Decoding Tax Regulations : Private Limited vs Partnership Registration in India

A company’s total income is calculated in accordance with the income tax laws, and income tax is then applied. The overall income of a business and its profit are closely related. Therefore, only if the company has total income would income tax be applicable. If a company’s total income is negative, meaning it made losses for the year, it would not be required to pay income tax. In light of the foregoing, we examine tax regulation for a private limited company as opposed to a partnership firm in this blog.

A Brief Overview of the Tax System in India

India has a sophisticated tax system with distinct lines of jurisdiction between the federal, state, and municipal governments. On people and goods, the central government imposes several direct and indirect taxes. Personal income tax, wealth tax, and corporation tax are examples of direct taxes, whereas sales tax, excise tax, customs duty, and service tax are examples of indirect taxes.

A firm may be subject to the following several types of taxes:

1. Minimum alternative tax (MAT)
2. Fringe benefits tax (FBT)
3. Dividend distribution tax (DDT)
4. Banking cash transaction tax (BCTT)
5. Securities transaction tax (STT)

Taxation for Private Limited Company

Corporate tax rates and how they are applied

In India, the corporate tax rate varies depending on the type of organization; for example, domestic corporations and international corporations pay tax at various rates. The following table shows the Indian corporate tax rates for the assessment year 2019–2020:

For AY 2019–2020, the appropriate corporate tax rate for domestic businesses is as follows:

DDT and its impact

Dividends are payments made from a company’s profits to its shareholders, and DDT is assessed on these payments. Contrarily, a corporation tax is a tax that is computed on a company’s net profit after deducting its expenses. Hence, DDT is a sort of tax that must be paid on the dividends that a corporation offers to its shareholders; higher dividends result in a higher tax burden for the corporate entity. It may also be referred to as the percentage of dividends that a particular corporation pays its stockholders.

The requirements of Section 115-O of the Income Tax Act, 1961, govern DDT. Currently, a firm must pay 15% of the gross amount given as dividends in DDT, which works out to a rate of 17.65% on dividends offered to shareholders.

GST registration and compliance requirements

The GST registration process can be completed online at www.gst.gov.in. Based on the annual turnover of a company, it must be done. Businesses that deal with the provision of commodities and have revenues greater than Rs. 40 lakhs in the prior fiscal year are affected.

Taxation for Partnership Firm

It’s a type of business that is created through an agreement between two or more parties in a partnership. All obligations incurred by the business are personally liable to the partnership’s members. Because one partner can financially harm the other partners, partnerships place a lot of liability on each individual partner.

Pass-through taxation is a common feature of partnerships, where the partners are taxed according to their ownership stake. In other words, each partner is responsible for paying taxes on the portion of his or her income that comes directly from the partnership. Once more, the Indian Revenue Service (IRS) mandates that partners report partnership income on their normal Form 1040 as ordinary personal income.

Corporate

Tax choices for corporations differ from those for other types of business ownership. The IRS views the owners of a corporation as a distinct legal entity from the corporation itself. Only the profits from the corporation that are given out as salaries and dividends to the owners are taxed.

The corporation also pays taxes on its profits at the existing corporate tax rates as a separate legal entity. Because companies pay taxes on their initial profits and then the owners pay personal taxes on the salary and dividends the firm pays out, this results in the form of double taxation.

The following are the highlights of the partnership firms’ taxation scheme:

Compliance requirements for partnership firms

Compliance refers to adhering to a set of laws, rules, policies, or standards. Compliances are necessary because they compel firms to operate in accordance with local laws that are in effect. Compliances ensure that a company’s incorporation and operations comply with the relevant laws.

Common compliances of a partnership firm

1. Firm registration with a one-year time limit.

2. Change of firm name, principal location, or business type with a 90-day deadline.

3. Branches may close and reopen with a 90-day window in between.

4. Compliance with the 90-day deadline for changing the partner’s name or address.

5. Constitutional amendment or dissolution with a 90-day deadline.

6. The moment a minor becomes a major and chooses, within 90 days, whether or not to become a partner.

7. In accordance with tax compliance, income tax return filing

Tax Benefits of Private Limited Company

• Founders’ or directors’ salaries – The profit sum will be distributed to the founders or directors according to a predetermined profit-sharing ratio, much like a dividend. To reduce their tax burden, directors may choose to receive profits instead of dividends.

• The director’s sitting fees – A corporation has the right to charge directors for attending board meetings. The board of directors determines the maximum amount that can be spent on director sitting expenses, which is Rs. 1,000,000.

• Initial costs – These are incorporation-related expenses incurred both before and after the PLC’s founding. Stamp duty, registrar fees, fees for establishing articles of association (AOA) and memorandums of association (MOA), and other fees are among them.

• Charges for rent – If it is the physical address of a firm, rent for a director’s or even a relative’s house may be properly recorded. Hence, in order to deduct rental costs and obtain tax benefits, we do not need to report the dwelling to the income tax department.

• Capitalizing capital assets and depreciation – An asset on the balance sheet that is no longer usable must be depreciated. It is currently shown as a cost. It must be included on the balance sheet. By doing this, tax benefits may be extended to the remainder of a corporation’s fiscal year and to the following year.

• The cost of the director’s vehicle – A car may have been used for travel and business meetings. The list of business expenses also includes fuel costs and the upkeep and repair of vehicles. With the correct planning and documentation, it is feasible to save between 22 and 30% on taxes.

How PLCs Can Reduce Their Tax Liability

Tax-saving tips

1) Salary to the founders or directors

1. Instead of paying a dividend, the profits can be transferred to the director as a salary in order to save on taxes.
2. A PLC is allowed to pay founders’ or directors’ salaries as a cost.

2) Sitting fees to directors

1. Businesses may pay directors sitting fees for attending committee or board meetings; however, these payments cannot exceed 1 lakh rupees per meeting.
2. It is exempt in the hands of a person but can be claimed as an expense by the firm.
3. In other words, businesses may pay directors sitting fees out of their revenues.

3) Preliminary expenses

1. The founders and directors bear a significant portion of the costs associated with establishing the business, such as professional fees for company registration, fees associated with the drafting of the MOA and AOA, costs associated with employee training, fees paid to the Registrar of Companies (ROC), etc.
2. By entering these expenses in the books of accounts, you can use them to your advantage and help your business save on taxes.

4) Pay advance tax

1. Advance tax, often called the “pay-as-you-earn” system, is a tax that you calculate your turnover and pay upfront.
2. By paying your advance tax on time, you can avoid paying late fees on taxes that are paid at the end of the fiscal year.

5) Director’s vehicle expenses

The director(s) incurs fees for the use of their automobiles when traveling for business and for attending meetings, for example: In addition to the expense of fuel, the vehicle’s upkeep and repairs may also be claimed. You would need the appropriate documentation for this.

6) Rent expenses

You can deduct this expense and receive a tax break if one of your company’s directors or a family member is named as the registered office.

7) Capitalizing on capital assets and depreciation

1. You must capitalize on an asset if it improves your firm and generates income.
2. Instead of appearing in your profit and loss statement, it will then appear on your balance sheet.
3. You must depreciate fixed assets for the duration of their useful lives if they are listed on your balance sheet. Consequently, we can benefit from the tax advantages.

8) Salary to a family member

Family members offer free advice and assistance to businesses. Their salaries can be included in the accounting books. Bring your earnings portion home with dual tax incentives to reduce your taxes.

9) Entertainment expenses

The company hosts a tea or an internal party for family members or partners following any significant achievement or roughly every three months. To avoid paying taxes, don’t forget to book these expenses.

10) Meeting expenses

To ensure your company’s success as a director, you must engage in a lot of social interaction. Such social gatherings can be reserved to reduce taxes.

How Partnerships Can Reduce Their Tax Liability?

As the partnership firm has already taxed the partners’ share of the business’ overall revenue, it is not subject to further taxation. Any capital gains from the sale of any asset are subject to taxation by the partnership firm under Section 112. The tax rate for LLPs and partnership firms is fixed at 30%.

As each partner reports the business gains or losses in their personal income tax return, partnerships are not required to pay income tax on the profits split among the partners. Since there are multiple owners, there is a better chance of raising money.

Comparison of Tax Implications for Pvt Ltd Company vs Partnerships Firm

Partnership – Profits from partnerships are taxed at a rate of 30% plus any applicable surcharges and cess.

Pvt Ltd Company – PLC profits are taxed at a rate of 30%, plus any relevant surcharges and cess.

Comparison of Tax Benefits Available to PLCs and Partnerships

Tax benefits for PLCs

• The tax rate is lowered from 30% to 25%.
• A few international enterprises are exempt from MAT’s rules.
• For taxation reasons, many capital asset transfers are not considered transfers.
• A deduction for costs related to starting or growing a business.

Tax benefits for partnership firms

The deductions and credits are also passed on to each partner in addition to the revenue. This indicates that only a personal level of taxation applies to the profits. By paying corporate tax first and then paying tax on their dividend shares, companies are subject to double taxation, which allows partnerships to avoid it.

A partnership also has the advantage of being far more adaptable than a corporation. They have the freedom to distribute income however they see fit, thanks to this flexibility.

As long as it is based on the partnership agreement, IRS Section 704(a) allows for varied allocations of income, profits, losses, credits, and deductions. It’s crucial that the special allocation is made for a valid purpose and not just to reduce one partner’s tax obligation.

Analysis of Which Entity Offers Better Tax Advantages

Owners of a partnership firm are responsible for all financial commitments and debts. Shareholders own PLCs, which are run by directors. Corporate loans have restricted liability, which lowers personal risk.

The maximum level of protection would be provided by a PLC because all owners would have limited liability. Normally, at least one partner in a partnership would be subject to limitless liability. But if you create a limited partnership, you could get complete security.

Conclusion

In comparison to a PLC, a partnership firm has far fewer compliance responsibilities. A PLC, however, has the following advantages over a partnership firm:

1. Ease of raising funds
2. Clear distinction of ownership
3. Liabilities in case of default
4. Future expansion of business
5. Listing with stock exchanges
6. Creditworthiness and sale value
7. Compounding and penalties

For the following reasons, you can always pick Kanakkupillai to assist you in case you’re interested in creating a PLC or a partnership firm: