tax Evasion, Avoidance & Planning • Tax Evasion: • “Evasion is illegal. It can involve acts of commission or omission” (Webley et al. 1991). • “Noncompliance is a more neutral term than evasion since it does not assume that an inaccurate tax return is necessarily the result of an intention to defraud the authorities and it recognizes that inaccuracy may actually result in overpayment of taxes” (Webley et al. 1991).

10. Tax Evasion, Avoidance & Planning • Tax Evasion: …… cont’d • “‘Tax cheating’ describes deliberate acts of noncompliance and does not entail the difficulty of legal proof of tax evasion” (Webley et al. 1991). • “In evading tax one is knowingly breaking the law. This has social and psychological consequences such as stigma and guilt and involves confronting different costs since there is a risk of being caught and fined or sent to prison” (Webley et al. 1991).

11. Tax Evasion, Avoidance & Planning • Tax Evasion: …… cont’d • “The expression ‘Tax evasion’ means illegally hiding income or concealing the particulars of income or concealing the particular source or sources of income or in manipulating the accounts so as to inflate the expenditure and other outgoings with a view to illegally reduce the burden of taxation. Hence, tax evasion is illegal and unethical” (Lakhotia and Lakhotia 1998).

12. Tax Evasion, Avoidance & Planning • Tax Avoidance: • According to Justice Jagadisan J., “Avoidance of tax is not tax evasion and it carries no ignominy with it, for, it is sound law and, certainly, not bad morality, for anybody to so arrange his affairs as to reduce the brunt of taxation to a minimum” – mentioned in the verdict of Aruna Group of Estate v. State of Madras (1965) case (Palkhivala and Palkhivala 1976).

13. Tax Evasion, Avoidance & Planning • Tax Avoidance: …… cont’d • Avoidance involves ‘every attempt by legal means to prevent or reduce tax liability which would otherwise be incurred, by taking advantage of some provision or lack of provision in the law … it presupposes the existence of alternatives, one of which would result in less tax than the other’ (Report of the Royal Commission of Taxation 1966, 538; vide Webley et al. 1991).

14. Tax Evasion, Avoidance & Planning • Tax Avoidance: …… cont’d • Tax avoidance “is the art of dodging taxes without breaking the law. ……tax avoidance means of traveling within the framework of the law or acting as per the language of the law only in form, but murdering the very spirit of the law and thus acting against the intention of the law and defeating the purpose of the particular legal enactment” (Lakhotia and Lakhotia 1998).

15. Tax Evasion, Avoidance & Planning • Tax Planning: • “‘Tax planning’ takes maximum advantage of the exemptions, deductions, rebates, reliefs and other tax concessions allowed by taxation statutes, leading to the reduction of the tax liability of the tax payer” (Lakhotia and Lakhotia 1998).

16. Tax Evasion, Avoidance & Planning • Tax Planning: …… cont’d • According to Shuklendra and Gurha (1992), the prime objectives of tax planning are to achieve the following results: (i) Reduction of tax liability, (ii) Minimization of litigation, (iii) Productive investment, (iv) Healthy growth of economy, and (v) Economic stability.

17. Tax Evasion, Avoidance & Planning • Tax Planning: …… cont’d • According to Scholes and Wolfson (1992), “Traditional approaches to tax planning fail to recognize that effective tax planning and tax minimization are very different things. The reason is that in a world of costly contracting, implementation of tax-minimizing strategies may introduce significant costs along nontax dimensions. Therefore, the tax-minimization strategy may be undesirable. After all, a particular easy way to avoid paying taxes is to avoid investing in profitable ventures.” Thus, effective tax planning means not to minimize tax, but to maximize after-tax rates of return on assets.

18. Effective Tax Planning Effective Tax Planning vs. Tax Avoidance

19. Effective Tax Planning Effective Tax Planning vs. Tax Avoidance …cont’d

20. Effective Tax Planning • Prerequisites of Effective Tax Planning: • Multilateral Approach • Importance of both implicit tax and explicit tax [Implicit tax is the decrease in return due to availing tax favored investment and Explicit tax is the tax deposited in the treasury.] • Importance of non-tax cost [e.g., advertising cost, cost for maintaining accounts, cost of obtaining information etc.] i.e., ALL PARTIES, ALL TAXES, ALL COSTS

21. Why Study Corporate Tax Management? • Taxpayer’s or Tax Professional’s Perspective: • Preparing to be a Tax Professional • Developing the tax assessment and tax auditing skill • Understanding the tax notices issued by the tax authority and preparing the responses to tax queries • Selecting a new Tax Professional or changing the existing Tax Professional • Selecting the services to be sought from a Tax Professional – tax compliance or tax planning services

22. Why Study Corporate Tax Management? • Tax Authority’s Perspective: • Preparing to be a Tax Executive • Developing the tax assessment and tax auditing skill • Preparing the tax notices to be issued and understanding the responses to tax queries • Selecting a Tax Professional in case of a decision of outsourcing • Selecting the services to be sought from a Tax Professional – tax compliance or tax planning services

23. Taxing Authority • Taxing Authority – as an uninvited party to all contracts: • Brings to each of its “forced” ventures with taxpayers a set of contractual terms (tax rules) • Does not negotiate the contractual terms separately for each venture • Announces a standard set of the above terms taxpayers must accept • Claims a partnership interest in taxpayer’s profit • Does not exercise any voting rights

24. Taxing Authority • Taxing Authority – as an uninvited party to all contracts:………………. cont’d • Does not directly monitor taxpayer’s performance to determine whether taxpayers are violating the contractual terms • But does conducts audits • Being a partner in all firms enable the taxing authority to determine when taxpayers are reporting result far out of line with what other taxpayers are reporting in similar situations (information that is used to select return for audit)

25. Decision Making Process • Time Value of Money • A Taka earned in the future is not as valuable as a Taka today • Cash received or disbursed at different times in the future must be discounted • Net present value (NPV) represents discounted value of all inflows and outflows associated with project

26. 1 = PV (Tk. 1 ) + n ( 1 r ) Present Value • Present value of a Tk.1 after n periods based upon a discount rate of r

27. Present Value-Example • What is the present value of Tk.1 received in 10 years discounted at a 8% interest rate? Answer Tk. 0.4632

28. 1 1 = - PV (Tk. 1 over n periods) + n r r ( 1 r ) Present Value-Annuity • Present value of Tk.1 received for n periods at a discount rate of r

29. Present Value-Annuity Example • Present value of an annuity of Tk. 1 to be received for 10 years discounted at an 8% rate Answer Tk. 6.71

30. Tax Rates • For planning purposes only relevant rate is rate at which the transaction will be taxed • Marginal rate - rate at which next Taka of income will be taxed • May change • Higher bracket due to more income • Law change

31. Why Tax Planning Arises? • Contractual terms that taxing authority imposes on its joint venture --- Tax Rules • Tax Rules result from a variety of socioeconomic forces:- * Finance Public Projects * Redistribute Wealth * Encourage Economic Activities

32. Why Tax Planning Arises? • Government ensures objectives of Tax Rules by – Designing to discriminate among different economic activities This has been done through two things:- • Progressive Taxation (for redistributing wealth) • Subsidy (for encouraging economic activities) Tax Rules provides also to arrange taxpayer’s affairs to keep the tax bite as painless as possible

33. Why Tax Planning Arises? Progressive Taxation, Subsidy and Provision to arrange taxpayer’s affairs to minimize tax-bite Gives rise to marginal tax rate (MTR) that widely varies From one contracting party to the next For a given contracting party over time For a given contracting party over different economic activities

34. Types of Tax Planning • All changes in tax regimes involve turning two types of dials: * Levels of tax rates * Relative tax rates varying -- -- Across different tax paying units -- Across different tax periods for the same taxpayer -- Across different economic activities for the same taxpayer and same time period

35. Types of Tax Planning Thus, types of income tax planning activities are: • Attempts to have income converted from one type to another (ordinary income vs. capital gain, regular income vs. windfall income, domestic income vs. foreign income, set-off of loss under any head); • Attempts to have income shifted from one pocket to another (taxable vs. tax-exempt sources); and • Attempts to have income shifted from one time period to another (delaying recognition of income, if tax rates are constant or declining over time, instant salary vs. deferred compensation)

36. Types of Tax Planning • In short, the types of income tax planning activities are: • Shifting income from one pocket to another • Shifting income from one time period to another • Converting income from one type to another

37. Tax-Favored Status • Full tax exemptions • Partial tax exemptions • Tax credit, rebate, relief, and concession • Tax deduction permitted at a rate faster than the decline in economic value of the asset • Taxable income permitted to be recognized at a rate slower than the increase in the economic value of the assets cash flow

38. Tax-Disfavored Status • Special tax assessment • Tax deduction permitted at a rate slower than the decline in the economic value of the asset • Taxable income permitted to be recognized at a rate faster than the increase in the economic value of the assets cash flow

39. Tax vs. Financial Management Decisions • Financial Management Decisions • Investment Decisions – decision regarding acquisition of fixed assets • Financing Decisions– capital structure decision • Dividend Decisions – decision regarding distribution and/or retention of earnings

40. Tax vs. Financial Management Decisions • Why do Tax Rules influence Investment Decisions? • Tax rules affect the before-tax rates of return on assets. Some firms select investments with high before-tax rates of return while others select assets with low before-tax rates of return even when both types of investments are available to all firms. • Before-tax rate of return means the rate of return earned from investing in an asset before any taxes are paid to domestic and foreign, central and local taxing authorities.

41. Tax vs. Financial Management Decisions • Why do Tax Rules influence Investment Decisions? ………….. cont’d • The before-tax rates of return differ because: • the returns to different types of assets are taxed differently, • the returns to similar assets are taxed differently if they are located in different tax jurisdictions, • the returns to similar assets located in the same tax jurisdiction are taxed differently if they are held through different legal organizational forms (such as a corporation versus a sole proprietorship), and

42. Tax vs. Financial Management Decisions • Why do Tax Rules influence Investment Decisions? ………….. cont’d • The before-tax rates of return differ because: .. cont’d • the returns to similar assets located in the same tax jurisdiction and held through same legal organizational form are taxed differently depending upon such factors as: • the operating history of the organization, • the returns to other assets held by the organization, and • the particular characteristics of the individual owners of the organization.

43. Tax vs. Financial Management Decisions • Why do Tax Rules influence Financing Decisions? • Tax rules influence the financing decisions of firms through their effect on the cost of financing the firm’s activities. • The cost of issuing a capital structure instrument depends on the tax treatment it is accorded, which, in turn, depends on whether the instrument – • is debt, equity, or a hybrid, • is issued to an employee, a customer, a related party, a bank, or any one of a number of other special classes of suppliers of capital, and • is issued by a corporation, a partnership, or some other legal organizational form.

44. Tax vs. Financial Management Decisions • Why do Tax Rules influence Dividend Decisions? • If investment by individual investor is deemed to be tax-advantageous relative to corporations, it is important to determine whether existing corporations should liquidate (so individual investors can reinvest the funds in ways that result in single-level taxation) or whether retained earnings should be reinvested at the corporate level, if there exist projects that generate returns above the competitive rate.

45. Tax vs. Financial Management Decisions • Why do Tax Rules influence Dividend Decisions? …………. cont’d • Say, a company distributes Tk. 1 as a dividend today, shareholders pay taxes at their own ‘personal tax rates’, and reinvest the ‘after-tax income on their own account for n periods at an after tax rate of return per period. If the company retains the Tk. 1 of after-tax corporate income, on the other hand, and invests it on corporate account, it returns at corporate rate per period after tax until it finally distributes the accumulated amount of retained earnings. At that time, shareholders pay tax on the distribution at his personal tax rate then. So we can compare the two alternatives as follows: • Liquidate and invest on personal account for n periods • Retain and invest on corporate account for n periods before liquidating

46. Tax vs. Financial Management Decisions • Why do Tax Rules influence Dividend Decisions?…………. cont’d • The best strategy depends upon two factors: • the investor’s marginal tax rate today, versus the investor’s marginal tax rate in the future, (a decreasing tax rate, or an ability to convert dividend income into a capital gain taxed at a reduced rate, favors dividend deferral), and • the corporate versus investor tax rate (a higher corporate rate favors current payout)

47. Tax Planning as a Tax-Favored Activity • Tax Planning itself is a tax-favored activity because- • Money spent thereon is tax deductible • Tax savings arising from tax planning is effectively tax exempt because they reduce taxes payable & hence, more tax-favored than tax-exemption When PTROR (pre-tax rate of return) is equal to ATROR (after-tax rate of return), then it is called tax exemption (a situation in which an asset escapes explicit taxation). PTROR=Pre-tax Return/Pre-tax Investment ATROR=After-tax Return/After-tax Investment

48. Tax Planning as a Tax-Favored Activity • Tax Planning itself, a tax-favored activity – Example • Two alternatives with marginal tax rate (MTR) of 15%: • Alternative-1: Invest Tk. 10,000 in fully taxable corporate bonds for one year with a yield of 10% p.a. before taxes. • Alternative-2: Invest Tk. 10,000 in tax planning services to save Tk. 11,0000 in taxes in one year. • PTROR (pre-tax rate of return) for Alternative-1: (Tk. 10,000x10%)/Tk. 10,000=10% • PTROR (pre-tax rate of return) for Alternative-2: (Tk. 11,000 – Tk. 10,000)/Tk. 10,000=10% • ATROR (after-tax rate of return) for Alternative-1: [(Tk. 10,000x10%)(1 – 15%)]/Tk. 10,000=8.50% • ATROR (after-tax rate of return) for Alternative-2: [(Tk. 11,000 – Tk. 10,000) (1 – 0%)]/[Tk. 10,000(1 – 15%)]=11.76% Thus, Alternative-2 yields higher ATROR & hence, tax-favored.

49. Factors Affecting Tax Planning • Which entity undertakes the transaction? • Over what period does transaction take place? • In which jurisdiction does the transaction take place? • What is the character of the income?

50. Tax Planning Principles • Taxes decrease if income earned by entity is subject to a low rate • Taxes decrease if payment can be deferred to a later year • Taxes decrease if income is generated in a low rate jurisdiction • Taxes decrease if income is taxed at a preferential rate