Yes, freelancers are indeed liable to pay taxes in India.
The first few months as a freelancer is tough. You have to learn or acclimatise to a lot of new things — working alone, marketing yourself, maintaining accounts, and so on. And to add to that, you have to take care of your tax liabilities too. Life’s a bit unfair, eh?
A lot of people find taxation to be overwhelming. There is a notion that it is too complicated and convoluted. However, the reality is that, if you have an excellent grasp of the basics of freelance taxation, you should be safe. You would be able to do everything on time and ensure that you are tax compliant.
In this article, we will help you understand who is considered as a freelancer in India, what the basic income tax laws are, what is ‘freelancing income’, and more.
Who is considered as a freelancer?
According to the Income tax act of 1961, there is no separate legal definition for freelancers. They fall under the broad term ‘self-employed’.
A self-employed individual is someone who is not permanently employed by a company. They are not the employees of the company and do not receive any of the benefits that a permanent employee would receive. They are hired on a contract basis for a stipulated period or till the completion of a specific project.
It doesn’t matter whether you are a doctor, a developer or a content writer, if you are not on the payroll of the company, you will be considered as a self-employed individual. Therefore the income you earn from freelancing engagements will be treated as ‘Income From Profit & Gains of Business & Profession’.
Fundamentals of Income Tax
Although taxation is a massive field with its own terminology, laws, and processes, you don’t need to learn it all unless you are thinking about becoming a Chartered Accountant.
As a freelancer, your focus should be on learning the basics of taxation and certain aspects that apply to you. Once you get a hang of things, it slowly becomes part of your routine, something that you don’t have to worry about actively.
To help you with that, we’ve listed down certain basic income tax terms and processes that freelancers must know:
1. Financial year and assessment year
For starters, Indian tax laws don’t follow the calendar year. In our country, financial books and accounts are prepared for the period from April 1st to March 31st. This period is called the accounting year and is used for computing tax too.
In taxation, the accounting year in which you earn your income is called Financial Year. The following accounting year is called the Assessment Year; it is when you have to file tax returns for the income you earned in the previous year (Financial Year).
Confused? Hope this example clears things up: if you have received a total of ₹ 10 lakhs from all your clients during the period April 1, 2018 – March 31, 2019, you have to file the return and pay tax for the same during April 1, 2019 – March 31, 2020. The former is the financial year, and the latter is the assessment year.
You are an assessee if you are liable to pay taxes on the income earned by you for a particular financial year. Besides that, any individual who is supposed to make payments to the government in the form of interest or penalty or anybody who is entitled to a tax refund under the IT Act is an Assessee.
3. Taxable income
As a freelancer, your gross income is the sum of all the payments (however small or significant the amount is) you received from your clients in the last financial year. From that, you are allowed to deduct the expenses you incurred while working on these projects. This calculation is done under the head, Profit & Gains of Business & Profession.
After that, add the income you earned under other heads of the Income Tax Act, namely salary, house rent, interest, dividend, and more. The resulting amount is your Gross Taxable Income.
Next step is to find out if you are eligible for any tax deductions under Chapter VI-A of the Income Tax Act. Add that all up and deduct that figure from your Gross Taxable Income, voila that’s your Net Taxable Income.
Here’s an example:
4. Tax Slab
Now that you know how to find your net taxable income, the next step is to find out the tax slab that you fall under. Income Tax Slabs prescribe the rates at which your tax payable is computed on your net taxable income.
Here are the rates for the Financial Year 2018-19:
You won’t have to pay the surcharge if your net taxable income is less than 50 lakhs. But, you will have to pay health and education cess at the rate of 4%.
Note: The health and education cess are computed on the sum of income tax and surcharge.
5. Tax Deducted at Source
As per the Income Tax Act, clients are required to deduct 10 per cent as TDS (Tax Deducted at Source) on every payment they make to the freelancer for the service they provide. If you don’t give the clients your PAN number, the rate goes up to 20 per cent. Furthermore, you won’t get tax credits for such deductions while you file your return.
While computing your final tax due, be sure to deduct the TDS that has already been cut by your clients. To find that amount, you can view or download your FORM 26AS from the Income Tax Website. In case you have paid more in TDS than, you can claim a refund too.
6. Expenses allowed as deductions
Freelancers are permitted to deduct certain business expenses from their Gross Income for tax purposes. It could be anything from your cab fare to your client’s office to the cost of software you purchased for work-related purposes.
The bottom line is that the expenses must be directly related to your job. To claim these expenses as deductions, you need to produce valid supporting documents — bills, receipts, and so on. Moreover, you need to maintain books of accounts if you want to claim these as expenses.
If you don’t want to maintain books of accounts or offer valid proof for your business expenses, opt for Presumptive Taxation Scheme under Section 44ADA. It allows you to claim 50 per cent of your Gross Annual Income as expenses. You can then deduct it from your income and pay taxes only for the remaining 50 per cent.
However, this is only applicable to individuals whose turnover during a financial year is less than ₹ 50 lakhs.
7. Sources of income
According to the IT Act of 1961, there are five heads of income. They are: a) Income from salary, b) Income from house property, c) Profits and gains from business and profession, d) Income from capital gains (profits from dealings in land, securities, and jewellery), and e) Income from other sources (interest on bank deposits and securities, dividend, royalty income, winning on lotteries and races).
Every source of income you have is classified under one of these categories. The income you earn from freelancing is computed under the head Profits and Gains from business and profession. If you are a full-time employee who is freelancing on the side, you will have to add your income from salary too while computing your tax liability.
8. Deductions under Section 80 and more
Every taxpayer is entitled to tax deductions provided you satisfy the prescribed conditions. This way you will be able to reduce your tax burden. Some of these deductions require you to invest in certain financial products like insurance, savings bank, loans, and more. While some others are based on your contribution to certain organisations.
Here’s a quick overview of tax deductions available to you:
9. Advance tax
Instead of paying your taxes all at once, the government lets you pay your taxes instalments. This is compulsory if your expected tax liability is more than ₹ 10,000. As a freelancer, your income might vary from month to month. So, set an average based on your current contracts and use that to compute your expected tax liability.
The schedule for payment of advance tax:
If you are opting for the presumptive taxation scheme, you should pay advance tax before March 15th.
10. Tax rebate
To protect people who belong to the lower income categories and reduce their tax burden, the lawmakers came up with the idea of Tax Rebates. It falls under Section 87A of the IT Act.
According to the present laws, if your income is less than ₹5,00,00, you are eligible for a rebate of ₹ 12,500. Besides that, if your taxable income is less than ₹3,50,000 there shall be an additional tax rebate of ₹2,500.
As a freelancer, you might be overwhelmed at the prospect of doing all this by yourself. Don’t be. The key is to stay proactive, keep a note of all the critical dates, stay abreast with policy changes, and ensure you do everything on time. And you are good to go.
This article is the first in our series ‘Freelancer taxes simplified‘. Next up, we will be discussing when and how to file your taxes.
Note to readers: The information presented in this article is for reference only. The rates and rules may change with government policies. So, it is always best to consult a Chartered Accountant or a Tax Professional for practical purposes.