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Corporate Tax Planning

Topic
: Tax Planning
Paper
: Corporate Taxation
Program : MBA

OBJECTIVES OF TAX
PLANNING

Reduction of tax liability


Minimisation of litigation
Productive investment
Healthy growth of economy
Economic stability

Basic principles
There are many perfectly legal and socially
acceptable ways to increase your wealth in a
tax efficient manner. Some of these methods
are very powerful. Legitimate methods of
increasing your tax efficiency are called tax
planning.
Methods that are unlawful are categorised
under two different labels:
Tax avoidance is where you set up contrived
accounting structures and strategies that abuse a
loophole so you can claim large tax deductions or
take advantage of some benefit that was never
intended to be used in such a way.
Tax evasion is where you deliberately try to hide
income from the Tax Office, by various methods
including secret bank accounts, not recording cash
transactions, cooking the books etc.

TAX PLANNING, TAX


AVOIDANCE AND TAX
EVASION

In the judgement of the Supreme Court in


McDowells case 1985 (154 ITR 148) SC, tax
avoidance has been considered as heinous as tax
evasion and a crime against society. The Supreme
Court held that it is true that planning may be
legitimate provided it is within the framework of the
law.
The line of demarcation between tax planning and
tax avoidance is very thin and blurred. There could
be elements of malafide motive involved in tax
avoidance also.
Any planning which, though done strictly according
to legal requirements defeats the basic intention of
the Legislature behind the statute could be termed
as instance of tax avoidance.

Review Question

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Review Questions

Deposit of Rs. 60,000 in public provident fund account to


reduce total tax liability.
Tax Planning : It is tax planning because depositing money of Rs.
60,000 in PPF and taking deduction under section 80C is as per the
provisions of law.
A company installed an air conditioner at the residence of its
director and treated it as business asset for depreciation.
Tax Evasion : Treatment of installed Air conditioner at residence of
director as business asset for depreciation would amount to tax
evasion if such installation is not as per the term of employment. Or
Tax Management : If the installation of AC at the residence of
director as per the terms of employment then treatment of it as
business asset for depreciation is tax management.
X Ltd. issued a credit note for Rs. 40,000 as commission
payable to Y who is son of X, managing director of the
company. The sole purpose was to transfer the income of the
company as income of Y.
Tax evasion : The issue of credit note for Rs. 40,000 as commission
to reduce the tax liability of company is tax evasion.

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Review Questions

Deposit of Rs. 60,000 in public provident fund account to


reduce total tax liability.
Tax Planning : It is tax planning because depositing money of Rs.
60,000 in PPF and taking deduction under section 80C is as per the
provisions of law.
A company installed an air conditioner at the residence of its
director and treated it as business asset for depreciation.
Tax Evasion : Treatment of installed Air conditioner at residence of
director as business asset for depreciation would amount to tax
evasion if such installation is not as per the term of employment. Or
Tax Management : If the installation of AC at the residence of
director as per the terms of employment then treatment of it as
business asset for depreciation is tax management.
X Ltd. issued a credit note for Rs. 40,000 as commission
payable to Y who is son of X, managing director of the
company. The sole purpose was to transfer the income of the
company as income of Y.
Tax evasion : The issue of credit note for Rs. 40,000 as commission
to reduce the tax liability of company is tax evasion.

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Review Questions

Y, a non-resident Indian citizen visits India every year only


for 181 days to remain non-resident.
Tax planning : It is tax planning, by residing in India for less than
182 days will reduce his tax liability and it is in accordance with
the provisions of tax laws.
Z Ltd. deduct tax at source but fails to deposit the same in
government treasury.
Tax Evasion : Fails to deposit the collected TDS shows that undue
benefit is taken by not complying tax provisions it is tax evasion.
B transferred 1,000 debentures of a company to his son C
before the due date of interest to reduce his tax liability.
Tax avoidance : In accordance with section 60 of the Act,
transfer of debenture to C and income thereon for reducing the
tax liability shall not to be clubbed in the hands of B as the asset
is also transferred along with the income. Hence, it is the case of
tax avoidance as advantage is taken by finding out loophole in the
law.

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Illustrative instances of
tax-planning measures

Varying the residential status (of a limited application).


Diversion of income by over-riding title
Choosing the suitable form of assessable entity (individual, HUF,
Firm, Co-operative society, Association of persons, Company, Trust,
etc. to obtain the maximum tax concessions e.g. hotel industry in
the form of a company to obtain tax holiday benefit.)
Choosing suitable forms of investment (share capital, loan capital,
lease, mortgages, tax exempt investments, priority sector, etc.)
Programmed replacement of assets to take free advantage of the
provisions governing depreciation and provisions governing
investment allowance, investment deposit account scheme.
Diversification of the business activities (hotel industry, agro-based
industry, export oriented industries, etc.)
The use of the concept of commercial expediency to claim
deduction in respect of expenditure, in computing business income.

Diversion of income by
overriding title and
application of income
Diversion of income is at source by an overriding title before it
reaches an assessee.
It can take place either under a legal compulsion or under a
contractual obligation or otherwise.
An obligation to apply the income in a particular way before it has
accrued or arisen to the assessee results in the diversion of the
income.
An obligation to apply income which has accrued or arisen or has
been received amounts merely to the apportionment or
application of the income and not to its diversion.
Sometimes the dividing line between diversion by overriding title
and the application of income after it has accrued is somewhat
thin.
By diversion, the assessee can avoid payment of taxes but tax has
to be paid before application of income.

IMPORTANCE OF TAX
PLANNING
Rebates and deductions not available at the time of
appeal
Severe penalties in case of tax avoidance and tax
evasion under various laws
Activities and programmes, which are of public
interest and good for a civilised society are
encouraged by the Government and incentives
provided in the tax laws.
With increase in profits, the quantum of corporate
tax also increases and it necessitates tax planning.
Essential to bear the burden of inflation
Needed for capital formation
Very important in credit squeeze and dear money
conditions

ESSENTIALS OF TAX
PLANNING
upto date knowledge of tax laws,
judgments , circulars, notifications,
clarifications and administrative
instructions
disclosure of all material information
sham transactions or make-believe
transactions or colourable devices,
entered into just with a view to circumvent
the legal provisions, must be avoided.

AZADI BACHAO ANDOLAN


(MAURITIUS)

Hutch-Vodafone deal

Hutchison International, a non-resident seller and parent company


based in Hong Kong sold its stake in the Cayman Islands (which, in
turn, held shares of Hutchison-Essar - Indian operating company,
through another Mauritius entity) to Vodafone, a Dutch non-resident
buyer. The deal consummated for total value of $11.2 billion, which
comprised a majority stake in Hutchison Essar India. In light of this,
the revenue issued show-cause to Vodafone asking for an explanation
as to why Vodafone Essar (which was formerly Hutchison Essar)
should not be treated as an agent (representative assessee) of
Hutchison International and asked Vodafone Essar to pay $1.7 billion
as capital gains tax.
The controversy in the case of Vodafone is about the taxability of
transfer of share capital of the Indian entity. Generally, the transfer of
shares of a non-resident company (the holding company of Hutchison
Essar India) by a non-resident (Hutchison International) to another
non resident (Vodafone) is not subject to tax in India. But the revenue
department is of the view that this transfer represents transfer of
beneficial interest in the Indian company and hence, it will be
subject to tax. On the contrary Vodafones argument is that there is
no sale of shares of Indian company and what it had acquired is a
company incorporated in the Cayman Islands, which in turn holds the
Indian entity. Hence, the transaction is not subject to tax in India.

Supreme Court decision


Applying the look at test in order to ascertain
the
true
nature
and
character
of
the
transaction, the offshore transaction between
two non-resident companies is nothing but a
bonafide structural foreign direct investment
into India which falls outside territorial
jurisdiction of India and is hence not taxable.
Thus, where the offshore transaction evidences
participating investment and not a sham or tax
avoidant pre-ordained transaction and the
offshore transaction is between two nonresident companies and the subject-matter of
the transaction is the transfer of the shares in a
foreign company, the Indian tax authority has
no territorial tax jurisdiction to tax the offshore
transaction.

AREAS OF TAX PLANNING IN


THE CONTEXT OF INCOME
TAX ACT, 1961
At the time of setting up of new business entity:

Form of organisation/ownership pattern;


Locational aspects;
Nature of business.

For the business entities already in existence:


Tax planning in respect of financial management
decisions;
Tax planning in respect of specific managerial decisions;
Tax planning in respect of corporate restructuring;
Tax planning in respect of employees remunerations;
Tax planning in respect of Foreign Collaborations and
Joint Venture Agreements;
Tax planning in the light of various Double Taxation
Avoidance Agreements.

Tax planning for business


deductions

a clear and thorough understanding of the various


statutory provisions governing the deductions.
Some general considerations
Allowability
Year of allowbility
Extent of allowability
Carry forward to future years
Specific deductions are subject to certain conditions and
limitations
Restrictive conditions apply to expenditure which is prima
facie suspect, such as transactions with the relatives or
associates within the same group coming within the
scope of section 40A(2). Such transactions are considered
as specified domestic transactions under section 92BA
and the transfer pricing provisions shall be applicable.

All Important deductions


relevant to A.Y 2015-16
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Capital or Revenue
Expenditure

Tests
The test of enduring benefit
Creation of fixed capital
Whether or not a new business/asset
comes into existence
Whether deduction of 100% of the
capital expenditure is available under
section 35AD
Whether the expenditure is illegal
expenditure
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Expenditure incurred on purchase of


computer software. The assessee has
capitalised such expenditure in
accounts.
As decided in CIT v. M/s Asahi India Safety Glass Ltd.,
the expenditure incurred on purchase of software or
application of software is allowable as revenue
expenditure.
The High Court held that the test of enduring benefit is
not certain or conclusive in determining the
expenditure as capital or revenue. The real intent of
the expenditure and whether the expenditure results
in creation of fixed capital for the taxpayer are to be
examined. In this case, payment for application
software though is an enduring benefit, does not result
in acquisition of any capital asset. Since, it merely
enhances the productivity or efficiency. Further, the
accounting entries in the books of accounts cannot
determine whether expenditure is revenue in nature or
capital in nature.
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Expenditure incurred on feasibility study conducted for


examining proposals
for technological advancement relating to the existing
business, where the
project was abandoned without creating a new asset.
In the case of Dy. CIT v. Assam Asbestos Ltd, the assesseecompany was engaged in the business of manufacture of
asbestos sheets and has incurred the expenditure in
connection with survey and feasibility report and various
technical services for setting up the cement plant,
however, the project was abandoned for the want of
permission from the Government. The assessee claimed
the expenditure to be revenue in nature. The High Court
observed that, in such cases, whether or not a new
business/asset comes into existence would become a
relevant factor. If there is no creation of a new asset, then
the expenditure incurred would be of revenue nature.
In this case, since the feasibility studies were conducted
by the assessee for the existing business with a common
administration and common fund and the studies were
abandoned without creating a new asset, the expenses
were of revenue nature.
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Amount spent on replacement of an old machine with a


new one. Assessee
claims that the machine installed in the textile plant is
a part of the entire
composite machinery of spinning mill, hence it is a
repair of the old and
existing machine.
Alternative 1
As decided in CIT v. Sri Mangayarkarasi Mills Pvt. Ltd., when
expenditure amounts to an enduring advantage for the
business, it is to be considered as of capital nature. Repair is
different from bringing a new asset for the business, bringing
into existence a new asset or an enduring benefit for the
assessee amounts to capital expenditure. Moreover,
replacement of asset is not deductible under section 37 of
Income Tax Act and hence not revenue in nature.
Alternative 2
An alternative submission was also made that when a
machine which is put to continuous use for decades is to be
replaced or where old parts are not available in the market
then even the expenditure incurred on the replacement of the
said machine is to be treated as expenditure on account of
current repairs in view of the judgment of the Supreme Court
as seen in the case of CIT v. Mahalakshmi Textile Mills Ltd.
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of machinery,
which broke down several years ago, to make the same
functional and increase
its useful life by replacing many vital parts, overhauling and
repairing of its
power transmission unit, replacing electronic panel,
geometrical aligning and
In Bharat Gears Limited
the assessee has
paintingv.ofCIT,
machine.

claimed certain expenditure as revenue expenditure


on the ground that it was incurred for repairs and
reconditioning of Fent Gear Machine and was in the
nature of current repairs. Income Tax Appellate
Tribunal observed that machine which was lying idle in
a broken down position and was unfit for production
resulted in a benefit of enduring nature by subsequent
reconditioning and imparting useful life to hitherto old
and unfit machinery.
This benefit of enduring nature was very much in
capital field and the expense, having regard to the
facts and circumstances of the case, has its bearing
on the fixed capital of the assessee, which, inter alia,
generates profits. Thus, expenditure is of capital
nature.
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Corporate membership fee paid by a company to


the golf club for running the business to earn profit,
if the membership is for a limited period of six
years.
The High Court made following observations in the
case of CIT v. M/s Groz Beckert Asia Ltd. :
The membership of club was obtained for business
purposes in as much as it facilitated interaction with
business associates etc.
Although the membership of the club provides an
enduring benefit as it is for a period beyond the year
of payment, the benefit remains in the revenue field
and not in the capital field.
Resultantly, the expenditure incurred on acquiring an
enduring benefit in the revenue field is liable to be
treated as revenue expenditure.
Hence, the corporate membership fee paid for six
years to a golf club for running the business to earn
profit is revenue expenditure.
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SOME OTHER
EXAMPLES.
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Convertible Debenture expenses: Karnataka High Court


decided that expenditure incurred on issue of convertible debentures
is to be allowed as revenue expenditure. Refer CIT v ITC Hotels
Limited 190 Taxman 430 (2010). Further, expenses incurred on issue
of right shares were held as capital expenditure.
Fees paid to ROC : It has been decided by the Rajasthan High
Court that fees paid to the registrar of Companies for bringing about
change in the memorandum and Articles should not be allowed.
Refer CIT v Aditya Mills 181 ITR 195 (1990). Further, fees paid for
increasing authorized capital is a capital expenditure. Refer CIT v
Tungabhadra Industries Limited 207 ITR 553 (1994), CIT v Hindustan
Insecticides Limited 250 ITR 228 (2001) & PSIDC v CIT 225 ITR 792
(1997).Such expenditure also not eligible for deduction under section
35D of the act.
Bank Guarantee : Gujarat High Court decided that any payment
of bank charges related towards bank guarantee required for
purchase of machinery should not be allowed as revenue
expenditure. Refer CIT v Bharat Suryodaya Mills Co Limited 202 ITR
942 (1993).

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Lease on permanent basis: Amount paid in installments for obtaining a lease on


permanent basis is a capital expenditure. Refer CIT v Project Automobiles 167 ITR 781
Compensation to Tenant: Amount paid by the assessee, who purchased the plot of
land, to the tenant occupying the structure erected by the tenant on such land for getting
vacant possession is a capital expenditure. Refer CIT v Lucky Bharat Garage 174 ITR 526
(1998) & Chloride India Limited v CIT 130 ITR 61 (1981). However, assessee entered into
an agreement for purchase of property for infrastructural facilities for business, assessee
terminated the agreement and paid compensation, payment to be treated as capital in
nature and not allowable as revenue expenditure. Refer Sap Labs India Pvt. Ltd. vs. ACIT 6
ITR 81.
New Project Report : Expenditure incurred on project report for setting up a new unit is a
capital expenditure. Refer CIT v J.K. Chemicals Limited 207 ITR 985 (1994)., However,
Consultation charges paid by the assessee in connection with the expansion of assessees
existing project were held to be allowable as revenue expenditure. Refer, Jyoti Ltd. 24 DTR
177. Similarly, Travelling and incidental expenditure in finalization of project for existing
business allowable as revenue expenditure. Refer, Jt. CIT vs. Rallies India Ltd. 3 ITR 1
(Mum.) (Trib.) When no new asset created , then revenue expenditure Refer, CIT v DLF
Commercial Developers Limited 323 ITR 321.
Logo Fees : Payment made by the assessee for non exclusive user of logo based on
turnover and not lump sum payment is allowable as revenue expenditure. ( Asst year
2006-07). Refer Asst CIT v Shriram Transport Finance Co Ltd 9 ITR ( Trib)

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Corporate Guarantee : Giving corporate guarantee


was not only one of the objects of the assessee
company but the same was given for its subsidiary
company and it was in the interest of the assessee
company and hence, the commercially expedient
decision, hence, one time settlement with bank was
allowable as business loss. Refer ACIT vs. Industries
(India) Ltd. 128 ITD 98.
Keyman Insurance Policy : Keyman Insurance
premium paid by the Company on the lives of Chief
cardiac surgeon, chairman, and managing director of
company was qualified as deduction under section
37(1). Consultancy fees paid for maintenance of
software were to be allowed as revenue expenditure.
Refer Escort Heart Institute & Research Center Ltd. vs.
ACIT 128 ITD 108
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Legal expenses : Deductibility of Legal Expenses will depend


on Nature & purpose of legal proceeding in relation to
business whose profits are under computation and cannot be
affected by final outcome of that proceedings. Refer Vivek P
Talwar v ACIT 8 Taxmann.com 268.However, Legal charges
incurred for defending criminal proceedings which has get
nothing to do with Assessee profession is definitely of
personal nature and such expenditure cannot be allowed
against income from business and Profession. Refer DCIT v
Salman Khan 9 Taxmann.com 74. However, in the case of KNP
Securities P. Ltd. I ITR 130 Assessee is barred from doing
business by SEBI till further orders. Assessee contesting order.
Expenses incurred in keeping business alive deductible. Again,
Legal expenses incurred on obtaining advice as to feasibility
of acquiring a new unit is a revenue expenditure. Refer, CIT
vs. United Breweries Ltd. 36 DTR 80 Foreign Exchange Loss
: Exchange loss on refund of advance received is business
exp. Refer Diamonds R US v DCIT 9 Taxmann.com 67.
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Public Utility : The contribution made by the assessee


due to various business reasons ,to participate in a
scheme framed by High court , as a remedy to a perpetual
public hazard , i.e. social cause , hence the expenditure
incurred allowable as revenue expenditure. Refer CIT v
Jayendra Kumar Hiralal 327 ITR 147. Again, Expenditure
incurred by the assessee on community assistance
programme and the welfare measures undertaken in the
vicinity of the manufacturing unit which also benefited its
employees is allowable as business expenditure. Refer
Madura Coats Ltd. 24 DTR 24.
Advertisement : Expenditure on advertisement to create
brand image, partly debited in profit and loss account and
balance deferred over a period of three years, expenditure
allowable as revenue expenditure, entry or absence of
entry does not determine allowability of expenditure.
Refer, Dy CIT v Godrej Tea Ltd. 4 ITR (Trib) 649.
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Depreciation
Section 32

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Depreciation (u/s 32)


Following conditions are to be fulfilled.
a) Assessee must be owner of the Asset.
b) Asset must be used for the purpose of business
or Profession.
Active use
Passive Use

c) Such use must be in the relevant previous year.

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Additional Depreciation
Additional Deprecation @ 20 % of Actual Cost of
Machinery acquired after 31.03.2002 for
a) New Industrial Undertaking
b) Existing Industrial Undertaking
Note : If the Asset is put to use for less than 180
Days in the year, depreciation will be allowed at
50 % of the eligible rate.

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New Section 32 AC
Manufacturing companies investing more than Rs.
100 crore( investment in one previous year Rs. 25
Crores for 2015-16 to 2016-17 u/s Sec) in new plant
and machinery during the period from 1.4.2013 to
31.3.2015 entitled to investment allowance@15%
The investment allowance@15% under this section
is in addition to the depreciation and additional
depreciation allowable under section 32(1). Further,
the investment allowance would not be reduced to
arrive at the written down value of plant and
machinery.
Investment allowance can be claimed only after
installation of the plant and machinery.
Provisions illustrated in V K Singhania para 110.3
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New Section 32 AC
The new plant and machinery in respect of which
investment allowance has been claimed under section
32AC cannot be sold or otherwise transferred for a
period of 5 years from the date of installation. If it is
sold or transferred within this period, the deduction
allowed earlier would be deemed as income
chargeable to tax under the head Profits and gains of
business or profession of the previous year in which
such new plant and machinery is sold or otherwise
transferred. This would be in addition to the taxability
of gains on transfer of such plant and machinery.
In case of amalgamation or demerger, this restriction
would continue to apply to the amalgamated company
or resulting company, as the case may be, as it would
have applied to the amalgamating or demerged
company.
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Example

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Solution

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Tax planning with reference


to financial management
decisions

Capital structure decision


Optimum capital structure maximizes shareholders
return.
Need to properly balance risk, cost, control and tax
consideration.
Dividend on shares is not deductible and distributed
profit is subject to dividend tax.
Interest on borrowed capital is allowed as a
deduction u/s 36(1)(iii).
Cost of raising loans is deductible in the year in
which it is incurred (except for pre-commencement
period expences)
Cost of issue of shares is allowed as deduction in five
years u/s 35D.

Review Question

Solution

Review Question

Solution

June 15 Question O/S

Tax planning with reference


to managerial decisions
Own the asset or take it on lease
Purchase the asset out of own funds or
borrowed funds
Make or buy

Lease vs. Purchase


Income- Tax Aspects of Leasing

The tax treatment of lease transactions in India is based on


whether the lease qualifies as a lease or will be treated as a hirepurchase transactions.
If the transaction is treated as a lease, the lessor shall be eligible
for depreciation on the asset. The entire lease rentals will be taxed
as income of the lessor. The lessee, correspondingly, will not claim
any depreciation and will be entitled to expense off the rentals.
If the transaction is a hire-purchase or conditional sale transaction,
the hirer will be allowed to claim depreciation. This is based on an
old Circular of the Deptt issued in year 1943. The financing charges
inherent in hire instalments will be taxed as the hire-vendor's
income and allowed as the hirer's expense.
Pollution control devices, energy saving devices, renewable energy
devices, rollers in flour mills, gas cylinders, etc.are entitled to
100% depreciation.

Purchase of assets out of own


or borrowed funds
Effective tax savings to be
determined with
Rate of depreciation
Marginal tax rate
Rate of interest

Decision making
Estimate the cash flows associated
with borrowing and buying the asset
Estimate the cash flows associated
with leasing the asset
Compare the two financing methods
to determine which has the lower
present value.

Decision making

Solution

Review Question
Discuss the facts and decision in the
case of ICDS vs. CIT as decided by
Supreme Court recently.

Review Question

Solution

Solution contd

Make or buy
Tax incentives u/s 10A, 10AA,32,
80IA, 80IB and 80IC to be kept in
mind.
Sale of plant and machinery- section
50 to be kept in mind.

Problem

XYZ needs a component in an assembly operation. It wants to


decide whether make it or buy it.
If the company decides to make the product itself, then it would
need to buy a second hand machine for Rs. 8 lakh which would be
used for 5 years. Manufacturing costs in each of the 5 years would
be Rs. 12 lakh, Rs. 14 lakh, Rs 16 lakh, Rs. 20 lakh and Rs. 25
lakhs resp.the relevant depreciation rate is 15%. The machine
would be sold for Rs. 1 lakh at the beginning of the sixth year.
If the company decides to buy the component from a supplier the
component would cost Rs. 18 lakh, Rs. 20 lakh, Rs. 22 lakh, Rs. 28
lakh and Rs. 34 lakh resp. in each of the five years.
The relevant discounting rate and tax rate are 14 percent and
33.99 percent resp. Additional depreciation is not available. Should
XYZ make or buy the component from outside?

Repair, replace, renew or


renovate
Repair, renewal whether deductible
as business expence.
If not deductible then, capitalise and
claim depreciation.