Small businesses: Taxation 101

Date : 25/07/2020
Read: 8 mins

Like everyone else, even small businesses must pay taxes. However, they are also entitled to various tax benefits. Here’s what you must know.

One of the most common questions small businesses owners in India ask is: Do they have to pay business tax? The answer is, yes. It is mandatory for everyone to pay income tax, whether the entity is a small or big company. If an enterprise earns a revenue above the threshold limit, based on the applicable business tax rate it must pay tax.

An enterprise is dubbed a small business if its paid-up capital is less than Rs. 50 lakhs, or such higher amounts as may be prescribed, but is not more than Rs. 5 crores. However, as small businesses are bank-dependent borrowers, they impact capital requirement, such as bank lending, loan terms, etc. Additionally, the threshold limit for small business regarding tax liability depends on the format of business.

The problem is, small business owners often tend to gloss over the significance of taxation when it comes to managing their business and its associated finances, allowing it to overwhelm them.

Understanding small businesses tax

It is important to accept that tax obligations cannot be wished away. However, by simply understanding the type of business they run, small business owners can make this process easier.

If a company functions as a sole proprietorship, it attracts the same tax rates as applicable for individual citizens. This also means that the unit is exempted from paying taxes on income of up to Rs. 2.5 lakhs for business owners below the age of 60 and 3 lakhs for senior citizens.
In the case of a private limited company, a partnership company, or limited liability partnership (LLP), there is no threshold limit and it must pay business tax on its total income.

Fortunately, in the sphere of sales and services, the new GST regime has subsumed a whole range of taxes such as VAT, central and state taxes, octroi, excise and other cesses.

In the case of business tax, tapping into areas where a company can claim exemptions is one method to stem tax outgoings and manage finances better.

Tax saving tips for sole proprietorships and small businesses

There are many small business tax deductions that businesses can use, provided they are necessary and for reasonable amounts. Moreover, they must be directly related to the business.

Business owners can seek deductions from income from house property, business or profession, capital gains and under Chapter VI of the Income-Tax Act of 1961.

Deductions from building

There are two ways to seek deductions from house property: (a) claim benefits of interest on housing loan (b) claim deductions on municipal taxes paid.

1. Housing loans: Availing bank loans for construction of business-related buildings can benefit a business owner, as borrowers can claim the interest as a deduction from the property. Additionally, they can claim the principal as a deduction under section 80C, along with other deductions, limited to Rs. 1.5 lakhs.

For tax purposes, the gross value is taken as zero, and claiming deduction results in loss under the head ‘Income from House Property’; this can be set off against incomes of other heads, bringing down the overall taxable income.

2. Municipal taxes: If municipal taxes are paid by cheque during the year, these can be claimed as deduction from income from house property.

Small business tax deductions and profession tax deductions

1. Cash expenses: As a thumb rule, labour wages account for a minimum of 40% of manufacturing expenses, including indirect wages such as loading and unloading expenses, which are often not recorded. This results in under-recording of expenses, on which otherwise tax deductions could have been claimed. That is why proper cash receipts with signature/thumb impressions of labourers are essential.

2. Depreciation: The Income-Tax Act provides for additional depreciation under section 35AD to manufacturing units. If a plant is installed during the year, these units can claim additional depreciation of up to 20% – over and above the normal depreciation – when the machinery is used.

3. Deduct tax at source: The Income Tax Act has also specified several transactions under which a buyer is required to deduct tax at source (TDS) while making payments to a seller. Failure to do so increases the tax burden.

Other tips to reduce your taxable income:

You can deduct travel expenses for both business and personal reasons, to reduce your taxable income.
Reimbursements that you provide to employees for travel, entertainment, equipment, or other costs come under an accountable plan. Small business can deduct these expenses and it is not treated as income to employees.
Other expenses like vehicle expenses, home office expenses, can also be shown as expenses that lead to a reduction in taxable income.

You can also consider business insurance expenses that are paid every year, such as liability insurance, workers compensation insurance, commercial auto insurance, etc.

Cash payments: The Act also does not allow the deduction of expenses if the payments exceed Rs. 10,000 paid in a day to one person, other than by way of cheque or draft. This was earlier Rs 20,000 but further reduced under The Finance Act 2017.

However, rule 6DD of the Income Tax Rules provide some exceptions. For example, cash limit for payment to transport contractors is Rs 35,000. It is essential that business owners check these before attempting cash payments.

Indirect income: Be careful to deduct indirect income taxed under other heads while calculating total profits. Often, such income is exempt under some sections. If not deducted from book profits, one may even end up not only paying higher taxes but also failing to avail existing tax benefits.

For example, interest income on a savings account is an indirect income. It is taxed under the head ‘Income from Other Sources’, but section 80TTA allows a deduction up to Rs 10,000 per year.

Timely small business tax filing: The IT office offers several benefits if business tax returns are filed on time, one being the carry-forward of losses on business income – for eight years consecutively. ‘On time’ here means filing business taxes on or before the due date.

Capital Gains tips

Capital Gains: People are often clueless about the concepts of short-term and long-term capital gains. Any capital asset held for more than 36 months is a long-term capital asset, and long-term capital gain arises from its sale. Anything sold before 36 months is considered a short-term asset and is taxed at a flat rate of 15%. Though different options are available in case of long-term capital gains, the holding period is 12 months instead of 36 for equity shares or debentures of a listed company, units of UTI, Zero Coupon Bonds, and equity-oriented Mutual Funds.

Treatment of SIP: Mutual fund units sold after 12 months will attract a capital gains tax at the rate of 10% for gains in excess of one lakh in a financial year. When a SIP is started, each instalment is considered a separate investment. So, it makes sense to sell the units on first-in first-out basis to avoid unnecessary tax on short-term capital gains.

Chapter VI Business tax deductions

Life Insurance: Life insurance policies, apart from the obvious, come with certain tax benefits. The premium paid on life insurance can be claimed under section 80C along with other deductions subject to a cap of Rs 1.5 lakhs.

PPF Investment: The government’s Public Provident Fund (PPF) provides a lucrative rate of interest akin to the rate of interest on Fixed Deposits offered by scheduled banks. It also allows the policy-holder to claim deductions of up to Rs. 1.5 lakhs along with other deductions under section 80C. Interest on PPF is also exempt under section 10.

Medical Insurance Premium: Deductions can be claimed on the premium paid on medical insurance policies for self, spouse, dependent children and parents under section 80D. Benefits range from Rs. 25,000 to Rs 1,00,000 basis the number and age of dependents.

LAST WORD

For business owners who are liable to pay self-assessment tax even after claiming credit of TDS, it is advisable to deposit advance taxes according to applicable business tax slab as prescribed at regular intervals.

Finally, hire the services of an expert; qualified chartered accountants can ensure savings of an optimum tax legally and availing the benefits of tax-saving schemes that will help companies runs smoothly.

Disclaimer: This article is intended for general information purposes only and should not be construed as investment, insurance, tax or legal advice. You are encouraged to separately obtain independent advice when making decisions in these areas.