Page 223 - DCOM508_CORPORATE_TAX_PLANNING

Corporate Tax Planning

Notes Questions

1. Study and analyse the case.
2. Write down the case facts.
3. What do you infer from it about issue of bonus shares in Indian Tax Regime?

Source: http://www.legalserviceindia.com/article/l204-Issue-of-Bonus-Shares.html

9.5 Summary

Financial management decisions include the decisions relating to planning, organising,
directing and controlling the financial activities such as procurement and utilisation

of funds of the enterprise. It implies application of general management principles to

financial resources of the enterprise. The key aspects of financial decision-making relate to

investment, financing and dividends.

Financing decisions are concerned with quality of finance basically focusing on achieving
an optimum mix between debts and equity. Capital structure decision is a matrix of three
considerations namely the risk, cost of capital and tax planning. Thus the tax planner
should properly make a balance between risk, cost of capital and tax saving consideration
in such a manner, which ensure maximum shareholder’s return with optimum risk.

Capital structure is a composition of different types of financing employed by a fi rm to
acquire resources necessary for its operations and growth. Capital structure primarily

comprises of long-term debt, preferred stock, and net worth. It can be quantified by taking

how much of each type of financing a company holds as a percentage of all its fi nancing.

Capital structure is different from financial structure as this includes short-term debt,
accounts payable, and other liabilities.

For the real growth of the company the financial manager of the company should plan an
optimum capital for the company. The optimum capital structure is one that smaximises
the market value of the fi rm.

Interest on debt finance is a tax-deductible expense. Hence, finance scholars and practitioners
agree that debt financing gives rise to tax shelter which enhances the value of the fi rm. The

tax advantage of debt should not persuade one to believe that a company should exploit
its debt capacity fully.
Capital structure decisions are likely to affect companies’ tax payments, since corporate
taxation typically distinguishes between different sources of finance. Interest payments

can generally be deducted from taxable profits while such a deduction is not available

in the case of equity financing. Taxation of capital income at the shareholder level often
differentiates between the types of capital as well. Therefore, it can be expected that the

relative tax benefits of different sources of finance have an impact on fi nancing decisions.

A dividend policy shows how a company determines the amount of earnings to be paid
out as dividends to its shareholders on a regular basis. It is characterised by its dividend
payout ratio, which is the percentage of net earnings paid out to shareholders.
The decision to pay dividends to investors does not have an impact on a company’s
corporate tax. Large investors can sometimes pressure the corporate board of directors,

influencing their decision to pay dividends or not. During years when dividend taxes
are lower than capital gains taxes, more companies use their excess cash to pay investor
dividends. During times when dividend taxes are high relative to capital gains tax, fewer
companies pay investor dividends.

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