Income Tax Taxation

Get Clarity on the Difference between Tax Planning and Tax Avoidance


Tax Planning is the process of reducing tax liability on taxpayers by making the maximum use of deductions, allowances, exemptions & relief provided under the Income Tax Act. It is conducted with an object of financial planning to ensure tax efficiency.

In layman terms, tax planning is the judicious planning of taxation by using all the reliefs available under the Income Tax Act. It is an honest approach that helps in achieving maximum tax benefits by being within the ambit of the law.

Tax Planning is an arrangement and structuring of financial affairs in such a manner that most of the tax benefits can be availed by an assessee. This is done by applying the majority of permissible benefits, deductions, rebates & reliefs, thereby reducing the taxable income.  

Objectives of Tax Planning

  • Tax Reduction: Assessee can considerably reduce his taxable income by making use of the various deductions/reliefs that are made available under the Income Tax Act 1961[1]. It involves the smart application of Income Tax provisions to reduce tax liability.
  • Avoidance of litigation: Taxpayers always want to minimize their tax liability, while the tax authorities want the same to be justified. The tax authorities ensure that no tax evasion is made by the assessees. Tax planning is one process that ensures that the tax liability of the assessee is reduced in conformity with the legal provisions. Hence, the dispute between the assessee and the tax authorities is avoided, which means the chances of litigation are avoided.
  • Productive Investment: Tax Planning helps in attaining the objective of channelizing the taxable income into various investment plans. The assessee can make intelligent investments and simultaneously reduce his tax liability.
  • Boosting the economy: An economy grows with the growth of its citizens. Tax Planning leads to the flow of white money freely, which in turn helps in the financial progress of the economy.
READ  Section 269SS of Income Tax Act 1961: An Overview

Understanding Tax Avoidance

In Tax Avoidance, a taxpayer arranges his financial affairs in such a way that his tax liability is reduced without going out the ambit of the law. Tax avoidance is legal. However, it is not considered ethical as the taxpayer takes undue advantage of the loopholes in the law to evade payment of tax.

It is pertinent to mention that tax avoidance is different from tax evasion. Tax Evasion is a criminal act punishable by law under the Income Tax Act as it involves illegal methods of avoiding payment of tax such as reporting of incorrect income or disclosing less income.

Methods of Tax Avoidance

Tax Avoidance is a way of avoiding tax payments in a manipulative manner. A taxpayer can avoid tax payment by indulging in different activities such as:

  • Hiding facts
  • Creation of sham transactions without reflecting the true purpose
  • Make fictitious contracts or transactions
  • Mold actions without falsification of the accounts

Difference between Tax Avoidance & Tax Planning

Point of Difference   Tax Planning Tax Avoidance
Meaning Tax Planning involves intelligent planning of reducing the tax liability by claiming all the eligible deductions, rebates & exemptions as per law. Tax Avoidance is the method of deliberately indulging in the practice of adjusting financial affairs to the extent that the tax liability is minimized.  
Nature Tax Planning is morally correct and legal practice. Tax Avoidance is legal practice but cannot be considered moral.
Practice Tax Planning is the practice of tax savings. Tax Avoidance is the practice of hedging of tax.
Legal implications Tax planning takes the benefits of deductions, exemptions, relief or rebates for reduction of tax liability   Tax avoidance makes use of loopholes for the reduction of tax liability.
Benefits Tax minimized through proper planning can be fruitful for long term Benefits of Tax Avoidance remains for short term

Practical Examples

Tax avoidance

  • A taxpayer for minimizing his tax liability can contribute to Individual Retirement account (IRA) before 15th April, because those contributions are deductible from the taxable income and lower the tax bills of the assessee.
  • Claiming deductions such as mortgage interest, property tax, medical expenses, charitable contributions, etc.
  • At times, companies indulge in the practice of tax avoidance by paying the director’s income in the form of a “Director’s loan.” Such loans are either not repaid or are written off at the end of the year.

Tax planning

  • By investing in any scheme of ELSS or tax-saving mutual fund with a lock-in period of 3 years.
  • By investing in tax saving, FDs, EPF, etc.
  • By making an investment in the national pension scheme that was introduced by the government for the unorganized sector or professionals to have a pension after retirement
  • Investment in Unit-linked Insurance Plans, which are a mix of insurance as well as investment.
  • Investment and withdrawals from the scheme of Sukanya Samriddhi Yojna, which are tax-free.

Steps of Tax Planning

  • Early Planning: Most of taxpayers start their paperwork when the due date of filing the tax return is close. Thus, taxpayers are encouraged to plan their tax savings early to have a better estimate of the investments and benefits that can be claimed by them.
  • Tax Liability: It is the step of the actual calculation of taxability based on income and after claiming all the rebates and deductions. Preparing an estimate of tax liability beforehand can also help in structuring the investment and savings part.
  • Risk level: This step involves estimating the optimal level of investment risk as per the current financial situation of the taxpayer. The following factors have to be considered for risk profile:
  • The risk associated with the amount of expected return
  • Level of risk that the taxpayer is ready to undertake
  • Level of risk that is acceptable by the taxpayer
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What is tax and tax planning?

A tax is a charge that government requires from individuals and companies that fall within their jurisdictions. While tax planning is refers to legal and strategic arrangement of financial activities to reduce the tax liabilities.

What are the difference between tax planning and tax evasion?

Tax evasion is when an individual avoids the tax payments, while tax planning is meticulously planning the payments to taxes in order to save money, along with following the rules.

What is the difference between tax planning and financial planning?

Tax planning is concerned with maximizing tax advantages while minimizing tax obligations within the bounds of law. Financial planning included a wider range of methods to achieve overall financial objectives such as budgeting, risk management, etc.

What is tax planning with example?

Tax planning is refers to legal and strategic arrangement of financial activities to reduce the tax liabilities. Examples of tax planning are tax credits and deductions, investing strategies etc.

What is tax planning in financial planning?

Tax planning is an essential part of financial planning. Tax planning means to effectively save taxes being in the limits of tax rules.

What is the difference between tax saving and tax planning?

Tax planning entails developing a strategy and setting up financial affairs to maximize tax benefits and reduce total tax burden, whereas tax saving refers to the act of lowering tax responsibility by lawful means.

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