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Should you incorporate a company?
One of the first questions you encounter when you begin your business is whether you should form a company. As such there is no legal rule that a ‘company’ must be formed to start a business. Incorporating a company has its own pros and cons. But so long as you are solo and your work is well managed, i.e. you act as a sole proprietor to your business, there is no mandate to form a company. By forming a company, your compliance work will increase. If your business is growing large and unmanageable, it helps to separate it into a separate legal entity which will have its own PAN and will file a separate tax return.
In case you choose to continue business as a freelancer, this does not require any formalities. You can continue to receive money to your existing savings bank account. And your income tax return will include income from your business or profession and you won’t need to file a separate income tax return.
Clients based in India are bound by local laws to deduct TDS from the payments they make to you. You can take credit of this TDS against your total tax liability. If excess TDS has been deducted you can claim a tax refund or pay if there are any additional dues. TDS deductions are linked to your PAN. Remember to provide PAN to all your clients. This is important since the tax department allows TDS credit which appears in your Form 26AS. Usually TDS for freelancers is deducted @10%. The deductor also provides you a Form 16A, which is basically a proof that TDS has been deducted from your income and deposited by him to the government.
If you work for clients out of India, payments may be received by you via paypal or as a direct credit to your bank account. Usually these payments are without TDS. In some countries, TDS may be deducted as per local laws. Don’t worry, you can still take credit of this paymentwith the help of the DTAAs (Double Tax Avoidance Agreements) which India has entered into with several countries With the DTAAs, your income is not doubly taxed. If no TDS has been deducted, there is nothing to worry. You need to include these receipts in your total income while making income calculations and pay applicable tax on them since you will be a tax resident of India. To meet advance tax requirements you may have to estimate your annual income from all sources.
Raising invoices, paying advance tax, filing an ITR-4 will soon be important part of your freelancing life. But that’s the only downside to being your own boss:
- Maintain a folder on Google Drive to store all your bank statements and receipts.
- Create an account on the Department website to download your tax credit statement. This will help you keep a tab on how much TDS your clients are deducting and how much taxes you need to pay.
Stay on track with a calendar
- Categorize your expenses and tag them as business or personal
Add this schedule to your Google calendar and be reminded of all the due dates and deadlines.
Hiring subcontractors and employees
During your time freelancing, you may have to take in some contractors.
Things to note:
- The salaries you pay your contractors is tax-deductible for you. You can claim such salaries paid as business expense in your tax return. Be sure to have proper agreements in place.
- When you hire subcontractors, you must deduct TDS under Section 194C before making a payment to them. You must also issue a Form 16A at the end of the year.
Read the ClearTDS guide on Section 194C
Calculating your freelancing income
Your income is the sum of receipts from the work you do for your clients. Your clients may be based in India or outside of India. You can use your bank account statements to add up all the receipts that have been credited to your account by clients.
You can deduct expenses that you have incurred directly to earn your freelancing income. These could be your phone bills, internet bills, travelling expense, conveyance, etc.
The remainder of the income after expenses is subject to income tax.
Calculating and paying tax
How to calculate and pay advance tax?
If you’re self employed, you’re going to have to periodically estimate your income and see if you have to pay advance tax. Advance tax has to be paid quarterly – once in June, September, December and March if your total income tax liability (after TDS already deducted on your income) exceeds Rs.10,000.
The deadlines are as under:
|Due Date||Advance Tax Payable|
|On or before 15th June||15% of advance tax|
|On or before 15th September||45% of advance tax|
|On or before 15th December||75% of advance tax|
|On or before 15th March||100% of advance tax|
To calculate your advance tax:
- Add up all the invoices received from April 1 and include future payments you will be receiving till March 31 to estimate your taxable income.
- Deduct expenses directly related to your business and any investments you have made under Section 80C, 80D, 80G etc.
- Use the ClearTax calculator to find out your tax liability. If it exceeds Rs.10,000, then pay the prescribed % of advance tax before the deadline.
If you’ve been collecting service tax or VAT as a freelancer or business, then you must start collecting GST effective from July 1, 2017. Migrate to GST now.
If you are not currently collecting service tax or VAT today, but expect to have a turnover of more than Rs.20 lakhs in FY 2016-17, then you must register for GST.
Under 194J of the Income Tax Act, a 10% TDS must be deducted on all payments for professional and sub-contracting services. So, if you employ sub-contractors or hire employees under you, then you must also deduct TDS before making payments.
When to deduct TDS?
- If the payment you make to others exceed Rs.30,000, then you must deduct 10% TDS before making the payment. In case, PAN is not provided then TDS @ 20% needs to be deducted.
- But one exception to this rule is that you must deduct TDS only if your books have been audited for the purpose of income tax in the previous financial year. The threshold to get books audited is Rs.50 lakhs if you are a professional and is Rs 1 crore if you are carrying on a businessSo if you are not liable to get your books audited, and your payments exceed Rs.30,000, then you don’t have to deduct TDS.
Tax savings for freelancers
Claiming business-related expenses is the single biggest way for freelancers to save taxes. Keep these bills carefully. In addition, just like a salaried individual, you can claim all the deductions under Section 80. If you have a PPF account, or have made investments in ELSS or purchased a LIC policy, you can claim deductions under Section 80C. Note that the maximum deduction allowed under this section is Rs.1,50,000.
If you have a medical insurance then you can claim its premium upto Rs. 25,000 for you, your spouse and children and upto Rs. 30,000 for your senior citizen parents under section 80D. However, there has been a proposal in Budget 2018 to raise the limit for senior citizens to Rs 50,000
If you have made any donation then you can claim the same under section 80G.
For a full list, see Deductions under Section 80.
What does presumptive taxation mean?
The Income Tax Department mandates that anybody earning income from business and profession must maintain books of account and get their books audited if they earn beyond Rs. 1 crore (for business) or Rs. 50 lakhs (for profession). To offer relief to small taxpayers, the presumptive income tax scheme was introduced. In this, instead of claiming businesses expenses against receipts and then paying tax on the balance, a certain percentage of your receipts is taken as your net income and you’ll pay tax on that income.
This cuts down all the effort of having to maintain profit and loss statements and estimating taxes over and over again.
If you opt for presumptive taxation, you must file an ITR-4S for five years straight.
Section 44AD: Presumptive taxation for business at 8%
Who can opt for the presumptive taxation under Section 44AD?
- Any business which has a turnover of less than Rs.2 crore and professionals not covered under Section 44ADA can opt to be taxed presumptively. This excludes life insurance agents, people earning commission of any kind or running business of plying, hiring or leasing goods carriages.
What are the benefits of presumptive taxation?
- In the presumptive taxation under Section 44AD, your net income is considered as 8% of your turnover and you will pay tax on that income.
- You can file your tax return in ITR-4S a much shorter and simpler form than ITR-4.
- If your receipts are in digital (non-cash) form then only 6% of your receipts is your net income and you will pay tax on that income. (applicable from FY 2016-17)
- You don’t have to maintain accounting records
- You don’t have to get your accounting records audited
- You have to pay advance tax – but instead of estimating income and paying tax each quarter, you can pay all your income tax before March 31. (From FY 2016-17, advance tax is to be paid by 15th March of the relevant financial year if you expect that your income tax liability will exceed Rs.10,000 in the financial year)
Section 44ADA: Presumptive taxation for professionals at 50%
Presumptive taxation under Section 44AD, which was only available to businesses, has now been extended to include professionals effective from FY 2016-17. This is covered under Section 44ADA.
Who can opt for the presumptive taxation under Section 44ADA?
Professional with receipts of Rs.50 lakhs or less can opt for this scheme. This also covers freelancers who do technical assignments such as website design or software development.
What are the benefits of presumptive taxation?
- In the presumptive taxation under Section 44ADA, 50% of your receipts is taken as expenses, and your business income is considered to be the remainder.
- You’ll pay tax on this income and file your tax return.
As a result, this means that:
- No books of account have to be maintained.
- No expenses can be claimed since your business income is automatically taken as 50% of your receipts.
- You’ll be filing a shorter tax return – the ITR4S.
- You’ll have to continue paying advance tax though, if you expect that your income tax liability will exceed Rs.10,000 in the financial year.
Filing tax returns
If you are an individual earning income from business and profession, you may have to file an ITR-4 or ITR-4S. ITR-4 is the longer income tax form which require additional disclosures in the form of balance sheet, profit and loss statement etc.
ITR-4S is the shorter income tax form where no such annexures are needed.
ITR4 vs. ITR4S
You’ll have to file an ITR-4 when:
- You have an income from profession or proprietary business.
- This includes F&O traders, life insurance agents, other commission agents too.
You’ll file an ITR-4S when:
- You’ve opted for presumptive taxation under Section 44AD/Section 44ADA/Section 44AE.
The Indian income tax law runs into hundreds of pages. There is no good reason for you to spend precious time finding your way through it. Here’s a little glossary to help you master some basic tax terms which can be very handy while filing your tax returns.
Books of accounts
Books of accounts means a record of all income, expenses, assets and liabilities of your business. These financial records are essential for understanding the performance of your business. These may be compulsorily required in some cases.
Income from all the five heads is summed up and is called gross total income. From this gross total income, deductions can be claimed. These deductions reduce your total tax outgo since they lower your gross total income. Investments such as PPF, NSC or certain expense like life insurance premium, interest on education loan, medical insurance are allowed as deduction from your gross total income.
When you purchase a capital asset, the benefit of such an asset is usually expected to last more than a year, such assets are ‘capitalized’ and not charged to expenses when they are bought. Every year a small portion of its cost is expensed and is allowed to be reduced from your income. This expense which is charged every year is called depreciation.
Tax Deduction at Source (TDS)
Persons responsible for making payments have to deduct tax before making payment. The tax department wants payers to deduct tax beforehand and deposit it instead of waiting for you (the recipient) to make the tax payment yourself. The recipient of income receives the net amount (after deduction of tax at source). The recipient adds the gross amount to his income. TDS is adjusted against final tax due, since it is tax already deposited on the recipient’s behalf. TDS ensures steady flow of taxes for the government.
Advance tax means income tax should be paid in advance instead of lump sum payment at year end. It is also known as ‘pay as you earn’ tax. These payments have to be made in installments as per due dates provided by the income tax department.
Form 26AS has all tax related information of your PAN. It shows how much tax has been received by the government against your PAN. It includes TDS, tax directly deposited by you, refunds made to you etc. You can understand how to view and download your Form 26AS
Other tax obligations
Tax audit is a review of your financial records by a Chartered Accountant.
Your books must be audited if:
- you are a professional earning gross receipts exceeding Rs.50 lakhs
- or a business owner with an annual revenue of over Rs.2 crores
- or you have opted for presumptive taxation, you declare your income below the prescribed percentage but your total income exceeds the basic exemption limit of Rs. 250,000.
While filing the audit report, both the CAs signature as well as yours need to be included. For this, you must get a digital signature. Digital signature certificate come with validity of one/two years.
Defective return notice under 139(9) for freelancers
When you file an income tax return using the ITR-4 Form, and you have ticked against “Are you liable to maintain accounts under section 44AA” but have failed to provide full details in P & L and Balance Sheet sections in the return, your return would be treated to be defective under Section 139(9)
List of deductible and nondeductible expenses
- Telephone and internet bills
- Rent for individual or shared office space
- Work-related meal and travel expenses
- Advertising, promotional and printing expenses
- Depreciation on assets such as laptops or computers. See Income Tax Department’s list of depreciation rates.
- Income tax return filing fees paid to private platforms like ClearTax
- Travelling expenses for professional work
- Conveyance expenses
Frequently Asked Questions
- When do I need a CA?
- You’re definitely going to need a CA if you need to get your books audited. A certified CA has to go over your books and submit an audit report in the tax return.
- You can also get a CA to manage your books of accounts and help you claim tax-deductible expenses. Tip: the cost to hire a CA is tax-deductible too.
- Is there a software I can use to file my tax return?
Yes, you can file ITR-4 and ITR-4S on ClearTax.
- Can professional file under ITR-4S?
Starting from FY 2016-17, professional can opt for presumptive taxation and therefore, can file ITR-4S. Under Section 44ADA for presumptive taxation for professionals, your professional income is considered as 50% of your total receipts and you will need to pay tax on that income. You can claim section 80 deductions as well.