Important Keyword: Income from House Property, Income Source, Section 80C, Section 80EE.
Table of Contents
Income from House Property and Taxes
India has experienced sustained and rapid growth over the past few decades, with aspirations to achieve developed nation status by its 100th year of Independence. In this journey towards progress, income from house property plays a significant role as a major source of passive income for many individuals. Rental income derived from properties, whether it’s a building or land attached to it, is subject to taxation under the head “Income from House Property.”
This taxation framework ensures that income generated from real estate assets contributes to the country’s economic growth and development. By taxing rental income, the government generates revenue to fund essential services and infrastructure projects, furthering the nation’s progress towards its vision of becoming a developed and prosperous society.
What is House Property?
House property encompasses a diverse range of real estate assets, including buildings and the land attached to them. This broad definition encompasses various types of properties, such as apartments, independent houses, shops, offices, warehouses, factories, and any other building or land that generates rental income. It’s important to note that the term “house property” isn’t limited to residential houses; it also includes commercial buildings.
This comprehensive classification highlights the inclusive nature of the term, covering both residential and commercial properties. Whether it’s a cozy home, a bustling office space, or a bustling retail outlet, any structure or land that generates rental income falls under the purview of house property. This wide-ranging definition ensures that all types of real estate assets are appropriately accounted for under the tax framework, reflecting the diverse nature of property ownership and rental income generation in India.
Income from house property is subject to taxation under specific conditions:
Ownership: The individual assessed must be the rightful owner of the property to be liable for taxation under the head “Income from House Property.” Ownership entails possessing legal title and the ability to exercise control over the property.
Non-Business Use: The property must be utilized for purposes other than conducting a business or profession. If the property is utilized for the owner’s business or profession, the income generated will be taxed under the head “Income from Business and Profession.”
Taxation Under Legal Owner: Income from house property will be taxable under the jurisdiction of the legal owner of the property. The legal owner is defined as the individual who holds the rights of ownership independently, without acting on behalf of another party.
Types of House Property under Income Tax
For tax purposes, the Income Tax Act categorizes house property into two types:
Self-Occupied House Property:
A self-occupied house property is one that is used for the owner’s own residence purposes. It may also be occupied by the owner’s family, relatives, or the owner themselves. If a property remains unoccupied, it is still considered a self-occupied property for income tax purposes.
If a taxpayer owns more than one house property, only one is treated as self-occupied for tax purposes, and the rest are assumed to be deemed let out. However, starting from the financial year 2019-2020, two properties can be considered as self-occupied. Taxpayers have the option to choose which property they want to designate as self-occupied.
Let-Out House Property:
Any house property that is rented out for all or part of the year is considered a let-out property for income tax purposes.
How to Calculate Income From House Property?
Calculation of Income from House Property:
For a self-occupied property used solely for residence or unoccupied throughout the previous year, its Annual Value is considered Nil, provided no other benefits are derived by the owner from such property.
When a property is let out for the whole or part of the financial year, the Gross Annual Value (GAV) is calculated as the higher of two factors:
a) Expected Rent (ER): This refers to the rent that the property is expected to fetch if it were let out at its full potential. It is determined based on factors such as the market rate for similar properties in the locality, the size and condition of the property, and other relevant market trends.
b) Actual rent received or receivable during the year: This is the rent actually received by the owner from the tenant(s) during the financial year. If the full rent has not been received due to any reason, the amount that is due and receivable is also considered.
The Gross Annual Value (GAV) is determined by taking the higher of these two values, ensuring that the income from the property is accurately assessed for taxation purposes.
Particulars
Self Occupied Property
Let Out Property
Gross Annual Value (GAV)
NIL
XXX
Less: Municipal Tax Paid
NIL
(XXX)
Net Annual Value (NAV)
NIL
XXX
Less: Standard Deduction u/s 24 @ 30% of NAV
NA
(XXX)
Less: Interest on Borrowed Capital u/s 24
(XXX)
(XXX)
House Property Income
XXX
XXX
In the case of a self-occupied property, the deduction for interest on a home loan is subject to a maximum limit of INR 2,00,000 under section 24 of the Income Tax Act. This means that regardless of the actual interest paid on the home loan, the maximum deduction allowed for interest is capped at INR 2,00,000 for self-occupied properties.
However, in the case of a let-out property, the entire amount of interest paid on the home loan can be claimed as a deduction without any upper limit. This means that the taxpayer can claim the full amount of interest paid on the home loan as a deduction from the rental income generated from the let-out property.
Deduction from House Property Income
Deduction for Home Loan Interest under Section 24
For a self-occupied house property, the owner can claim a deduction of up to INR 2 lakhs (INR 1,50,000 for e-filing FY 2013-14) on home loan interest. However, in the case of a let-out property, the entire interest paid on the home loan is allowed as a deduction.
The deduction for home loan interest is subject to certain conditions. If any of these conditions are not met, the deduction is restricted to INR 30,000. These conditions include:
The loan must have been taken on or after 1st April 1999.
The home loan must have been taken for the purchase or construction of a new property.
The acquisition or construction must be completed within 5 years from the end of the financial year in which the loan was taken.
Additionally, if the loan is taken for repairs or reconstruction of the property, the deduction for interest is limited to a maximum of INR 30,000. Pre-construction period interest paid can be claimed as a deduction in five equal installments starting from the year in which the construction of the property is completed.
Deduction for principal repayment of the home loan under Section 80C is also available, up to a maximum of INR 1,50,000, subject to certain conditions:
The loan must be taken for the purchase or construction of a new property.
The property must not be sold within five years of taking possession, otherwise, the deductions for repayment collected will be added back to the income in the year of sale.
Stamp duty, registration charges, and other transfer-related expenses are also deductible under section 80C, subject to a maximum limit of INR 1,50,000. These deductions are allowed in the year in which they are paid.
Deduction for first time Home buyers under Section 80EE
The first home loan from a bank or housing finance corporation, up to INR 25 lakhs, is eligible for an additional deduction of interest up to INR 1 lakh. To claim this deduction, the following conditions must be fulfilled:
The loan sanction must have been between 1st April 2013 to 31st March 2014.
The home loan amount does not exceed INR 25 lakhs.
The value of the house property does not exceed INR 40 lakhs.
The assesses does not own any other residential house property on the date of sanction of the loan.
The benefit of the deduction spans over FY 2013-14 and FY 2014-15. If the total limit of INR 1,00,000 is not utilized in FY 2013-14, the balance amount can be claimed as a deduction in FY 2014-15.
It is not necessary that the residential house property has to be self-occupied to claim this deduction.
Under Section 80EEA, the deductible amount for first-time homebuyers has been extended from INR 50,000 to INR 1,50,000. Only individuals can claim this deduction until they repay their home loan.
In the new income tax regime, individuals cannot claim home loan interest on self-occupied house property under Section 24(b). However, they can claim interest on home loans for let-out property only up to the amount of their rental income.
Chapter VI deductions, including deductions under 80C, 80EE, and 80EEA, are not available under the new regime.
Income Tax Deductions for Joint Owners
When it comes to co-ownership and co-borrowing scenarios in relation to a self-occupied house property and a home loan, there are specific tax implications:
Co-owners and Co-borrowers:
If co-owners of a self-occupied house property are also co-borrowers of a home loan, each co-owner/co-borrower can claim a deduction on interest on the loan, up to Rs. 2 lakh each.
Additionally, they can claim deductions on principal repayments, stamp duty, and registration charges under Section 80C, with a combined limit of Rs. 1.5 lakh.
The allocation of deductions for each benefit will be based on the respective share of ownership in the property.
Co-borrowers but not Co-owners:
If an individual is a co-borrower of a loan but not a co-owner of the property, they cannot claim interest on the home loan paid.
Moreover, they are not eligible for benefits related to principal repayment, stamp duty, etc.
Co-owners but not Co-borrowers:
If an individual is only a co-owner of the property and not a co-borrower of the loan, they cannot claim interest on the home loan paid.
However, each co-owner can still claim deductions on stamp duty and registration charges under Section 80C, with the allocation based on their respective ownership shares in the property.
Setting off losses from house property
Let’s calculate the income from house property for Rahul’s property in Ajmer under both scenarios:
Let-Out Property:
Rental Income: INR 40,000 * 12 = INR 4,80,000 per annum
Gross Annual Value (GAV): INR 4,80,000
Less: Municipal Taxes Paid: INR 30,000
Net Annual Value (NAV): INR 4,50,000
Less: Deduction for Standard 30%: INR 1,35,000 (30% of NAV)
Taxable Income from House Property: INR 3,15,000
Less: Deduction for Interest on Home Loan: INR 2,35,000
Net Taxable Income from House Property: INR 80,000
Self-Occupied Property:
Since the property is self-occupied, the Gross Annual Value (GAV) is Nil.
Therefore, the Net Annual Value (NAV) is also Nil.
Deduction for Interest on Home Loan: INR 2,35,000 (up to a maximum of INR 2,00,000 for self-occupied property)
Taxable Income from House Property: Nil (As the NAV is Nil for self-occupied property)
So, Rahul’s taxable income from the house property would be INR 80,000 if the property is let-out, and Nil if it is self-occupied.
Particulars
Let Out
Self Occupied
Gross Annual Value(GAV)
4,80,000
NIL
Less: Property Taxes paid
30,000
NIL
Net Annual Value (NAV)
4,50,000
NIL
Less: Standard Deduction @30%
1,35,000
NIL
Less : Interest payable on Home Loan
2,35,000
2,00,000
Income/Loss from House Property
80,000
2,00,000
In summary:
Self-Occupied Property:
Deduction for Interest on Home Loan: Maximum of INR 2,00,000
Loss from House Property can be set off against income from other heads, such as salary or business income.
Rental income from subletting is taxed as income from other sources.
Let-Out Property:
Entire amount of interest on home loan can be claimed as a deduction.
Loss from House Property can be set off against income from other heads.
Rental income from subletting is not taxed as income from House Property but under the head ‘Income from other sources’.
Documents Required to File ITR for Income from House Property
The House Property Income Documents Checklist is as follows:
PAN
Aadhaar
Utility Bill
Rent Agreement
Form 16A
Home loan repayment certificate/ Interest Certificate from the bank
Municipal Tax Receipts
I receive HRA from my employer, can I also claim a deduction for my Home Loan?
Certainly! You can benefit from both HRA (House Rent Allowance) and deduction for Home Loan simultaneously under certain circumstances.
Living in a Rental House with Family in Owned House:
You can claim HRA for the rent paid for the rental house.
Additionally, you can avail deduction for Home Loan interest on your owned house, up to a maximum of INR 2,00,000.
Living in a Rental House and Renting out Owned House:
You can claim HRA for the rent paid for the rental house.
There’s no limit on the deduction for Home Loan interest on your owned house that you’ve rented out.
Important Keyword: Capital Gains, Income from House Property, Income Source.
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What is Capital Gain?
Capital Gain is simply the profit or loss that arises when you transfer a Capital Asset. If you sell a Long Term Capital Asset, you will have Long Term Capital Gains and if you sell a Short Term Capital Asset, you will have a Short Term Capital Gain. If the result from the sale is negative, you will have a capital loss. The Capital Gain will be chargeable to tax in the year in which the transfer of capital assets takes place.
What is a Capital Asset?
A capital asset encompasses any property you own, regardless of its connection to your business or profession. This includes movable and immovable assets, tangible and intangible assets, rights, and choices in actions. Examples of capital assets include house property, land, buildings, goodwill, patents, trademarks, machinery, jewelry, cars, and paintings.
However, certain assets are excluded from the definition of capital assets:
Stock in trade, consumables, or raw materials held for business or professional purposes.
Personal effects like clothing or furniture held for personal use.
Agricultural land situated outside specified areas based on population density.
Gold Bonds, Special Bearer Bonds, and Gold Deposit Bonds issued by the Government of India.
The term “transfer” refers to any action that leads to the profit or gain from a capital asset, constituting a capital gain. Transfer includes:
Sale, exchange, or relinquishment of the asset.
Extinction of any rights in the asset.
Compulsory acquisition of an asset.
Conversion of a capital asset into stock in trade.
Maturity or redemption of zero coupon bonds.
Any other transaction affecting the possession or enjoyment of an immovable property.
Transactions involving gift, will, or inheritance of a capital asset are not considered transfers for tax purposes. Additionally, if the asset transferred is not a capital asset, the provisions of capital gains tax do not apply.
What is Long Term and Short-Term Capital Asset?
Yes, the classification of assets as short-term or long-term capital assets depends on the duration of ownership before their sale. Typically, assets held for 36 months or less are considered short-term, while those held for more than 36 months are categorized as long-term.
However, there are exceptions to this rule:
Equity shares or preference shares, debentures or government securities, units of UTI, units of equity-oriented mutual funds, and zero-coupon bonds are treated as short-term capital assets if held for 12 months or less. If held for more than 12 months, they are classified as long-term capital assets.
Other assets, not falling under the exceptions mentioned above, follow the general rule of 36 months for determining short-term or long-term status.
It’s essential to recognize these distinctions, as the tax implications vary based on whether the gains or losses arise from short-term or long-term capital assets. The table given below defines period of holding for different classes of asset in order to be classified as short term or long term:
Asset
Period of holding
Short Term / Long Term
Immovable property
< 24 months
Short Term
>24 months
Long Term
Listed equity shares
<12 months
Short Term
>12 Months
Long Term
Unlisted shares
<24 months
Short Term
>24 months
Long Term
Equity Mutual funds
<12 months
Short Term
>12 months
Long Term
Debt mutual funds
<36 months
Short Term
>36 months
Long Term
Other assets
<36 months
Short Term
>36 months
Long Term
Note: Determination of period of holding is important because it impacts the method of calculating Capital Gains and also the tax rates.
How to determine the holding period if the asset was gifted?
When calculating Capital Gains, various factors come into play, depending on whether the asset is categorized as a Long Term or Short Term Capital Asset. Here’s a breakdown of key terms and concepts involved in the process:
Full Value of Consideration:
This refers to the total amount received or expected to be received by the seller upon transferring the asset to the buyer. Capital Gain is taxable in the year of transfer, regardless of when the consideration is received.
Cost of Acquisition:
The cost at which the seller initially acquired the asset is known as the Cost of Acquisition.
Cost of Improvement:
Any expenses incurred for improving, repairing, or enhancing the asset after April 1, 1981, are considered as the Cost of Improvement. These costs are factored in when determining the Capital Gain.
Indexation:
Indexation involves adjusting the cost of acquisition and improvement using the Cost Inflation Index (CII) notified by the Central Government annually. This adjustment accounts for inflation, ensuring that the purchasing power of the asset remains intact over time.
Additionally, it’s important to consider certain scenarios that impact the calculation of the holding period:
In cases where the asset was received as a gift, inheritance, or through succession, the holding period of the previous owner is also included in the total holding period for the current owner.
For bonus shares or right shares, the holding period is calculated from the date of their allotment.
How to Calculate Short Term Capital Gains Tax?
Particulars
Amount
Full Value of Consideration
XXXX
Less: Expenditure incurred exclusively in connection with the transfer. Cost of Acquisition. Cost of Improvement.
(XXX)
(XXX) (XXX)
Less: Exemption under Section 54B
(XXX)
Short Term Capital Gain (1-2-3)
XXXX
How to Calculate Long Term Capital Gain Tax?
Particulars
Amount
Full Value of Consideration
XXXX
Less: Expenditure incurred exclusively in connection with the transfer. Index* Cost of Acquisition. Index* Cost of Improvement.
Can I claim any expenses as a deduction from the full value of consideration?
Yes, you can claim certain expenses as deductions from the full value of consideration when calculating Capital Gains. These expenses must be directly related to the transfer of the property. Here’s a breakdown of allowable expenses for different types of sales transactions:
Sale of Shares/Stocks:
Brokerage or sales commission paid to brokers or agents.
Note that Securities Transaction Tax (STT) is not allowed as a deduction.
Sale of House Property:
Commission or brokerage paid to property agents or brokers.
Stamp duty paid on the transfer of property.
Any travel expenses incurred to facilitate the sales transaction.
Legal charges associated with obtaining a succession certificate or executor fees in case of property transfer through inheritance.
Litigation expenses for claiming enhanced compensation in case of compulsory acquisition.
It’s important to remember that these expenses are deductible only for the purpose of calculating Capital Gains and cannot be claimed as deductions from any other heads of income. Additionally, the cost of acquisition and cost of improvement can also be deducted from the sales consideration.
Taxation on Long-term and Short-term Gains
Type of Capital Gain
Tax Rate
Long Term Capital Gain under Section 112 (when Securities Transaction Tax is not applicable)
20% + Surcharge and Education Cess
Long Term Capital Gain under Section 112A (when Securities Transaction Tax is applicable)
10% over and above INR 1 lakh
Short Term Capital Gain (when Securities Transaction Tax is not applicable)
Normal slab rate applicable to Individuals
Short Term Capital Gain under Section 111A (when Securities Transaction Tax is applicable)
15% + Surcharge and Education Cess
The taxability of gains from the sale of Equity and Debt mutual funds are different. Funds with more than 65% of the portfolio consisting of equities are called Equity Funds.
Short Term Capital Gain
Long Term Capital Gain
Debt Funds
Normal slab rate applicable to Individuals
20% with Indexation + Surcharge and Education Cess
Equity Funds
15% + Surcharge and Education cess
Exempt
Note: Unlike Equity mutual funds, debt funds have to be held for more than 36 months to qualify as Long Term Capital Assets.
Capital Gain Exemption
Indeed, the Income Tax Act provides avenues for total or partial exemption from Capital Gains tax under various sections. Taxpayers can benefit from multiple Capital Gains exemptions offered by these sections simultaneously. However, it’s crucial to note that the total amount of exemption claimed cannot surpass the total Capital Gain amount.
These exemptions serve as valuable tools for taxpayers to reduce their tax liabilities and optimize their financial planning strategies. By leveraging these provisions effectively, taxpayers can maximize their tax savings while ensuring compliance with the relevant tax regulations.
Residential house or residential plot of land (LTCA)
Subscription in equity shares of eligible startup
Individual/HUF
Gathering the necessary documents is crucial when dealing with Capital Gains and filing your tax returns. Here’s a rundown of the essential documents you’ll need:
PAN (Permanent Account Number): This alphanumeric ID, issued by the Income Tax Department, links all your financial transactions with your income. It’s essential for tax compliance and filing your Income Tax Return (ITR).
Aadhaar Card: The 12-digit unique identification number issued by UIDAI is mandatory for Resident Individuals when filing their ITR. It’s another crucial document for tax purposes.
Details for Capital Gains Calculation and ITR-2 Filing:
Purchase Date
Sale Date
Period of Holding the Asset
Transaction or Brokerage Charges (if applicable)
Form 16: Salaried individuals who have had TDS deducted from their salary receive Form 16 from their employer. It provides a detailed statement of the salary earned during the Financial Year, along with deductions, exemptions, and taxes deducted at source.
Form 26AS: This is a consolidated Tax Credit Statement that provides various details to taxpayers, including:
Taxes deducted from the taxpayer’s income
Taxes collected from the taxpayer’s payments
Advance Tax, Self-Assessment Tax, and Regular Assessment Taxes paid by the taxpayer
Details of refunds received during the year
Details of high-value transactions, such as shares and mutual funds
Investment Proofs: Certain investments and expenses are eligible for deductions under Chapter VI-A of the Income Tax Act. You’ll need investment proofs to claim these deductions, which can help reduce your taxable income.
Gathering and organizing these documents ensures smooth and accurate tax filing, helping you comply with tax regulations and potentially reduce your tax liability through eligible deductions.
Important Keyword: Business and Profession, Income from Business & Profession, Income Source, Speculative Income.
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What is Business and Profession?
Exactly! Income from business or profession falls under the category of “Income from Business and Profession” for tax purposes. Here’s a breakdown of what constitutes business and profession:
Business: Business involves any activity carried out by a person with the intention of earning a profit. It encompasses a wide range of activities such as trade, commerce, manufacturing, and providing services to others. Examples of businesses include owning a shop, running a hotel, transportation services, operating a travel agency, and share broking.
Profession: Profession refers to vocations or occupations that require specialized knowledge, skills, and expertise. Professionals typically earn their livelihood through the application of their intellectual or manual abilities. Examples of professions include legal services, medical practice, engineering, chartered accountancy, architecture, and various other specialized fields.
Income generated from both business and profession activities is considered taxable under the head “Income from Business and Profession” in the Income Tax Act. This classification helps tax authorities and taxpayers differentiate between various sources of income and apply the relevant tax rules and provisions accordingly.
Maintaining Books of Accounts
Let’s summarize the key points:
Business Income:
Books of Accounts Maintenance: Businesses need to maintain books of accounts if income exceeds INR 1,20,000 or total sales, turnover, or gross receipts exceed INR 10,00,000 in any of the three immediately preceding previous years.
For individuals and HUF, the thresholds are income exceeding INR 2.5 Lakhs or total sales, turnover, or gross receipts exceeding INR 25 Lakhs in any of the three immediately preceding previous years.
Types of Incomes:
Non-Speculative Businesses/Professions
Speculative Businesses
Specified Businesses
Expenses Allowed: All expenses incurred wholly and exclusively in relation to the business and profession are allowed as deductions.
Profession Income:
Books of Accounts Maintenance: Professionals need to maintain books of accounts if gross receipts exceed INR 1.5 Lakhs in any of the three immediately preceding years.
Types of Incomes: Similar to Business Income, but for professions.
Expenses Allowed: Same as for business income.
Tax Computation:
Taxable income from business and profession is profits after deducting allowable expenses.
Tax is calculated at slab rates applicable to the taxpayer for the relevant financial year.
Examples of Allowable Expenses:
Rent and insurance of the building
Payments for Legal and Professional services
Remuneration, Bonus, Commission, etc. to employees
Interest and remuneration to working partners
Traveling and conveyance expenses
Membership fees
Depreciation on fixed assets
Advertisement expenses
Financial Charges (e.g., Interest on loans)
Entertainment/Business Promotion expenses
Staff Welfare expenses
Printing and stationery expenses
Postage expenses
All other expenses relating to business/profession
It’s crucial for taxpayers to maintain accurate records and understand the tax implications of their business or profession income to ensure compliance with tax laws.
Total Income
Tax Rate
Up to INR 2,50,000
NIL
INR 2,50,000 to 5,00,000
5%
INR 5,00,000 to INR 10,00,000
20%
Above INR 10,00,000
30%
Additional Cess:
An additional 4% Health and Educational Cess is applicable to the tax amount calculated.
Set off and Carry Forward of Losses:
Non-Speculative Business Loss: Can be set off against any income except Salary in the current year. Remaining loss can be carried forward for 8 years and set off against Business Income in future years.
Speculative Business Loss: Can be set off against Speculative Business Income only. Remaining loss can be carried forward for 4 years and set off against future Speculative Business Income only.
Specified Business Loss: Can be set off against any income except Salary in the current year. Remaining loss can be carried forward for 9 years and set off against Business Income in future years.
TDS/Advance Tax on Income from Business and Profession:
TDS (Tax Deducted at Source): TDS gets deducted on payments made to taxpayers for any goods or services sold. Any TDS deducted can be claimed while filing ITR for business and profession.
Advance Tax: If the tax liability is expected to exceed Rs. 10,000, the taxpayer must calculate and pay Advance Tax in quarterly installments to avoid Interest under Section 234B and 234C.
Due date of installment
Advance Tax payable by Individual and Corporate Taxpayers
On or before 15th June
15% of the tax liability
On or before 15th September
45% of the tax liability
On or before 15th December
75% of the tax liability
On or before 15th March
100% of the tax liability
In the realm of self-employment lies the domain of freelancers, individuals who have the autonomy to select their projects and tasks. Their income, which lacks steadiness, is predominantly professional in nature, falling under the category of “Income from Business and Profession” as per the Income Tax Act.
For freelancers, taxable income is the sum of all receipts received from various projects, minus the expenses incurred in their freelance endeavors. This net taxable income formula allows freelancers to deduct expenses related to their work, optimizing their tax liabilities.
What is Speculative Business Income?
Understanding Speculative Business Income is pivotal in comprehending the nuanced aspects of freelance taxation. Speculative transactions involve contracts for the purchase or sale of commodities, like stocks and shares, settled periodically without actual delivery or transfer. Income derived from such transactions constitutes Speculative Business Income, distinct from regular business income.
Presumptive Taxation Scheme
The Presumptive Taxation Scheme provides relief to small taxpayers from the burdensome task of maintaining books of accounts and undergoing audits. Professionals with gross revenue up to INR 50 lakhs can opt for this scheme, declaring 50% of their gross revenue as taxable income. However, opting for this scheme precludes the ability to claim profession-related expenses as deductions.
Tax Audit Applicability
Tax audit becomes applicable to businesses with a gross turnover exceeding INR 1 crore in a financial year. Similarly, professionals are subject to tax audit if their gross receipts under the profession exceed INR 50 lakhs in any given financial year. Failure to undergo a tax audit incurs a penalty of up to 0.5% of gross revenue or INR 1.5 lakhs, whichever is lower.
ITR Form and Document Checklist
When it comes to filing income tax returns, freelancers must use the appropriate form, such as ITR 3 for individuals or HUFs earning from business or profession, or ITR 4 for those opting for the presumptive taxation scheme. Additionally, GST becomes applicable if the turnover exceeds Rs. 40 lakhs for businesses or Rs. 20 lakhs for professions, necessitating registration and return filing.
Navigating the intricacies of taxation as a freelancer requires a thorough understanding of these concepts, ensuring compliance with regulatory requirements while optimizing tax liabilities.
Important Keyword: Income Source, Presumptive Tax, Section 44ADA, Section 80C, Section 80U.
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Who is a Freelancer?
Absolutely, freelancers operate their own businesses and are responsible for managing their income and expenses. Unlike salaried individuals, freelancers have the flexibility to choose their projects, set their rates, and work with multiple clients. However, with this freedom comes the responsibility of managing their finances, including paying income tax on their earnings.
Freelancers can deduct legitimate business expenses from their income before calculating their taxable income.
These expenses can include costs associated with running their business, such as:
Equipment and tools: Computers, software, cameras, and other tools necessary for their work.
Workspace: Rent for a home office or co-working space, utilities, and internet bills.
Supplies: Stationery, printing costs, and any other materials needed for their work.
Travel: Transportation expenses related to client meetings, conferences, or project-related travel.
Marketing and advertising: Costs associated with promoting their services, such as website development, advertising, and networking events.
Professional services: Fees paid to accountants, lawyers, or other professionals for business-related services.
Training and education: Costs of courses, workshops, or certifications related to their profession.
Insurance: Professional liability insurance or other business insurance premiums.
It’s essential for freelancers to keep detailed records of their income and expenses to accurately report their taxable income and claim deductions while filing their income tax returns. This helps them minimize their tax liability while ensuring compliance with tax laws and regulations.
What does the Income of a Freelancer Include?
Exactly, gross receipts represent the total amount of money received by a freelancer for their work or services rendered. It’s crucial for freelancers to accurately track and document their gross receipts to ensure compliance with tax regulations.
Gross receipts typically include all payments received directly for freelancing work, whether they are deposited into a bank account or received in cash. It’s essential to distinguish between income earned from freelancing activities and other sources of income, such as interest from fixed deposits or rental income from property.
While income from freelancing is considered part of the business or professional income category, other sources of income fall under different heads in the income tax return. By accurately categorizing and reporting income, freelancers can ensure compliance with tax laws and optimize their tax planning strategies.
Books of Accounts for Freelancers
Accrual Basis of Accounting:
Income is recognized when it’s earned, regardless of when it’s received.
Expenses are recognized when they are incurred, regardless of when they are paid.
Provides a more accurate reflection of the freelancer’s financial position and performance over a period of time.
Requires tracking accounts receivable (income yet to be received) and accounts payable (expenses yet to be paid).
Commonly used by businesses with significant credit transactions or those that offer goods or services on credit terms.
Cash Basis of Accounting:
Income is recognized only when it’s actually received.
Expenses are recognized only when they are paid.
Simple and straightforward method, suitable for small businesses with straightforward financial transactions.
Provides a clear picture of actual cash flow.
Doesn’t require tracking accounts receivable or accounts payable.
May not accurately represent the freelancer’s financial position and performance, especially if there are significant credit transactions or outstanding invoices.
Choosing between accrual and cash basis accounting depends on various factors, including the nature of the freelancer’s business, the volume of transactions, and personal preferences. Some freelancers may prefer cash basis accounting for its simplicity, while others may opt for accrual basis accounting for its accuracy and ability to provide a comprehensive financial picture.
Accrual Basis
Cash Basis
Incomes are accounted when the right to receive occurs
Incomes are accounted only when the cash is actually received.
For Example, you raise an invoice on your client on 7th February but receive the payment on 10th April, revenue would be booked in your accounts on the basis when invoice is raised to the client i.e, 7th February.
Now, in the same case if it’s Cash Basis of Accounting, revenue would be accounted for only on 10th April (the tax year next to the year in which invoice was raised or work got completed) when payment is received.
Similarly, expenses are accounted right when the obligation is incurred.
Expenses are accounted only after they’re paid off.
For Example, your Internet bill dated 18th February to 18th March has been received. This will be captured as an expense in the accounts of March, even if you don’t pay this until 31st March (even in the next tax year). Note that on an estimated basis your Internet cost for remaining 13 days of March may also be accrued when your books of accounts are closed on 31st March.
Here, the same Internet bill will be booked as an expense in the month of March only if you pay it before the 31st March (in the same tax year). If you pay it in April, it will get booked as an expense in the next tax year (even when the expense pertains to the previous tax year)
Tax liability is considered for the booked income. So even the income yet not recieved may be liable for Tax.
As here, the income is not booked until actually receiving it, the income not received yet will not be liable for Tax
This method can be followed for all types of income. In fact, it’s commonly used for Income from Salary, House Property, and Capital gains
This method is only applicable to Profits and gains from Business and Profession and Income from Other Sources
Correct, selecting the appropriate accounting method is crucial for freelancers as it impacts how income and expenses are recorded and ultimately affects tax obligations. While the cash basis may offer simplicity, the accrual basis provides a more accurate reflection of financial performance over time.
In terms of tax implications, both methods have their considerations. While cash basis accounting may delay tax payments by postponing income recognition until it’s received, it doesn’t necessarily reduce the overall tax liability. Accrual basis accounting, on the other hand, allows for a more comprehensive assessment of income and expenses, aiding in accurate tax calculations for the current year.
When calculating taxable income for freelancers, deductions play a significant role in reducing the overall tax liability. Deductions such as business expenses, investments, and eligible exemptions are subtracted from the gross taxable income to arrive at the net taxable income, which is then subject to applicable tax rates based on the taxpayer’s age and income level.
Calculating and paying advance tax is essential for freelancers to avoid penalties and ensure compliance with tax regulations.
Here’s a step-by-step guide to calculating and paying advance tax:
Determine Total Income: Add up all payments received for freelance work and any income from other sources.
Subtract Work-related Expenses: Deduct all legitimate business expenses from the total income. This includes expenses such as equipment, software, office supplies, travel costs, and any other expenses directly related to your freelance work.
Add Income from Other Sources: If you have income from sources other than freelancing, include it in your total income calculation.
Calculate Tax Due: Determine your tax liability based on the total taxable income after deducting expenses and considering any applicable deductions or exemptions. Use the income tax slab rates applicable to your income level to calculate the tax due.
Deduct TDS: If any tax has been deducted at source (TDS) from your income, deduct it from the tax calculated in step 4.
Check if Advance Tax is Due: If the remaining tax due after deducting TDS exceeds INR 10,000, advance tax is applicable.
Pay Advance Tax: If advance tax is due, make the payment by the due dates specified by the tax authorities. The due dates for advance tax payments are typically as follows:
On or before 15th June: 15% of the total tax liability
On or before 15th September: 45% of the total tax liability
On or before 15th December: 75% of the total tax liability
On or before 15th March: 100% of the total tax liability
By following these steps and making timely advance tax payments, freelancers can fulfill their tax obligations and avoid penalties for non-compliance.
Due date of installment
Advance Tax payable by Individual and Corporate Taxpayers
On or before 15th June
15% of the advance tax liability
On or before 15th September
45% of the advance tax liability
On or before 15th December
75% of the advance tax liability
On or before 15th March
100% of the advance tax liability
That’s correct! Freelancers and professionals can indeed opt for the presumptive taxation scheme under Section 44ADA from the assessment year 2017-18 onwards. This scheme simplifies tax compliance for them, as they can file their income tax returns using Form ITR 4 and are not required to maintain detailed books of accounts.
Regarding the payment of advance tax, freelancers opting for the presumptive taxation scheme are required to pay the entire amount of advance tax in a single installment before 31st March of the financial year. This differs from the usual quarterly installment schedule for advance tax payments applicable to other taxpayers. By paying the advance tax before the deadline, freelancers can ensure compliance with tax regulations and avoid penalties.
Exactly! Freelancers can deduct various expenses incurred exclusively for their freelancing work from their gross income to arrive at their net taxable income. These deductions help in reducing their overall tax liability.
Some common expenses that freelancers can claim as deductions include:
Rent expenses for office space or workspace used for freelancing.
Electricity, telephone, and internet expenses directly related to freelancing work.
Petrol or diesel expenses incurred for business-related travel.
Travel expenses related to freelancing work, such as transportation costs for meetings with clients.
Local taxes and insurance premiums for business property.
Meal, entertainment, or hospitality expenses incurred while meeting with clients or conducting business activities.
Depreciation on capital assets purchased for work, such as laptops, printers, or vehicles used for business purposes.
Office supplies and other miscellaneous expenses directly related to freelancing work.
Any other expenses incurred solely for the purpose of earning revenue from freelancing activities.
Additionally, freelancers can also claim deductions under various sections of the Income Tax Act, such as:
Section 80C: Deductions for investments in instruments like PPF, NSCs, life insurance premiums, etc.
Section 80D: Deductions for medical insurance premiums paid by the freelancer.
Other sections like 80E, 80G, 80TTA, etc., may also provide deductions for specific expenses or investments.
These deductions help freelancers optimize their tax planning and reduce their overall tax burden, ensuring they maximize their net income from freelancing activities.
Indeed, TDS (Tax Deducted at Source) is an important aspect for freelancers to consider, especially when receiving payments for their services.
Here’s a breakdown of TDS for freelancers:
TDS Rate: For freelancers, TDS is deducted at a rate of 10% under Section 194J of the Income Tax Act.
TAN Requirement: The entity making the payment, whether an individual or a company, needs to have a Tax Deduction and Collection Account Number (TAN) to deduct TDS from payments made to freelancers. If the client does not have a TAN, they cannot deduct TDS.
International Clients: Companies or individuals from outside India may not have a TAN, so no TDS is applicable in such cases. Freelancers are then responsible for depositing Advance Tax, if applicable, on their own.
TDS Credit: If TDS has been deducted from payments made to a freelancer, they can claim credit for this tax deducted while calculating their final tax liability.
Tax Refund: Freelancers whose income does not exceed the Basic Exemption Limit or who have TDS exceeding their tax liability may be eligible for a tax refund from the Income Tax Department.
In addition to TDS, freelancers may also need to consider other taxes such as Service Tax, Excise Duty, and Sales Tax, depending on the nature of their services and business operations.
When filing their Income Tax Returns (ITR), freelancers typically use either Form ITR 3 or Form ITR 4. Form ITR 3 is suitable for reporting income from business and profession, while Form ITR 4 is specifically designed for professionals who opt for the presumptive taxation scheme under Section 44ADA.
Having the necessary documents ready, such as income statements, expense records, TDS certificates, and other relevant documents, is essential for smooth and accurate filing of the ITR. This ensures compliance with tax regulations and helps freelancers manage their tax obligations efficiently.
