Finance is a vast subject which has several branches. The modern business world is changing rapidly and moving forward towards a direction of advancement in terms of its functioning. One has to be familiar with the terminology associated with the finance world.
This website, ‘Simplified Fiscal Affairs’ presents to you the various topics/concepts in the form of series and imparts the knowledge in a simplified way.
Corporate Finance:
Corporate finance deals primarily with the acquisition and use of capital by business corporation.” Henry Hoagland
Corporate finance deals with the raising and utilisation of Finance by a business organisation. It deals with the financing activities of the entity its capital structureing and planning the Investments.
The two main decisions of corporate Finance are financing decision and investment decision:
Financing Decision:
The business firm has access to capital markets to finance its various needs. The business entity has multiple choices to raise funds from which can either be equity capital or debt capital.The finance manager has to make sure that the capital raised has a right makes of debt and equity.
Investment decision:
Once the business firm has enough capital, the finance manager has to make sure that the funds raised are systematically channelised to such avenues which will bring maximum return to its owners.For generating good returns the firm needs to compute the cost of capital, by this the form can systematically invest the funds in a manner that the returns are more than the cost of capital.
Taxation:
- Income tax is levied by the central government under entry 82 of the Union of Schedule Vll to constitution of India. This entry deals with, tax on income other than agricultural income.
- Section 4, which is the charging section, provides that Income Tax is it tax on the total income of a person called the assesse of the previous year relevant to the assessment year at the rates prescribed in the relevant Finance Act.
- Tax is the primary source of public revenue, major part of revenue income is generated from tax by the Central Government.
- It is a compulsory duty imposed by the government. If any individual refuses to comply with tax payments, he can be punished.
- Tax is a duty of every citizen and not a penalty.The payment of tax involves some understanding and sacrifice on the part of a tax payer.
Type of Taxes:
Direct Taxes:
- Direct taxes are direct in nature their impact and incidence is on the same person, they can not be shifted. These taxes are imposed on individuals, organisations and are personal in nature. For example: income tax, wealth tax.
- Direct tax is one which is paid by a person on whom it is legally imposed and the burden of which cannot be shifted to any other person. The tax payer is the tax bearer. The impact (the initial burden) and its incidence (the ultimate settlement) of direct tax is on the same individual.
- Direct taxes cannot be transferred to other person. The concept of shifting of tax does not apply to direct tax.
Indirect taxes:
- Indirect taxes can be shifted from one individual to another. These taxes are imposed on manufactured goods in India. Indirect tax is imposed by the government and collected by a third party from the person who bears the ultimate economic burden of the tax.
- This means that the final consumer has to bear the ultimate economic burden of the tax imposed. This kind of tax, intern, increases the amount of money payable for something.
- Indirect tax is one in which the burden can be shifted to others, the tax payer is not a tax bearer. Impact and incidence or settlement of indirect taxes are on different persons.
The Fundamental Canons of Taxation by Adam Smith:
Canons of Taxation:
Canons of Taxation represent the main basic principles or rules laid down to establish a good tax system. Canons of taxation were first originally laid down by economist Adam Smith in his famous book the “ The Wealth of Nations”.
In this book, Adam Smith gave the following four main canons of taxation:
- Canon of Equity: This principal aims to provide economic and social justice to the people. This principle or canon, states that every person should pay to the government depending upon his ability to pay. The taxes paid should be in proportion to the income generated.
- Canon of Certainty: As per this canon, Adam Smith, is of this opinion that the tax payer should know in advance how much tax is to be paid, at what time he has to pay the tax and in what form the tax is to be paid to the government. This canon, ensures that the individual as well as the government should be certain about the amount that will be paid and collected respectively.
- Canon of Convenience: There should be convenience in the mode and timing of tax payment. The tax system prevalent should be convenient enough for the tax payer, otherwise, an inconvinent tax collection system may lead to tax evasion.
- Canon of Economy: This principle clearly states that there should be economy in tax administration. The cost of tax collection should be lower than the amount of tax collected.
Additional canons: In due course of time the government adopted the policy of welfare state which has increased significantly the expenditure of the government. Governments are expected to maintain economic stability, full employment, reduce income inequality and promote growth and development. The tax system should be structured as such, that it caters to the needs of the growing state affairs.
- Canon of Productivity: Also known as the canon of fiscal adequacy. The tax system should be able to generate enough revenue for the treasury and the government should not have the need to depend on deficit financing.
- Canon of Elasticity: The imposition of tax by the government should be flexible in nature.
- Canon of Flexibility: There must be enough flexibility in the tax system. It should be easily possible for the government to revise the tax structure.
- Canon of Diversify: There’s a need of diversification in the way the government collect taxes. If the tax revenue comes from a diversified source then any reduction in tax revenue due to any one cause is bound to be less.
- Canon of Simplicity: The tax system prevalent should be simple as far as possible. It should be easy to comprehend and administer.
Characteristics of a Good Tax System:
- There must be an equitable distribution of tax burden. Each and every individual must be made to pay as per his or her ability.
- A tax system should be diversified. It should have various sources of income and should not rely on a single source.
- A tax system must be productive in nature, it must encourage savings and investment which will lead to favourable allocation of resources.
- The primary goal of the modern tax system is to generate adequate revenue to meet the public expenditure as the modern governments are welfare oriented and require adequate funds to cater to the various demands.
- Good tax system should facilitate stability and development of the economy.
- There should be economy in the collection of taxes. Administrative machinery should be efficient and should involve minimum cost of collection.
- The tax system prevalent should be flexible enough to keep up with the changing requirements of the government and the economy.
- The tax system, framed should be simple, certain and convenient. It should acknowledge the basic rights of the tax payer.
Insurance:
Insurance is an important economic tool to manage risks and to maintain a good ratio of risks and rewards. It is a financial hedging instrument.
Critical Components of Most Insurance Policies:
- Premium: The consideration for which the insurer agrees to insure or secure the insured. The premium is determined by the insurer based on your business’s risk profile, which may include creditworthiness.
- Policy Limit: The policy limit is the maximum amount that an insurer will pay under a policy for a covered loss. Maximums may be set per period (e.g., annual or policy term), per loss or injury, or over the life of the policy, also known as the lifetime maximum.
- Subject Matter: It refers to the subject or entity that is life property cargo or ship which is insured against which the policies taken.
Principles of Insurance:
- Principle of Utmost good faith: In all insurance contracts both the parties must have utmost good faith towards each other. The insurer and insured must disclose all material facts clearly, completely and correctly regarding the subject matter of insurance. Similarly, the insurer must provide relevant information regarding the terms and conditions of the contract. Failure to provide complete information may lead to non settlement of claim.
- Principle of insurable interest: Insurable interest means some financial interest in the subject matter. This principle is applied to all the insurance contracts. For example, a person has insurable interest in his own life. A business entity has insurable interest in the goods it deals with.
- Principle of indemnity: Indemnity means a guarantee or assurance to put the insured in the same financial position in which he or she was immediately prior to the happening of the uncertain event. This principle is applicable to fire, marine and general insurance. It is not applicable to Life insurance as loss of life can never be measured in monetary terms. In case of death of the ensured the actual sum assured is paid to the nominee of the ensured.
- Principle of subrogation: As per this principle, after the ensured is compensated for the loss due to damage of the property insured then the right of ownership of such property passes on to the insurer. This principle is applicable only when the damaged property has any value after the happening of the uncertain event.
- Principle of contribution: Where the insured has taken out more than one policy for the same subject matter. Under this principle, the insured can claim the compensation only to the extent of actual loss either from one insurer or all the insurers. The claim will only be settled for the actual loss occurred.
- Principle of mitigation of loss: Insured must always try to minimise the loss of the property in case of uncertain events. The insured must take all possible measures and necessary steps to control and reduce losses.
- Principle of Causa- Proxima: The principle of Causa- Proxima means, when a loss is caused by more than one causes, then proximate cause of loss should be taken into consideration to decide the liability of the insurance. The subject matter is insured against some causes and not all the causes. If the direct cause is one which is insured against the ensure insurance company is bound to settle the claim.
