The presumptive taxation scheme is designed to reduce accounting requirements for some individuals and small business owners. Typically, when you are a freelancer or a small business owner, you calculate your taxable income by subtracting your business expenses from your revenue. But, if you qualify for the presumptive taxation scheme, you simply apply a certain percentage to your revenue and that becomes your taxable income.
The presumptive tax scheme has a couple of different sections. To qualify under section 44AD, you must be a resident:
- Hindu undivided family, or
- partnership firm as long as it’s not a limited liability partnership firm.
Your total annual turnover must be less than ₹2 crores. In addition to this, you can run any type of business, except businesses that involve leasing goods carriages. Or businesses based on commission or brokerage.
For instance, insurance agents earn commission so they cannot use this scheme.
If you run any of the following types of businesses, you don’t qualify for the presumptive taxation scheme under section 44AD:
- Technical Consultancy
- Interior Design
But if your total gross receipts for the year are less than ₹50 lakh, you may be able to qualify under section 44ADA.
Calculating Taxable Income
If you qualify under section 44AD, you need to report 8% of your total gross receipts as income. To explain, imagine that you collected ₹1 crore in total revenue through the tax year. To determine your taxable income, you simply multiply that amount by 8%. That becomes ₹1,00,00,000 x .08 = ₹800,000. As a result, your taxable business income is ₹8 lakh.
There is an exception to this rule. If you have revenue that you received by an account payee cheque or through an electronic clearing system, your taxable income is just 6% of that total.
For example, say you sell services on a subscription based model. Therefore, all your clients pay electronically or with cheque. In this case, your taxable income is just 6% of your total receipts. Depending on how you receive payments from your customers, you may end up applying both rates to your income. Business owners who qualify under section 44ADA must apply a 50% rate to their income. For instance, if you are a doctor and you have ₹40 lakh in total receipts or revenue for the year, your taxable income is half that amount — ₹20 lakh.
Pros and Cons of the Presumptive Taxation Scheme
When you qualify for the presumptive taxation scheme, you don’t have to keep detailed records of your business expenses. While that can save time, tracking all of your expenses may result in a lower income than that of the presumptive tax scheme.
Under the presumptive taxation scheme, there is always a risk that you may end up paying more tax than you should. To ensure that the presumptive taxation scheme is truly beneficial for you, you may want to track the numbers using cloud-based accounting software such as QuickBooks. In addition to tracking the numbers you need for your tax return, this software can also help you track key financial metrics related to your business’s growth and profitability.