Question

  Explain some of the various reasons one would want to use effective tax planning methodologies when establishing an S Corporation.

Answer 1

Tax planning

Tax Planning involves planning in order to avail all exemptions, deductions and rebates provided in Act. For availing benefits, one should resort to bonafide means by complying with the provisions of law in letter and in spirit. Tax Planning is resorted to maximize the cash inflow and minimize the cash outflow. Since Tax is kind of cast, the reduction of cost shall increase the profitability. Every prudence person, to maximize the Return, shall increase the profits by resorting to a tool known as a Tax Planning.

• The Planning should be done before the accrual of income. Any planning done after the accrual income is known as Application of Income and it may lead to a conclusion of that there is a fraud.
• Tax Planning should be resorted at the source of income.
• The choice of location of business , undertaking, or division also play a very important role.
• Choice to Buy or Lease the Assets. Where the assets are bought, depreciation is allowed and when asset is leased, lease rental is allowed as deduction.
• Capital Structure decision also plays a major role. Mixture of debt and equity fund should be balanced, to maximize the return on capital and minimize the tax liability. Interest on debt is allowed as deduction whereas dividend on equity fund is not allowed as deduction.

The following are the reasons it is resorted for effective use of tax planning methodologies while establishing an S corporation:-

• Profit shifting strategy - The organisation will having head office in one country and branches in another country. Accordingly tax regime will be different with regard to Country to Country. The corporation will have to bear huge taxes if proper planning is not followed.
• Transfer pricing:- This is the setting of prices for transactions between companies that are part of the same MNC. In the past this mainly concerned physical goods but now involves the rights to use intangible goods, and use of services such as headquarters' support. Over half of international transactions are inter-company transactions, and are therefore not at "arms-length" prices, i.e. as if purchased from an unrelated third party. Where the price is inflated, "abusive transfer pricing" is said to occur. This is one way to move profits where a subsidiary in a medium or higher-tax jurisdiction buys products from another group company in a lower tax country.
• Corporate debt-equity:- Inter-company loans given from entities in lower-tax states to subsidiary companies in higher-tax countries pass interest income to the lower-tax state, reducing the taxable profit in the higher-tax country. This profit is further reduced the higher the interest rate or level of debt. Luxembourg has beneficial tax treatment of interest income. Accordingly if proper tax planning is not done, the corporation may incur huge taxes.
• Payments for intangibles :- A group company in a lower-tax environment with company IPR ownership rights, charges another group entity in a higher-tax state for use of an intangible, such as a technology royalty, licences, brands or patents. The pricing should reflect the value of the technology, i.e. how important the technology is in the creation of the profits.