Newly Set Up Business Under Previous Year: Navigating Income Tax in India

Starting a new business is an exciting venture, but understanding the nuances of Income Tax law is crucial for ensuring compliance and minimizing potential liabilities. This article provides a comprehensive overview of the income tax implications for businesses newly established during the "Previous Year" as defined under the Income Tax Act, 1961, focusing specifically on the Indian context.

Understanding Key Terms

Before diving into the specifics, let's clarify some fundamental terms:

• Previous Year: As per Section 3 of the Income Tax Act, 1961, the "Previous Year" is the financial year immediately preceding the Assessment Year. In India, the financial year runs from April 1st to March 31st. For instance, for the Assessment Year 2024-25, the Previous Year would be April 1, 2023, to March 31, 2024.

• Assessment Year: The "Assessment Year" is the year in which the income earned during the Previous Year is assessed and taxed. For example, if you earned income from April 1, 2023, to March 31, 2024 (Previous Year), that income would be assessed and taxed in the Assessment Year 2024-25.

• New Business: For income tax purposes, a "new business" is one that has been set up and has commenced its operations for the first time during the Previous Year.

• Income Tax Act, 1961: The primary legislation governing income tax in India.

Applicability to New Businesses

The Income Tax Act treats newly established businesses no differently than established ones, in terms of basic tax principles. However, certain aspects require special attention:

• Commencement of Business: Determining the exact date of commencement is critical, as expenses incurred before this date but relating to setting up the business are generally treated as capital expenditure. Expenses incurred after commencement are usually treated as revenue expenditure.

• Accounting Method: A new business needs to decide on its accounting method – cash or accrual. Under the cash method, income and expenses are recognized when cash is received or paid out. Under the accrual method, income and expenses are recognized when they are earned or incurred, regardless of when cash changes hands. Section 145 of the Income Tax Act, 1961, deals with the method of accounting to be followed by the assessee. Once a method is chosen, it should be consistently followed.

• Maintenance of Books of Accounts: Section 44AA of the Income Tax Act mandates the maintenance of books of accounts by certain businesses. The specific requirements depend on the nature of the business and its turnover. For example, if the gross receipts from business or profession exceed ₹ 1.20 lakhs or the income exceeds ₹ 12,000 in all the three preceding years, then the assessee has to maintain books of accounts. In case of individuals and Hindu Undivided Families (HUFs), the threshold is higher, being ₹ 2.5 lakhs and ₹ 25,000 respectively.

Key Income Tax Provisions for New Businesses

Several provisions of the Income Tax Act, 1961, are particularly relevant to newly established businesses:

• Taxable Income: The taxable income of a new business is calculated by deducting allowable expenses from the gross receipts or revenue.

• Allowable Expenses: Section 30 to 37 of the Income Tax Act specify the expenses that are allowable as deductions. These generally include:

  • Rent, rates, taxes, repairs, and insurance of premises (Section 30)
  • Repairs and insurance of machinery, plant, and furniture (Section 31)
  • Depreciation on assets (Section 32) – discussed in detail below
  • Investment allowance (if applicable and claimed)
  • Scientific research expenditure (Section 35)
  • Bad debts (Section 36(1)(vii))
  • Insurance premium for stock (Section 36(1)(i))
  • Interest on borrowed capital (subject to certain conditions)
  • Employee benefits (subject to certain conditions)

• Disallowable Expenses: Certain expenses are not allowed as deductions. Common examples include:

  • Personal expenses: Expenses of a personal nature are not deductible.
  • Capital expenditure: Expenditure incurred on acquiring fixed assets is treated as capital expenditure and is not deductible as an expense. However, depreciation on these assets is allowed.
  • Payments exceeding ₹10,000 in cash to a single person in a single day (Section 40A(3)): Such payments are disallowed to discourage cash transactions.
  • Tax payments: Income tax paid by the business is not deductible.
  • Expenses that are not wholly and exclusively for the purpose of the business: Expenses that are partly for personal use and partly for business use must be apportioned, and only the business portion is deductible.

• Depreciation (Section 32): This is a crucial allowance for new businesses investing in fixed assets. Depreciation allows a deduction for the wear and tear of assets used in the business.

  • Depreciation is allowed on tangible assets (buildings, machinery, plant, furniture) and intangible assets (know-how, patents, copyrights, trademarks, licenses).
  • The Income Tax Rules prescribe specific rates of depreciation for different classes of assets.
  • "Block of Assets" concept is used. Assets falling within the same class (e.g., computers) are grouped into a "block," and depreciation is calculated on the block's value.
  • For new businesses, claiming the correct depreciation amount is essential to reduce taxable income.

• Section 44AD: Presumptive Taxation Scheme: This scheme is designed for small businesses (with turnover not exceeding ₹ 2 crore) and professionals (with gross receipts not exceeding ₹ 50 lakhs), aiming to simplify tax compliance. Under this scheme:

  • The assessee declares income at a prescribed rate (generally 6% of total turnover or gross receipts received through digital means or account payee cheque/draft, otherwise 8%).
  • The assessee is not required to maintain detailed books of accounts (subject to certain conditions).
  • Once the assessee opts for Section 44AD, they are required to remain under the scheme for five years. If they opt out before five years, they are barred from opting in again for the next five years.
  • While advantageous for simplification, the scheme may not always result in the lowest tax liability, especially if actual profits are lower than the presumptive income.

• Section 44ADA: Presumptive Taxation for Professionals: This section provides a similar presumptive taxation scheme specifically for specified professions (like lawyers, doctors, architects, engineers, etc.). The income is presumed to be 50% of the gross receipts. The gross receipt should not exceed Rs. 50 Lakhs.

• Section 44AB: Tax Audit: If the turnover of a business exceeds ₹ 1 crore (or ₹ 10 crore if certain conditions related to digital transactions are met), a tax audit is mandatory under Section 44AB. This involves getting the books of accounts audited by a Chartered Accountant. The audit report is submitted electronically to the Income Tax Department. For professionals, the tax audit threshold is ₹ 50 lakhs.

• Carry Forward and Set Off of Losses (Sections 70-80): If a new business incurs losses in the initial years, these losses can be carried forward and set off against profits in subsequent years, subject to certain conditions. This helps in reducing the overall tax burden over time. For instance, business losses can be carried forward for eight assessment years immediately succeeding the assessment year in which the loss was first computed.

Specific Considerations for New Businesses

• Start-up India Scheme: If the new business qualifies as a "start-up" under the Startup India initiative, it may be eligible for certain tax benefits, including:

  • Tax Holiday: Section 80-IAC provides a tax holiday for eligible start-ups. This allows a deduction of 100% of profits and gains derived from eligible business for three consecutive assessment years out of ten years from the date of incorporation. However, certain conditions need to be fulfilled to claim this benefit.

• GST Registration: While not directly related to Income Tax, GST (Goods and Services Tax) registration is a separate legal requirement. If the aggregate turnover exceeds ₹ 20 lakhs (₹ 10 lakhs for certain special category states), GST registration is mandatory. Proper accounting and compliance with GST regulations are essential.

• PAN and TAN: Every business needs to obtain a Permanent Account Number (PAN) for income tax purposes. If the business is required to deduct tax at source (TDS), it also needs to obtain a Tax Deduction and Collection Account Number (TAN).

Important Points to Remember

• Maintain Accurate Records: Meticulous record-keeping is essential. This includes maintaining accurate books of accounts, receipts, invoices, and other supporting documents. This will facilitate tax compliance and help in defending your tax position in case of scrutiny.

• Seek Professional Advice: Given the complexities of income tax law, it's advisable to consult with a qualified Chartered Accountant or tax professional. They can provide tailored advice based on your specific business circumstances and help you navigate the tax regulations effectively.

• File Returns on Time: File your income tax returns before the due date. Late filing can attract penalties and interest.

• Stay Updated: Income tax laws and regulations are subject to change. Stay updated on the latest amendments and notifications to ensure compliance. Keep checking the official website of the Income Tax Department.

Conclusion

Navigating income tax for a newly established business requires careful planning and attention to detail. By understanding the relevant provisions of the Income Tax Act, maintaining accurate records, and seeking professional advice, you can ensure compliance, minimize your tax liabilities, and focus on growing your business successfully. Remember that this article provides general information and should not be considered legal advice. Always consult with a qualified professional for specific guidance tailored to your business.