CHAPTER 3

TAXATION
A tax (from the Latin taxo; "rate") is a financial charge or other levy imposed upon a taxpayer
(an individual or legal entity) by a state or the functional equivalent of a state such that failure to
pay, or evasion of or resistance to collection, is punishable by law. Taxes are also imposed by
many administrative divisions Taxes consist of direct or indirect taxes and may be paid in
money or as its labor equivalent.
Tax is imposing financial charges on individual or company by central government or state
government. Collected Tax amount is used for building nation (infrastructure & other
development), to increase arms and ammunition for defense of country and for other welfare
related work. Thats why it is said that Taxes are paid nation are made.

Definition
A means by which government finance their expenditure by imposing charges on citizens and
corporate entities. Governments use taxation to encourage or discourage certain
economic decisions. For example, reduction in taxable personal (or household) income by
the amount paid as interest on home mortgage loans results in greater construction activity, and
generates more jobs. See also taxation principles.
The legal definition and the economic definition of taxes differ in that economists do not
consider many transfers to governments to be taxes. For example, some transfers to the public
sector are comparable to prices. Examples include tuition at public universities and fees for
utilities provided by local governments. Governments also obtain resources by creating money
(e.g., printing bills and minting coins), through voluntary gifts (e.g., contributions to public
universities and museums), by imposing penalties (e.g., traffic fines), by borrowing, and by
confiscating wealth. From the view of economists, a tax is a non-penal, yet compulsory transfer
of resources from the private to the public sector levied on a basis of predetermined criteria and
without reference to specific benefit received.
In modern taxation systems, taxes are levied in money; but, in-kind and corve taxation are
characteristic of traditional or pre-capitalist states and their functional equivalents. The method
of taxation and the government expenditure of taxes raised is often highly debated
in politics and economics. Tax collection is performed by a government agency such as
the Canada Revenue Agency, the Internal Revenue Service (IRS) in the United States, or Her
Majesty's Revenue and Customs (HMRC) in the United Kingdom. When taxes are not fully paid,
civil penalties (such as fines or forfeiture) or criminal penalties (such as incarceration)[1]may be
imposed on the non-paying entity or individual.

TYPES OF TAXES
A business must pay a variety of taxes based on the company's physical location, ownership
structure and nature of the business. Business taxes can have a huge impact on the profitability of
businesses and the amount of business investment. Taxation is a very important factor in the
financial investment decision-making process because a lower tax burden allows the company to
lower prices or generate higher revenue, which can then be paid out in wages, salaries and/or
dividends. Business may be required to remit the following types of taxes:
A. DIRECT TAXES:

These types of taxes are directly imposed & paid to Government of India. There has been a
steady rise in the net Direct Tax collections in India over the years, which is healthy signal.
Direct taxes, which are imposed by the Government of India, are:

1. INCOME TAX:
Income tax, this tax is mostly known to everyone. Every individual whose total income exceeds
taxable limit has to pay income tax based on prevailing rates applicable time to time.
By doing investment in certain scheme you can save Income Tax.

2. CAPITAL GAINS TAX:
Capital Gain tax as name suggests it is tax on gain in capital. If you sale property, shares, bonds
& precious material etc. and earn profit on it within predefined time frame you are supposed to
pay capital gain tax. The capital gain is the difference between the money received from selling
the asset and the price paid for it.
Capital gain tax is categorized into short-term gains and long-term gains. The Long-term Capital
Gains Tax is charged if the capital assets are kept for more than certain period 1 year in case of
share and 3 years in case of property. Short-term Capital Gains Tax is applicable if these assets
are held for less than the above-mentioned period.

3. SECURITIES TRANSACTION TAX:

A lot of people do not declare their profit and avoid paying capital gain tax, as government can
only tax those profits, which have been declared by people. To fight with this situation
Government has introduced STT (Securities Transaction Tax ) which is applicable on every
transaction done at stock exchange. That means if you buy or sell equity shares, derivative
instruments, equity oriented Mutual Funds this tax is applicable.
This tax is added to the price of security during the transaction itself, hence you cannot avoid
(save) it. As this tax amount is very low people do not notice it much.

Current STT Rates are:-
Securities Transaction Tax
Market Type Current Rate
Futures & Options 0.0117%
Capital Market (Delivery) 0.125%
Capital Market (Intra Day) 0.025%

4. PERQUISITE TAX:

Earlier to Perquisite Tax we had tax called FBT (Fringe Benefit Tax) which was abolished in
2009, this tax is on benefit given by employer to employee. E.g If your company provides you
non-monetary benefits like car with driver, club membership, ESOP etc. All this benefit is
taxable under perquisite Tax.
5. CORPORATE TAX:

Corporate Taxes are annual taxes payable on the income of a corporate operating in India. For
the purpose of taxation companies in India are broadly classified into domestic companies and
foreign companies.

B. INDIRECT TAXES:

1. SALES TAX:
A tax imposed by the government at the point of sale on retail goods and services. It is collected
by the retailer and passed on to the state. Sales tax is based on a percentage of the selling prices
of the goods and services and is set by the state. Technically, consumers pay sales taxes, but
effectively, business pay them since the tax increases consumers costs and causes them to buy
less.

The Sales Tax is the most important source of revenue of the state governments; every state has
their respective Sales Tax Act. The tax rates are also different for respective states.
Sales tax is a tax charged on products from end users. It is imposed by government of a state or
country and is a percentage of the cost. Sales taxes are varying from country to country and even
differ in cities of a single state. Some countries avoid imposing sales tax on food products but in
restaurants sales taxes are charged on it. Services are exempted from sales taxes as well as some
exemptions are also given to certain customers or on a specific group of merchandise.
The reason of sales taxes is to manage whole nation by stabilizing financial resources. The
revenue generated from sales tax supporting the financial condition of a country. Government
then use these taxes for the welfare of public like using the revenue in healthcare sector, national
defense, social security, free elementary education, public housing and lots of other social
programs.
2. VALUE-ADDED TAX:
A national sales tax collected at each stage of production or consumption of a good. Depending
on the political climate, the taxing authority often exempts certain necessary living items, such as
food and medicine from the tax.
Tax imposed by Central government on sale of goods is called as Sales tax same is called as
Value added tax by state government.VAT is additional to the price of goods and passed on to us
as buyer (end user). Around 220+ Items are covered with VAT.VAT rates vary based on nature
of item and state.
In simple words, the value added to a product by any business is actually the sale price charged
from the customer, less the cost of materials and similar taxable inputs. A Value Added Tax is
somewhat similar to sales in the fact that eventually only the end consumer is taxed. However,
unlike a sales tax (which involves the customer being taxed only once), the value added tax
involves collections and remittances to the government, as well as credits for already paid taxes
occurring every time products are purchased by a business in the supply chain.

3. CUSTOM DUTY & OCTROI (ON GOODS):
Custom Duty is a type of indirect tax charged on goods imported into India. One has to pay this
duty, on goods that are imported from a foreign country into India. This duty is often payable at
the port of entry (like the airport). This duty rate varies based on nature of items.
Octroi is tax applicable on goods entering in to municipality or any other jurisdiction for use,
consumption or sale. In simple terms one can call it as Entry Tax.

4. SERVICE TAX:
Most of the paid services you take you have to pay service tax on those services. This tax is
called service tax. Over the past few years, service tax been expanded to cover new services.
Few of the major service which comes under vicinity of service tax are telephone, tour operator,
architect, interior decorator, advertising, beauty parlor, health center, banking and financial
service, event management, maintenance service, consultancy service
Current rate of interest on service tax is 12.36%. This tax is passed on to us by service provider.

5. EXCISE DUTY:
An excise or excise duty is a type of tax charged on goods produced within the country. This is
opposite to custom duty which is charged on bringing goods from outside of country. Another
name of this tax is CENVAT (Central Value Added Tax).
If you are producer / manufacturer of goods or you hire labor to manufacture goods you are
liable to pay excise duty.

6. ANTI DUMPING DUTY:
Dumping is said to occur when the goods are exported by a country to another country at a price
lower than its normal value. This is an unfair trade practice which can have a distortive effect on
international trade. In order to rectify this situation Central Govt. imposes an anti dumping duty
not exceeding the margin of dumping in relation to such goods.
C. OTHER TAXES:-

1. PROFESSIONAL TAX:
If you are earning professional you need to pay professional tax. Professional tax is imposed by
respective Municipal Corporations. Most of the States in India charge this tax.
This tax is paid by every employee working in Private organizations. The tax is deducted by the
Employer every month and remitted to the Municipal Corporation and it is mandatory
like income tax.
The rate on which this tax is applicable is not same in all states.

2. DIVIDEND DISTRIBUTION TAX:
Dividend distribution tax is the tax imposed by the Indian Government on companies according
to the dividend paid to a companys investors. Dividend amount to investor is tax free. At
present dividend distribution tax is 15%.
3. MUNICIPAL TAX:
Municipal Corporation in every city imposed tax in terms of property tax. Owner of every
property has to pay this tax. This tax rate varies in every city.
4. ENTERTAINMENT TAX:
Tax is also applicable on Entertainment; this tax is imposed by state government on every
financial transaction that is related to entertainment such as movie tickets, major commercial
shows exhibition, broadcasting service, DTH service and cable service.
5. STAMP DUTY, REGISTRATION FEES, TRANSFER TAX:
If you decide to purchase property than in addition to cost paid to seller. You must consider
additional cost to transfer that property on your name.
That cost include registration fees, stamp duty and transfer tax. This is required for preparing
legal document of property.
In simple sense this tax is imposed on the handing over of the title of property ownership by one
person to another. It incorporates a legal transaction fee & stamp duty. This amount varies from
property to property based on cost.

6. EDUCATION CESS, SURCHARGE:
Education cess is deducted and used for Education of poor people in INDIA. All taxes in India
are subject to an education cess, which is 3% of the total tax payable. The education cess is
mainly applicable on Income tax, excise duty and service tax.
Surcharge is an extra tax or fees that added to your existing tax calculation. This tax is applied on
tax amount.
7. GIFT TAX:
If you receive gift from someone it is clubbed with your income and you need to pay tax on it.
This tax is called as gift tax.
This tax is applicable if gift amount or value is more than 50000 Rs/- in a year.

8. WEALTH TAX:
Wealth tax is a direct tax, which is charged on the net wealth of the assessee. Wealth tax is
chargeable in respect of Net wealth corresponding to Valuation date.Net wealth means all assets
less loans taken to acquire those assets. Wealth tax is 1% on net wealth exceeding 30 Lakhs (Rs
3,000,000). So if you have more money, assets you are liable to pay tax.
9. TOLL TAX:
At some of places you need to pay tax in order to use infrastructure (road, bridge etc.) build from
your money given to government as Tax. This tax is called as toll tax. This tax amount is very
small amount but, to be paid for maintenance work and good up keeping.
So in total you pay 20 different taxes in direct or indirect way. At the end in order to make you
laugh i will tell you one small joke on tax.







FINANCIAL ANALYSIS
Financial analysis (also referred to as financial statement analysis or accounting analysis or
Analysis of finance) refers to an assessment of the viability, stability and profitability of
a business, sub-business or project.
It is the process of understanding the risk and profitability of a firm (business, sub-business or
project) through analysis of reported financial information, by using different accounting tools
and techniques.
Analysis means establishing a meaningful relationship between various items of the two
financial statements with each other in such a way that a conclusion is drawn. By financial
statements we mean two statements:
(i) Profit and loss Account or Income Statement
(ii) Balance Sheet or Position Statement
These are prepared at the end of a given period of time. They are the indicators of profitability
and financial soundness of the business concern.
It is performed by professionals who prepare reports using ratios that make use of information
taken from financial statements and other reports. These reports are usually presented to top
management as one of their bases in making business decisions.
Continue or discontinue its main operation or part of its business;
Make or purchase certain materials in the manufacture of its product;
Acquire or rent/lease certain machineries and equipment in the production of its goods;
Issue stocks or negotiate for a bank loan to increase its working capital;
Make decisions regarding investing or lending capital;
Other decisions that allow management to make an informed selection on various
alternatives in the conduct of its business.





GOALS
1. Profitability
Its ability to earn income and sustain growth in both the short- and long-term. A
company's degree of profitability is usually based on the income statement, which reports
on the company's results of operations;
2. Solvency
Its ability to pay its obligation to creditors and other third parties in the long-term;
3. Liquidity
Its ability to maintain positive cash flow, while satisfying immediate obligations;
Both 2 and 3 are based on the company's balance sheet, which indicates the financial
condition of a business as of a given point in time.
4. Stability
The firm's ability to remain in business in the long run, without having to sustain
significant losses in the conduct of its business. Assessing a company's stability requires
the use of the income statement and the balance sheet, as well as other financial and non-
financial indicators.

TECHNIQUES AND TOOLS OF FINANCIAL ANALYSIS

1. COMPARATIVE STATEMENT ANALYSIS (COMPARATIVE BALANCE SHEET
ANALYSIS)
A statement which compares financial data from different periods of time. The comparative
statement lines up a section of the income statement, balance sheet or cash flow statement with
its corresponding section from a previous period. It can also be used to compare financial data
from different companies over time, thus revealing the trend in the financials.
The comparative balance sheet shows the different assets and liabilities of the firm on different
dates to make comparison of balances from one date to another. The comparative balance sheet
has two columns for the data of original balance sheets. A third column is used to show change
(increase/decrease) in figures. The fourth column may be added for giving percentages of
increase or decrease. While interpreting comparative Balance sheet the interpreter is expected to
study the following aspects:
(I) Current financial position and Liquidity position
(ii) Long-term financial position
(iii) Profitability of the concern
A format of the Comparative Income Statement is given below:
Comparative Income Statement
For the year ending.............
A
Particulars
B
Previous Year
(Rs)
C
Current Year
(Rs)
D = C - B
Absolute Change
(Rs)
E = D 100/B
Change In Per-
centage (%)
Sales (Net)
Less: Cost of Goods Sold
Gross Profit
Less: Operating Exp.
Office Expenses
Selling Expenses
Operating Profit
Add: Non-Operating
Incomes
Less: Non-Operating
--------


(--------)
--------


(--------)
--------


--------
--------


--------
--------


(--------)

(--------)
--------


(--------)

(--------)
--------


--------

--------
--------


--------

--------
Expenses
Profit before Tax
Less: Tax paid
Profit after Tax
--------


--------

(--------)

--------


--------

(--------)
--------


--------

--------
--------


--------

--------


2. COMMON SIZE STATEMENTS
Common size financial statements are different from the customary financial statements. Where
the traditional financial statements are used for the reporting purposes and to report the monetary
position of the company, the common size financial statements are used for the decision-making
purposes. If an investor wants to compare the financial statements of two companies, there have
to be some sort of scale to overcome the limitations of the comparisons and match the two
unrelated business for investment purposes. Since the sizes of companies are not same, this
usually leads to misleading and wrongful comparisons that affect the investments of the
investors.
With the use of this method of common-size financial statements, the comparisons between the
financial statements of different companies become easy. In this method, each of figures in the
financial statements is reported in the form of percentage. This percentage is the figure of one
frequent base figure. This base figure determines the percentile of all the figures in the common-
size financial statements. By using this method, it is easy to compare the financial statements of
the same company from different periods or comparing the companies of different size. Due to
this method, the bias between the company sizes is removed, and investor can effectively
compare the financial statements. The selection of base figure depends on the financial
statements' head. In income statements, the revenue can be selected as the base figure and all the
incomes and expenses can be measured against it.




FORMAT OF A COMMON SIZE BALANCE SHEET
Common Size Balance Sheet
as at ...................
Particulars Previous
Year
(Rs)
Current
Year
(Rs)
Previous
Year
(%)
Current
Year
(%)
Assets:
Fixed Assets
Investments
Current Assets

- - - -
- - - -
- - - -

- - - -
- - - -
- - - -

- - - -
- - - -
- - - -

- - - -
- - - -
- - - -
Total Assets - - - - - - - - 100 100
Liabilities:
Equity Share Capital
Pref. Share Capital
Reserves and Surplus (Less
Misc. Exp.)
Secured Loans
Unsecured Loans
Current Liabilities
Provisions

- - - -
- - - -

- - - -
- - - -
- - - -
- - - -
- - - -

- - - -
- - - -

- - - -
- - - -
- - - -
- - - -
- - - -

- - - -
- - - -

- - - -
- - - -
- - - -
- - - -
- - - -

- - - -
- - - -

- - - -
- - - -
- - - -
- - - -
- - - -
Capital & Liabilities - - - - - - - - 100 100



3. FUND FLOW STATEMENTS
The term "Flow of Funds" refers to changes or movement of funds or changes in working capital
in the normal course of business transactions. The changes in working capital may be in the form
of inflow of working capital or outflow of working capital. In other words, any increase or
decrease in working capital when the transactions take place is called as "Flow of Funds." If the
components of working capital results in increase of the fund, it is known as Inflow of Fund or
Sources of Fund. Similarly, if the components of working capital effects in decreasing the
financial position it is treated as Outflow of Fund. For example, if the fund rose by way of issue
of shares will be taken as a source of fund or inflow of fund. This transaction results in increase
of the financial position. Like this, the fund used for the purchase of machinery will be taken as
application or use of fund or outflow of fund. Because it stands to reduce the fund position.
In the analysis and interpretation of financial statements fund flow statement is one of the
important techniques. The statement of changes in working capital is prepared with the help of
current assets and current liabilities. Similarly, fund from operation is prepared on the basis of
profit and loss account to find out the exact movement of funds in different operations. After
preparing schedule of changes in working capital and fund from operations, at the last stage a
comprehensive fund flow statement can be prepared on the basis of component of non-current
assets, non-current liabilities of balance sheet and relevant information. In other words, this
statement is prepared with the help of the changes in non-current assets and non-current
liabilities of balance sheet.
Fund flow analysis involves the following important three statements such as :
I. Fund from Operations
II. Statement of Changes in Working Capital
III. Fund Flow Statement.

4. CASH FLOW STATEMENTS
In the analysis and interpretation of financial statements fund flow statement is one of the
important techniques. The statement of changes in working capital is prepared with the help of
current assets and current liabilities. Similarly, fund from operation is prepared on the basis of
profit and loss account to find out the exact movement of funds in different operations. After
preparing schedule of changes in working capital and fund from operations, at the last stage a
comprehensive fund flow statement can be prepared on the basis of component of non-current
assets, non-current liabilities of balance sheet and relevant information. In other words, this
statement is prepared with the help of the changes in non-current assets and non-current
liabilities of balance sheet.
Direct Method
In this method, cash receipts from customers and cash paid to suppliers and employees are
calculated and presented on the cash flow statement. The difference between the cash receipts
and cash payments will be the net cash flow provided by (or used in) operating activities.
Indirect Method
In this method, the net profit (before tax and extraordinary items) is taken as a starting point. The
net profit disclosed by Profit and Loss Account cannot be treated as cash from operating
activities because there are some non-cash items on the debit side of Profit and Loss Account
which do not result in the outflow of cash. Such items are added back to net profit.
Similarly, there are certain items of incomes which are shown on the credit side of Profit and
Loss Account, but they are non-operating incomes. These items should be deducted from net
profit to compute cash from operating activities.
In addition to the above, there are some other items which do not appear in the Profit and Loss
Account, but results into increase or decrease of cash. These items must also be adjusted for
calculating cash from operating activities.

SOME OF THE DIFFERENT TYPES OF CASH FLOWS
Cash Flows Related to Operating Activities:
Cash receipts and collections from sales of goods and services
Cash receipts from earnings on investments in securities (interest and dividends)
Payments to suppliers
Payments to employees
Payments for interest
Payments for taxes
Cash Flows Related to Investing Activities:
Cash receipts from the sale of securities of other companies
Cash receipts from sales of productive assets
Payments for the purchase of securities of other companies
Payments at the time of purchase for the acquisition of productive assets
Cash Flows Related to Financing Activities:
Proceeds from issuing capital stock or other equity securities
Proceeds from issuing debt securities or obtaining loans (other than trade credit)
Payments for reacquisition of capital stock or other equity securities of the entity
Payments for the retirement of debt securities (excluding interest)
Payments of principal on loans (other than trade payables)
Payments of dividends

5. TREND ANALYSIS
Review of three or more financial statement periods typically represents trend analysis, a
continuation of horizontal analysis. The base year represents the earliest year in the data set.
Although dollars can represent subsequent periods, analysts commonly use percentages for
comparability purposes. Users review statements for patterns of incremental change representing
changes in the business in questions. Financial statement improvements include increased
income and decreased expenses.
The trend analysis is a technique of studying several financial statements over a series of years.
In this analysis the trend percentages are calculated for each item by taking the figure of that
item for the base year taken as 100. Generally the first year is taken as a base year. The analyst is
able to see the trend of figures, whether moving upward or downward.


6. TIME SERIES ANALYSIS
It is also called as intra-firm comparison. According to this method, the relationship between
different items of financial statement is established, comparisons are made and results obtained.
The basis of comparison may be:
Comparison of the financial statements of different years of the same business unit.
Comparison of financial statement of a particular year of different business units.

7. RATIO ANALYSIS
Ratios express a relationship between two or more financial statement totals, and compare to
budgets and industry benchmarks. Five common categories of ratios exist: liquidity, asset
turnover, leverage, profitability and solvency. Reviewing ratios for performance compared with
prior periods or industry specific benchmarks provides financial statements users with
recognition of strengths and weaknesses. Risk Management Association, or RMA, publishes data
on industry specific benchmarks for more in-depth analysis.
It is the technique of the competition of number of accounting ratios from the data derived from
the financial statements and comparing those with the ideal or standard ratios or the previous
years ratios or the ratios of other similar concerns.


Classification of ratios:
1. LIQUIDITY RATIO
It enables the lenders to know the repayment ability of an organization within short
period.
a. CURRENT RATIO =


Ideal Ratio- (2:1)

b. QUICK RATIO =


(ideal ratio-1:1)

Quick Assets =

c. ABSOLUTE LIQUID RATIO =


(ideal ratio-1:2)

2. CAPITAL STRUCTURE RATIO
Financial capacity of the concern over a period of time to meet its financial commitments
through its capital allocation in various assets.
a. DEBT EQUITY RATIO =




b. FIXED ASSETS TO NETWORTH RATIO =

c. CURRENT ASSETS TO NETWORTH RATIO =

d. PROPRIETORY RATIO =

e. FIXED ASSET RATIO =




f. BOOK VALUE RATIO =




g. SOLVENCY RATIO =




h. CAPITAL GEARING RATIO =



FIBF =



i. INTEREST COVERAGE RATIO =




j. OVERALL PROFITABLITY RATIO =

3. PROFITABILITY RATIO

b. GROSS PROFIT RATIO =




c. OPERATING RATIO =




d. OPERATING PROFIT RATIO =




e. EXPENSE RATIO

Cost of goods sold ratio =




Administration Expense Ratio =




Sales and Distribution Expense Ratio =






f. NET PROFIT RATIO =




g. PROFIT EARNING RATIO =




h. NETWORTH RATIO or RETURN ON INVESTMENT =






i. TOTAL ASSET TURNOVER RATIO =




j. RETURN ON CAPITAL EMPLOYED =




k. EARNING PER SHARE RATIO =




l. DIVIDEND PAYOUT RATIO =

OR




m. DIVIDEND YIELD RATIO =




4. ACTIVITY RATIO OR TURNOVER RATIO

a. STOCK TURNOVER RATIO =




b. DEBTORS TURNOVER RATIO =




c. CREDITORS TURNOVER RATIO =




d. CAPITAL TURNOVER RATIO =


OR

e. WORKING CAPITAL TURNOVER RATIO =


OR