Lower Income Tax on Digital Turnover for Small Businesses in India

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By Melissa Cyrill

Responding to the challenges arising from the demonetization of high value currency, the government has been keenly promoting digital financial literacy across the country. In fact, a new mantra has emerged towards the development of a cashless economy. Towards this, several new initiatives have been unveiled including widespread campaigns to spread the adoption of digital payment mechanisms, such as the ‘Digi Dhan Abhiyan’ by the Ministry of Electronics and IT (MeitY). Through the Digi Dhan Abhiyan over 55,000 merchants have begun offering digital payment options to rural customers, and more than 2.5 million people in rural areas (districts and blocks) have started using digital modes of payments. Moreover, upon new RBI regulations, Paytm has begun allowing its “registered” merchant customers to transfer US$ 737 (Rs 50,000) to their bank accounts; the maximum limit was US$ 368 (Rs 25,000) earlier.

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Proposed Amendment to Section 44AD of the Income-tax Act of 1961

On December 19, the finance ministry announced that the government will lower the income-tax on the digital earnings of small businesses up to a turnover of US$ 294,771 (Rs 20 million). This means that if a trader conducts his/her transactions in cash on a turnover of US$ 294,771 (Rs 20 million), then their income (or profits) under the proposed scheme will be presumed to be US$ 23,582 (Rs 1.6 million), calculated at 8 percent of the turnover. After availing of the US$ 2211 (Rs 150,000) deduction under Section 80C of the Income-tax Act, the trader’s total tax liability would amount to US$ 3947 (Rs 267,800).

However, if the trader shifts completely towards adopting digital transactions, his/her profit earnings estimate will be lowered for the benefit of tax purposes. Consequently, under the new announcement, the profit will be calculated at 6 percent of the turnover, or US$ 17,686.28 (Rs 1.2 million). Further, after availing of the US$ 2211 (Rs 150,000) tax deduction under Section 80C, the trader’s final tax liability will be a much reduced US$ 2125 (Rs 144,200).

It should be noted that the new amendment defines the scope of digital transactions to include payment received by check as well as through other digital means.

The following table illustrates the benefit obtained by traders and small businesses in three different scenarios:

India digital turnover tax

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Apart from making a tax saving of almost 46 percent by migrating to the formal banking mode, small businesses will find it easier to build their accounting books, which in turn may allow them to secure bank loans easily.  Finally, if transactions are carried out through formal banking channels, then any business having an annual turnover of up to US$ 97,274.56 (Rs 6.6 million) will have zero tax liability after availing the benefit of Section 80C of the Income-tax Act of 1961.

This will come into effect once the new rate structure gets legally incorporated through an amendment to the Act.

Observation: The above announcement is the latest in a series of measures for promoting digital alternatives to cash payment. Indirectly, the proposed tax break incentivizes the greater rural and small business adoption of digital financial transactions and online banking. Ultimately, the government aims to formalize the unorganized sector and thereby widen the overall taxable net.

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