May 2020 Q3

Tax planning is the arrangement of one’s affairs in such a manner that the tax planner may either reduce the incident of tax wholly or reduce it to maximum possible extent as may be permissible within the framework of the taxation laws. It does not amount to evasion of tax. It is an act of prudence and farsightedness on the part of the taxpayer who is entitle to reduce the burden of his tax liability to the maximum possible extent under the existing law. Tax planning ensures not only accruals of tax benefit within the four corners of law, but it also ensures that the tax obligations are properly discharged to avoid penal provision.

The first and foremost characteristic of tax planning is that it results in the reduction in tax liability of an individual which ensure that an individual has more disposable income which can be used by the individual for consumption or for making investments which can come in handy in future.

Another feature of tax planning is that one needs to plan in advance regarding how to make sure that tax liability is reduced to the maximum, possibly by investing in tax saving instruments right from start of the financial year. If a taxpayer is thinking that he/she can reduce tax liability by doing tax planning the night before the last date for filing income tax returns, then he/she will be in for disappointment.

Another feature of tax planning is that effective tax planning can be done only by investing in tax saving instruments which can be through tax exemptions, rebates, allowances and other reliefs or benefits permitted under the Law.

Tax planning is one thing which has to be made every year and unlike other investments like real estate or shares where one has to review the investment after 2 or 3 years.

Lastly, tax planning is dynamic in nature because every year you have to modify your tax plan according to rules framed by the government as the government keeps changing tax laws which in turn keep the tax planner on toes as he or she has to change his or her investment in tax saving instruments accordingly.
(3 marks for explanation of tax planning)
(2 marks for any two features of tax planning)

Intended objectives of Tax Planning

• Reduction of Tax Liability: A taxpayer can save the maximum amount of tax, by properly arranging his/her operations as per the requirements of the law, within the framework of the statute.
• Minimization of Litigation: There is a war-like situation between the taxpayers and tax authorities as the taxpayer wants the tax liability to be minimum while the authorities attempt to extract the maximum. So, a proper tax planning aims at conforming to the provisions of the tax law, in such a way that incidence of litigation is minimized.
• Productive Investment: One of the major objectives of tax planning is to channel taxable income to different investment plans. It aims at the optimum utilization of resources for productive causes and relieving the taxpayer from tax liability.
• Healthy Growth of Economy: The growth and development of the economy greatly depend on the growth of its citizens. Tax planning measures involve generating more money that flows freely and results in the sound progress of the economy.
• Economic Stability: Proper tax planning brings economic stability by various techniques such as mobilizing resources for national projects or availing ways for investments which are productive in nature.
• Employment generation: Tax planning creates employment opportunities in different ways. Firstly, efficient tax planning requires some sort of expertise that creates job opportunities in the form of advisory services. Secondly, amount saved through tax planning is generally invested in commencement of new business or the expansion of existing business. This creates new employment opportunities.                                            (Any 5 points for 5 marks)

Time Variable
When investors expect tax rates to decrease or remain constant over time, one desirable goal is to postpone the moment of taxation as further in the future as possible. Even when tax rates are expected to rise a little, one could benefit from delaying the recognition of income due to the concept of time value of money. However, if one expects a sharp increase in tax rates, acceleration of the recognition of income becomes rewarding.

Due to the decline in the present value of money, the further into the future that the money is received or paid out, the effect of a tax on income will be less if it occurs further in the future. Likewise, a tax deduction is more valuable if taken sooner rather than later, assuming that tax rates remain unchanged during the relevant time frame. Thus, taxes can be lowered by both postponing taxation of income items to later tax years and accelerating tax deductions to earlier tax years.

Also rules of taxation pertaining to taxpayers vary with respect to time. One set of rules may apply for the first five years and a different set will apply thereafter. Thus, a tax benefit available in one year may disappear in the next just as a statutory restriction causing a tax problem this year may be lifted in the future.

This planning technique is most effective when the taxation of the income can be deferred without differing the related cash flow from the income. In the same manner, greater tax savings will result if one is able to accelerate the deductions without altering the timing of the related cash payments.                                     (2.5 marks)

Jurisdiction or Location Variable
Another method to reduce income tax bill is to ensure that an additional income will be attributed to a family member (in case of individuals) or subsidiary (in case of corporations) with the lowest marginal tax rates. Such behaviour is especially profitable in countries with progressive income tax system and also in case of multinationals. We distinguish between two subtypes of such schemes: those that are purely under the jurisdiction of one tax authority (domestic transactions) and those that have an international scope (international transactions). Tax authorities around the world try to enforce the Substance-Over-Form and Business-Purpose Doctrines when dealing with the contracts between related parties (Scholes et al. 2005). They are much less concerned when contracts are written between parties with opposite interests as in those cases the use of arms-length prices is usually a rule.

All citizens and residents, including companies incorporated in Ghana are subject to income tax provided the income is accrued in, derived from or brought into Ghana. In Ghana the rate of corporate income tax differs depending on where the entity is located or the type of industry in which the company is operating. For example, within the Ghana Tax Jurisdiction companies located in the Free Zone Areas have different rules. Manufacturing Companies in Accra/Tema, Regional capital and other areas enjoy location incentives. Agro-based companies established in Ghana enjoy tax holidays and companies producing cocoa by-products from cocoa waste have different tax rates depending on where they are located.

In summary, tax plays an important role in location decisions, principally in three ways: the fiscal burden, the administrative burden, and long-term stability and predictability.                                     (2.5 marks)

Character or Activity variable
The third type of tax planning activities includes transactions which convert one type of income into another. In many countries “ordinary income” (like wages, dividends, interests etc) is taxed more heavily than capital gains. Sometimes the distinction has been made between “active income” and “passive income”. In the next two sections we analyze one relatively widespread scheme in Estonia that relies on differential taxation of dividends vis-à-vis compensation for work.

Every income item is characterized as either ordinary income or capital gain. Ordinary income is generated from sale of goods or performance of services in regular course of business. Income generated by investments (interest, dividends, royalties, and rents) is ordinary. Capital gains are generated by the sale or exchange of capital assets

Most business income is characterized as ordinary income and taxed at the rates applicable to the taxpayer earning the income. Several tax characters may provide for taxation at a lower rate. For example, individual taxpayers earning interest on Treasury bill issued by the Government of Ghana are exempted from tax. In addition, Banks’ lending to the agricultural sector have different rate from lending to other sectors of the economy.

When income is taxed at a preferential rate, the before-tax return earned may be lower than the returned earned on income subject to a higher tax rate. The reduction in pre-tax return inherent in tax-favoured investments is often referred to as an implicit tax. Implicit taxes arise in many jurisdictions in which preferential tax treatment is granted to certain activities but not to others. For instance, most tax laws encourage the acquisition of business property by allowing accelerated depreciation of asset costs over recovery lives much shorter than the assets economic lives. This situation leads to tax benefits decreasing the after-tax cost of purchasing assets relative to leasing comparable property. As a result, the cost of leasing may decline to induce business to continue to rent rather than buy assets.                          (2.5 marks)

Entity Variable
Different entities, such as sole proprietorships, partnerships, limited liability companies and corporations, are taxed at different rates, so choosing the right entity may minimize taxes. For instance, corporations do not pay employment tax, so if a taxpayer organizes his business as a corporation, he can receive part of his income as a dividend, which is not subject to employment taxes.

This focuses essentially on individuals and companies as the two types of taxpaying entities involved in business and investment transactions. Given the progressive nature of income tax rates in Ghana, the marginal tax rate applying to each taxpaying entity will depend on that entity’s particular circumstances. As a result, the tax rates are bound to differ among these organizations. Entity variable tax planning therefore takes advantage of these rates differentials to improve NPV. Entity variable refers to planning opportunities that shift income to an entity, which is subject to a lower marginal rate of tax or a shift of deductions to an entity subject to higher marginal tax rate.

An individual beginning a business or investing in another person’s business must carefully weigh the tax benefits and costs of different organizational forms against the non-tax costs or benefits of these entities before the business or investment is undertaken.

Tax costs decrease (and cash flows increase) when income is generated by an entity subject to a low tax rate.                (2.5 marks)