Understanding Tax on Consultancy Services: A Detailed Guide

Consulting services, from financial advice to IT support and management consulting, are vital components of many businesses. Understanding the provisions of the Income Tax Act of 1961 that apply to the services that consultants provide is crucial. Consultants need to know the rules outlined in the Income Tax Act 1961 to plan taxes effectively. The Income Tax Act's Section 194J deals with Tax Deducted at Source (TDS). It applies to payments made for technical services or professional fees and is a very effective way to collect taxes. It ensures effective tax collection for the government while relieving taxpayers of the burden. In this article, we will share a detailed overview of tax on consultancy services.

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Table of content

Who is a Consultant?

Tax Applicability on Consultancy Services

Tax Rate Applicable on Consultant

ITR to be Filed by Consultants

TDS Applicable to Consultants

Tax Benefits for Consultants

Conclusion

Most Asked Questions

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Who is a Consultant?

There is no clear definition of "consultant" or "profession" in the 1961 Income Tax Act. Nonetheless, the definition of "profession" in Section 2(36) and the explanation of Section 194J provide some insight.

Professional Services under Section 194J of the Income Tax Act: Legal, medical, engineering, architecture, accounting, technical consulting, interior design, and advertising are examples of professional services. Additionally, they cover professionals listed by the CBDT, including authorized representatives, movie artists, secretaries, IT workers, athletes, and more.

Fees for Technical Services under Section 194J of the Income Tax Act: "Fees for technical services" include technical, managerial, and consulting services; they do not include salary-related payments.

• Technical Services: These call for technological know-how or technical proficiency.

• Managerial Services: The services comprise the knowledge and skills required to manage and oversee a client's company.

• Consultancy services: These help clients with their business decisions and plans by providing advice and direction.

Tax Applicability on Consultancy Services

The regular provisions of the Income-tax Act, of 1961, which apply to individuals, apply to the taxation of a consultant's income. The following is the tax structure that applies to consultants:

• Presumptive Taxation Scheme: This scheme provides simplified tax filing for consultants with yearly gross receipts under Rs. 50 lakhs. 50% of gross receipts is the estimated profit under presumed taxation. This method simplifies the tax filing process and lessens the burden of compliance. For consultants who maintain minimum cash transactions throughout the year (less than 5% of total gross receipts), the applicability limit rises to Rs. 75 lakh.

Note: You must choose presumed taxation if your gross receipts are less than the designated thresholds. Consultants file their income taxes by standard procedures if their income surpasses these thresholds (Rs. 50 lakh or Rs. 75 lakh, depending on cash transactions).

• The basic exempt limit for individuals is Rs. 2,50,000 or Rs. 3,00,000. Accordingly, income tax is not due on the first Rs. 2,50,000 or Rs. 3,00,000, as appropriate, of their income.

The old and new tax regimes have different Section 87A rebates available:

• Old Regime: A Rs. 12,500 rebate is available to consultants with taxable incomes up to Rs. 5,00,000.

• New Regime (Applicable from Assessment Year 2024-25): Consultants who earn up to Rs. 7,000,000 in taxable income are eligible for a Rs. 25,000 rebate under the new regime.  

• Previous Tax System:

• Consultants can claim deductions under sections such as 80C, 80D, 80E, and others to lower their taxable income. Their net taxable income is less as a result. 

• Consultants making up to Rs. 5,00,000 can also take advantage of a Section 87A rebate, which reduces their tax obligation by Rs. 12,500.

• New Tax System (Effective from 2024–2025 Assessment Year):

• With a few notable exceptions, consultants who choose the new regime would not be eligible for more deductions. Section 87A of the new regime provides a larger tax refund.

• For consultants earning up to Rs. 7,00,000, this Rs. 25,000 rebate can effectively eliminate their tax obligation. For lower-paid consultants, this offers substantial tax relief.

Therefore, if a consultant chooses to use the new regime under the Act, their entire income would be exempt from income tax if their income in a fiscal year is up to Rs. 7,00,000. It gives consultants with comparatively lower incomes some relief and encourages them to engage in economic activity by ensuring they are not affected by income tax obligations.

Tax Rate Applicable on Consultant

Revenue from consulting services is subject to taxation at the consultant's applicable slab rate. For income obtained through consulting services, there is no distinct tax rate.

ITR to be Filed by Consultants

When choosing the presumptive taxation scheme, consultants use ITR-4 to file their Income Tax Return (ITR). Consultants who do not opt for the presumptive taxation scheme are required to use ITR-3 to file their ITR.  

TDS Applicable to Consultants

Tax must be withheld at the source when residents are compensated for professional or technical services, according to Section 194J. These are the relevant TDS rates:

• The tax deduction for professional consulting is 10%.

• The tax deduction for technical consulting is 2%.

Unless they are obligated to audit their books under Section 44AB, TDS under this section does not apply to individuals or Hindu Undivided Families (HUFs). The amount paid or payable to a resident in a fiscal year that surpasses Rs. 30,000 necessitates the deduction of TDS under Section 194J. This threshold includes the total amounts the payer has credited, paid, or is anticipated to credit or pay the payee during the fiscal year.

Nonetheless, you must seek the assistance of a qualified tax consultant, as they have the skills and understanding to handle the intricacies of tax regulations and guarantee that your tax return is precise and tailored to your unique financial circumstances. Speaking with a tax expert can help you maximize tax savings, minimize liabilities, and steer clear of mistakes or audits by offering individualized advice based on your unique situation.

Tax Benefits for Consultants

• Your clients, spending limit, and projects are all up to you. 

• Receiving your pay check credited to your bank account does not require waiting until the end of the month. Most clients make payments as soon as the project is submitted.

• Working from any location is an option. You don't have to worry about being on time or traveling to work. But ensure you finish the assigned task by the deadline.

• You are free to work whenever it is most convenient for you. 

• Being a consultant requires little financial outlay. A smartphone and a desktop or laptop are easy places to start. 

• You are eligible for several tax benefits that a regular employee is not.

• Reduced TDS rate: If you are an independent consultant, you will have a flat 10.3% tax deduction at source. However, for a regular employee, TDS is withheld from their salary based on their tax slab.

• Option to minimize total outgo: Another significant advantage is the freedom to optimize income and expenses to lower your overall tax outgo. Many businesses neglect to create a suitable compensation plan for their regular staff. Employees cannot maximize their tax outflow and ultimately pay higher taxes.

• Benefits of being a consultant are easily accessible: Being a consultant allows you to deduct business expenses such as 

• Gasoline 

• Auto loan interest

• Auto insurance 

• Charges for stationery 

• Courier service

• Internet fees 

• If you work from home, rent 

• Bills for phones 

• Driver's pay 

• Maintenance fees for devices such as laptops and smartphones 

• Travel expenses for work, etc.

• Obtaining tax deductions and claiming tax benefits is simple because, unlike regular employees, consultants are not dependent on their employers to do so. You don't need to depend on others to take advantage of your tax deductions and benefits; you can do it alone.

• Zero tax liability: You are exempt from paying taxes on your income if your yearly income is less than or equal to Rs. 20,000.

Conclusion

Working autonomously, organising and managing resources, and not having to be in an office are all benefits of being a consultant. However, you will be giving up the comfort of a steady salary and job security. The risk of an independent business is present in consulting arrangements. At the same time, you must know about the applicability of taxes on the services you provide as a consultant. 

FAQ

Q1. What is the threshold limit for opting presumptive scheme of taxation for a consultant?

Section 44ADA is only available to consultants with yearly gross receipts under Rs 75 lakhs (the previous threshold was Rs 50 lakh as of April 1, 2024).  

Q2. Can a consultant claim expenses like internet, rent, travelling, etc. under Section 44ADA?

A consultant who has chosen the Presumptive Scheme must report 50% of their gross income as income in line with Section 44ADA. Without accounting records, it is possible to report profit as a fixed percentage of receipts. As a result, the consultant can't make any more expense claims. You can still claim Chapter VI-A deductions for LIC subscriptions and Mediclaim premiums.

Q3. Is service tax applicable to consultancy?

In addition to income tax, consultants must pay service tax. They are sometimes free from service tax. For example, the tax is not liable if a person works abroad or the payment is made in a foreign currency, the tax is not liable.

Q4. What is the TDS rate for consultancy services?

Under Section 194J, professional fees, technical fees, and royalties are typically subject to a 10% TDS deduction.

Q5. What is the limit of tax audits for consulting services?

If the total sales, turnover, or gross receipts of a taxpayer's business exceed Rs. 1 crore during the fiscal year, the taxpayer undergoes a tax audit. This threshold is Rs 50 lakh unless 95% of their receipts are in digital format, in which case the threshold is Rs 75 lakh.

Q6. Which is better, consultant or employee?

Your unique situation will determine the best course of action for you. You might do better as a consultant if your business expenses are high. However, you might be better off as a salaried employee if you would rather have a more straightforward tax filing process.

Q7. How to calculate income tax for consultants?

The following tax structure applies to the consultants: Scheme for Presumptive Taxation: This program provides simplified tax filing for consultants with yearly gross receipts under Rs. 50 lakhs. 50% of gross receipts is the estimated profit under presumed taxation.

Q8. Do consultants have to pay GST and income tax?

When your yearly income surpasses Rs. 20 lakh, you must obtain a GST registration number as a consultant. Because you must compute your monthly GST payment, determine how much input tax credit (ITC) you are eligible to receive, and submit returns regularly, this improves tax compliance.

Q9. What is the TDS deduction limit under Section 194J? 

TDS must be withheld under Section 194J if the annual payment for professional or technical services exceeds Rs. 30,000.