Corporate Tax Planning Practicing Problems

Sundar B. N. Assistant professorin Commerce
G.F.G.C. For Women, Holenarasipura
PROBLEMS ON DIVIDEND DISTRIBUTION AND BONUS SHARES
1) From the following information compute the tax liability of Z Ltd
Accumulated profits of the company on 31.3.2017 30,00,000
On 28.8.2017 the company redeemed bonus Preference
shares issued to equity shareholders
8,00,000
On 9.9.2017 the company declared dividend
in its annual general body meeting
10,00,000
A shareholder holding 15% equity shares in the
Company borrowed on 30.1.2017 @ 12% p.a. interest
60,00,000
Computation of Tax Liability of Z Ltd. for the assessment year 2018-19
Redemption of bonus shares
[Treated as dividend distribution u/s 2/22 (a)]
8,00,000
Dividend declared 10,00,000
Dividend liable to tax u/s 115-0 18,00,000
Tax on dividend distribution: Income Tax @20.55 % 3,69,900
Add: Surcharge @ 12% 44,388
4,14,288
Add : Education cess @ 4% 16,572
Tax liability of the company 4,30,860

2) A domestic company possesses huge accumulated reserves. It wants to
distribute dividends of Rs. 100 crore to its equity. For this purpose it may issue
3 year 10% redeemable preference shares or 3 year 10% redeemable
debentures. Keeping in view the following information suggest to the company
whether it should issue bonus shares or bonus debentures so that the tax
liability of the company and its shareholders is reduced: Assume Rate of tax on
income of company and shareholder is 30% and Dividend Distribution Tax is
15%.
Option I-Tax Liability When Company Issues Bonus Shares
A) Tax liability of Company :
On issue of bonus shares Nil
On dividend distribution on Rs. 100 crore for 3 year
@ 15% - DDT
4,50,00,000
On redemption of bonus shares at Rs. 100 crore @
15% - DDT
15,00,00,000
Total Tax Liability 19,50,00,000
B) Tax liability of Shareholders:
At the time of receiving bonus shares Nil
on dividend for 3 years Nil
On redemption of bonus shares Nil
Total Tax Liability Nil
Therefore Total Tax liability of company and shareholders under option-I
(a+b) Rs. 19,50,00,000

Option-II- Tax Liability when Company Issues debentures:
(a) Tax liability of company: (b) Tax liability of Shareholders:
Particulars Rs. Particulars Rs.
On issue of debentures on
Rs. 100 crore @ 15% -
DDT 15,00,00,000
At the time of receiving
bonus debentures Nil
On paymentof interest
on debentures
Nil
On interest Rs. 10 crore @
30% = Rs. 3 crore On
interest for 3 years (Rs. 3
crore× 3
9,00,00,000
On redemption of
debentures
Nil
On redemption of bonus
debentures
Nil
Tax saved by company on
interest payment on
debentures Rs. 100 crore
@ 10%, i.e., on Rs. 10
crore@ 30% = Rs. 3 crore
Tax saved for 3 years (Rs.
3×3) 9,00,00,000
Tax Liability 6,00,00,000
Tax Liability 9,00,00,000
Total tax liability of company and shareholders is Rs. 15 crore under the
option II

PROBLEMS ON MAKEOR BUY DECISIONS
EXAMPLE 1
Z Ltd. produces of its own parts and components. The standard wage
rate in the parts department is Rs. 6 per hour. Variable manufacturing
overhead is applied at a standard rate of Rs. 4.50 per labour-hour. For its
current year’s output, the company will require a new part. This can be made
in the parts department without any expansion of existing facilities.
Nevertheless, it would be necessary to increase the cost of product testing and
inspection by Rs. 1,500 per month. Estimated labour time for the new part is
half an hour per unit. Raw materials cost has been estimated at Rs. 24 per unit.
The other alternative before the company is to purchase part from an outside
supplier at Rs. 36 per unit. The company has estimated that it will need 20,000
new parts during the current year.
Advise the company whether it would be more economical to buy or make the
new parts.
Solution:
Total cost if the parts are bought Rs. 20,000 × 36 = Rs. 7,20,000.
Hence, it is advisable to make the parts as there is saving of Rs. 12,000. The
above illustration does not attract any special tax consideration as whether
we manufacture or buy the goods, the expenses relating to both are allowed
as deduction.
Per unit (Rs.)
Cost of
Manufacturing
Total (Rs.)
Raw material (24*20000) 24.00 4,80,000
Direct wages 6.00 1,20,000
Variable overheads 4.50 90,000
Producttesting and inspection (Rs.
1,500 × 12) 0.90(18000/20000) 18,000
Total cost 35.40 7,08,000

Example 2:
A company requires a component. From the following information suggest to
the company whether it should make the component or buy it from the
market:
A) For Making the component:
A new machine will be purchased for Rs. 10,00,000. After five years it
will be sold for Rs. 2,00,000. Rate of depreciation 15%. Manufacturing
cost of component:
1) year Rs. 14,00,000; 2) year Rs. 16,00,000; 3) year Rs. 18,00,000; 4) year
Rs. 20,00,000;
5) yearRs. 24,00,000; Rate of tax 30%
B) Buying the component: Cost:
I. year Rs. 20,00,000; II. yearRs. 22,00,000; III. yearRs. 24,00,000; IV.
yearRs. 26,00,000; V. year Rs. 30,00,000;
Solution:
(A)Making the Component
(Computation of Depreciation)
Year Depreciation WDV
I 1,50,000 8,50,000
II 1,27,500 7,22,500
III 1,08,375 6,14,125
IV 92,119 5,22,006
V 78,301 4,43,705
Short-term capital loss:
WDV Rs. 4,43,705 – Selling Price Rs. 2,00,000 – Rs. 2,43,705

Computation of Cost of Component for making
(1) Y
ear
(2) Manufac
turing Cost
(3) Depreciatio
n
(4) Total
cost(2+3)
(5)Tax
saving
(6)Net
cost(4-5)
I 14,00,000 1,50,000 15,50,000 4,65,000 10,85,000
II 16,00,000 1,27,500 17,27,500 5,18,250 12,09,250
III 18,00,000 1,08,375 19,08,375 5,72,513 13,35,862
IV 20,00,000 92,119 20,92,119 6,27,636 14,64,483
V 24,00,000 78,301 24,78,301 7,43,490 17,34,811
STCL 2,43,705 73,112 1,70,593
Total cost 69,99,999
(B)Buying the Component
Year Total Cost Tax Saving Net Cost
I 20,00,000 6,00,000 14,00,000
II 22,00,000 6,60,000 15,40,000
III 24,00,000 7,20,000 16,80,000
IV 26,00,000 7,80,000 18,20,000
V 30,00,000 9,00,000 21,00,000
Total Net
Cost - - 85,40,000
Conclusion- In case of making the component the cost is Rs. 69,999,999 and
in case of buying the component the cost is Rs. 85,40,000. Hence, the
component should be manufactured.

PROBLEMS ON OWN OR LEASE
Example 3:-
Fromthe following information advise whether the assetshould be
owned or taken on lease.
1. Cost of Asset - Rs. 1,00,000
2. Rate of Depreciation - 15%
3. Rate of interest 10%
4. Repayment of loan by the assessee Rs. 20,000p.a.
5. Rate of tax 30.9%
6. Residual value- Rs. 20,000 after five years.
7. Profit of the assessee Rs. 1,00,000beforedepreciation, interest and tax.
8. Lease rent Rs. 30,000 p.a.
Solution
I When Asset is purchased
YEARS
I II III IV V TOTAL
Rs. Rs. Rs. Rs. Rs. Rs.
A Depreciation 15,000 12,750 10,838 9,212 7,830 55,630
B Interest 10,000 8,000 6,000 4,000 2,000 30,000
C Tax 23,175 24,488 25,697 26,817 27,863 1,28,040
D Profitaftertax 51,825 54,762 57,465 59,971 62,307 2,86,330
E Total 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000
Loss on sale of asset = Rs. 1,00,000 – (55,630 + 20,000) = Rs. 24,370

II . Asset on lease
YEARS
I II III IV V TOTAL
Rs. Rs. Rs. Rs. Rs. Rs.
A Lease Rent 30,000 30,000 30,000 30,000 30,000 1,50,000
B Tax 21,630 21,630 21,630 21,630 21,630 1,08,150
CProfit after tax 48,370 48,370 48,370 48,370 48,370 2,41,850
D Total 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000
When asset is purchasedprofit is (Rs. 2,86,330 – 24,370=) Rs. 2,61,960 When
asset is takenon lease profit is Rs. 2,41,850. Hence, asset may be purchased.

Example 4:- (when P.V. Factor is considered)
A Ltd. wants to acquire an asset costing Rs. 1, 00,000. It has two alternatives.
The first one is buying the asset by taking a loan of Rs. 1,00,000 repayable in 5
equal instalments of Rs. 20,000 each with interest @ 14% p.a. The second one
is leasing the asset for which annual lease rent is Rs. 30,000 up to 5 years. The
lessor charges 1% as processing fees in the first year. Assume the internal rate
return to be 10%. The present value factors are as under.
Years: 1 2 3 4 5
PV Factor: 0.909 0.826 0.751 0.683 0.621
Assumelease rentals, processing fees, loan as well as interest amount
are payable at year end. Suggestwhich alternative is better for the company.
Assumerate of depreciation @ 15% and tax rate at 33.99%.
Solution:
Asset Taken on Lease
PARTICULARS
YEARS
1 2 3 4 5
Rs. Rs. Rs. Rs. Rs.
1) Lease rent 30,000 30,000 30,000 30,000 30,000
2) Processing fee 1,000 -------- ------- ------- ------
3) Gross cashflow
(1+2) 31,000 30,000 30,000 30,000 30,000
4) Tax saved @
33.99% on 3 10,537 10,197 10,197 10,197 10,197
5) Net Cash flow (3-
4) 20,463 19,803 19,803 19,803 19,803
6)P.V. factor @ 10% 0.909 0.826 0.751 0.683 0.621
7)P.V. of net cash
outflow 18,601 16,357 14,872 13,525 12,298
Total Net present value of cash out flow = Rs. 75,653

Asset purchasedby borrowedfunds
PARTICULARS
YEARS
1 2 3 4 5
Rs. Rs. Rs. Rs. Rs.
1) Loan repayment 20,000 20,000 20,000 20,000 20,000
2) Interestpaid 14,000 11,200 8,400 5,600 2,800
3) Cash outflow (1+2) 34,000 31,200 28,400 25,600 22,800
4) Depreciation @
15% 15,000 12,750 10,838 9,212 7,830
5) Total (2 and 4) 29,000 23,950 19,238 14,812 10,630
6) Tax saved @
33.99% (5) 9,857 8,141 6,539 5,035 3,613
7) Net cash outflow
(3-6) 24,143 23,059 21,861 20,565 19,187
8)P.V. factor @ 10% 0.909 0.826 0.751 0.683 0.621
9)P.V. of net cash
outflow 21,946 19,047 16,418 14,046 11,915
Total P.V. of net cash outflow = Rs. 83,372
Conclusion: Asset shouldbe takenon lease because P.V. of cash outflow is
lesser.

PROBLEMS ON PURCHASE BY INSTALLMENTS OR BY HIRE
Example: 1
Fromthe following information determine whether the assesseeshould
purchasethe machine by instalment or hire it.
1. Cost five annual instalments of Rs. 2,00,000 each payablein the beginning of
each year.
2. Hire charges Rs. 1,50,000 p.a. for eightyears payable in the beginning of
each year.
3. Residual valueRs. 50,000 after eighth year.
4. Rate of depreciation 15%
5. Cost of Capital 10%
6. Rate of tax 30%
7. Present value @ 10%
1 2 3 4 5 6 7 8
.909 .826 .751 .683 .621 .564 .513 .467

Solution:
(A) Asset purchasedby instalments
Date of payment Instalment(Amount) Present Value
Rs. Rs.
Down payment 2,00,000 2,00,000
Instalment-I 2,00,000 1,81,800
Instalment-II 2,00,000 1,65,200
Instalment-III 2,00,000 1,50,200
Instalment-IV 2,00,000 1,36,600
Cash Outflow 8,33,800
Cash inflow at the end of 8th year Rs. 50,000 on account of residual value of
machine. Present value Rs. 23,350.
Savings on account of depreciation:
Year
Amount of
Depreciation
Tax savings on
depreciation PV of tax saving
Rs. Rs. Rs.
Year I 1,50,000 45,000 40,905
Year II 1,27,500 38,250 31,595
Year III 1,08,375 32,514 24,418
Year IV 92,119 27,636 18,875
Year V 78,301 23,490 14,587
Year VI 66,555 19,967 11,261
Year VII 56,572 16,972 8,707
Year VIII 48,086 14,426 6,737
7,27,513 1,57,085
Short-term capital loss on sale of machine = Rs. 10,00,000 – (7,27,513 +
50,000) = Rs. 2,22,487 may be set off Tax saved on Rs. 2,22,487@30% = Rs.
66,746, Present value of tax savings = Rs. 31,170
Cash Outflow Rs. Rs.
8,33,800
Less: (i) Cash inflow on sale of machine 23,350
(ii) Tax savings on accountof depreciation 1,57,085
(iii) Tax savings on account of STCL 31,170 2,11,605
Net Cash Outflow 6,22,195 6,22,195

(B) Asset taken on Hire
Date of
Payment Hire
Discounted
Value PV of Tax savings
Rs. Rs. Rs.
Year I 1,50,000 1,50,000 45,000
Year II 1,50,000 1,36,350 40,905
Year III 1,50,000 1,23,900 37,170
Year IV 1,50,000 1,12,650 33,795
Year V 1,50,000 1,02,450 30,735
Year VI 1,50,000 93,150 27,945
Year VII 1,50,000 84,600 25,380
Year VIII 1,50,000 76,950 23,085
12,00,000 8,80,050 2,64,015
Present value of Cash outflow on accountof
Hire 8,80,050
Less : Present value of tax savings 2,64,015
Net CashOutflow 6,16,035
Conclusion - Asset should be taken on lease.

PROBLEMS ON SHUT DOWN OR CONTINUE
Example 6:
X Ltd. a domestic company, has two businesses A and B. For the last two years
business A has been running into a loss wiping out the entire, profits of
business 'B. At the end of financial year 2014-15 there are brought forward
losses of Rs. 8,00,000 and unabsorbed depreciation Rs. 5,00,000. In the
financial year 2016-17 onwards it is expected that business B will earn a profit
of Rs. 5,00,000 annually and if business A is continued at a minimum level
there will be an annual loss of Rs. 1,00,000. Please suggest to the management
of the company regarding: (i) Whether business A should be continued or shut-
down. (ii) If continued for how many years.
Solution
If business A is continued in P. Y. 2016-17 the company will not loose the right
to carry forward and set-off the past losses and unabsorbed depreciation. Let
us calculate profit after tax in both the situations: (i) business A continued; (ii)
business A discontinued, and then arrive at any conclusion
Business A Continued
Future Years
I II III IV
Rs. Rs. Rs. Rs.
Profitof businessB 5,00,000 5,00,000 5,00,000 5,00,000
Less: CurrentLossof businessA 1,00,000 1,00,000 1,00,000 1,00,000
4,00,000 4,00,000 4,00,000 4,00,000
Less: B/f Previouslossof
businessA 4,00,000 4,00,000 ------- ---------
Less: Unabsorbed depreciation Nil Nil 4,00,000 1,00,000
Profitof BusinessB Nil Nil Nil 3,00,000
Tax @ 30.9% Nil Nil Nil 92,700

Business A Discontined
Future Years
I II III IV
Rs. Rs. Rs. Rs.
Profitof businessB 5,00,000 5,00,000 5,00,000 5,00,000
Less: B/f Previouslossof businessA 5,00,000 3,00,000 ------- ---------
Less: Unabsorbed depreciation Nil 2,00,000 3,00,000 Nil
Profitof BusinessB Nil Nil 2,00,000 5,00,000
Tax @ 30.9% Nil Nil 61,800 1,54,500
Conclusion:Business A shouldbe continuedfor at least four years.

EXCERSIE
1. An assetcosting Rs. 1,00,000is to be acquired. There are two alternative
available to the taxpayer. Firstone is buying the assetout of own funds. The
second one is taken on lease for which annual lease rent is Rs. 40000 upto 5
years. Leasemanagement fee :Rs. 1,000. Suppose:
(i) Internationalrate of return to be 10% and present value at 10% is: .909;
.826; .751; 683; .621 for 5 years.
(ii) Rate of IncomeTax - 30%
(iii) Rate of Depreciation - 30% Ans. : The assetshould be bought
2. ProblemBright Ltd. Manufactureelectric pumping sets. The company has
the option to either make or buy from the market component Y used in
manufactureof the sets. The following details are available: The component
will be manufactured on new machine costing Rs. 1 lakh with a life of 10 years.
Material costs Rs. 2 per kg. and wages re. 0.30 per hour. The salary of the
foreman employed is Rs. 1,500 per month and other variableoverheads
included Rs. 20,000 for manufacturing 25,000 components per year. Material
requirement is 25,000 kgs. and 50,00 labour hours required. Thecomponentis
available in the market at Rs. 4.30 per piece. Will it be profitable to makeor to
buy component? Does it makeany difference if the componentcan
manufactured on an existing machine?
Ans. Case-I - Better to buy Case-II - Better to manufacture

Corporate Tax Planning Practicing Problems

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