Planning a Start Up? Along with key revenue generators, think about the key taxation elements involved as well, else a large tax bill could eat into your bottom line figures, writes Aashish Ramchand, from Makemyreturns.
Aashish is a Chartered Accountant by qualification and the Co- founder of makemyreturns.com, an online tax advisory and filing site. He is very passionate about Indian taxes and loves to write articles about the Indian tax system. He has worked with KPMG and JRC advisory both in international and domestic taxation respectively. His cumulative experience in taxation is 5 years. He has also completed level 1 of CFA (USA) exam.
The 5 key matters are:
1. Service Tax and Input Credit
If you are a service provider, you most likely have to charge Service Tax on the services that you offer to your customers. This service tax has to be collected and paid to the tax authorities every month and a return has to be filed every quarter. Now suppose you pay service tax to one of your suppliers or service providers (For Example the service tax that you pay on your telephone bill, or the service tax that is paid when you pay your advertising agency). This Service tax paid can essentially be used as an input credit to the tax that you collect from your customers, thereby reducing the tax bill by the amount of service tax that you paid to your suppliers.
2. TDS and TAN Number
As a startup, you are bound to have several initial expenses. Do keep in mind that any payment over Rs. 20000 for professional fees or any salary payment to your employees (who earn over the basic tax limit annually) should be made only after deducting the appropriate Tax Deducted at Source (TDS). This tax that you deduct has to be deposited with the Income Tax Department by the 7th of the calendar month, which comes after the month in which you have deducted this TDS. Further, you have to apply for a TAN (Tax Deduction Account Number), which you have to use when you make the deducted tax payment to the IT Department. Do remember, if you fail to deduct TDS on an eligible payment, that expense may be disallowed by the IT Department.
3. Funding through an Angel Investor
As on 1st April 2012, the Government of India introduced a new clause in Section 56 (2) of the Indian Income Tax Act. This act primarily says that if any resident person who purchases equity shares of an Indian company for a price that exceeds the fair market value of those shares, then the excess amount will be taxed by the income tax department as “Income from other sources”. Therefore in the case of start-ups who receive funding from an angel investor or family and friends for a stake in their company, usually receive funding for an amount that exceeds the market value of the equity shares. This poses a large problem for such entrepreneurs as this excess amount is then taxed by the Income Tax department. Though, a possible loophole to this provision is that if the company receives funding from a Venture Capital Company or Fund, then this excess is not taxed. Another possible exclusion to this provision could be that a Non Resident Individual could possibly invest in your company without the need to pay taxes on the excess amount as the rule only applies to “Residents”.
4. Deducting Profession Tax on Salaries Paid
Another regulation that most employers have to keep in mind when paying salaries to your employees. A profession tax has to be deducted based on the salary that you pay an employee. Salaries paid upto Rs. 5000 per month do not attract any profession tax. Salaries between Rs. 5001 and Rs. 10000 Per month attract a profession tax of Rs. 175 and Salaries over Rs. 10001 attract profession tax of Rs. 200. Do not forget to have these deducted from the salaries that you pay as the penalties and legal proceedings that follow can be quite cumbersome.
5. Company Structure and taxation
A Startup has three possible company formations:
- A Proprietorship: Easy to Incorporate. The individual (in this case the entrepreneur himself) is the company. You simply need to think of a name of a company and open a bank account using your own individual PAN Card. Taxed as a Business Income of an Individual. Basic Exemption limits of the individual apply.
- A Partnership: Easy to incorporate. Need to execute a partnership deed mentioning names and holdings of the partners. The company has a separate identity and is taxed at Corporate Tax Rates. This form of a company has unlimited liability and the assets of the partners can be attached in case of bankruptcy.
- A Private Limited Company: Harder to incorporate. Need to fulfill several regulatory requirements from the Ministry of Corporate Affairs (MCA) before receiving approval for company formation. Once approved, the MCA issues an Incorporation certificate, which forms a part of the company identity. The company is taxed at corporate rates. The company has limited liability, so in case in bankruptcy, only the company assets are attached.