Tax Planing with reference to form of organization

Decision as regards the form of proposed business organization is influenced by a variety of

considerations, such as (a) nature of business ;(b) capital requirements;(c) degree of risk, etc. However,
tax implications of setting up a particular form of business organization also need careful consideration.
The best form of business organization from tax point of view is one, which attracts minimum tax liability.
Below, a discussion of the tax implications, as also devices of tax planning, in case of different form of
business organization:

Individual: An individual pays tax on this total income at prescribed rates on the basis of slab system.
However, he is not entitled to a deduction, in computing business income, any remuneration for work
done by him and interest on capital or own loan invested in the business.
An individual can claim certain deduction u/s 80 C to 80 U.
In case of a business growing at a higher speed, and yielding higher profits, a sale proprietary
organization may not be beneficial. As the salary paid to the proprietor and interest paid on capital are
not allowable, the profits become higher and tax incidence goes high

Hindu Undivided Family:

A joint Hindu Family Pays tax on its total income at prescribed rates on the basis of slab system. The
family can pay reasonable remuneration to the Karta and other family members for their services to the
business and it is allowed as a deduction in computing the business income.
However, interest on capital contributed by the family for the business is not deductible in computing
business income. The member of the family, who has received the remuneration from the family will,
induced it in his income under the head ‘salaries’.
A Hindu individual family is entitled to the deduction U/S 80 C, 80D, 80DD, 80DDB, which are allowed to
individuals from gross total income.

Firm: A Firm pays tax on its total income at a flat rate 30% +2% Education cess & 1% SHEC after
allowing interest and remuneration to working partners. In computing the business income the following
payments to the partners are deductible:
1. Interest on capital/loan to partners at the maximum rate of interest is 12 p.a.
2. Remuneration to working partners subject to the limits mentioned in section 40 (b).

Section 40(b) : Book Profit

In the case of a firm carrying on a specified profession:
(a) On the first Rs. 3,00,000 of the Rs. 1,50,000 or at the rate of 90% of the
book-profit or in case of a loss book-profit, whichever is more;
(b) On the balance of the book-profit at the rate of 60%

Allowed Remuneration:
Remuneration calculated as per section 40(b)
OR
Actually paid
Which ever is less.

Any salary, bonus, commission or remuneration by whether name called due to or received by a partner
of a firm shall not be treated as salary for the purpose of Section 15, but it shall be treated as income from
business or profession for the purpose of section 28. However, the share in the profit of partnership firm
is exempt from tax under section 10(2A) of the income tax act.

Further a partner, being an individual is entitled to the same deductions from his gross total income.
The form of organization is suitable from income-tax point of view in such cases where the amount of
profit is not large and the partners of the firm do not have any other additional income except by way of
remuneration and interest from the partnership firm. In such a case the profit of the firm shall be lower and
the individual partners can also avail of the maximum ceiling of income exempt under the income tax Act.

Company: A domestic company liable to pays tax on its total income @ 30% plus 10% surcharge (when
total income exceeds Rs. 1 Croe +2% Education cess & 1% SHEC.
Dividend tax @(15% + 10% Surcharge) + 3% EC & SHEC

In computing the business income, the company can deduct the whole amount of interest paid on loan
taken for business purposes and the remuneration paid to managing director, directors and other staff.
However, the amount of dividends distributed on its share capital is not deductible in computing the
income.

Rates of income tax for the assessment year 2008-09

 For man, resident in India and below the age of 65 years at any time during the previous
Upto Rs. 1,60,000 Nil
Rs. 1,60,001 to 3,00,000 10%
Rs. 3,00,001 to 5,00,000 20%
Above5,00,000 30%

 For woman, resident in India and below the age of 65 years at any time during the previous
Upto Rs. 1,90,000 Nil
Rs. 1,90,001 to 3,00,000 10%
Rs. 3,00,001 to 5,00,000 20%
Above5,00,000 30%

 For an individual (man or woman), resident in India who is of the age of 65 years or more at
any time during the previous
Upto Rs. 2,40,000 Nil
Rs.2,40,001 to 3,00,000 20%
Above 3,00,000 30%

Education cess: Education cess @ 2% on income-tax and surcharge.

Secondary and Higher Education Cess (SHEC) : SHEC @ 1% on income tax and surchaege.

Q. 1- (Individual vs. HUF)

There are two members A and B in a joint Hindu family having a capital of Rs. 12,50,000. They can run a
business as a business of an individual joining the other as an employee and moneylender or as a H.U.F.
(i) If the business is run as of an individual, the other member will receive salary of Rs. 1.25 lakh and
interest @ 12% on Rs. 6,25,000.
(ii) If the business is run as a H.U.F. each member will receive salary Rs. 75,000.
Suggest which form of business organization should be adopted from tax point of view, if the expected
business income is Rs. 4,00,000 for P.Y. 2009-10.

Q.5- On the basis of the following information suggest to A and B whether they should invest their funds
in their own partnership firm @ 12% p.a. or invest it in the firm of C and D @ 15% p.a. (the market rate of
interest) and accept deposit of C and D @ 15% p.a. for their firm:
(i) Profits of firm before interest and remuneration to partners Rs. 2,00,000
(ii) Remuneration to partners Rs. 3,000 p.m. each;
(iii) Funds for investment Rs. 2,00,000 each; (iv) other income of partners Rs.1, 10,000 each.

Mr. Kapil nad Sachin proposed to set up a businesses either as a partnership or as a private
limited company, with a capital contribution of Rs. 10,00,000 each. Profit of the business bedfore
charging their remuneration at Rs. 15,000 p.m. each and interest @ 12% is estimated at Rs. 18,
00,000. Profits after tax are proposed to be distributed equally as profit/dividend. Advise them with
appropriate working about the form of organization they should choose from the point of view of
tax implication involved in each case, assuming that they have no income other than from the
proposed business.

Q.7. Mr. A wants to start a retail business. Keeping in view the provisions of section 44AF and the
following information suggest him whether he should run the business as a sole proprietary concern or a
partnership firm:
1. Estimated sales for the year 2009-2010 Rs. 35,00,000.
2. Estimated profits u/s 44AF Rs. 1,75,000.
3. If he runs the business as a proprietary concern, he will pay Rs. 5,000 p.m. as salary to his son.
4. If he runs the business as partnership firm both the partners (A and his son) will receive salary
Rs. 5,000 p.m. each.
5. Capital of the business will be Rs. 2,00,000 but the son does not have any fund. So for capital
contribution in the firm he will borrow Rs. 1,00,000 from his father @ 15% p.a.
6. The firm will pay interest @ 12% p.a. to the partners.

Q.10- A and B want to start a business. They have two options for selecting form of organization,
partnership firm or a private company. The estimated profits of which, before the following deductions are
Rs. 15,48,000
1. Remuneration Rs. 30,000 p.m. each
2. Each will give a loan to the business of Rs. 10,00,000 @12% p.a.
3. Contribution as capital Rs. 10,00,000 each. On this interest will be paid @12% p.a. However
the company cannot pay the interest on it.
4. The profit after tax will be distributed equally as profits/ dividends.
Which option is better from tax point of view.

Q.11- A and B want to start a business, the estimated profits of which for the year are Rs.5, 00,000.They
have two options for selecting a form of organization;
(a) Partnership firm:
(i) 12% interest on capital of Rs. 5,00,000 each.
(ii) Salary Rs. 1,00,000 p.a. each.
(iii) Equal distribution of remaining profits.
(b) Company:
(i) Rs. 2,50,000 each as share capital and Rs. 2,50,000 each as loan @ 15%.
(ii) Salary Rs. 1,00,000 p.a. each.
(iii) Distribution of remaining profits as dividends equally.
Which option is better from tax point of view.

Q.12- A and B propose to set up a business, either as a partnership or as a private limited company, with
capital contribution of Rs.10, 00,000 each. Profit of the business, before charging their remuneration at
Rs.14, 000 p.m. each, are estimated at Rs.8, 00,.000. Profits after tax are proposed to be distributed
equally as profits/dividend. Advise them, with appropriate workings, about the form of organization they
should choose from the point view of tax implications involved in each case, assuming that they have no
income other than that from the proposed business.

Q.13- A and B want to start a business. They have two options for selecting form of organization.
(a) Partnership firm : (i) 12% interest on capital of Rs. 2,00,000 each (ii) Remuneration Rs. 4,000 p.m.
each, (iii) Remaining profit equally.
(b) Company : (I) Capital Rs. 1,00,000 each, (ii) Loan @ 15% Rs. 1,00,000 each (iii) salary Rs. 4,000
p.m. each, Remaining profit as dividend equally.
Estimated income before interest and salary Rs. 2,50,000.
Suggest whether you should form a partnership firm or a company.
Q.14- A and B proposed to set up a business either as a partnership or as a private limited company with
capital contribution of Rs.10, 00,000 each. Profit of the business before charging their remuneration at
Rs.15,000 per month each and interest 12% p.a., is estimated at Rs.18,00,000. Profits after tax are
proposed to be distributed equally as profit/dividend. Advise them with appropriate working about the
form of organization they should choose from the point of view of tax implication involved in each case,
assuming that they have no income other than from the proposed business.