India is witnessing an upsurge of freelancing, and as such, it becomes essential to comprehend the tax implications imposed on such individuals. Self-employed people, unlike paid employees, have to deal with taxes, and this involves keeping account books and knowing when an audit is required. Freelancers should be aware of section 44AA of the Income Tax Act, as it explains what records to keep and whether a freelancer can expect to be audited. This blog will describe these requirements, discuss other sections, such as Section 44ADA, and offer ideas for the taxes.
Introduction to Section 44AA and Its Importance for Freelancers
Section 44AA states that the below-mentioned classes of persons shall maintain the volume of accounts if their income exceeds a prescribed limit. This is particularly important for freelancers because many of them perform services comparable to those that the act covers. The idea behind such a requirement is to promote the proper filing of revenue and expenditure, which may help the tax department verify the outlined income.
Lack of accounting and tax knowledge means that freelance workers might end and underpaying for tax, which is not good for them as they will be penalized for it. Therefore, independent contractors whose income exceeds the exemption limit must clearly understand section 44AA to avert unnecessary run-ins with the taxman.
Who Needs to Maintain Books of Accounts?
Section 44AA provides that individuals and companies belonging to a specific list of categories, including freelancers, should maintain the books of accounts if their income or turnover exceeds a particular limit during the year. Here’s how the rule breaks down:
- Specified Professionals: Starting from 01/04/2018, the following classes of persons are required to maintain books if gross receipts are more than INR 1,5 lakh in a financial year: Any person who is a ‘freelancer ‘ and engaged in legal, medical, engineering architecture, accountancy, interior decoration, technical consultancy or in any other professions as notified.
- Non-Specified Professionals (Other Freelancers): The requirement applies to all other freelancers that do not fall into these specified professions if their gross earning exceeds INR 2.5 lakh or gross turnover is more than INR 25 lakh in a financial year. It helps during the ITR-1 filing every year.
These rules in effect, mean that freelancers who exceed these thresholds need to keep certain records so as to remain compliant with the tax authorities. Hence, freelancers who earn below the stated income or turnover may not be under legal obligation to keep formal accounts, but record-keeping practices are advisable.
What Records are Required for Audit purposes?
For freelancers needing to maintain accounts, here are some key records required under Section 44AA:
- Cash Book: The daily sales and purchases of cash.
- Journal: A journal may be mandated, at certain times, to produce more comprehensive entries for each particular transaction.
- Ledger: Compiles all financial operations in different accounts, income as well as expenditure accounts.
- Receipts and Payment Vouchers: Some examples of source documents are: Money documents include receipt vouchers and those that acknowledge receipts of incomes, payment vouchers, and include vouchers for payments for expenditures.
- Copies of Bills or Invoices: Original and copies of generated invoices for services and goods sold to clients as well as invoices for expenses incurred, should be retained by freelancers.
The records enable freelancers to monitor the money they are making and the amount they are spending, making it easier for them to determine their financial status. It also makes income tax calculation easier since freelancers can offer real financial details instead of extending guesses.
Provisions of Section 44AA Relating to Audit
None of the freelancers currently need an audit. However, they are subjected to an audit if they fall under the guidelines of the Income Tax Department. These include:
- Turnover Limits: Every freelancer who crosses INR 1 crore of turnover needs to get his books audited. For those who have chosen to be subjected to presumptive taxation, the maximum amount is INR 2 crore.
- Income Declaration Under Presumptive Taxation: Freelancers, if they declare income less than the presumed income under Section 44ADA and earn more than the limit of basic exemption, there will be a need for an audit.
- Avoiding Non-Compliance Penalties: Failure to do so involves penalties under section ‘Over’ sections 271A and 271B, which propose 1.5% of total sales or turnover or INR 1.5 lakhs, whichever is less.
Section 44ADA and the Presumptive Taxation Scheme
Specifically, Section 44ADA rules for professional taxpayers on regular tax calculation and allows them to take 50% of gross receipts as taxable income to minimize the chances of an audit. To be eligible, freelancers need to meet the following conditions:
- Profession Type: Specifically designed for designated employees, including lawyers, engineers, architects, and consultants, among others.
- Income Limit: This scheme is available for professionals up to gross receipts of INR 500000/-.
As per the Indian Income Tax Ordinance Section 44ADA freelancers can declare up to 50 percent of their total receipts as their income and need to pay taxes as per the received amount only. This presumptive scheme can help freelancers lessen their administrative concerns as much as it can help them lessen the computation of taxes needed to be paid. However, if they declare an income of less than 50 percent, then a taxpayer is subjected to an audit.
Practical Tips for Freelancers on Tax Compliance
Here are some essential tips for freelancers to ensure compliance and streamline tax filing:
- Keep Digital Records: Provide for bookkeeping by preserving records of revenues, expenditures, and bills through the use of computer aids. There are many programs of accounting, with easy to use interfaces that are suitable for freelancers.
- Separate Personal and Business Finances: It is also advised to open a different bank account to have records of your income as well as expenses you get/ have for freelancing.
- Track Business Expenses: Categorically and dutifully document expenses for software subscriptions, internet connection, professional courses, and office equipment because they will decrease your taxable income.
- File Regularly: You may not need to keep your formal accounting records or book or file tax each year to establish compliance records.
- Consult a Tax Advisor: Due to the various factors involved in compliance with tax laws, consult a tax attorney to advise on Section 44AA and Section 44ADA to make the right decision on your freelancing business.
Adopting such practices, freelancers are safe from penalties and more informed of the taxes they are bound to pay.
Also Read: GST on Freelancers – Applicability & Rates
Section 44ADA vs. Regular Taxation
It is mandatory to understand when it is possible to use Section 44ADA and when an individual should use regular taxation as a freelancer becomes critical.
According to Section 44ADA, One can claim 50% of turnover or gross receipts without including purely incidental sales as his turnover for that year, and his income is taxed as per the IT slab rates. This presumptive scheme is most convenient for persons with lower overhead expenses because they do not need to maintain detailed records of their income and expenditures, as would be called for by standard tax laws.
However, freelancers with higher business expenses spending money on tools, advertising or office space will find a better favorable position in regular taxation. Under a normal tax regime, the freelancer can take an actual deduction from the gross receptionists, which may ultimately lead to a small taxable income. Here’s a quick example to clarify:
- Presumptive Scheme (Section 44ADA): A freelancer earning INR 30 lakh of gross receipts would claim INR 15 lakh (50%) as the income under section 44 ADA made for taxation standard depending upon the income tax slabs.
- Regular Scheme: For instance, if the actual TP-INR of a freelancer is INR 20 lakh, their TP-INR would be INR 10 lakh (gross receipts minus actual expenses), presumably making their taxation more beneficial to them than under the presumptive scheme.
The option of Section 44ADA and normal taxes depends on how much freelancers usually spend. For example, Freelancers generating more than 50% of gross receipts as expenses may be better off applying the regular tax scheme.
Also Read: Income Tax Return (ITR) Filing Tips for Individual and Business for the New Financial Year
Penalties for Non-Compliance with Section 44AA and Related Provisions
Failure to Maintain Books of Accounts (Section 271A)
- Penalty Amount: Up to INR 25,000
- Explanation: For instance, if a freelancer who is legally bound to keep books of accounts fails to do so, then he or she may be subjected to penalties. This is particularly important for freelancers whose income or turnover crosses some threshold level (INR 2.5 lakh in cases where no class of profession is categorically stated, and INR 1.5 lakh where the freelancer is required to state the class of profession distinct from others, for example, a consultant, architect, etc.).
- Impact: This penalty shows one of the most important aspects of record-keeping. Lack of books eases the preparation of returns by freelancers and checks by the authorities hence raising the possibility of triggering the alarm and leading to more scrutiny.
Failure to Get an Audit When Required (Section 271B)
- Penalty Amount: The penalty is 5% of total turnover or gross receipts or an amount equivalent to one hundred and fifteen thousand and five hundred only.
- Explanation: Freelancers are required to go for an audit in the instance they receive income more than specified limits of income or turnover and/or if they declare income that is lower than allowed under presumptive taxation schemes like Sec 44ADA of the Income Tax Act. If a freelancer fails to perform the audit to expectation, he/she suffers some losses.
- Impact: This penalty brings into the fray matters of record-keeping. Lack of books affects freelancers when preparing their returns as well as authorities as it may trigger issues of audit or further inquiry.
Penalties for Filing Incorrect Income (Under-reporting or Misreporting of Income)
- Penalty Amount: Another sanction is a penalty of 50% of the tax attributable to under-reported income.
- Penalty for Misreporting: Misreported income is penalized at 200 percent of the tax that would otherwise be payable.
- Explanation: Under-reporting means that freelancers declare a lower income received than the actual income, while misreporting is when freelancers invent some expenses that are not eligible under the costs of a freelancer. Both can lead to substantial penalties, even more for intentional distortions, as the Income Tax Department views it as a tax evasion effort.
- Impact:
- These penalties act as a preventive measure to eliminate cases of unstandardized reporting and put pressure on freelancers to be honest in tax returns. Misreporting or under-reporting an income also creates a bad rapport when dealing with a freelance tax authority, and the freelancer stands a high chance of being audited in the future.
Also Read: What are The Consequences of Incorrectly Claiming an Exemption?
Interest on Unpaid Tax Liability (Section 234B and Section 234C)
- Section 234B (Non-payment of Advance Tax): 90-100% or 1% interest per month on unpaid tax if at least 90% of total tax liability is not paid by the end of the year.
- Section 234C (Delay in Advance Tax Payment): A penalty rate of 1% per month on parts of quarterly installments received after the due date.
- Explanation: Filers of quarterly income tax returns are required to make payment of advance tax in quarterly installments if their tax liability exceeds ten thousand Indian Rupees. The inability to meet these objectives leads to Section 234B Interest Penalties as well as Section 234C Interest Penalties.
- Impact: Such interest charges motivate freelancers to budget for advance tax payments; they are used instead of paying all the taxes that are due at a given month in that month, and the taxes are spread throughout the year. Failure to meet an advance tax date can cause cash flow problems because as every year accrues, interest will build up the total amount of tax payable.
Conclusion
This article first examines the troubles that freelancers face when aliens with regard to tax compliance, then outlines the details of Section 44AA of the Income Tax Act of India. However, the following matters should be kept and understood so that freelancers can have an easy time with their taxes:
- The accounts for which must be maintained
- The conditions that make the audit to be conducted
- Depending on the freelancer’s eligibility, Section 44ADA can be used.
It may be seen that compliance which has been done that way, is in the right direction and may not attract penalties in the future and at the same time establish the company for future business opportunities.
Keeping records for independent workers to be free from penalties; for others who earn over the exemption limits, keeping records is more than meeting regulatory requirements; it is best for evaluating your independent business’s financial performance.
