Ramesh, an engineer employed with a global company, receives ₹7.5 lakhs per annum and pays a tax of, say, ₹22,000.
Suresh, his brother, an entrepreneur, earns the same income annually, but pays ₹10,000.
This is not a hypothetical situation. This is the difference in the amount an entrepreneur and a salaried employee, earning the same income, must pay as tax.
Surprised? You should not be.
The Income Tax Department runs on a simple fundamental. You earn, and you pay a portion of it to the government to run the country. Rightfully so.
But it does not want to be a demon in society and suck your purchasing power from you. So, it lays out a list of deductions and allowances as benefits – which, of course, can be claimed when you pay and file your taxes.
Now, an entrepreneur is paid for more than his profit share. The difference between the earnings of Ramesh and Suresh is that Suresh passes on a larger sum of money towards other expenses to run and manage his business.
One may argue that the deductions make salaried individuals pay more. However, they are charged on what is left in their pocket after reducing their living expenses like rent, medical expenses, etc. Businesspeople, on the other hand, have more expenses to claim against their taxable income for a deduction.
The salaried individual pays his taxes first (via TDS) and then spends. The entrepreneur does it the other way round. This approach reduces their effective tax rate (the rate at which they eventually pay, after reflecting all deductions and allowances) to as much as 22-23% from a 30% tax rate.
That said, an entrepreneur can only claim these expenses if they are effected for business purposes and he can prove it with documentation. His business account in the bank too must reflect his transactions. If these transactions involve cash, only up to ₹20,000 can be claimed as a deduction.
The government aims at encouraging entrepreneurship since it has a direct impact on pushing India’s economy. These deductions are their way to incentivize individuals to start businesses.
Also read: Income tax act 80C: how to save money/tax?
These are expenses related directly to their business. To claim these, the individual must have used them fully for work, and not on capital assets.
For example, if I as a freelancer purchase a laptop which I use for both work and personal purposes, or go for a trip, claim it for business but show no proof of business, I cannot claim it under this label.
Extended professional fees
Entrepreneurs often hire other professionals in various fields to aid their business operations and marketing. This fee can be also claimed as a deduction.
When the entrepreneur purchases machinery/other capital assets like furniture or gadgets solely for work, he can claim depreciation under the Income Tax Act on them. The rate of depreciation on specific assets for a specific duration is prescribed in the Act. There is also a provision to claim additional depreciation for certain assets.
One major component of most entrepreneurial expenditures is training expenses to enhance business growth. They can claim up to 30% of such training expenses.
All these expenses can be claimed only when there is documented proof of this. To claim them as deductions against his taxable income, the entrepreneur must show them in his tax returns.
Given the unstructured operations of entrepreneurs working at a small or micro scale, the required proof may not be available. But that does not block them from reducing their tax liability.
There is a provision of something called Presumptive Income in the Income Tax Act. This, as the name suggests, presumes the income level of the entrepreneur.
Entrepreneurs with a gross receipt of less than 50 lakhs and a turnover of less than 2 crores can calculate their taxable income on a presumptive basis.
The income as per this approach is assumed to be 8% of the business turnover. In the case of professional practice, it is 50% of the fees received.
In fact, to promote digital transactions, the government reduces this rate from 8% to 6%.
This provision relieves entrepreneurs from the obligation of maintaining books of accounts and is optional for individuals. However, this does not let them claim any of the deductions mentioned above.
Contrary to the larger belief that salaried professionals suffer from extra tax liability, we would like to highlight here the troubles of entrepreneurship. Salaried professionals have a stable income, which undoubtedly grows over time. Business income, on the other hand, is less predictable.
This uncertainty may make individuals escape from the risk. But if they do that, the economy loses its contribution. These allowances by the Income Tax Department are simply a way to cushion their risks and give them the ability to execute their business.