Setting up and Commencement of Business Under Previous Year
Setting up and Commencement of Business Under Previous Year
Setting up a new business is an exciting and rewarding endeavor, but it also comes with a variety of legal and tax implications. Under the Indian Income Tax Act, the previous year is the financial year in which the income of the business is assessed. When a business is set up and commences operations, it is essential to understand the tax implications and compliance requirements under the Income Tax Act.
Definition of Previous Year
Under the Income Tax Act, the previous year is defined as the financial year immediately preceding the assessment year. For example, if a business is set up in the financial year 2021-2022, the assessment year would be 2022-2023, and the previous year would be 2021-2022. It is important to correctly determine the previous year as it is the basis for the assessment of the business’s income and tax liability.
Setting up a Business
Before delving into the tax implications of setting up a business, it is important to understand the legal aspects of the process. In India, businesses can be set up as sole proprietorships, partnerships, limited liability partnerships (LLPs), private limited companies, or public limited companies. Each form of business has its own set of legal requirements and compliance obligations.
Sole Proprietorship
A sole proprietorship is the simplest form of business entity, where a single individual owns and operates the business. Setting up a sole proprietorship involves obtaining the necessary licenses and registrations, such as the Shops and Establishments Act registration, GST registration, and any industry-specific licenses or permits required for the business.
Partnership
A partnership is formed when two or more individuals come together to carry on a business with a view to profit. The formation of a partnership involves executing a partnership deed, which outlines the terms and conditions of the partnership, including profit-sharing, decision-making, and management responsibilities.
Limited Liability Partnership (LLP)
An LLP is a hybrid form of business entity that offers the benefits of limited liability to its partners, similar to a company, and the flexibility of a partnership. Setting up an LLP requires the filing of an incorporation document with the Registrar of Companies (RoC) and obtaining a certificate of incorporation.
Private Limited Company
A private limited company is a separate legal entity from its owners and is governed by the Companies Act, 2013. Setting up a private limited company involves the drafting of a memorandum and articles of association, obtaining director identification numbers (DINs) and digital signatures for the directors, and filing for incorporation with the RoC.
Public Limited Company
A public limited company, similar to a private limited company, is a separate legal entity and is regulated by the Companies Act, 2013. The process of setting up a public limited company is more complex and involves the issuance of a prospectus, obtaining a certificate of commencement of business, and compliance with additional regulatory requirements.
Tax Implications of Commencement of Business
Once a business is set up and commences operations, it is required to comply with various tax laws and regulations under the Income Tax Act. The commencement of business also triggers certain tax implications, including the determination of the previous year, accounting methods, and filing of tax returns.
Previous Year for Commencement of Business
The previous year for a newly set up business is the financial year in which the business commences its operations. It is important to correctly determine the previous year, as it determines the period for which the business’s income will be assessed for tax purposes. Any income earned or expenses incurred from the date of commencement of business until the end of the financial year will be included in the assessment of income for that previous year.
Accounting Methods
When a business commences operations, it must adopt a method of accounting for determining its income and expenses. The Income Tax Act allows businesses to follow either the cash basis or accrual basis of accounting. Under the cash basis, income is recognized when received, and expenses are recognized when paid. Under the accrual basis, income is recognized when earned, and expenses are recognized when incurred, regardless of when the cash is received or paid.
Filing of Tax Returns
Once a business commences operations, it is required to file its tax returns in accordance with the provisions of the Income Tax Act. The tax return for a business includes the computation of income, claiming of deductions and exemptions, and the payment of tax, if any. The due date for filing tax returns for businesses varies based on the form of business entity and the turnover of the business.
Tax Deductions and Exemptions for New Businesses
Newly set up businesses are eligible for certain tax deductions and exemptions under the Income Tax Act to promote investment and entrepreneurship. These deductions and exemptions are aimed at reducing the tax burden on new businesses and encouraging them to invest in growth and expansion.
Deduction for Start-up Expenses
Section 35AD of the Income Tax Act allows a deduction for capital expenditure incurred by a new business in specified industries, such as setting up and operating a cold chain facility, developing and building a hotel, hospital, or laboratory, and developing and maintaining infrastructure for the warehousing of agricultural produce.
Deduction for Investment in New Plant and Machinery
Section 32AC of the Income Tax Act provides for a deduction of 15% of the actual cost of new plant and machinery acquired and installed by a new business in the manufacturing sector. This deduction is aimed at incentivizing investment in new plant and machinery to promote industrial growth and modernization.
Exemption for Start-up Entities
Under Section 80IAC of the Income Tax Act, a start-up entity is eligible for a deduction of 100% of its profits and gains for a period of 3 consecutive assessment years out of 7 years, if it is engaged in eligible business activities, such as in the field of technology, innovation, or development of products, processes, or services with a high potential for wealth and employment generation.
Compliance Requirements for New Businesses
In addition to the tax implications, new businesses are required to comply with various legal and regulatory requirements under the Income Tax Act. These compliance requirements are aimed at ensuring transparency, accountability, and good governance in the operations of the business.
Obtaining Permanent Account Number (PAN)
Every new business is required to obtain a Permanent Account Number (PAN) from the Income Tax Department. The PAN is a 10-digit alphanumeric number that serves as a unique identifier for the business and is used in all tax-related transactions, such as filing tax returns, making tax payments, and conducting financial transactions.
Registration under Goods and Services Tax (GST)
If the turnover of the new business exceeds the specified threshold limit, it is required to register under the Goods and Services Tax (GST) regime. GST is a comprehensive indirect tax that is levied on the supply of goods and services and is aimed at simplifying the indirect tax structure and creating a unified national market.
Compliances under the Companies Act
For businesses set up as companies, compliance with the provisions of the Companies Act, 2013 is mandatory. This includes holding regular board meetings, conducting annual general meetings, maintaining statutory registers and records, filing of annual returns with the RoC, and compliance with other regulatory requirements relating to corporate governance.
Tax Deduction and Collection Account Number (TAN)
If the new business is required to deduct tax at source or collect tax at source, it is required to obtain a Tax Deduction and Collection Account Number (TAN) from the Income Tax Department. TAN is a 10-digit alphanumeric number that is used in all tax-related transactions involving the deduction or collection of tax at source.
Conclusion
Setting up and commencing a new business is an important milestone for entrepreneurs and business owners. Understanding the tax implications and compliance requirements under the Income Tax Act is essential for the smooth and efficient operation of the business. By adhering to the legal and tax principles outlined in this article, new businesses can ensure compliance with the law and avail of the available deductions and exemptions to foster growth and success.