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Tax Management with reference to – ‘Capital Structure'


Tax Management With Reference To Capital Structure


What is the Optimum Capital Structure :   The optimum capital structure is a mix of equity capital and debt funds. Their composition depends upon many factors namely :

  1. Cost of Capital and also expenditure incurred in raising of such capital.

  2. Expectation of shareholders by way of dividend, growth etc.

  3. Expansion need of the business  i.e. the rate by which profits of the business shall be again ploughed back in the business.

  4. Taxation policy ; and

  5. Rate of return on investment ( Equity + Debt funds ).


  1. Interest on debt fund is allowed as deduction as it is a business expenditure. Therefore, it may increase the rate of return on owner’s equity.

  2. Dividend on equity fund is not allowed as deduction as it is the appropriate of profit. Dividend is exempt in the hands of shareholders u/s  10(34) . However, the company declaring the dividend shall pay dividend distribution tax @ 12.5% + surcharges + education cess.

  3. The Cost raising owner’s fund is treated as capital expenditure therefore not allowed as deduction. However if conditions of Sec. 35D is satisfied then specified expenditures can be amortized.

  4. The Cost of raising dent fund is treaded as revenue expenditure. It can be claimed as deduction in computing the total income.

  5. Where the assesses is entitled to incentives u/s 10A etc. maximum equity fund should be utilized.

  6. Where interest on debt fund is payable outside India, tax should be deducted at source otherwise deduction is not allowed.


  1. If the return on investment > rate of interest , maximum debt funds may be used, since is shall increase the rate of return on equity . However, cost of raising debt fund should be kept in mind.

  2. if rate of return on investment  < rate of interest, minimum debt funds should be used.

  3. Where assessee enjoys tax holidays under various provisions of Income-Tax in such case minimum debt fund should be used, since the profit arising from business is fully exempt from tax which increase the rate of return of equity capital. But the borrowed funds reduces the profits ( profits less interest) before tax and to the extent exemption is reduce.

The balance of capital structure shall depend upon maximizing the return on capital employed which is computed by using following formula :

Distributable Profit

_________________________  X 100

Equity Capital

> Tax Management in reference to Location & Nature of New Business
> Tax Management In Nature Of The New Business
> Tax Management with reference to -Deemed Dividend
> [ SEC. 2(22)(a) ] : Tax Management with reference to -Deemed Dividend- ( Any Distribution Entailing Release)
> [ SEC. 2(22)(b) ] : Any Distribution By Way Of Debenture Etc.
> [ SEC. 2(22)(e) ] : Payment By Way Of Advance Or Loan To Shareholders
> Tax Management with reference to –Lease or Buy Decisions
> Tax Management with reference to –Repair, Replace, Renewal Or Renovation
> Tax Management with reference to – ‘Make Or Buy’ Decisions
> [Sec.- 46] : Capital Gains on Distribution of Assets by Companies
> Tax Management in reference to-Sale of Scientific Research Asset
  Tax Management with reference to –‘Capital Structure'
> Conversion of Firm / Sole Proprietorship to Company

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