Tax Matters of Self Employed

June 13 , 2013

Being self-employed has the great advantage of deducting expenses for running the business while computing income tax liability.

e-filing of taxes

It is mandatory for every individual whose total income exceeds Rs 5 lakhs to file income tax returns. Those whose income exceeds Rs 10 lakhs must mandatorily file it online. Different forms are applicable for different assessees depending on their sources of income. The form applicable for a self employed individual for tax e-filing is ITR-4 for income from proprietary business/profession, which can be downloaded from the website of the Directorate of Income Tax.

Permissible deductions

  • Rent, rates, taxes, repairs and insurance of premises utilized for the profession.
  • Repairs, depreciation and insurance of machinery, plant and furniture utilized for the profession.
  • Expenditure in respect of scientific research, like in-house research, contribution to an approved university, college, or association, etc.
  • Premium in respect of insurance against risk of damage or destruction of stock and stores used for profession.
  • Premium in respect of health insurance of the employees.
  • Bonus and commission to employees.
  • Interest on capital borrowed for profession.
  • Contribution to a recognized provident fund or an approved gratuity fund.
  • Bad debts related to the profession. - Bad debts have to be written off as 'unable to recover' in the books by the assessee in the previous year.
  • Banking cash transaction tax, securities transaction tax and commodities transaction tax are allowed as deductions.
  • Any expenditure (not capital and personal) incurred wholly and exclusively for the profession and within the legal rules.

Expenses not allowed as deduction

  • Expenditure on advertisement in any souvenir, etc. of a political party.
  • Any interest, salary, royalty, fees for technical services or other sum payable outside India from which TDS as not been deducted.
  • Any tax calculated on the basis of profits or gains of profession, e.g. income tax, wealth tax.
  • Expenses exceeding Rs 20,000, e.g.: X pays Rs 6,000 Rs 20,000 and Rs 20,500 by account payee cheques. Hence, it is best to pay amounts exceeding Rs 20,000 by cheque.

Book-keeping requirements                              

If the gross receipts are less that Rs 1.50 lakh (Rs 150,000), the assessee has to maintain his accounts which enables the Income Tax official to compute the taxable Income. If the gross receipts exceed Rs 1.50 lakh, the assessee has to maintain books of accounting like the cash book, journal, ledger, copies of bills exceeding Rs 25. Accounts should be maintained either on mercantile basis or cash basis.

In case of professional income, accounts have to be audited if gross receipts exceed Rs 10 lakh (Rs 1 million). This audit report should be submitted along with the income tax return, before September 30.

Advance tax

Since a professional earns his own income, there is no TDS. Hence, he is liable to pay advance tax as he earns income. Thus, advance tax is payable on the basis of estimated income of the current financial year. Advance tax is payable only in cases where tax payable is in excess of Rs 5,000.

Advance tax can be paid in the following schedule.

  • 30% on or before September 15
  • 30% on or before December 15
  • Remaining 40% on or before March 15

If there was shortfall in earlier installment, it should be made up in subsequent installment.

Due dates for filing returns

Assessee having income from profession but who do not have to get the accounts audited under Income Tax or any other law has to file returns by 31st July. Assessee who gets his accounts audited has to file returns by September 30.

Tips for being tax-efficient

To avoid tax-time surprises, periodically review your taxes throughout the year. Don't forget to make necessary quarterly tax payments to avoid under-withholding penalties. Complete all of your paperwork on-time, particularly if you are billing clients or customers. Many companies will take several weeks to process invoices. Keep copies of all receipts for tax time.

Under the tax laws, the income of a self-employed person (freelance writer/journalist, independent consultant, and businessman, professional) would fall under the head of income from business or profession. 

A self-employed person can have income that is more tax efficient by at least 15% as against similar salary income.

1. Business expenses

All expenses related to the business can be claimed as business expenses. Vouchers/bills would be required to support expenses and hence book keeping is important for this category. Other expenses including rent or home office expense, travel costs, communication costs (telephone, internet), business meetings, supplies and utilities can be claimed as expenses. For being deductible, expenses must be both ordinary (common and accepted) and necessary (appropriate and helpful) in your work/business. If such expenses are incurred partly for work purposes and partly for personal purposes, you can deduct only the work related expense.

If the business/ work employs assets like laptops/computers, furniture, UPS and vehicles, depreciation can be claimed on them. Make it a point to maintain bills of capital expenditures. Bad business debts may also be written off. Business losses can be carried forward for 8 years.

2. Avail usual deductions

Section 80C allows investments in PPF (Public Provident Fund), insurance /unit linked insurance plans, pension plans, ELSS (equity linked savings scheme), NSC (National Savings Certificate), infrastructure bonds, FDs (fixed deposits) apart from home loan principal repayment.

Tuition fees for your child's education can also be claimed. The overall limit of this section is Rs 1 lakh. Section 80D provides deduction for medical insurance premiums of oneself and family up to Rs 15,000. An additional Rs 15,000 can be claimed towards medical premiums of parents. If you are staying in a rented home you can claim the rent paid as deduction u/s 80GG, up to Rs 24,000, based on certain conditions. If you buy a house, you can claim a deduction of up to Rs 1.5 lakh on interest paid.

3. Insurance benefits

Avail a family floater policy with reasonable cover to protect your family from any major medical costs that might arise. The premiums paid towards life and health policies will provide for tax breaks u/s 80C and 80D. It is important to have appropriate life insurance cover to offer protection for family, especially since there would be no benefits from the company (if one were salaried) that would have accumulated. 

4. Distribute your income

If you have family members who can help in various aspects of your business, it makes sense to employ them (legitimately) and offer an appropriate remuneration. By hiring a family member to work, you will effectively shift a part of your income to your relative.

Your business can take a deduction for reasonable compensation paid to an employee, which in turn reduces the amount of taxable business income that flows through to you. One can also form a Hindu Undivided Family (HUF) as a separate entity, which helps to further distribute income to this entity as well.

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