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How people try to evade tax but still lead to losses

“Don’t evade taxes, do tax planning”

People think they can save amounts of taxes using the concept of ‘tax evasion’. But guys, it will not help you every time but may caught you in a problem and you can face lakhs and crores of losses as per the volume of your transaction if you haven’t knowledge about the provisions of taxes.

Let’s understand with the help of example:-

Suppose Mr. X purchase a commercial property of Rs. 40 crores on 7th of June 2005, but in actual he is not using the same for his business purposes. The property has been sold in FY 2022-23 of Rs. 70 crores. Assuming there is only one property in this block.

Intension of Mr. X

  • Purchase property for investment purpose
  • Thinking that, in future the price of the property will increase and he will earn profit.

Now, Mr. X has two options:-

Option: 1 : Show property as used for business purposes i.e “Tax evasion route”:

Under this option, Mr. X claim depreciation @ 10% each year by showing property as commercial and used for business purposes. Therefore, effectively, in 1st year, he has claimed depreciation of Rs 4 crores and save taxes of Rs 1.6 crores assuming tax rate is 40% (40% of Rs 4 Cr.) and so on in coming years accordingly.

Primarily, it seems that, we should go with this option because this way, we can save amounts of taxes with the help of depreciation. But , it will not give you the benefits if analyse the transaction properly. Whether the transaction is legal or illegal, it’s a different matter. But, how this will lead to loss for Mr. X?

  • In year 2005-06 in our example, we claimed full year depreciation @ 10% on Rs 40 cr. i.e. 4 Cr
  • Total no of years we had claimed depreciation = 17 years (From 2005-06 to 2021-22)
  • In year 2022-23, Mr X can’t claim depreciation on WDV because asset has been sold in mid of the year.
    • From FY 2005-06 to FY 2021-22, total depreciation claimed= Rs 33.33 Cr
    • Savings in each year = 40% on the amount of depreciation claimed
    • WDV as on 01/04/2021 = Rs 6.7 Cr (Rs 40 cr- Rs 33.33 Cr)

At the time of sale of this property under this option, Short Term Capital Gain(STCG) will arise as block has been lapsed.

Calculation of STCG:

Sales consideration: Rs.70 Crores

Less: WDV of property: Rs 6.7 Crores

Less: Transfer Expenses: Nil (Assume)

STCG: Rs.63.3 Crores

Tax = 40% of Rs. 63.30 Cr = 13.33 Cr

Net tax paid = (63.30*40%) i.e. STCG – (33.33Cr*40%) i.e. tax saved on depreciation becomes Rs 12 Crores.

Option: 2: Show the purpose of property for which it has been purchased i.e for investment and not used for business purposes i.e “No Tax evasion route”:

  • Under this option, Long term capital gain (LTCG) arises because period of holding in more than 24 months.
  • There is no concept of depreciation because property has not been used for business purposes.
  • Indexation benefit is there.
  • Tax rate is 20% as per Sec 112 of income tax act, 1961.

Calculation of LTCG:

Sales consideration: Rs.70 Crores

Less: Cost of acquisition: Rs 113.16 Crores (40cr*331/117)

Less: Transfer Expenses: Nil (Assume)

LTCG/LTCL: -Rs.43.16 Crores

Net Tax payable is zero and tax saving is 8.64 cr (20% of Rs 43.16 cr)

Accordingly, option 2 is beneficial and transaction is also legal.

But it doesn’t mean that people start purchasing property as per option 1 and showing as per option 2 because it is beneficial. Because if property has been purchased for business use, it’s compulsory to depreciate the same as per sec 32 of income tax act, 1961. There is no option.

At the end, the conclusion is, tax evasion practice not always helps you. Therefore, try to save your taxes with appropriate tax planning.

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2 Comments

  1. NARESH KUMAR SHARMA says:

    However in option Ist, one can invest the amount of tax savings on account of depreciation for earning risk free returns which may fetch more cash flow as compared to to option 2nd at the end of 17th year. in such situation option Ist will be more beneficial. at 6% risk free roi amount invested in option Ist may fetch 26.77 Cr. at the end of 17th year

    1. shweta.choraria@yahoo.com says:

      Yes, you are right.It might be possible.But this article is written by keeping in mind that IRR is different in each and every assessee. Therefore this idea has been present ingoring IRR and risk factor.

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