A new breed of employees is fast emerging in the Indian market.
Popularly, known as 'consultants', they are hired by organisations for specific purposes. For instance, a software firm can hire consultants to do a certain project where it may not have a domain expertise.
This arrangement also helps companies to reduce their paperwork of verifying allowances, tax deductions and rebates, and these 'professionals' manage their taxes themselves. But consultants are considered to be running their own 'businesses', so their tax liabilities are under different heads.
This fact was first recognised in the Union Budget 2004, when the finance ministry introduced a subtle change in the Income Tax Act where a person with income under the head 'salaries' was denied the benefit to set off losses under the head of 'business'.
Under the new rules, such business loss could not be set off against income from other heads, and must be carried forward to be set off only against business income of subsequent year(s).
This change was effected to prevent salaried individuals from taking advantage of the 'business income' head and claiming a set-off on interest on motor cars purchased from loans from banks.
The salaried individual would typically stake this claim by declaring that they were earning some nominal income as a consultant. They would also claim depreciation on the car which otherwise could not have been allowed for the salaried. This is one reason why individuals are also opting for becoming consultants.
As a consultant and running a 'business', the individual is eligible for several deductions and allowances. Sections 36 and 37 provide for deduction for salaries, rent for premises, interest, insurance premium and 'any other expenditure' laid out for the purposes of business or profession.
Therefore, the scope for claiming expenses under the head 'business or profession', under which consultancy income gets taxed is large. A businessman or a professional is expected to spend on a host of items like rent, stationery, salary, telephones, interest on borrowings, depreciation on computers, furniture, motor car etc.
There is also the possibility of expenses exceeding income resulting in business loss at least, in the initial years of setting up of business. And this is recognised in the Income Tax Act.
Other advantages include not having a full-fledged separate office necessarily. A consultant can conveniently conduct consulting work from his house, for which he could incur expenditure by way of rent, pay telephone bills etc. He can even pay a salary to his wife for acting as an office assistant. A salaried individual cannot claim any of these under the head of 'business' expenses.
However, consultants lose out on the benefits of contributory provident fund, superannuation fund, gratuity fund and host of allowances and perquisites granted to persons who are employees. All said and done, where ever the flexibility of becoming a consultant is available, it is always better off from the tax point of view.
As we can see from the table that a salaried and consultant have the same income of Rs 15 lakh (Rs 1.5 million). However, since the consultant is able to claim part of rent, depreciation on car and laptop, interest payout on loans, among others, the taxable income goes down by almost Rs 120,000.
However, one should remember that the paperwork for a consultant is a difficult task and needs to be maintained diligently. But the biggest benefit is that under the head 'salaries' one can never have a 'loss' while under the head 'business', loss is a possibility.
Such business loss can be set off in the same year against any other income (except salary) and the loss not so fully set-off can be carried forward for eight long years for its set-off against subsequent years' business incomes.
The writer is chartered accountant
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