Tax Planning is closely related to tax avoidance and evasion. Therefore a discussion on tax planning must inevitably begin from the definition and distinction between tax avoidance and evasion. As discussed earlier, tax avoidance is the legal way to minimize tax liability without contravention of the law in order to minimize tax liability.
Tax planning is the art and technique of careful structuring one’s future business transactions in order to realize tax savings (minimization of tax liability) but without contravention of the tax statutes (tax laws.) The concept of tax planning is thus more closely related to tax avoidance rather than tax evasion.
Objectives of Tax Planning
- The main objective of tax planning and tax avoidance is tax minimization or the realization of tax savings or the elimination of tax liability altogether but within the legal requirements.
- However, the other objective of tax planning is to ensure the availability of adequate funds to meet any tax obligations when it falls due for payment to avoid late payment penalties.
It is of primary importance to carefully interpret and apply the tax laws. Proper planning leads to tax minimization or avoidance, which is acceptable. Tax evasion , which is not acceptable , cannot and should not be tolerated. However, it is necessary to quantify the expected tax gain or saving before indulging in the exercise of tax planning. It is advisable not to engage in blind tax planning schemes, which may be more expensive than an anticipated imaginary gain. Any tax planning must be based on the cost-benefit analysis.
Guides to Tax savings
There are certain guideposts that can be used in tax planning. These will assist in achieving the objective of tax planning: tax savings. The road to tax savings has at least ten main branches. They point the direction tax-saving efforts should take. The following are some of these guideposts:
- Keep income stable to avoid top rate brackets.
- Speed up or defer income and expenses to take advantage of anticipated higher or lower tax rates
- Spread income among several taxpayers.
- Spread income over several years to keep out of higher tax brackets and postpone tax.
- Transform ordinary income into long-term capital gain.
- Take full advantage of all exemptions and deductions
- Take advantage of elections e.g. when to claim specific deduction.
- Use tax-free money to expand business operations.
- Select the best form of your business operations.
- Set up business deals along lines that make overall use of tax rates, earning potential, losses and assets that can be depreciated.
The art and technique of tax planning
Successful tax planning may sometimes realize significant tax savings. However, it requires a thorough knowledge of the tax legislation in both theory and practice. This is a clear reference to the technical and practical competence of the tax consultant.
While intelligent and imaginative tax planning may result into substantial tax savings, the tax planner should not ignore the significance of sound business management and corporate financial planning and discipline. The two must go hand in hand. It should also be noted that tax planning is a continual process during the whole year rather than a decision to be made at the beginning or middle of the year and left to work itself out. A series of actions or decisions may be necessary before the actual tax savings are realized.Tax planning and avoidance is possible through two main areas:
- Taking advantage of existing legal provisions that allow tax minimization.
Examples include tax shelters (capital expenditure that attracts favorable capital deductions), indefinite loss carry forward provision, election when to claim specific deductions e.g. Investment deduction, claim of capital expenditure against revenue income allowed specifically by law e.g. Cost of clearing land and clearing and planting permanent and semi-permanent crops etc.
- Favorable interpretation of the statute especially on vague clauses, words and phrases that have more than one meaning; e.g. “heavy industrial machinery” for the purposes of wear and tear deduction.
The use of tax shelters in tax planning:
A tax shelter is a capital investment or expenditure on which the investor (taxpayer) is entitled to claim capital allowances for tax purposes.
The cost of the capital investment is normally written off within a short period of time. Tax sheltering is particularly applicable in the industrial, mining and manufacturing sectors, which require heavy capital investment on plant, machinery and research and development.
Tax sheltering is not relevant in the service and retail trading investment where heavy plant and machinery is generally not required.
However, a tax shelter does not quite result into complete tax exemption or saving. It merely defers the tax liability into future years when the write off of the capital cost through capital deductions claim is exhausted. It is therefore important to provide for the deferred tax. Alternatively the investor may ensure continued tax deferral by sustaining the capital investment by periodic business expansion programmes and diversification. Yet such sustained investment may not be easy in practice.
Pitfalls (dangers) in tax sheltering
Before any investment is undertaken to take advantage of a tax shelter, the investor may wish to consider and guard against the fallowing pitfalls:
- The certainty of the allowability of the capital deduction or write-off; The reliability of the forecasts (data used) particularly on the profitability of the investment. Where the investor makes losses the capital deductions are not immediately of any benefit; The reliability, reputation and technical competence of the tax consultant undertaking the tax-planning scheme. Is he infact capable of planning a successful tax-planning scheme? Is there any resent evidence of previous successful tax planning scheme in a similar industry and on a similar scale? If the answer is no, the end result may as well be a disaster!
- The liquidity position of the investment project i.e. the investor should not tie up substantial working capital into fixed assets to jeopardize the liquidity of the company. In most such heavy investments loans are contracted hence the repayment schedule must be carefully watched otherwise default in repayment may increase indebtedness by way of interest.
Use of tax havens in tax planning
An investor may also resort to the use of tax havens in his planning efforts. Tax havens are geographical regions or countries where the tax rates are deliberately kept very low or zero in order to attract investors and savings. Remember that taxation is one of the major considerations in investment decision-making process.
Features of tax haven:
- Low tax rates
- No exchange control restrictions. Transfers of cash into and out of the region or country are completely free and unrestricted.
- Complete secrecy of investments and finance particularly banking.
- Provision of efficient and effective financial, (e.g. banking and insurance services), legal, consultancy services and communication facilities.
- No or little control on investments.
- Some examples of tax havens are the Channel Islands, Liberia, Switzerland, Mauritius, etc
Example of tax planning:
A plan of a tax efficient employee’s remuneration package.
The tax consultant is often required to advice on employees remuneration package that attracts the minimum tax liability. The objective being to recruit and retain competent employees by maximizing the take home pay (net salary) as one form of staff motivation for increased efficiency. A lowly paid employee is inevitably inefficient and not committed to his employment.
Although the scope of employees remuneration tax planning is limited (i.e. All allowances are required to be consolidated for tax purposes), a possible tax efficient remuneration package may explore the following areas: -
- Provide free medical services (not taxable)
- Provision of house by the employer- the maximum taxable benefit is 15% of the salary.