Tax Implications of Specific Management Decisions in Business

1. Dividend Declaration vs. Retained Earnings

• Dividends:
  • Taxable in shareholders’ hands (10% TDS if >₹5,000)
  • No deduction for company (Dividend Distribution Tax abolished)
• Retained Earnings:
  • No immediate tax impact
  • Future capital gains tax when shares are sold

Tax-Smart Approach: Retain earnings if shareholders are in high tax brackets; declare dividends if tax-efficient.

2. Lease vs. Buy Decisions

• Leasing:
  • Lease payments fully deductible as business expense
  • No depreciation claim
• Buying:
  • Claim depreciation (15-60% depending on asset)
  • Interest on loan deductible

Tax Impact: Leasing often better for short-term needs; buying better for long-term assets with high depreciation.

3. Employee Compensation Strategies

Optimal Strategy: Balance between salary and equity to minimize combined tax burden.

4. Inventory Valuation Methods

• FIFO:
  • Higher COGS during inflation → lower taxable income
• LIFO:
  • Not permitted under Indian tax laws
• Weighted Average:
  • Moderate tax impact

Tax Effect: FIFO generally preferred in inflationary periods to reduce tax liability.

5. Debt vs. Equity Financing

Decision Factor: Debt financing often more tax-efficient due to interest deductibility.

6. Business Structure Choices

• Proprietorship:
  • Taxed at individual rates
  • No separate tax
• Partnership:
  • Pass-through taxation
  • No DDT
• Company:
  • 25-30% corporate tax
  • Dividend tax in shareholders’ hands

Tax Considerations: Companies better for reinvestment; partnerships for profit distribution.

7. Capital Expenditure Timing

• Pre-Year End Purchases:
  • Claim full depreciation even if used for 1 day
• Post-Year End Purchases:
  • Depreciation starts next year

Strategy: Time large purchases just before year-end to accelerate deductions.

8. International Expansion Decisions

• Branch vs Subsidiary:
  • Branch profits taxable immediately
  • Subsidiary profits taxable only when repatriated
• Transfer Pricing:
  • Must comply with arm’s length principles
  • Documentation requirements

Tax Planning: Subsidiary structure often preferred for tax deferral opportunities.

9. R&D Investment Decisions

• Deductions Available:
  • 100% deduction for in-house R&D (Section 35)
  • 150% deduction for payments to approved institutions
• Capital Expenditure:
  • Normal depreciation or 100% write-off

Optimal Approach: Cluster R&D spending to maximize deduction benefits.

10. Business Exit Strategies

Tax-Efficient Exit: Share sale typically most favorable for tax purposes.