Budget 2023: Income tax changes that professionals, small businesses want

India has one of the largest startup ecosystems in the world and is expected to witness massive growth in the coming years. Further, India is becoming one of the most preferred destinations for businesses to invest considering its resilience and continued growth momentum despite global slowdown and recessionary pressures. As per data from the Ministry of Micro, Small & Medium Enterprises (MSMEs), as of November 25, 2022, the Udyam Registration portal has registered 12,201,448 MSMEs, which comprises of micro-enterprises at 11,735,117 (96.17% app.), followed by small enterprises at 426,864 (3.49% app.) and midsized enterprises at 39,467 (0.32% app.). Notably, India has a significant number of MSMEs, which also play a pivotal role in  economic growth.

Thus, to further boost small and medium businesses in India, the government should consider rationalising certain income tax provisions for small business and professionals in Budget 2023.

  1. Increasing the monetary limit for presumptive taxation and extending the benefit to LLPs – Section 44AD:

Section 44AD of the Income Tax Act, 1961  is a special provision for computing profits and gains of business on presumptive basis. As per the prevailing provisions, an eligible taxpayer engaged in an eligible business (specified under the section) can directly treat 8% of the Gross Receipts/Sales/Total Turnover as business income. However, in case  the gross receipts or total turnover pertaining to the relevant financial year is received by specified modes such as an account payee cheque, account payee bank draft, ECS or through such other electronic mode (i.e. specified modes other than cash, bearer cheque, etc.) , then such presumptive rate would be further reduced to 6% in respect of such turnover.   

The limit for presumptive taxation was last increased in Budget 2016 from Rs 1 crore to Rs 2 crore. Therefore, to accommodate for  growth in  economic activity and the volume of business since then, it is suggested that the ceiling may be increased to Rs. 5 crore.

Further, the said section explicitly provides that Limited Liability Partnerships’ (LLPs’) cannot take benefit under this section. In our opinion, many small businesses in India are incorporated as LLPs and are unnecessarily deprived from availing the benefit of presumptive tax rates. Hence, it is suggested that the benefit of section 44AD may also be extended to LLPs in cases where the sales  does not cross the specified limit.

  1. Rationalising certain provisions of section 44ADA applicable for professionals:

Section 44ADA contains presumptive tax provisions for professionals engaged in legal, medical, engineering or architectural profession or the profession of accountancy or technical consultancy or interior decoration or any other profession as  notified by the CBDT. Further, the benefit under this section is only for those professionals whose respective total gross receipts/total sales do not exceed Rs 50 lakh in a particular financial year. Eligible professionals can treat 50% of the total gross receipts as business income.[SL1] 

In order to encourage and extend benefit to  small and medium professionals, it is recommended to appropriately increase the threshold limit of Rs 50 lakh  to at least Rs 1 crore. This will help  bring more professionals within the ambit of this section and would be a move towards ease of doing business.

Further, due to the increasing  cost of rendering services by professionals, treating 50% of the gross receipts as income may ultimately prove to be unfavorable for professionals with small businesses. This high rate may lead to  a lot of professionals not  opting for this scheme thereby defeating the ultimate objective behind this provision. Hence, it is also suggested that the presumptive rate of income at 50% of the total gross receipts may be reduced appropriately, say to 30%.

  1. To address issue of non-grant of full TDS credit appearing in Form 26AS

As per the existing income tax return (ITR) processing mechanism, small businesses and professionals  are not granted full TDS credit appearing in Form 26AS in cases where the income offered in the ITR form (as per books) is lower than that  reflecting in Form 26AS.

It is important to note that the receipts as appearing in Form 26AS may be pertaining to income already offered to tax in preceding financial years or may be receipt of advance income and appearing in current year’s Form 26AS due to difference in method of accounting followed by the deductor and the taxpayer.

The result is non-grant of TDS credit to the taxpayer either in the preceding financial year in which income has been offered (as TDS credit does not appear in Form 26AS for that financial year) or in the subsequent year in which it is appearing in Form 26AS (as the income as per books is lower than gross receipts appearing in Form 26AS), resulting in loss of TDS credit to the taxpayer.

Therefore, in such cases, it is recommended to modify the ITR processing mechanism procedure and ensure TDS Credit be allowed in the year in which it is appearing in Form 26AS even if gross receipts as per Form 26AS are higher than income as offered in the ITR..

  1. Enhancing the threshold limit of TDS u/s 194J and extending the same to directors

Budget 2012 amended the provisions of section 194J of the Income-tax Act. This section requires tax to be deducted at source  at 10% on any remuneration or fees or commission, by whatever name called, paid to a director of a company. This excludes salary payment on which tax is deductible at source under section 192. However, if the payment is made for royalty, fee for technical services, fee for professional services and non-compete fees then the obligation to deduct TDS arises only if the said payment exceeds Rs 30,000, independently.

In our view, this unintended disparity between payment to directors and other payments should be rationalized and the independent limit of Rs 30,000 should also be extended for payments to directors. Also, small business and professionals are unnecessarily burdened with TDS compliances because of the low threshold limit and thus, the said limit must be revised upward to Rs 50,000 so as to exclude small business enterprises from its scope.

  1. Reduction in income tax rate for Partnership Firms and LLPs with small businesses

Professionals and small businesses are often incorporated as partnership firms or LLPs as compared to corporates due to ease of formation, low cost of operation, reduced compliance burden and many such factors. As per the present law, partnership firms and LLPs are taxed at flat 30% (plus applicable surcharge and cess). However, those businesses set up and operating as private limited companies are given the benefit of reduced effective tax rates such as 25.17% or 17.16%, subject to fulfillment of certain conditions.

A significant class of small and medium businesses operate either as partnership firms or LLPs and they pay tax at a much higher rate and moreover, they do not have any option to pay tax at a concessional rate.   Thus, in order to promote entrepreneurship, to encourage more business entities in India and to reach the milestone of USD 5 trillion economy by 2025, there is a need to reduce the tax rates for partnership firms and LLPs or introduce a concessional regime for partnership firms and LLPs having turnover up to a certain limit so as to bring them at par with the corporates. 

  1. Rationalisation of TDS rates for start-ups, small businesses

Certain sections provide a nominal TDS rate(for instance, Section 194C – applicable for contracts imposes a TDS rate @ 1%/2% depending upon the nature of tax deductee whereas 194H- applicable for commissions imposes a TDS rate of 5%) whereas the TDS rates in certain other sections (Section 194J – applicable for Professional Services and Section 194-I – applicable for TDS on rent of land & building) may go up to 10%.

Subjecting small businesses and start-ups to withholding requirements imposes restriction on their liquidity which is a vital factor for functioning of the business operations and creates working capital issues. Thus, it is recommended that  the TDS rates will be rationalized and reduced  from 10% to 5% under section 194J and 194I.