Page 74 - DCOM301_INCOME_TAX_LAWS_I

Unit 3: Tax Planning: An Introduction

Wise corporate officials take time to perform due diligence in researching the availability of tax Notes
reducers, such as deduction and credits. They will use this research to design business activities
to qualify for these reducers as often as possible. Corporate officials also can minimize tax
liability by strategically locating business activities where they can take advantage of low tax
environments, deductions and credits.

3.2.4 Case for Levy of Corporate Tax

Under a system of general income taxation, whether companies should be taxed independently
as separate entitles has been the subject matter of prolonged debate among tax economists. One
view is that since corporations are not persons, strictly speaking, there is no case in equity for
taxing the profits of companies as such. The tax should be levied only on the owners, that is, the
equity holders, by attributing the profits of the companies to the shareholders. Such a system,
however, can operate smoothly only if all profits are distributed every year among the
shareholders. Where part of the profits is retained, the gain to the shareholders accruing from
appreciation in the value of equities escapes taxation unless there is an effective tax on realised
capital gains or unless the undistributed profits are attributed notionally to the shareholders.
This is not simple in the case of large corporations in which the shares undergo sale or transfer
all the time.
Since capital gains are usually treated preferentially, even where the income tax is levied on
capital gains, exclusion of retained profits of companies from taxation provides an easy way of
avoiding taxation by accumulating profits under the corporate cover. Taxation on the basis of
attribution also encounters problems in the determination of capital gains when the shares are
transferred, as the cost basis has to be adjusted annually to take account of the notional distribution
of accumulated profits underlying the capital gain. Besides, taxation on notional basis gives rise
to liquidity problems and hence does not seem equitable or feasible. It is therefore generally
accepted that some tax has to believe on the profits of companies so long as individuals and
unincorporated enterprises are subjected to tax on their profits.
Taxation of companies as separate entities is also justified as a withholding tax, which may be a
useful means of ensuring that income flowing through the conduit is taxed in a comprehensive
and timely manner and that the base of the individual income tax is protected. Many economists,
including some who have not advocated full integration, have argued that this withholding
function is indeed the main argument for the imposition of a tax on corporate income.

A separate tax on the profits of companies is considered reasonable also on the ground that
incorporation confers substantial benefits such as limited liability of shareholders, right to sue
and be sued and so on. What is more, corporate taxation is an administratively simple device for
taxing an important type of income from capital.

Self Assessment

Fill in the blanks:
4. ………………………Planning is the strategies to reduce the taxes.

5. Corporate officials also can …………………..tax liability by strategically locating business
activities.
6. Taxation on notional basis gives rise to ………………..problems.

LOVELY PROFESSIONAL UNIVERSITY 69