It is one of the most asked questions by an entrepreneur.
How to save tax on my business income? Tax Planning
To save taxes on business income, it is important to know the Income-tax rules and provisions and the related compliances to be made. If a provision is not complied with, the expenses will be disallowed resulting in higher tax payment.
In general there are 2 ways to save tax
One is by claiming expenses as deductions and the other is by reducing your taxable profits. But both must be done legally and ethically keeping in mind the compliances required to be made.
Here follows the top tax saving tips for entrepreneurs.
Your business stock valuation
You would normally value your business stock at cost but maintain a habit of maintaining a policy of periodically checking the shelf life of your stock. In case the value of your stock depreciates in the market, bring it down to NRV or Net realizable value. Due to bringing down the cost of the stock, the value of your closing stock will come down hence ensuring that your stock is not overvalued which means payment of higher tax on the overvalued amount.
Frequency of Cash payments
Do you keep track of how much cash payments are being made per day by your business/enterprise? If your answer is no, start keeping track from today as Income tax disallows your expenditure if an amount of more than Rs 20000 is being paid through cash in a single day to a single person.
For eg, let’s say your business infrastructure needed some repairing or modification (revenue expense) and you pay Rs 21000 to the repairer in cash that day itself. The income tax officer is empowered to disallow your entire Rs 21000 which means you have to pay tax on this amount. But if you pay the same through cheque or banking channels, you can claim this expense as a deduction in your profit and loss account.
Certain conditions are prescribed in Rule 6DD of the Income Tax Rules to make sure you carry out your business expenditures in a tax-free manner. Do make sure that you maintain proper cash records to prevent yourself from getting into any hassle.
Limit your withdrawals from your business account
Many businessmen tend to withdraw amounts from the business for personal purposes for instance for buying life insurance on himself or his family members. This leads to disallowance of the expenses made as they are personal in nature. Any kind of personal expenses on your car or staff expenses of personal nature will be straightaway disallowed.
Make sure you deduct incomes which are taxable under other heads
Let’s take a case where you have interest earned on your business savings account. You put it in the credit side of your profit and loss account taking it to be your business income. By doing this you will be missing out deduction u/s 80TTA which is limited up to Rs 10000. It’s the same for dividends earned by your business. If your business had invested its funds as a shareholding in some domestic company, you can get dividend exemption by showing it under the head Income from Other sources. This way you can make sure you are availing the benefits legally by showing your income under the correct taxable heads.
Filing income tax returns on time
The due date for filing income tax returns for businesses is 30th September of the Assessment year. What is the importance of filing returns on time?
The first benefit undoubtedly is avoidance of penalty charged by the government for the late filing of returns. The second benefit is that you can carry forward your business losses which could not have been done otherwise if your returns were not filed on time. For instance, if you had incurred a business loss in the FY 2016-17 and did not file your return for the AY 2017-18, the loss would be regarded as a dead loss as you cannot carry forward and set off this loss to set off from your business profits in future.
Filing your returns on time makes sure that you are using the benefit of your business loss to reduce your taxable profits. It must be kept in mind that your business losses can be set off for a maximum period of 8 years starting from the next AY. Also to avail certain deductions, you must file your returns on time or else you will miss out on legal deductions available to you.
Expenses that can be claimed as deduction on payment basis u/s 43B
To safeguard the interest of specific parties for eg employees working in your enterprise or interest on a borrowed loan to banks, the government will disallow any deductions of business expenses claimed by you in respect of payments not made to the parties in the same financial year.
There are 6 types of expenses that need to be paid for real if you want to claim deduction:
- Any tax or duty or any fees to be paid to the government
- Any bonus or commission payable to your employee
- Payment of leave encashment to your employee
- Interest on loan borrowed from banks
- Contribution by you as an employer to your employees’ provident fund or superannuation fund or gratuity fund or ESI or any other fund created for the welfare of the employees in general.
- Expenses payable to the Indian Railways for using any of its assets for the benefit of your business.
If you have not made these payments yet, make sure you clear these payments today itself. If you don’t pay these expenses before the due date of filing your ITR returns that is generally before 30th September of the relevant AY, you can claim deduction in respect of these payments only when you pay them. This disallowance will be reflected in your statement of particulars that is Form 3CD at the time of ITR filing.
Timely deduction of TDS while making business payments
If you were supposed to deduct TDS on payment being made to a party and you haven’t done so, a part or entire amount of expenditure would be disallowed depending on whether the payment had been made to a resident or a non resident.
If on payment to a Non resident
- Any interest
- Fees for technical services
- Any other expenses taxable under the Act
Any TDS was supposed to be deducted and was not deducted or if TDS had been deducted but payment has not been made on or before due date of filing of ITR, such sum will be disallowed in its entirety or in other words entire amount will be disallowed until the required TDS is deposited with the government.
Similarly if on payment to a Resident
- Any interest
- Fees for technical services
- Commission or brokerage
- Fees for professional services
- Contract payments
- Any other expenses for which TDS compulsory
On which TDS had not been deducted or not paid to the government on or before due date of filing of ITR, 30% of the amount will be disallowed. Only 70 % of such expenses can be claimed as deduction. If you want to claim the remaining 30%, you need to deduct TDS or if TDS already deducted, pay it to the government.
Think about opting for presumptive scheme if your taxable turnover is below the prescribed limits
If the turnover of your business is below Rs 2 crores, you can opt for taxation on presumptive basis u/s 44AD or 44AE or 44ADA as the case may be. If you have a firm or is providing professional services, your gross receipts must be less than Rs 50 lakhs in order to opt for this scheme. If you have a business of plying of goods carriages and you have not more than 10 good carriages at any point of time in the relevant financial year, you are eligible to opt for this scheme.
If you earn profits on your turnover at a rate higher than 6%, your profits will still be taxed at 6% when you opt for this scheme. If you do not receive receipts through banking channels, a rate of 8% would be applicable to you. Think about it when you are earning profit at 20 percent on turnover but due to presumptive tax scheme, you have to pay at such a reduced rate!
Opting for presumptive tax scheme can considerably reduce the tax paid to the government. Not only you would enjoy low tax but also you would not have to get your accounts audited unless your turnover exceeds Rs 2 crores. But you must keep in mind that this scheme works only for those who have a profit margin more than 6% or 8%. In case of manufacturing entities were profit margins are low, you must not opt for this scheme then.
If your business is a startup, claim deduction u/s 35D
If you have incurred expenditure before the commencement of operation of your new business, then use the benefit offered to you by section 35D (Amortisation of preliminary expenses) where you can amortise such expenses over a 5 year period. For eg if your expenses incurred were Rs 10 lakhs, every year you can claim a deduction of 2 lakhs which will write off 10 lakhs completely over a period of 5 years.
You can also claim this expenditure incurred after the commencement of business. But such expenditure made must be to expand your business or setting up of a new undertaking.
How much expenditure can you claim?
There is a limit on the expenditure you can claim. It is limited to the
5% on the cost of project or 5% on the capital employed whichever is higher
Cost of capital employed means:
- Issued share capital (Not paid up)
- Long term borrowings if the repayment period is more than 7 years.
Cost of project means the actual fixed cost of the asset lying in the balance sheet as on the last day of the previous financial year when the business has commenced or the extension work is completed. For this we have to remove all the depreciation charged till then as we need the actual cost and not the WDV of the asset.
Saving tax through additional depreciation
If you are buying a new plant and machinery this year, make sure in addition to claiming normal rate of depreciation, you claim an additional depreciation of 20%. For instance you buy a machinery of Rs 200000 in the FY 2019-20. Normal depreciation rate is 15% on it. So in addition to claiming depreciation of Rs 30000 during the year, you can claim a depreciation of another 20% that is Rs 40000. Hence total depreciation claimed during the year will amount to Rs 70000.
However one thing must be kept in mind that such deduction is available only when you claim it in the year of purchase itself. After that you become eligible to claim additional depreciation. But in case your new plant and machinery is put to use for less than 180 days, half of 35% can be claimed in the year immediately succeeding the previous year.
Also you must not use any of the new plant and machinery in your office premises or in other words use it for the production of your goods or else you will be ineligible for such benefit.
If you have any unabsorbed depreciation, use it to save tax
When you have a business loss and also some depreciation that could not be claimed due to the occurrence of loss, such depreciation is known as unabsorbed depreciation. This depreciation can be set off like any other loss from your business profits. Also the carry forward of this loss has no time limit unlike business loss that has a time limit of 8 years.
These are the top saving tips that will help you to save tax on your business income.