Tax planning in business bangladesh perspective by swapan kumar bala ssrn-id991329

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Tax Planning in Business: Bangladesh Perspective
Swapan Kumar Bala, FCMA
Associate Professor
Department of Accounting & Information Systems
University of Dhaka, Dhaka
Abstract:
This paper highlights the tax planning issues in the context of business environment in Bangladesh. Given the complexity and the tax law ambiguity prevailing in Bangladesh, this paper encompasses the traditional tax planning devices along with a brief overview of the Scholes-Wolfson paradigm of tax planning strategies. The fiscal plans are referred to the related tax law provisions (mentioned in the appendices in a very organized manner), which are expected to be very useful for the existing and potential businessmen.
Keywords:
Tax compliance, Tax minimization Effective tax planning, Tax strategy, Tax incentives.
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Tax Planning in Business: Bangladesh Perspective
Swapan Kumar Bala, FCMA
Associate Professor
Department of Accounting & Information Systems
University of Dhaka, Dhaka
Introduction
The term ‘tax planning in business’ consists of three main words: tax, planning, and business. Tax is “a contribution exacted by the state” – Chambers English Dictionary (1992). “The term taxes is confined to compulsory, unrequited payments to general government” – (OECD, 1988: 37; vide Wilkinson, 1992: 2). Planning is “the process of determining in advance the factors necessary to achieve a set of goals; designing an effective means of achieving some future goals (ends)” – Kohler’s Dictionary for Accountants (Cooper and Ijiri, 1984: 383). Business means “the carrying on of trade or commerce, involving the use of capital and having, as a major objective, income derived from sales of goods or services” – Kohler’s Dictionary for Accountants (Cooper and Ijiri, 1984: 78). According to section 2(14) of the Income Tax Ordinance (ITO), 1984, “business” includes any trade, commerce or manufacture, or any adventure or concern in the nature of trade, commerce or manufacture.1 Thus, ‘tax planning in business’ means dealing with the tax matters of a business entity with a view to maximizing the after-tax rate of return on investments after ensuring voluntary tax compliance. For this purpose, each business entity has to –
1. ensure that it keeps proper records;
2. deduct tax at source where it is necessary;
3. pay advance tax in time, if applicable;
4. file returns in time;
5. comply with notices received from the tax authorities; and
6. be aware of legal remedies where it does not have its rights under the law recognized.
Tax function activities of a business entity are those activities which are concerned with fiscal issues. These functions are of two types: (1) tax compliance activities, and (2) tax planning activities. Tax compliance activities are those activities which include the functions or obligations according to the provisions of various fiscal statutes. Tax planning activities means dealing with the tax matters of a taxpayer with a view to maximizing the after-tax rate of return on investments after ensuring voluntary tax compliance.
FORMS OF BUSINESS VS. TAX PAYING ENTITY
A business entity may be of three types: sole-proprietorship, partnership firm and company. “Sole- proprietorship” has not been defined by the Income Tax Ordinance.
Under section 2(32) of the ITO, “firm” has the same meaning as assigned to it in the Partnership Act, 1932 (IX of 1932). Under section 4 of the Partnership Act, 1932, “Partnership” is the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all. Persons who have entered into partnership with one another are called individually “partners” and collectively “a firm”, and the name under which their business is carried on is called the “firm name”.
1 Section, sub-section, rule, sub-rule, clause or proviso mentioned elsewhere in this paper without referring to any enactment shall be referred to the Income Tax Ordinance, 1984 (Ordinance No. XXXVI of 1984) and the Income Tax Rules, 1984 [No. S.R.O. 39/L/85 dated 14.01.1985, vide sec. 185(4) of the Income Tax Ordinance, 1984].
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Under section 2(20) of the ITO, “company” means a company as defined in the Companies Act, 1913 (VII of 1913) or Companies Act, 1994 (Act No. 18 of 1994)* and includes –
(a) a body corporate established or constituted by or under any law for the time being in force;
(b) any nationalised banking or other financial institution, insurance body and industrial or business enterprise;
(bb) an association or combination of persons, called by whatever name, if any of such persons is a company as defined in the Companies Act, 1913 or Companies Act, 1994;
(bbb) any association or body incorporated by or under the laws of a country outside Bangladesh; and;
(c) any foreign association or body, not incorporated by or under any law, which the National Board of Revenue may, by general or special order, declare to be a company for the purposes of the Income Tax Ordinance.
For preferential tax purpose, from assessment year (AY) 2002-2003 [vide the Finance Act 2002 to the Finance Act 2006] companies are classified into following groups:
(1) Company being bank, insurance or financial institution;
(2) Other companies:
(a) Company not publicly traded; and
(b) Publicly traded company.
From AY 2002-2003, as per the Explanation given in the relevant Schedule for income tax rates in the Finance Act, “publicly traded company” means a company which fulfills the following conditions:
(a) The company is registered in Bangladesh under the Companies Act 1913 or 1994;
(b) The company is enlisted with the Stock Exchange before the end of the concerned income year in which income tax assessment will be made.
Taxpayer’s Status: Under the Income Tax Ordinance, 1984, a taxpayer has two types of status: personal status and residential status. A sole-proprietorship has no separate tax paying identity and individual owner running the sole-proprietorship will have “Individual” status of the owner and not of the business entity, but both partnership firm and company have distinct personal status – “Firm” and “Company” respectively. Residential status may be resident [defined u/s 2(55), ITO] or non- resident [defined u/s 2(42), ITO]. Under section 17, resident assessee (taxpayer) has to pay income tax on total global income including foreign income, but non-resident taxpayer has to pay income tax only on his total domestic (Bangladeshi) income as determined u/s 18 (income deemed to accrue or arise in Bangladesh). Under section 2(55), an individual is to be a resident if his period of stay in Bangladesh is at least 182 days in the concerned income year, or at least 90 days in the concerned income year, and at least 365 days in the preceding 4 income years. A partnership firm is considered as resident, if the control and management of its affairs situated wholly or partly in Bangladesh in the concerned income year. A company will be a resident, if control and management of its affairs situated wholly in Bangladesh in the concerned income year. Otherwise, a taxpayer will be treated as non-resident [u/s 2(42)].
Levels of Taxation: Question regarding whether the entity itself and/or the owner(s) of the entity is(are) taxable is explained on the basis of two concepts: pass-through entity (or flow-through entity) and non-pass-through entity:
• Pass-Through Entity: This entity is not taxable itself. The income of the entity will pass through the owners and is taxable after its accumulation with the owner’s other income. Sole- proprietorship is a pass-through entity. The owner of the entity is taxable for the entire income of the business entity (whether withdrawn or not) along with his/her other income.
* Under section 2(1)(d) of the Companies Act 1994, “company” means a company formed and registered under this Act or an existing company.
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• Non-Pass-Through Entities: This entity is taxable itself. The income of the entity may be distributed to the owners and is usually again taxable in the hands of owners after its accumulation with his/her other income. Partnership firm and company are non-pass-through entities.
A partnership firm is taxable for its income in first instance as a non-pass-through entity. The partners of the firm shall include the share of total income of the firm in the income year [to be computed u/s 43(3)] and but to avoid double taxation, the share of income will be treated as tax-free income subject to “tax rebate at average tax rate (ATR)” if the firm has already paid tax on its income [paragraph 16, Part-B, Sixth Schedule]. But where any tax payable by any partner of a firm in respect of his share of income cannot be recovered from him, then DCT (Deputy Commissioner of Taxes) shall collect it from the firm [sec. 98]. In case of discontinued business of a firm or if the firm is dissolved, the partners are jointly and severally liable to pay due tax, if any [sec. 99]. See few other statutory issues regarding partnership firm and partners in Appendix-I.
A company is taxable for its total income always as a non-pass-through entity. The shareholders of the company are taxable for the income of the entity, only if distributed to them as dividend, which is subject to a source-tax (@ 10% (u/s 54). At the time of sale/transfer of shares, the shareholder may require to pay tax on capital gain arising from the sale or transfer. Thus, shareholder-level of tax (ts) usually includes tax on dividend distributed and tax on capital gain on sale/transfer of shares. However, capital gain on transfer of shares of a company established under the Companies Act 1994 is subject to a reduced rate of 10% [S.R.O. No. 220-Ain/Aykar/2004 dated 13.07.2004], but the capital gain on transfer of stocks and shares of public companies listed with a stock exchange in Bangladesh is fully exempted [sec. 32(7)].
In case of a non-pass-through entity, there is at least double-level taxation. First, a tax is paid by the entity and then a second tax is paid by the owners of the entity (partners of a firm or shareholders of company). In case of firm which has duly paid its tax, double taxation is avoided by considering the share of firm’s income as tax-free and allowing a tax rebate thereon to the partners. But in case of a company, the company has to pay tax on its income at 30%, 40% or 45% and then the individual shareholders have to pay source-tax at 10%, which will be treated as advance income tax (AIT) and then considering the marginal tax rate of the concerned shareholders, tax rate on dividend may be up to 25% for high-income taxpayers. In case of a company investing in shares of another company, there will be triple taxation. The company of which shares have been purchased has to pay first-level tax on its income at 30%, 40% or 45%. Then the investing company has to pay second-level tax on distributed dividend at 15% and when it will distribute its income as dividend, its individual shareholder has to pay third-level tax (source-tax and possible extra tax).
TAX EVASION, TAX AVOIDANCE, AND TAX PLANNING
Tax reduction strategies are often tainted with legality. Income tax statutes have provisions for charging tax on “any income, profits or gains, from whatever source derived” u/s 2(34)(a) and hence, according to the spirit of this provision, legality of the source may not be questioned if tax is duly paid. Suffice it to say, in the Income Tax Ordinance, there are several sections where investment out of undisclosed income can be legalized by paying tax at a stipulated rate not always on the invested amount and the tax rate is often very low [e.g., specific tax rate at Taka 300 or Taka 500 or Taka 200 per square meter for investment in house property u/s 19B, 7.5% of the deed value in case of investment u/s 19BB, and 10% or 15% of the purchase value in case of investment in motor vehicle]. Income by way of winnings from “card games and other games of any sort or from gambling or betting” referred to in section 19(13) is subject to source-tax of 20% (u/s 55) and this tax deducted at source is a “final discharge of tax liability” u/s 82C(4). However, given these moral issues, while dealing with any sort of strategy regarding tax, we must be aware about the distinctions among tax evasion, tax avoidance and tax planning.
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Tax Evasion
Tax evasion has the objective of reduction of tax illegally. Sometimes, it is referred to as ‘tax cheating” through acts of commission or omission. Deceit, concealment, and/or misrepresentation are common elements in most illegal tax plans (Sommerfeld et al., 1980: 28/1). As stated by Webley et al. (1991: 2-3), “Noncompliance is a more neutral term than evasion since it does not assume that an inaccurate tax return is necessarily the result of an intention to defraud the authorities and it recognizes that inaccuracy may actually result in overpayment of taxes. … In evading tax one is knowingly breaking the law. This has social and psychological consequences such as stigma and guilt and involves confronting different costs since there is a risk of being caught and fined or sent to prison.”
According to Lakhotia and Lakhotia (1998: 9), “The expression ‘Tax evasion’ means illegally hiding income or concealing the particulars of income or concealing the particular source or sources of income or in manipulating the accounts so as to inflate the expenditure and other outgoings with a view to illegally reduce the burden of taxation. Hence, tax evasion is illegal and unethical.”
Tax Avoidance
Tax avoidance and tax evasion usually both have same objective of reduction of tax, but tax avoidance encompasses only legal means of achieving the objective.
Justice Jagadisan J. has mentioned in the verdict of Aruna Group of Estate v. State of Madras (1965) case, “Avoidance of tax is not tax evasion and it carries no ignominy with it, for, it is sound law and, certainly, not bad morality, for anybody to so arrange his affairs as to reduce the brunt of taxation to a minimum.” (Palkhivala and Palkhivala 1976: 46).
Avoidance involves ‘every attempt by legal means to prevent or reduce tax liability which would otherwise be incurred, by taking advantage of some provision or lack of provision in the law … it presupposes the existence of alternatives, one of which would result in less tax than the other’ (Report of the Royal Commission of Taxation 1966: 538; vide Webley et al. 1991: 2).
Tax avoidance “is the art of dodging taxes without breaking the law. ……tax avoidance means of traveling within the framework of the law or acting as per the language of the law only in form, but murdering the very spirit of the law and thus acting against the intention of the law and defeating the purpose of the particular legal enactment” (Lakhotia and Lakhotia 1998: 10).
Perhaps the most celebrated statement made in defense of tax avoidance came from the pen of Judge Learned Hand. In a dissenting opinion, in Commissioner v. Newman case, he once said:
Over and over again courts have said that there is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible. Everybody does so, rich or poor, and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere cant. [Commissioner v. Newman, 159 F.2d 848 (CA-2,1947), vide Scholes et al., 2002: 5].
Tax Planning
As stated earlier, tax planning is legal, desirable for the fiscal policymakers and ethical. In a narrow sense, tax planning and tax avoidance are used interchangeably. But for tax avoidance purpose, usual means are the exploiting the ‘tax loopholes’, or getting the advantages of tax law ambiguity, and hence it is often distinguished from tax planning. According to Lakhotia and Lakhotia (1998: 10), “‘Tax planning’ takes maximum advantage of the exemptions, deductions, rebates, reliefs and other tax concessions allowed by taxation statutes, leading to the reduction of the tax liability of the tax payer.”
However, according to Scholes and Wolfson (1992: 3), “Traditional approaches to tax planning fail to recognize that effective tax planning and tax minimization are very different things. The reason is that in a world of costly contracting, implementation of tax-minimizing strategies may introduce significant costs along nontax dimensions. Therefore, the tax-minimization strategy may be
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undesirable. After all, a particular easy way to avoid paying taxes is to avoid investing in profitable ventures.” Thus, effective tax planning means not to minimize tax, but to maximize after-tax rates of return on assets.
COMPLIANCE OBLIGATIONS OF A BUSINESS ENTITY UNDER ITO
Following are the tax compliance obligations of a business entity as per various sections the Income Tax Ordinance 1984:
(1) Obligations of a business entity as an assessee (taxpayer):
(2) Obligations of a business entity as a tax collector on behalf of tax authority:
(3) Obligations of related persons of a business entity.
(1) Compliance as an assessee (taxpayer):
- Collection of TIN (Tax-payer’s Identification Number) Certificate u/s 184B, 184A
- Displaying of TIN Certificate u/s 184C
- Advance income tax payment u/s 48, 64-73
- Preparation of tax return u/s 75
- Payment of tax as per tax return u/s 74
- Filing of tax return and statements in prescribed forms u/s 75
- Filing of revised return if any omission or incorrect statement in the previously filed return discovered before the assessment is made u/s 78
- Maintenance of accounts and documents: u/s 35
- Production of accounts and documents on receipts of a notice from the DCT: u/s 79
- Cooperation with income tax authority during inspection (u/s 114), survey (u/s 115), enquiry (u/s 116), search and seizure (u/s 117) and verification regarding deduction or collection of tax at source (u/s 117A)
- Compliance with various notices:
• Notice of Demand u/s 135,
• Notice to file return u/s 77,
• Notice to produce accounts, statements and documents u/s 79,
• Notice to file statement of assets, liabilities and life style u/s 80 [normally applicable for individual assessee],
• Notice to attend hearing u/s 83(1) in case of assessment after hearing,
• Notice to inform re-assessment u/s 93(1),
• Notice to attend hearing u/s 130 in case of imposing penalty u/s 123-128,
• Notice to the transferor, the transferee and the person in occupation of the immovable property to initiate the proceedings for acquisition of the immovable property u/s 32(4) and u/r 42 if the fair market value of the property exceeds the transferor’s declared value and others], and so on.
(2) Compliance as a tax collector on behalf of tax authority:
- Collection of Tax Collection Account number u/s 184BB
- Tax deduction at sources (TDS), if applicable, and deposit thereof to the Treasury u/s 48-63
- Giving documents of TDS with necessary information u/s 58, and
- Furnishing annual returns in case of payment of salary (u/s 108), interest (u/s 109) and dividend (u/s 110).
(3) Compliance obligations of related persons of a business entity.
- Appearance on behalf of the assessee at any income tax proceedings u/s 174,
- Legal representative to be treated as deemed to be assessee in case of a deceased person u/s 92,
- Liability in certain cases (as a representative of another person u/s 95, as an agent of a non- resident principal u/s 96, 102 and 103A),
- Filing a return of the income of any other person for whom the company is assessable [u/s 75(1B)],
- Joint liability in case of director of a private company (u/s 100), and
- Joint liability in case of liquidator of a private company (u/s 101).
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In case of non-compliance with any of the above issues, a business entity may face different types of enforcements by the tax authority (such as inspection of register of companies u/s 114, survey u/s 115, enquiry and production of documents u/s 116, search and seizure u/s 117, verification of deduction or collection of tax u/s 117A, best judgment assessment u/s 84 and thereafter recovery of tax u/s 134- 143, imposition of penalty u/s 123-133, prosecution u/s 134-171), disallowances of deductions u/s 30, disallowances of exemptions due to not having appropriate evidence of the income, imposition of penalty interest u/s 57 & 73, etc. For these reasons, a business entity may be involved with litigations for which it might seek appeals u/s 153-159, revision u/s 120-121, and references u/s 160-162. But everything is costly and is subject to not only pecuniary costs, but also political and psychic costs.
TRADITIONAL TAX PLANNING TECHNIQUES
Traditional tax planning is equivalent to tax avoidance with the main purpose of legal reduction of tax liability. Following are the major issues regarding this type of tax planning.
Tax Planning Principles: Jones and Rhoads-Catanach (2004) have suggested following four tax planning principles:
Ž Taxes decrease if income earned by entity is subject to a low rate.
Ž Taxes decrease if payment can be deferred to a later year, because tax deferred is tax reduced.
Ž Taxes decrease if income is generated in a low rate jurisdiction.
Ž Taxes decrease if income is taxed at a preferential rate.
For planning purposes only relevant rate is rate at which the transaction will be taxed, i.e., marginal rate – rate at which next Taka of income will be taxed. The marginal tax rate may change as follows: (a) higher bracket due to more income, or (b) law may be changed and a new rate is prescribed.
Factors Affecting Tax Planning: According to Jones and Rhoads-Catanach (2004), following are the factors affecting tax planning:
• Which entity undertakes the transaction?
• Over what period does a transaction take place?
• In which jurisdiction does the transaction take place?
• What is the character of the income?
The above factors have been briefly discussed below.
Ž Choice of Entity: The first factor to affect the tax planning is the entity undertaking the transaction. Different entities have different tax rates. Pass-through entities (sole-proprietorship) allow shifting income to owner and one level of tax. Non-pass-through entities (companies) are subject to double taxation, once at corporate level and then again at the shareholder level.
Ž Period of Transaction: Tax planning is affected by the period over which a transaction takes place. Tax deferred is tax saved based upon time value of money. Common techniques are to accelerate deductions (e.g., following accelerated depreciation) and to defer income (e.g., through installment sale). A taxpayer has to consider when taxes are actually paid (e.g., quarterly estimates versus end of year computation).
Ž Tax Jurisdictions: The third factor by which tax planning is affected is the jurisdiction in which the transaction takes place. Tax liability depends whether the income will be accrued in foreign country (subject to exemption or tax relief) or Bangladesh or whether the income will be earned by establishing the entity in a low tax zone or a high tax zone.
Ž Character of Income: The final affecting factor is the character of the income. Depending on the income character, certain types of income are exempted fully or partially. Certain types of income are taxed at preferential rates (e.g., capital gain on transfer of stocks and shares of private limited company taxed @ 10%, dividend income from shares taxed to companies @ 15%).
A final tax liability is a function of three variables: the law, the facts, and the administrative (and sometimes judicial) process. If any taxpayer is not satisfied with either the law or the administrative and judicial processes, there is relatively little that s/he can do (unless, of course, s/he has enough money and clout to get a tax law change). The facts, however, are generally amenable to modification. If a taxpayer is wise enough to understand when and how to modify them, s/he may very well reduce
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her/his tax liability significantly. The most highly qualified professional tax experts earn most of their lucrative fees by giving advice on alternative ways of arranging facts. In other words, most professional tax planning is little more than the prearrangement of facts in the most tax-favored way (Sommerfeld et al., 1980: 28/1). Even the International Accounting Standard 12, Income Taxes (IAS 12) has suggested exploiting tax planning opportunities through changing the accounting method or arranging the facts. Under paragraph 30 of IAS 12, tax planning opportunities are actions that the enterprise would take in order to create or increase taxable income in a particular period before the expiry of a tax loss or tax credit carryforward. IAS 12 has mentioned following few examples how, in some jurisdictions, taxable profit may be created or increased:
(a) by electing to have interest income taxed on either a received or receivable basis;
(b) by deferring the claim for certain deductions from taxable profit;
(c) by selling, and perhaps leasing back, assets that have appreciated but for which the tax base has not been adjusted to reflect such appreciation; and
(d) by selling an asset that generates non-taxable income (such as, in some jurisdictions, a government bond) in order to purchase another investment that generates taxable income.
Where tax planning opportunities advance taxable profit from a later period to an earlier period, the utilisation of a tax loss or tax credit carryforward still depends on the existence of future taxable profit from sources other than future originating temporary differences (IASB, 2004: 740).
However, Chapter-XI (sections 104 to 107) of the Income Tax Ordinance, 1984 is on “Special Provisions Relating to Avoidance of Tax” as follows:
• Section 104: Avoidance of tax through transactions with non-residents
• Section 105: Avoidance of tax through transfer of assets
• Section 106: Avoidance of tax by transactions in securities
• Section 107: Tax clearance certificate required for persons leaving Bangladesh.
Appendix-II delineates the Special Provisions Relating to Avoidance of Tax under Chapter-XI of the Income Tax Ordinance, 1984.
Critical Variables of Traditional Tax Planning in Business
Traditional tax planning is based on maximizing the tax-favored status and minimizing the tax- disfavored status, which are usually as follows:
Tax-Favored Status
Tax-Disfavored Status
Ž Full tax exemptions
Ž Partial tax exemptions
Ž Tax credit, rebate, relief, and concession
Ž Tax deduction permitted at a rate faster than the decline in economic value of the asset
Ž Taxable income permitted to be recognized at a rate slower than the increase in the economic value of the assets cash flow
Ž Special tax assessment
Ž Tax deduction permitted at a rate slower than the decline in the economic value of the asset
Ž Taxable income permitted to be recognized at a rate faster than the increase in the economic value of the assets cash flow
Traditional tax planning starts with finding the critical variables for which a simple tax formula as follows may help:
Line No.
Item
1
Aggregate Income
2
–
Exclusions
3
=
Gross Income
4
–
Allowable Deductions
5
=
Taxable Income [‘Total Income’ is the legal term used as tax-base]
6
×
Tax Rate(s)
7
=
Gross Tax
8
–
Tax Credit, Tax Rebate, & Tax Relief
9
=
Tax Payable
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Since the ultimate objective of traditional tax planning is the minimization of the bottom line – that is, the minimization of the net tax payable – the rules of simple arithmetic suggest that tax planning must necessarily involve the maximization of tax credits/rebates/reliefs, the minimization of the applicable tax rate(s), and the maximization of deductions and/or exclusions. In other words, the items on all even-numbered lines in the above formula constitute the critical variables in tax planning. Each of these variables is briefly explained below.
Maximization of exclusions: Exclusions are the incomes which are not included in the tax-base of the income tax [‘total income’ as defined u/s 2(65), the scope of which is outlined u/s 17 and computed u/s 43 according to the heads of income u/s 20, but to be reported under the heads mentioned in the ‘Form of Return of Income’ (Form IT-GA) u/r 24]. Under section 44(1), any income or class of income or the income of any person or class of persons specified in Part A of the Sixth Schedule shall be exempt from the tax, subject to the limits, conditions and qualifications laid down therein and shall be excluded from the computation of total income. Along with this list under Part A of the Sixth Schedule, Government has issued a number of Statutory Rules and Orders (S.R.O.) u/s 44(4) of the Income Tax Ordinance, 1984 to extend this exclusion list. Few SROs issued u/s 60(1) of the Income-tax Act 1922 are still in force for similar exclusion purpose. The business entities which have been allowed tax holiday u/s 46A or under any SRO are able to exclude their income enjoying tax holiday. See Appendix-III for a checklist of all these exemptions to date. Through maximizing these exclusions, tax-base and consequent tax liability can be minimized.
Maximization of deductions: Except ‘Salaries’ head u/s 21, all other statutory heads of income have provisions of deductions: section 23 for deductions from “Interest on securities”, section 25 for deductions from “Income from house property”, section 27 for deductions from “Agricultural income”, section 29 for deductions from “Income from business or profession” [along with section 30 for inadmissible expenses from “Income from business or profession”], section 32(1) for deductions from “Capital gains” [along with section 32(12) for restricted deductions from “Capital gains”], and section 34 for deductions from “Income from other sources”. All these deductions are subject to limits, and conditions and subject to evidential proofs. So a business entity must be careful about these conditions, limits and authenticity of the transactions and thereby, disallowances may be avoided and deductions can be maximized. See Appendix-IV for the provision of accelerated depreciation (as an alternative to tax holiday) and initial depreciation (as an extra allowance in addition to normal depreciation).
Under section 37, in the year of loss, losses under any head other than two losses – loss in speculation business and loss under the head “Capital gains” –can be set-off against other head(s) except against speculation business income and capital gain. But one speculation business loss can be set off against other speculation business income only and one capital loss can be set off against other capital gain only. Under other provisions of sections 38-42, set-off of losses can be done in future six successive income years only against the concerned head of income and applicable only for following incomes: speculation business income (u/s 39), other business income (u/s 38), Capital gains (u/s 40), and agricultural income (u/s 41). But in case of capital loss, carry-forward can be done after deduction of Taka 5,000 [u/s 40(3)]. Loss will be calculated for carry-forward after deducting any cash subsidy from the Government [second proviso to section 37]. Loss due to depreciation can be carried forward for unlimited period [u/s 42]. In case of loss, how to maximize the setting-off of the loss in the year concerned should be given special attention and in case of unset-off losses, special tax planning regarding accounting method can help to set off those losses before the expiry of the time limits.
Minimization of the tax rate(s): As noted earlier, marginal tax rate is the relevant tax rate for any business decision. Sommerfeld et al. (1980: 28/4) have mentioned, “the marginal tax rate is to business affairs what the law of gravity is to physics. Just as water seeks its lowest level (due to the laws of gravity), so also taxable income seeks its lowest marginal tax rate. The tax planning objective is achieved, of course, when the marginal tax rate is minimized.” See Appendix-V for the statutory tax rates for business entities and some other reduced tax rates for some industrial sectors and some specific types of income.
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Maximization of credits/rebates/relief: Final emphasis for tax planning is to be given to maximize tax credits, tax rebates and tax reliefs. Again these are subject to conditions, limits and special applicability. Appendix-VI shows the areas where one can get these benefits.
Alternative View of Tax Planning Opportunities:
An alternative way of viewing tax-planning opportunities is to observe that income tax is constrained by time, entity, and accounting method. Since income tax rates “start over” with each new tax year and because very few taxpayers have a constant level of taxable income in each year, there tend to be high-tax years and low-tax years. The ‘tax value’ of a deduction is directly dependent on the marginal tax bracket of the party reporting it. Obviously, therefore, taxpayers tend to recognize losses and other deductions in high-tax years and to defer the recognition of taxable income to low-tax years. To the extent that a taxpayer can control tax timing, s/he should do so only after giving full considerations to the time value of money. Sometimes the financial cost of deferral is greater than the tax benefit (Sommerfeld et al., 1980: 28/5).
Method of Accounting in ITO: All income classifiable under the head “Agricultural income” [u/s 26 & 27], “Income from business or profession” [u/s 28-30, 30A] or “Income from other sources” [u/s 33, 34, 36 & 43] shall be computed in accordance with the method of accounting regularly employed by the business entity [sec. 35(1)]. However, every public or private company as defined in the Companies Act, 1913 or 1994 shall, with the return of income required to be filed under the Income Tax Ordinance for any income year, furnish a copy of the trading account, profit and loss account and the balance sheet in respect of that income year certified by a chartered accountant (CA) [sec. 35(3)]. Where no method of accounting has been regularly employed, or if the method employed is such that, in the opinion of the DCT, the income of the assessee cannot be properly deduced therefrom; or where a company fails to furnish financial statements certified by a CA with its return, the income of the entity shall be computed on such basis and in such manner as the DCT may think fit [sec. 35(4)]. The method of accounting may be ‘mercantile system’ (or accrual basis) or ‘cash system’ (or cash basis) or a hybrid system (i.e., mixture of these two for separate heads of income). However, in the income tax laws, few incomes must be computed under a specific accounting method. For instance, declared dividend is taxable under mercantile system [u/s 19(7)], income from house property is taxable under cash system [S.R.O. No. 454-L/80 dated 31.12.1980, vide sec. 60(1) of the Income-tax Act 1922], and advance salary income are taxable under cash system [u/s 21(1)(b)] subject to a relief u/s 172.
The time constraint may also be important in case of working with a closely held private company as a shareholder director, i.e., the owner/operator (O/O). The salaries with arrangement of tax-deduction at source (TDS) of the director are an allowable deduction with some other limits u/s 30 in case of determining the total income of the company. The salaries are taxable in the hand of the director subject to the exclusions under rules 33 and 33A-33J and Part A, Sixth Schedule. The method of accounting followed by the company may be ‘mercantile system’, but the accounting method followed by the director may be ‘cash system’. Depending on this entity level advantage (as O/O of the company), a year-end bonus to the director may be shown as a deduction under accrual basis but the O/O is not required to show it as an income until the time of receipt. Even income year might be different from the entity to its O/O. Such accounting legerdemain is a common practice for tax planning purpose.
TAX PLANNING UNDER THE SCHOLES-WOLFSON PARADIGM
Myron S. Scholes, the 1997 Nobel Winner in Economics as the co-originator of the Black-Scholes option pricing model and a partner of Oak Hill Capital Management and Mark A. Wolfson, a managing partner of Oak Hill Capital Management, have jointly developed a paradigm for tax strategy in 1992 through their book titled Taxes and Business Strategy: A Planning Approach. They have adopted a contractual perspective for their paradigm and suggested three key aspects of tax planning globally:
1. Multilateral Approach: All contracting parties must be taken into account in tax planning, which allows a global or multilateral, rather than a unilateral, approach.
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2. Importance of Hidden Taxes: All taxes (both implicit tax and explicit tax) must be taken into account considering the global measures of taxes. Implicit tax is the decrease in return due to availing tax favored investment and explicit tax is the tax deposited in the treasury.
3. Importance of Nontax Costs: All costs of business must be considered, not just taxes.
Thus, the paradigm is based on consideration of ALL PARTIES, ALL TAXES, ALL COSTS.
Taxing Authority: How to Consider Its Presence in Tax Planning?
According to Scholes and Wolfson, taxing authority is always an uninvited party to all contracts. Taxing authority’s roles can be seen as follows. Taxing authority –
Ž Brings to each of its “forced” ventures with taxpayers a set of contractual terms (tax rules) ;
Ž Does not negotiate the contractual terms separately for each venture;
Ž Announces a standard set of the above terms taxpayers must accept;
Ž Claims a partnership interest in taxpayer’s profit but not at the time of loss;
Ž Does not exercise any voting rights in the entity;
Ž Does not directly monitor taxpayer’s performance to determine whether taxpayers are violating the contractual terms;
Ž But does conduct audits; and
Ž Being a partner in all firms enables the taxing authority to determine when taxpayers are reporting result far out of line with what other taxpayers are reporting in similar situations (information that is used to select return for audit).
Types of Tax Plans:
Contractual terms that taxing authority imposes on its joint venture are the tax rules, which result from a variety of socioeconomic forces: (i) finance public projects, (ii) redistribute wealth and (iii) encourage economic activities. Government ensures objectives of the tax rules by designing to discriminate among different economic activities. This has been done through two things: progressive taxation (for redistributing wealth) and subsidy (for encouraging economic activities). Tax rules provide also to arrange taxpayer’s affairs to keep the tax bite as painless as possible. Thus, progressive taxation, subsidy and provision to arrange taxpayer’s affairs to minimize tax-bite give rise to marginal tax rate (MTR) that widely varies: (1) from one contracting party to the next; (2) for a given contracting party over time; and (3) for a given contracting party over different economic activities.
Changes in tax statutes are a regular and frequent event. At the time of passing the budget, these changes are almost obvious. Even in the name of revenue, SROs (sometimes cynically referred to as Short Route to Opulence) may be issued at any time for changing the taxing provisions. All changes in tax regimes involve turning two types of dials:
1. Levels of tax rates (in case of slab-taxation system, slabs may be changed);
2. Relative tax rates varying:
• Across different tax paying units;
• Across different tax periods for the same taxpayer; and
• Across different economic activities for the same taxpayer and same time period.
Thus, types of income tax planning activities are:
Ž Attempts to have income converted from one type to another (ordinary income vs. capital gain, regular income vs. windfall income, domestic income vs. foreign income, set-off of loss under any head);
Ž Attempts to have income shifted from one pocket to another (taxable vs. tax-exempt sources); and
Ž Attempts to have income shifted from one time period to another (delaying recognition of income, if tax rates are constant or declining over time, instant salary vs. deferred compensation)
In short, the types of income tax planning activities are:
Ž Shifting income from one pocket to another
Ž Shifting income from one time period to another
Ž Converting income from one type to another.
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Tax Planning as a Tax-Favored Activity
Tax planning itself is a tax-favored activity because money spent thereon is tax deductible and tax savings arising from tax planning is effectively tax exempt because they reduce taxes payable and hence, more tax-favored than tax-exemption. When PTROR (pre-tax rate of return) is equal to ATROR (after-tax rate of return), then it is called tax exemption (a situation in which an asset escapes explicit taxation).
For example, there are two alternatives with marginal tax rate (MTR) of 15%: Alternative-1: Invest Tk. 10,000 in fully taxable corporate bonds for one year with a yield of 10% p.a. before taxes. And Alternative-2: Invest Tk. 10,000 in tax planning services to save Tk. 11,0000 in taxes in one year. PTROR (Pre-tax Return/Pre-tax Investment) for Alternative-1 will be 10% [= (Tk. 10,000x10%)/Tk. 10,000]. And PTROR for Alternative-2 will also be 10% [=(Tk. 11,000 – Tk. 10,000)/Tk. 10,000]. But ATROR (After-tax Return/After-tax Investment) for Alternative-1 will be 8.5% [={(Tk. 10,000x10%)(1 – 15%)}/Tk. 10,000]. And ATROR for Alternative-2 will be 11.76% [= {(Tk. 11,000 – Tk. 10,000) (1 – 0%)}/{Tk. 10,000(1 – 15%)}]. Thus, Alternative-2 (tax planning) yields higher ATROR and hence, tax-favored.
A Brief Highlight on Scholes-Wolfson Tax Strategy
Scholes-Wolfson tax strategy depends on identification of tax clientele, which is based on implicit tax and also the adoption of tax arbitrage. Implicit tax arises because the pre-tax investment returns available on tax-favored assets are less than those available on tax-disfavored assets. Taxpayers wishing to obtain the tax-favored treatment offered by the investment bid up the price of the investment lowering the pre-tax return. Thus, a desperate effort to avoid tax might emphasize only to reduce explicit tax by adopting tax-favored treatments, might reduce the after-tax return and hence there will be a decrease in after-tax return, which is nothing but an implicit tax. Implicit tax rate is the difference in pretax returns on a given asset, and the benchmark asset (usually, “fully taxable bonds” taken as benchmark asset). Say, pretax return on fully taxable bond is 10%, and fully tax- exempted return on government security is 7%, then implicit tax rate on government security 30% [=(10% – 7%)/10%]. Thus, paying tax at a rate of 30% on fully taxable bond would result in a return of 7%, the same as the pretax return on tax-exempt government security. Taxpayers who are indifferent between purchasing two equally risky assets, the returns to which are taxed differently, are called the marginal investors. Taxpayers that prefer one investment over another are referred to as the tax clientele for the preferred investment. Unless investors correctly identify their proper tax clientele, they will not maximize their after-tax rates of return. Usually to identify the proper tax clientele, one way is to compute the implicit tax on tax-favored investment based on a fully taxable investment, then clientele of the fully taxable investment will be the taxpayers having “marginal explicit tax rates” (METR) below the implicit tax found. For example, pretax return on fully taxable bond is assumed at 10%, and fully tax-exempted return on government security is 7%, then implicit tax rate on government security is 30% [=(10%–7%)/10%]. The clientele for fully taxable bond are taxpayers with METR below 30%. A taxpayer with 20% METR will earn 8% [=10%(1–20%)] after- tax by investing in fully taxable bond, 1% greater than in tax-exempt government security.
Tax arbitrage is the purchase of one asset (a “long” position) and the sale of another (a “short” position) to create a sure profit despite a zero level of net investment. Through tax arbitrage, one can maximize after tax return effectively without adopting easy and desperate tax-minimization strategies which might introduce significant nontax costs. There are two types of tax arbitrage: organizational- form arbitrage and clientele-based arbitrage. They can be briefly explained as follows:
Arbitrage
Type of taxpayers
Long Position in
Short Position in
Organizational- form
All taxpayers
An asset or productive activity through a favorably taxed organizational form
An asset or productive activity through an unfavorably taxed organizational form
High-tax-rate taxpayers
A relatively tax-favored asset (one that bears a relatively high implicit tax)
A relatively tax-disfavored asset (one that bears a relatively more explicit tax)
Clientele-based
Low-tax-rate taxpayers
A relatively tax-disfavored asset
A relatively tax-favored asset
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But tax arbitrage may be prevented by tax-rule restrictions and frictions. Tax-rule restrictions are the restrictions imposed by the taxing authority, which prevent taxpayers from using certain tax arbitrage techniques to reduce taxes in socially undesirable way (e.g., placing limits by tax authority on taxpayer’s ability to deduct interest only from the income out of investment by the borrowing) and frictions are the direct transaction costs. Although tax-rule restrictions and frictions may impede employment of tax arbitrage technique, but it is these frictions and tax-rule restrictions that make potential returns to tax planning so high.
CONCLUSION
Tax planning as a tax favored activity should be devised in such a way, so that ultimate after-tax rate of return can be maximized. Then the trade-off between extra income and tax cost can be achieved. In cases of business decisions having dichotomous alternatives, tax provision is favorable only for one. For instances, deciding on centralized vs. decentralized management, opening a branch vs. establishing a subsidiary, buying resources from local supplier vs. foreign supplier, dividend distribution vs. retention, raising capital through issuing equity vs. debt securities, repatriation vs. reinvestment (in case of multinational subsidiary), tax is one of the most influential factors that should be evaluated critically. Sometimes, a hassle-free provision may not be favorable to some taxpayers (e.g., treating tax deducted at sources as final discharge of tax liability under section 82C is not desirable for losing business enterprises). Absence of any provision may be utilized as a tax loophole to exploit its benefit (e.g., absence of provision to compute ‘loss under the head Capital Gains’ can be used to show never a capital loss, which cannot be set off against other income). This paper highlights various aspects of tax planning and tax strategies for a business entity, although not in an exhaustive way. But for this purpose thorough background of accounting, finance, economics and fiscal regulations are also equally needed to make the plans and strategies successful.
References:
Chambers English Dictionary. New Delhi: Allide Publishers Ltd., 1992.
Cooper, W.W. and Y. Ijiri (eds.). 1984. Kohler’s Dictionary for Accountants. New Delhi: Prentice-Hall of India Private Ltd.
International Accounting Standards Board (IASB) (2004), International Financial Reporting Standards (IFRSs™) 2004. London: International Accounting Standards Board. “International Accounting Standard IAS 12, Income Taxes” has been provided in pp. 721-780.
Jones, S. M. and S. C. Rhoads-Catanach. 2004. Principles of Taxation: Advanced Strategies. New York: McGraw-Hill Companies, Inc.
Lakhotia, R. N., and S. Lakhotia. 1998. Corporate Tax Planning. New Delhi: Vision Books.
OECD (Organization for Economic Co-operation and Development). 1988. The Revenue Statistics of OECD Member Countries 1965-87. Paris: OECD.
Palkhivala, N. A., and B. A. Palkhivala. 1976. Kanga and Palkhivala’s the Law and Practice of Income Tax – Volume I. Bombay: N. M. Tripathi Private Ltd.
Rajaratnam, S. 1994. Tax Management. Madrsa, India: Forum for Legal Studies Pvt. Ltd.
Robinson, M. (ed.). 2004. Chambers 21st English Dictionary. New Delhi: Allied Chambers (India) Ltd.
Scholes, Myron S. and Mark A. Wolfson. 1992. Taxes and Business Strategy: A Planning Approach. Englewood Cliffs, New Jersey: Prentice-Hall, Inc.
Scholes, Myron S., Mark A. Wolfson, Merle Erickson, Edward L. Maydew and Terry Shevlin. 2002. Taxes and Business Strategy: A Planning Approach. Upper Saddle River, New Jersey: Prentice-Hall.
Shuklendra, A., and M. G. Gurha. 1992. Tax Planning under Direct Tax. Allahabad: Modern Law House.
Sommerfeld, R. M., H M. Anderson and H. R. Brock. 1980. An Introduction to Taxation. New York: Harcourt Brace Jovanovich, Inc.
Webley, P., H. Robben, H. Elffers, and D. Hessing. 1991. Tax Evasion – An Experimental Approach. Cambridge: Cambridge University Press.
Wilkinson, M. 1992. Taxation. Hong Kong: The Macmillan Press Ltd.
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Appendix-I: Partnership Firm and Its Partners
• Payment of interest, salary, commission or remuneration made by a firm to its partners is not allowed as deduction [u/s 30(b)].
• Share of income of a partner out of the capital gains on which tax has been paid by the firm is fully tax- exempted [para 18, Part A, Sixth Schedule]
• Income from partnership firm [para 16 of Part B, Sixth Schedule] will be treated as tax-free income if, the firm has already paid tax on its income. This tax-free income will be included in total income of partners and a tax rebate will be allowed on this income at ATR (average tax rate) [proviso to para 16 of Part B, Sixth Schedule and sec. 43(2)].
• Where the assessee is a partner of a firm, then, whether the firm has made a profit or a loss, his share (whether a net profit or a net loss) shall be taken to be any salary, interest, commission or other remuneration payable to him by the firm in respect of the income year increased or decreased respectively by his share in the balance the profit or loss of the firm after the deduction of any interest, salary, commission or other remuneration payable to any partner in respect of the income year and such share shall be included in his total income [sec. 43(3)]. But Provided that if his share so computed is a loss, such loss may be set off or carried forward and set off in accordance with the provisions of section 42 [proviso to sec. 43(3)].
• Where the assessee is the firm, the loss sustained by it under any head of income shall be set off under section 37 only against the income of the firm under any other head and not against the income of any of the partners of the firm [sec. 42(3)(a)].
• Where the assessee is a partner of the firm, he shall not be entitled to have any loss sustained by the firm carried forward and set off against his own income [sec. 42(3)(b)].
• In the case of a firm in the constitution of which a change has occurred, the firm shall not be entitled to set off so much of the loss proportionate to the share of a retired or deceased partner as exceeds his share of profits, if any, of the income year in the firm [sec. 42(5)(a)].
• In the case of a firm in the constitution of which a change has occurred, a partner of the firm shall not be entitled to the benefit of any portion of the said loss as is not apportionable to him [sec. 42(5)(b)].
• So much of the income of the spouse or minor child of an individual as arises, directly or indirectly, from the membership of the spouse or from the admission of the minor child to the benefits of partnership in a firm in a firm of which such individual is a partner, is to be shown under the head “Income of the Spouse or Minor Child as applicable: u/s 43(4)” [sub-clauses (i) and (ii) of clause (a) of sec. 43(4)].
• A partnership is exempted from tax on its income subject to the following conditions:
(a) Income of the firm is professional;
(b) Income of the firm is dependent wholly or principally on the personal qualification of the partners; and
(c) The firm cannot be registered as a limited liability association under the Companies Act, 1913 or the Companies Act, 19994 due to any Act in force for the time being or any other provision:
Provided that the firm exempted from tax under this notification income tax return, statement of accounts and necessary documents are to be submitted to the concerned Deputy Commissioner of Tax (DCT) for the income year related to the exemption and the DCT shall complete the assessment of the firm under sections 28 and 29 of the Income Tax Ordinance:
Provided further that in case of partners of the concerned firm, any tax deducted at source under section 52A of the Income Tax Ordinance against such exempted firm shall be deemed to be tax paid in advance in proportion to their distribution of profit. [S.R.O. No. 150-Ain/95 dated 28.08.1995, amended by S.R.O. No. 183-Ain/98 dated 19.08.1998 and S.R.O. No. 181-Ain/99 dated 01.07.1999].
Appendix-II: Special Provisions Relating to Avoidance of Tax under Chapter-XI of ITO
• Section 104: Avoidance of tax through transactions with non-residents [Where any business is carried on between a resident and a non-resident and it appears to the DCT that, owing to the close connection between them, the course of business is so arranged that the business transacted between them produces to the resident either no profits or profits less than the ordinary profits which might be expected to yield in that business, the DCT shall determine the amount of income which may reasonably be considered to have accrued to the resident from such business and include such amount in the total income of the resident.]
• Section 105: Avoidance of tax through transfer of assets [Any income which becomes payable to a non-resident by virtue, or in consequence, of any transfer of assets, whether alone or in conjunction with associated operations, shall be deemed to be the income of the person who (a) has acquired, by means of such transfer or associated operations, any right by virtue, or in consequence, of which he has power to enjoy, whether forthwith or in future, the income which becomes so payable to the non- resident, or (b) has received or is entitled to receive at any time, for reasons attributable to such transactions or associated operations, any sum paid or payable by way of loan or repayment of loan or
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any other sum, not being a sum paid or payable as income or for full consideration of money or money’s worth; subject to other conditions of section 105.]
• Section 106: Avoidance of tax by transactions in securities [Where the owner of any securities sells or transfers those securities and buys them back or reacquires them, or buys or acquires similar securities, and the result of the transactions is that any interest becoming payable in respect of the original securities sold or transferred by the owner is not receivable by the owner, the interest payable as aforesaid shall be deemed to be the income of such owner and not of any other person; subject to other conditions of section 106.]
• Section 107: Tax clearance certificate required for persons leaving Bangladesh [Subject to such exceptions as the NBR may make in this behalf, a person who is not domiciled in Bangladesh, or a person who being domiciled in Bangladesh at the time of his departure is not, in the opinion of an income tax authority likely to return to Bangladesh, shall not leave Bangladesh without obtaining from the DCT authorised in this behalf by the NBR (a) a tax clearance certificate, or (b) if he has the intention of returning to Bangladesh, an exemption certificate which shall be issued only if the DCT is satisfied that such person has such intention; and such exemption certificate may be either for a single journey or for all journeys within the period specified in the certificate; subject to other conditions of section 107.]
Appendix-III
Exclusions from Total Income [Part A, Sixth Schedule, vide sec. 44(1), SROs issued u/s 44(4) of the ITO and SROS issued under the Income-tax Act 1922]:
(a) Exclusions from “Salaries” Income
Items of Salary and Extent of Taxability: Rules 33, 33A-33J & Part A, Sixth Schedule
Pay & Allowances
Taxability or Exemption
Conveyance allowance (without any car) [rule 33C]
Exempted up to Taka 18,000
Provision of car for personal and/or official purpose (without any cash allowance) [rule 33D]
Taxable amount: 7.5% of basic salary
Less: Amount deducted from salary (if any)
Provision of car for personal and/or official purpose (with cash allowance) [rule 33E]
Taxable amount: 7.5% of basic salary plus Cash allowance
House rent allowance (cash) [rule 33A]
Exempted: 50% of basic salary or Taka 15,000 per month, lower one
Medical allowance [rule 33I]
Exempted: Actual medical or hospitalization expense
Interest accrued on recognized provident fund [Para 25, Part A, Sixth Schedule]
Exempted: 1/3rd of salary or 14.5% interest rate [S.R.O. 310-L/84 dated 27.06.1984]
Special allowance, benefits or perquisite granted to meet official expenses [Para 5, Part A, Sixth Schedule]
Fully exempted
Deemed income for free furnished/unfurnished accommodation [rule 33B(1)]
Taxable: (Rental value or 25% of basic salary, whichever is less) minus Cash house rent allowance waived
Less: Amount deducted from salary (if any)
Furnished/unfurnished accommodation with concessional rent [rule 33B(2)]
Taxable: (Rental value or 25% of basic salary, whichever is less) minus Cash house rent allowance waived less Rent paid by employee
Free or concessional passage for travel abroad [rule 33G]
Exempted: once in every 2 years if provided as per terms of employment
Free or concessional passage for travel within Bangladesh [rule 33G]
Exempted: if provided as per terms of employment
Free or concessional passage provided by an organization doing transport business [rule 33G]
Fully exempted
Entertainment allowance [rule 33H]
Fully taxable (except free tea, coffee, beverage or like provided during the office hour)
Other benefits [rule 33J]
Exempted: if provided for official purpose
* A shareholder, being director of more than one company, shall be entitled to the benefits under rule 33 for one company only [rule 33(2)(b)].
Retirement Benefits Exempted under Part A, Sixth Schedule: (a) Income of a Government provident fund (GPF) and workers participation fund (para 4); (b) Income of a recognized provident fund (RPF), an approved superannuation fund and an approved gratuity fund (para 6); (c) Payment from GPF, RPF,
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approved superannuation fund or workers participation fund (para 21); (d) Pension (para 8); and (f) Gratuity (para 20).
(b) Exclusions from “Interest on Securities”
• Interest on tax-free Government securities is fully exempted [para 24, Part A, Sixth Schedule]. Previous exemption on interest income on savings instruments [Pratiraksha Sanchaypatra, Five-Year Term Bangladesh Sanchaypatra, Bonus Sanchaypatra, Three-Year Term Sanchaypatra, Six-Month Interval Profit-Based Sanchaypatra and Family Sanchaypatra] under S.R.O. No. 178-Ain/89 dated 04.06.1989 (amended by S.R.O. No. 201-Ain/97 dated 01.09.1997) was repealed by S.R.O. No. 173- Aykar/2002 dated 03.07.2002. Only yield of Post Office Savings Certificates is exempted [S.R.O. No. 454-L/80 dated 31.12.1980, vide sec. 60(1) of the Income-tax Act 1922]. But since the Post Office has no securities now, practically there is no tax-free Government security.
• Interest from taxable Government securities up to Taka 5,000 [para 12, Part A, Sixth Schedule].
• Interest on debenture up to Taka 20,000, provided that joint exemption on interest on debenture and interest from taxable Government is up to Taka 20,000 [para 13, Part A, Sixth Schedule].
• Income exceeding Taka 25 thousand received from interest on savings instruments, where no source- tax is deducted u/s 52D (i.e., savings instruments purchased during 10 June 1999 to 31 December 2003) [para 31B, Part A, Sixth Schedule].
• Income up to Taka 25,000 earned from investment in Zero-Coupon Bond issued an organization approved by the Bangladesh Bank and the Securities & Exchange Commission is exempted [S.R.O. No. 203-Ain/Aykar/2005 dated 06.07.2005, vide sec. 44(4)].
• Interest up to Taka 25,000 earned from investment in ‘Bangladesh Industrial Development Bond’ of various terms issued a nationalized commercial bank (NCB) is exempted. If the interest exceeds Taka 25,000, then tax is to be deducted at source at 10% on full amount of interest and such interest deducted at source shall be treated as final settlement of tax liability [S.R.O. No. 203-Ain/Aykar/2005 dated 06.07.2005, vide sec. 44(4)].
• Both the principal and interest on the purchase of Wage Earners Development Bond [S.R.O. No. 160- L/81 dated 25.05.1981, vide sec. 60(1) of the Income-tax Act 1922].
(c) Exclusions from “Income from Other Sources”
• Income from dividend of a mutual or Unit Fund where such dividend does not exceed 25,000 taka [para 22A, Part A, Sixth Schedule].
• Interest provided by a Scheduled Bank on Savings Pension Scheme introduced by the Scheduled Bank and approved by the Government [S.R.O. No. 89-Ain-Aykar/2003 dated 02.04.2003, w.e.f. 26.01.2003, vide sec. 44(4)]. This exemption was first provided under S.R.O. No. 54-Ain/95 dated 04.04.1995, which was repealed by S.R.O. No. 21-Ain-Aykar/2002 dated 26.01.2002.
• Interest accrued in from the Non-Resident Foreign Currency Deposit Account is exempted [S.R.O. No. 415-L/82 dated 23.10.1983, vide sec. 60(1) of the Income-tax Act 1922].
• The interest on deposits in the Post Office Savings Bank is exempted [S.R.O. No. 454-L/80 dated 31.12.1980, vide sec. 60(1) of the Income-tax Act 1922].
• Scholarships granted to meet the cost of education is exempted [S.R.O. No. 454-L/80 dated 31.12.1980, vide sec. 60(1) of the Income-tax Act 1922].
(d) Exclusions from “Income from Business or Profession”
• 50% of the export income except in case of an assessee, who is enjoying exemption of tax or reduction in rate of tax by any notification [para 28, Part A, Sixth Schedule].
• Income of the mutual fund of the person issuing such mutual fund [para 30, Part A, Sixth Schedule].
• Income of Unit Fund of the Investment Corporation of Bangladesh is exempted [S.R.O. No. 187-L/83 dated 12.06.1983, vide sec. 60(1) of the Income-tax Act 1922].
• Income of Mutual Funds of the Investment Corporation of Bangladesh is exempted [S.R.O. No. 88- L/80 dated 01.04.1980, vide sec. 60(1) of the Income-tax Act 1922].
(e) Exclusions from Income under any Head
• Tax on donation up to Taka 500,000 out of income of an assessee made to the organizers of first class national and international sports programs held or to be held in Bangladesh is exempted [S.R.O. No. 202/Ain/91 dated 01.07.1991, vide sec. 44(4)].
• Tax payable on so much of the income of an assessee donated towards the “Prime Minister’s Relief Fund” is exempted [S.R.O. No. 125-Ain/91 dated 05.05.1991, vide sec. 44(4)].
• Tax payable on so much of the income of an assessee donated towards the “President’s Relief Fund” is exempted [S.R.O. No. 254-L/85 dated 10.06.1985, vide sec. 44(4)].
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• Tax payable on so much of the income of an assessee donated towards the “CMLA’s Flood Relief Fund” is exempted [S.R.O. No. 389-L/83 dated 23.10.1983, vide sec. 60(1) of the Income-tax Act 1922].
(f) Exclusions from “Capital Gains”
• Capital gain on transfer of capital asset being Government securities and stocks and shares of public companies listed with a stock exchange in Bangladesh [sec. 32(7); w.e.f. AY 1995-96].
• Profits and gains on transfer of stocks or shares of a public company as defined in the Companies Act, 1994 received by an assessee, being a non-resident, subject to the condition that such assessee is entitled to similar exemption in the country in which he is a resident [proviso to sec. 31, inserted by the Finance Act 1990]. Section 2(1)(j) of the Companies Act 1994 defines a ‘public company’.
• Capital gain on transfer of machinery or plant used for the purpose of business or profession [Para 31A of Part A, Sixth Schedule],
• Capital gain on transfer of any business capital asset (other than machinery or plant) if the capital gain is utilized to acquire similar asset within one year before or after the date of transfer [sec. 32(5)],
• Capital Gain on transfer of buildings or lands to a new company for equity financing [sec. 32(10)],
• Capital gain on transfer of capital asset of a partnership firm to a new company for equity financing [sec. 32(11)],
• Capital gain on transfer of an asset of an assessee to a new company for equity financing [sec. 32(11A)].
(f) Exclusions of Foreign Income
• Income derived by a citizen of Bangladesh, irrespective of the residential/nonresidential status, outside Bangladesh and brought into Bangladesh under the laws in force is exempted under the Income Tax Ordinance, 1984 [S.R.O. No. 216-Ain/Aykar/2004 dated 13.07.2004, vide sec. 44(4)].
• Income earned abroad by a resident is exempted under the Income Tax Ordinance, 1984 subject to the following conditions: (a) the income is brought into Bangladesh in foreign currency exchangeable without any restriction through banking channel; and (b) the money brought shall be spent in repaying default bank loan of the concerned person. No question regarding the source of the income earned abroad, if the conditions of this notification are complied with [S.R.O. No. 322-Ain/2001 dated 09.12.2001, vide sec. 44(4)].
(g) Exclusions of Income for allowing Tax Holiday
Tax holiday u/s 46A: This is a period (4 years or 6 years) for which the company is allowed full exemption of tax on its “income from business or profession” for prescribed sectors.
Location
Tax Holiday Period
Dhaka & Chittagong Divisions except 3 hill districts of Rangamati, Bandarban and Khagrachari [sec. 46A(1)(a)]
4 years
Barisal, Khulna, Rajshahi, Sylhet and 3 hill districts of Rangamati, Bandarban and Khagrachari [sec. 46A(1)(b)]
6 years
Tax holiday under S.R.O.:
Type of Industry/Income
Tax Holiday Period
Income of any industry established in any Export Processing Zones (EPZ) [S.R.O. No. 289-Ain/89 dated 17-08-1989]
10 years from the date of commercial production
Income of a private sector Power Generation Company established under the fulfillment of all the conditions mentioned in the Private Sector Power Generation Policy of Bangladesh [S.R.O. No. 114-Ain/99 dated 26-05-1999, which repealed S.R.O. No. 35-Ain/97 and S.R.O. No. 36-Ain/97 dated 03.02.1997].
Other Tax-Exempted Incomes: (a) Income of the foreign individuals working in the company for 3 years from the date of their entering into Bangladesh [w.e.f. 03.02.1997]; (b) Interest payable on foreign loan taken by the company [w.e.f. 26.05.1999]; (c) Royalties, Technical Know-how and Technical Assistance Fee payable by the company [w.e.f. 26.05.1999]; and (d) capital gain arising from transfer of the shares of the company [w.e.f. 26.05.1999].
15 years from the date of commercial production [w.e.f. 03.02.1997]
Agro-processing industries [S.R.O. No. 166-Ain/Aykar/2006 dated 06.07.2006, which repeals S.R.O. No. 214-Aykar/2003 dated 19.07.2003. SRO of 2003 repealed S.R.O. No. 175-Aykar/2002 dated 03.07.2002 effective from 1-7-2002]
from 01-07-2002 to 30- 06-2008
Income of any Bangladeshi resident person from computer software business [S.R.O. No. 172-Aykar/2002 dated 03.07.2002]
from 01-07-2002 to 30- 06-2005
17

Tax holiday under S.R.O.: ….. cont’d
Type of Industry/Income
Tax Holiday Period
Income attributable to export of handicrafts [S.R.O. No. 191-Ain/97 dated 29.08.1997, which repeals S.R.O. No. 313-L/86 dated 24.07.1986]
Effective from 01-07- 1986
Company investing in any sector of Bangladesh economy on a commercial basis under an agreement between Bangladesh Government and any other foreign government or any investment organization established by the foreign government [S.R.O. No. 32/Ain/90 dated 24.01.1990, which repeals S.R.O. No. 147-Ain/87 dated 15.07.1987 under which investment in agriculture and industry was covered]
Effective from 15-07- 1987
Any income attributable from various agro-farms (fish farming, poultry farming, duckery, pelleted poultry feed production, seed production, marketing of locally produced seeds, cattle farming, dairy farming, frog farming, horticulture, cultivation of mulberry, sericulture, mushroom farming, and floriculture) [S.R.O. No. 206-Ain/Aykar/2006 dated 06.07.2005, which is amended by S.R.O. No. 215- Aykar/2003 dated 19.07.2003; later S.R.O being amended by S.R.O. No. 168- Ain/2001 dated 28-06-2001]
Subject to some conditions: (a) if the tax-exempted income exceeds Tk. 1 lakh, at least 10% of such income is to be invested in bond or security issued by Government within 6 months from the end of the concerned income year; (b) income tax return is to be submitted to the DCT for each year related to the tax exemption period; (c) tax exempted income cannot be transferred within 5 years from the concerned tax exempted activities.
from 01-07-2001 to 30- 06-2008
[first allowed from 1-7- 1980 under S.R.O. No. 317-L/80 dated 28-8-1980 for fish farming, poultry farming, duckery, cattle farming, dairy farming and horticulture]
Any new hospital (i) set up between 1-7-1999 and 30-6-2008 under the Companies Act 1994, (ii) set up on own land of the hospital, (iii) having at least 200 beds in case of general hospital and at least 50 beds in case of specialization for heart-disease, kidney and cancer, (iv) having 10% beds for free treatment of poor patients [S.R.O. No. 180-Ain/99 dated 01.07.1999 and S.R.O. No. 204- Ain/Aykar/2005 dated 06.07.2005]
5 years
Appendix-IV: Some Accelerated Deductions
(a) Initial depreciation allowance: From financial year 2002-03, under paragraph 5A of the Third Accelerated Depreciation: This is an extraordinary depreciation allowance as per paragraphs 7 and 7A of the Third Schedule of the Income Tax Ordinance 1984:
¾ from AY 2006-07, 50% in the first year, 30% in the second year and 20% in the third year (previously 100% in the first year up to AY 2005-06) provided as per paragraph 7 [the application for accelerated depreciation is accompanied by a declaration in writing that the concerned industrial undertaking has not approved for tax holiday and that no application has been made for tax holiday u/s 45 or 46A]; or
¾ 80% in first year and 20% in second year provided as per paragraph 7A [applicable in case of machinery or plant (other than office appliances and road transport vehicles) which not having been previously used in Bangladesh, has been or is used in the expansion unit set up between from 1-7-1995 to 30-6-2005 (both days inclusive) in any existing undertaking enjoying tax holiday u/s 46A].
Prescribed hitech electronic industry set-up in Export Processing Zones (EPZ) is entitled to accelerated depreciation of 100% of the actual cost of machinery or plant (other than office appliances and road transport vehicles) within the tax exemption period of 10 years, but application for accelerated depreciation is to be made within 4 months from the end of the month of installation of the machinery or plant to the NBR [S.R.O. No. 269-L/86 dated 01-07-1986].
Tax holiday and accelerated depreciation are mutually exclusive [paragraph 7(2)(d) and paragraph 7A(1)(a) of Third Schedule].
Tax Holiday vs. Accelerated Depreciation: Criteria for selection if both are available
Tax Holiday
Accelerated Depreciation
Labour-intensive
Capital-intensive
Profitable venture from starting
Initially losing venture
Loss during the tax holiday period cannot be carried forward beyond tax holiday.
Loss due to depreciation can be carried forward for unlimited period.
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(b) Initial depreciation allowance: From financial year 2002-03, under paragraph 5A of the Third Schedule, initial depreciation allowance is allowed for the first year at 10% on the cost of building and 25% on the cost of machinery or plant (other than ships or motor vehicles not plying for hire or any machinery or plant which has previously been used in Bangladesh).
Appendix-V: Tax Rates – Statutory and Reduced
(a) Income Tax Rates:
ƒ Tax Rate for Non-Corporate Taxpayers including Firm:
Tax Rates for AY
Types of Assessee
Type of Income
2006-07
2007-08
(1) Long-term capital gain
15% or Av. Tax Rate on total income including capital gain, lower one
Same
(2) Accidental income u/s 19(13)
20% or ATR on total income including accidental income, lower one
Same
(3) Other income
Total Income-Slab
2006-2007
2007-2008
On first Tk.
On next Tk.
On next Tk.
On next Tk.
On balance Tk.
120,000
250,000
300,000
350,000
Balance
120,000
250,000
300,000
350,000
Balance**
Nil
10%
15%
20%
25%
Nil
10%
15%
20%
25%
Resident individual assessee*, non- resident Bangladeshi, association of persons, firm and other artificial juridical persons
Minimum tax (Tk.)
1,800
1,800
Non-company non-resident assessee (except any Bangladeshi)
Total income
25%
25%
* The tax exemption benefit on remittance from abroad for resident persons who are not citizens of Bangladesh has been withdrawn from FY 2006-07.
** But 10% tax rebates on the additional tax paid by those individual taxpayers paying tax at the highest rate of 25% disclosing more than 10% higher income in the assessment year (AY) 2007-08.
ƒ Tax Rate for Corporate Taxpayers:
Tax Rates for AY
Types of Company
Type of Income
2006-07
2007-08
- Transfer of stocks & shares of private limited company [S.R.O. No. 220-Ain/Aykar/2004 dated 13.07.2004]
10%
10%
(1) Capital gain arising out of
- Transfer of other capital assets
15%
15%
(2) Dividend income
15%
15%
Bank*, insurance, financial institutions
(3) Other income
- Both for publicly traded and not publicly traded company
45%
45%
- Transfer of stocks & shares of private limited company [S.R.O. No. 220-Ain/Aykar/2004 dated 13.07.2004]
10%
10%
(1) Capital gain arising out of
- Transfer of other capital assets
15%
15%
(2) Dividend income
15%
15%
- For publicly traded company
* Dividend declared by less than 10% or failure to pay declared dividend within SEC stipulated time
* Other situation
40%
30%
40%
30%
Other company**
(3) Other income
- For other company
40%
40%
* Under section 16C, a bank company, if shows, in the return, profit exceeding 50% of the aggregate sum of capital and reserve, shall pay tax @ 15% of such excess profit as additional tax.
** Under section 16B, a listed company other than a banking or insurance company, if has not issued, declared or distributed dividend or bonus share equivalent to at least 15% of paid-up capital within six months immediately following any income year, shall pay tax @ 5% of “undistributed profit” (accumulated profit including free reserve) as additional tax.
19

(b) Reduced Tax Rate for Industrial Sectors:
Industries
Reduced tax rate
Companies engaged in thread-production, thread-dyeing, finishing, conning, cloth-making, cloth-dyeing, finishing, printing or one or more similar process relating to textile production [S.R.O. No. 168- Ain/Aykar/2006 dated 06.07.2006, which repeals S.R.O. No. 219- Ain/Aykar/2004 dated 13.07.2004]. Under S.R.O. No. 218- Ain/Aykar/2003 dated 19.07.2003, initially reduced rate of 20% introduced with effect from 1-7-2006.
15% [w.e.f. 1-7-2004 to 30- 6-2008]
[20% for income year 2003- 04]
Enterprise engaged in producing jute products [S.R.O. No. 169- Ain/Aykar/2006 dated 06.07.2006, which repeals S.R.O. No. 218- Ain/Aykar/2004 dated 13.07.2004]
15% [w.e.f. 1-7-2008 to 30- 6-2008]
Income attributable from export by enterprises engaged in producing readymade garments [S.R.O. No. 217-Aykar/2003 dated 19.07.2003, repealed by S.R.O. No. 201-Ain/Aykar/2005 dated 06.07.2005]
10% [w.e.f. 1-7-2003 to 30- 6-2005; initially effective up to 30-6-2006]
Income attributable from export of knit-wear and woven garments by an exporter [S.R.O. No. 205-Ain/Aykar/2005 dated 06.07.2005].
Subject to some conditions: (a) income deemed to be income u/s 19 or income due to disallowances u/s 30 shall not be income subject to settled tax; (b) income to be determined by assuming an income tax rate of 10%; (c) income under other heads shall be computed normally; (d) income tax return shall be submitted to the concerned DCT along with statements of accounts and necessary documents.
0.25% of the total export proceeds deducted at source by the collecting bank u/s 53BB [w.e.f. 1-7-2005 to 30-6-2010]
Any new industry (i) set up between 1-7-2002 and 30-6-2005 under the Companies Act 1994, (ii) set up not as an expansion unit of an existing industry, (iii) not applied for tax holiday u/s 46A, (iv) not applied for accelerated depreciation, and (v) computing normal depreciation allowance on actual value rather than ‘written down value’ [S.R.O. No. 177-Aykar/2002 dated 03.07.2002]
20% [w.e.f. 1-7-2002 for 5 years]
Income derived from only diamond cutting and polishing business by a company engaged in diamond cutting and polishing industry [S.R.O. No. 174-Ain/Aykar/2006 dated 06.07.2006]
15% [w.e.f. 1-7-2006 to 30- 6-2008]
(b) Reduced Tax Rate for Specific Income:
Income
Reduced tax rate
Capital gain on transfer of shares of a company established under the Companies Act, 1994 [S.R.O. No. 232-Aykar/2003 dated 31.07.2003].
10% [w.e.f. 31-7-2003]
Capital gain on transfer of shares of a company established under the Companies Act 1994 [S.R.O. No. 220-Ain/Aykar/2004 dated 13.07.2004]
10% [w.e.f. 13-7-2004]
Appendix-VI: Tax Credits, Tax Rebates and Tax Relief
(a) TAX CREDIT @ 15% on Allowable Investments/Donations/Zakat:
Under section 44(2)(b), an assessee shall be entitled to a credit from the amount of tax payable on his total income of an amount equal to 15% of the sums specified in all paragraphs excluding paragraphs 15 and 16 of the said Part B of the Sixth Schedule.
Under section 44(3), the aggregate of the allowances admissible under all paragraphs excluding paragraphs 15 and 16 of Part B of the Sixth Schedule shall not exceed 250,000 taka. But the amount admissible shall not, under any circumstances, exceed 20% of the total income of the assessee excluding [refer to Proviso to Para 4, Part B, First Schedule]:
• employer’s contribution to recognized provident fund (PF) and
• taxable interest on accumulated balance of recognized provident fund, if any (interest on accumulated balance of an employee in a recognized PF is exempted up to 1/3rd of salary or 14.5% interest rate, under para-25 of Part A, Sixth Schedule & S.R.O. 310-L/84 dated 27.06.1984).
Under section 43(2), in computing the total income of an assessee, there shall be included any exemption or allowance specified in Part B of the Sixth Schedule.
20

Forced Investment by Salaried Employees:
• Sum deducted from salary for a deferred annuity or of making provisions for his wife or children, up to deduction of 1/5th of salary (para 3)
• Contribution to any Government provident fund (para 4)
• Assessee’s and employer’s contribution to a recognised PF (para 5)
• Ordinary annual contribution to approved superannuation fund (para 6)
• Payment to a benevolent fund or any group insurance premium (para 17)
Passive Investments:
• Insurance premium or payment towards deferred annuity contract, on the life of the assessee or spouse or minor children up to 10% of policy value (para 1)
• Investment in stocks or shares of a company (listed with a Stock Exchange in Bangladesh) or other body corporate by non-corporate assessee (para 8)
• Investment in the purchase of debentures or debenture-stocks from primary market by a non- corporate assessee, up to lesser of following two: (a) Net investment in concerned income year; (b) Net investment in last three income years (para 9)
• Investment by a non-corporate assessee in the purchase of: (a) savings certificates or instruments; (b) ICB unit certificates and mutual fund certificates; (c) other Government securities (including Development loans or Bonds); and (d) shares of investment companies, but investment tax credit will be disallowed if sold within 5 years from the date of investment (para 10)
• Contribution by an individual in Deposit Pension Scheme (para 11) Donations:
• Donation by an assessee to a charitable hospital (para 11A)
• Donation by an assessee to an organization set up for the welfare of retarded people (para 11B)
• Donation to any socio-economic or cultural development institution established in Bangladesh by the Aga Khan Development Network (para 21)
• Donation to a philanthropic or educational institution (para 22); Ahsania Mission Cancer Hospital approved by the NBR as a philanthropic institution [S.R.O. No. 202-Ain/Aykar/2005 dated 06.07.2005].
Zakat:
• Zakat to the Zakat Fund (para 13).
(b) TAX REBATE:
• Under section 44(2)(a), tax shall not be payable by an assessee in respect of any income or any sum specified in paragraphs 15 and 16 of Part B of the Sixth Schedule.
• Income from partnership firm [para 16] and income from “association of person” or AOP (other than a Hindu undivided family or HUF, or a company or a firm) [para 15] will be treated as tax-free income if, the firm or AOP has already paid tax on its income. This tax-free income will be included in total income of partners/members and a tax rebate will be allowed on this income at ATR (average tax rate) [provisos to para 15 and para 16 of Part B, Sixth Schedule and sec. 43(2)].
• Rebate of Higher Dividend by Listed Industrial Companies: Listed industrial companies are entitled to 10% tax rebate if they declare dividend at more than 20% [Finance Acts, 2005 & 2006].
• Rebate on Higher Productivity: Any assessee being the owner of a small or cottage industry situated in the Less Developed Area [prescribed through the S.R.O. No. 411-L/85, dated 22.09.1985 u/s 45(2A)(c)] or Least Developed Area [prescribed through the S.R.O. No. 412-L/85, dated 22.09.1985 u/s 45(2A)(b)] and engaged in the production of such cottage industry, will be allowed on the income derived from such small or cottage industry a rebate at following rates [Finance Acts, 2005 & 2006]:
Production during the concerned year is higher than the production in the preceding year by
Rate of Rebate
(a) More than 15%, but not more than 25%
5% of tax payable on such income
(b) More than 25%
10% of tax payable on such income
• But 10% tax rebates on the additional tax paid by those individual taxpayers paying tax at the highest rate of 25% disclosing more than 10% higher income in the assessment year (AY) 2007-08 [Finance Act, 2006]..
(c) TAX RELIEF:
• Double taxation relief: When any income is already taxed but non-assessable, then pre-tax amount of the income will be included in total income, a tax relief will be allowed at a rate lower of the two rates – Bangladesh tax rate and the tax rate at which the income is taxed.
• This relief is usually allowed on foreign income under Seventh Schedule [section 144].
21

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