• Insights

Entrepreneurship is about visualizing a business opportunity, making a plan, arranging the resources for it, and successfully organizing them in a venture. What makes an entrepreneur stand out is the ownership of the venture and the urge to innovate new products, processes and marketing strategies. Access to early stage financing, a conducive legal framework and infrastructure are necessary triggers.

India currently ranks 93rd in the world on the Entre-preneurship & Opportunities variable (The 2010 Legatum Prosperity Index), indicating that impediments exist for the nation to flourish. Yet the recent Economic Survey maintains that micro, small and medium enterprises contribute 8 percent to the country’s GDP. This indicates the potential for entrepreneurship in India. There are multiple levels of entrepreneurship in India, the largest being in agriculture and trading services. Other major ones include manufacturing and organized, old-economy, traditional sectors. Entrepreneurial activities, in the real sense, are miniscule in number and belong to emerging sectors that are knowledge and technology intensive.

An important first decision an entrepreneur has to take has to do with the ownership structure of a business. Apart from the vision of the size and nature of the business and the level of control one wishes to exercise, this is an essential component in the taxation aspect. The multiplicity and complexity of taxes and procedures are considered to be major hurdles to entrepreneurship.

Sole Proprietorships, Association of Persons (AoPs) and Partnerships as business structures have the advantage of ease of formation, control in decision-making and profits. However, there are some obvious drawbacks: insufficient access to capital, low risk management, lack of a continuity plan, and unlimited liability of the owners. Worldwide, the Limited Liability Company has emerged as a desirable ownership structure, assimilating characteristics of a corporation as well as the protection and tax privileges of a Limited Partnership. It offers the management flexibility in terms of participation and decision-making, stockholder rights, and writing-off business losses. The opportunity to invite angel investors in the business and rights to transfer ownership are other attractions.

A Limited Liability Partnership (LLP) is created in India to take care of smaller firms under the Limited Liability Partnership Act, 2008. The constitution of an LLP is in corporate form, though it is essentially a partnership with a separate legal identity distinct from its partners who have limited liability within the partnership, akin to shareholders of a limited company. The LLP Act provides for the conversion of general partnerships and private limited companies or unlisted public companies into an LLP. No tax liability would arise in case of a conversion of a general partnership into an LLP, subject to the fulfillment of some conditions. For LLPs, no Dividend Distribution Tax and surcharge are applicable. LLPs, however, have been specifically excluded from the provisions of presumptive tax at 8 percent applicable on the income of the general partnerships.

The recent Budget has proposed the introduction of Alternate Minimum Tax (AMT) at an effective rate of 19.055 percent on the Adjusted Total Income (ATI), which adds back deductions claimed under Chapter VIA and Section 10AA of the Indian Income Tax Act, 1961. This would discourage the conversion of private limited/unlisted public companies into an LLP, but are a dampener to the tax benefits enjoyed by an LLP in the first place.

The Indian Income Tax Act, 1961, provides various tax benefits to boost entrepreneurial activities. Section 35AD provides for the deduction of the whole of the capital expenditure prior to commencement in case of building a new hotel, hospital, housing project, or setting up a cold chain facility or a warehouse. Section 35ABB allows for deduction of expenditure incurred in obtaining a license for telecommunication services. Section 35 provides deduction for various forms of expenditure incurred on scientific research. Section 44AD and 44AE exempt a qualifying business with gross receipts up to Rs.60 lakh the maintenance of books of accounts and a compulsory audit under presumptive taxation.

Tax planning for an entrepreneur in an individual capacity would be based on the nature of the income derived. The income from entrepreneurial activity before the incorporation of the company, as promoter fees, would fall under the profits and gains from business or profession category. After incorporation, it is classified under income from salary; in this case, beneficial exemptions for allowances and perquisites can be availed. In case of a partnership firm and an LLP, the partner’s share of income and interest would be taxable to the extent that it is deductible from the gross profit of the firm. Additionally, expense-based beneficial deductions for insurance, donations, rent, etc. can be availed from the gross total income.

Such benefits and drawbacks must be evaluated for a viable business structure and its ownership status in the long run. The advice of a Certified Financial PlannerCM professional would help in taking holistic tax planning decisions, both at the individual entrepreneur level and at the entity level. Being the driver of a business, an entrepreneur should have the right grip on making strategic tax-efficient decisions.

The views expressed here are personal and do not necessarily represent those of the organization.

RANJEET S. MUDHOLKAR is working with Financial Planning Standards Board India (FPSB India) in the capacity of Principal Advisor and Member-Board of Directors. FPSB India is the sole marks licensing authority for the CFP marks in India, through agreement with U.S.-based FPSB Ltd.

©Entrepreneur May 2011