How your business structure affects taxes (2024)

By Tanvi Loond

Entrepreneurs identify the relevant business organization based on several factors such as ease of commencing operations, compliance requirements and the costs involved, agreement with other members and need to raise funds.

Each structure attracts a certain tax liability and it is important to consider the tax implications before finalizing the formation. In this article, we list out business structures considered by SMEs and the taxes that follow.

Limited Liability Partnership or Partnership Firm
A firm is taxed as a separate legal entity. In computing the taxable income of a firm any salary, bonus, commission or remuneration which is due to or received by a partner is allowed as a deduction subject to certain restrictions. Where a firm pays interest to a partner, the firm can claim deduction of such interest from its total income. However, the maximum rate at which interest is allowed to a partner is 12% per annum.

Rate of tax
The income of a firm is taxed at a flat rate of 30% plus surcharge plus cess

Surcharge

Cess

Health and education cess is computed as 4% on income tax and surcharge

Alternate Minimum Tax
Tax payable by firm cannot be less than 18.5% (plus surcharge and cess as applicable) of adjusted total income as defined in section 115JC

Private Limited Company
A company is a juristic person having a separate legal entity distinct from the members who constitute it. A company is incorporated as per the provisions laid out in the Companies Act 2013. Section 2(68) of the Companies Act defines a private limited company as a company having a minimum paid up share capital and which by its articles

- restricts the right to transfer its shares
- limits the number of members to 200
- prohibits any invitation to the public to subscribe for any securities of the company

For the purpose of taxation, companies have been classified into two categories - Domestic company and Foreign company.

Rate of tax

Surcharge
Surcharge is applicable at the rates given below:

Cess
Health and education cess is computed as 4% on income tax and surcharge

Minimum Alternate Tax
Tax payable by firm cannot be less than 18.5% (plus surcharge and cess as applicable) of adjusted total income as defined in section 115JC

One Person Company
One Person Company is a relatively new concept which was introduced in the Companies Act, 2013 to help the solo entrepreneur so that he/she can create a formal company structure without needing a director / partner as is the case with a private company/ partnership. Section 2(62) defines an OPC as a company which has only one person as a member. Like a Private Limited Company an OPC is a separate legal entity distinct from the member who constitutes it.

Rate of tax
For the purpose of taxation, an OPC is recognized as a private company under the Income Tax Act and is therefore subject to the same rate of tax as a domestic company. It is important to note that an OPC can only be incorporated by an Indian citizen resident in India.

Sole proprietorship
A sole proprietorship, as the name suggests, is owned by a single individual. It is not legally recognized as a separate legal entity and is therefore an informal structure usually adopted by small businesses.

Rate of tax
A sole proprietorship is taxed according to the relevant income tax slab of the individual and therefore is a more suitable structure compared to an OPC.

Rebate
Resident individuals whose income does not exceed the notified limit (Rs 5,00,000 for Financial Year 2019-20) can avail rebate under section 87A. This rebate is deductible from income tax before calculating education cess. The amount of rebate is 100% of income tax or 12,500 p.a., whichever is less.

Surcharge
Surcharge is applicable at the rates given below:

Cess
Health and education cess is computed as 4% on income tax and surcharge

Alternate Minimum Tax
Tax payable by a non-corporate assessee cannot be less than 18.5% (plus surcharge and cess as applicable) of adjusted total income as defined in section 115JC

Co-operative Society
A co-operative society is registered under the Cooperative Societies Act, 1912 and constitutes a separate unit of assessment. The object of a co-operative society is the promotion of economic interests of its members in accordance with co-operative principles.

Rate of tax

Surcharge
Surcharge is applicable at the rates given below:

Cess
Health and education cess is computed as 4% on income tax and surcharge

Alternate Minimum Tax
Tax payable by a co-operative society cannot be less than 18.5% (plus surcharge and cess as applicable) of adjusted total income as defined in section 115JC

Local Authorities
A local authority is defined as a person by the Income Tax Act, 1961 and is therefore a separate entity. Local authorities include municipal corporations, Panchayat, Port Trusts etc.

Rate of tax
A Local Authority is taxable at the rate of 30% plus surcharge plus cess

Surcharge
Surcharge is applicable at the rates given below:

Cess
Health and education cess is computed as 4% on income tax and surcharge

Alternate Minimum Tax
Tax payable by a local authority cannot be less than 18.5% (plus surcharge and cess as applicable) of adjusted total income as defined in section 115JC.

The writer is the Founder and CEO, Insta C.A. (www.InstaCA.in). Insta C.A. is an online tax and accounting service for SMEs and startups. For more information contact info@instaca.in or follow them at their twitter handle @InstaCA1