My latest at Yahoo: The Invisible Benefits of Starting Up.
Starting your own business seems to be the fashionable thing to do nowadays, what with so many early stage funds, incubation companies and startup events in every city. But it doesn’t only take an “ecosystem” to help startups click, they get the kind eye from the taxman as well.
Tax benefits help people who set off on their own. As an employee, you’re at the bottom end of the tax chain. Your equation goes somewhat like this:
Salary -> Pay tax at source -> You get what’s left -> You spend on stuff
Some exemptions are available of course, like an 800 rupee per month travel allowance, a certain part of your rent and certain medical expenses. But for a consultant or a business the equation is slightly more complex:
Income -> Minus small amount of tax -> Business expenses -> Taxes paid in stages -> You spend on personal stuff.
“Business expenses” means what you can write off what it costs to have earned your income. That means internet bills (even at home), mobile phones, the cost of your car depreciated over time, petrol bills and so on. Of course, you will need to segregate what you spend for personal use versus official – but consider this: As a salaried employee, when you pay your broadband bill, travel in your own vehicle on a business visit, or buy a vehicle or laptop, you will have to use your post-tax money.
Effectively: If you’re an employee, you pay tax and then spend money; if you run a business or are a consultant, you get to spend the money and then work out what your taxes will be. Some taxes are deducted at source – usually 10% – but this offsets your eventual tax liability.
While it’s true that the income-tax department will catch you if you declare something out of the ordinary (like attempting to expense a toy-train as a business expense), there is a lot more you can charge as expenses that you ordinarily will not demand from an employer – from magazine subscriptions to the new iPad.
Interestingly, businesses – including consultants – have to pay tax in phases, not every month. The idea is to pay some part of your taxes in June, September, December and March. This gives you more freedom than having it deducted every month, and you might choose to spend more on the business instead of paying taxes. In addition to income tax, for most consultants, you need to charge an additional 10% as service tax, but that can be offset against service tax paid for input services (like those charged in telephone bills). Try getting that back, as an employee.
Businesses are also allowed to offset past losses. That means even if you spend more than you earn today, you will be allowed to set future income off against this loss. Employees get no luck from the taxman if they remain unemployed for a few months – fresh income attracts fresh taxes with no memory of the unemployed period.
The flip side: While the taxation gap may sound big, as you grow in an organization, companies may go an extra mile to transfer your expenses to themselves instead. Cars are hired and provided to employees, houses rented in company names and furnishings bought in the name of the company. The tax department has addressed a number of these gaps with a notification, though, and even then, there is the conundrum of what happens to perquisites if one resigns. (“Do I need to vacate the house I live in?”)
In India, companies tend to desire hiring employees full-time rather than employ consultants oroutsource work, which has come from a long history of employee costs being a disproportionately small expense. But as salaries go up and companies get more efficient, we are likely to see more independent consultants or startups emerge in the space. Already, a business can get accounting, legal, housekeeping, web presence and other services outsourced, where most of this would be done in-house just 10 years ago.
Building an asset
The main benefit of owning a business is that you build yourself an asset. That means something that you own. As an employee, you build knowledge. But all the benefits of the code you write, the brands you build, the people you hire – are lost when you shift from one job to another. The future impact of what you build today is lost if you lose your job or retire. As a business owner, you get to retain some or all of it, as a stake in the business. If you hire smarter people and make yourself redundant, you still get a piece of the business as people better than you grow it further without your effort. Building an asset at work is as good as investing in stock markets or bonds; it helps create a future income stream. In fact, it’s better than a stock – you get to shape the course of what makes you the money.
It is tempting to classify some such work as “passive” – like writing a book in your spare time and raking in royalties forever. But people who write books seem to vehemently disagree – either they spend disproportionate amounts of time writing, or they make little or no real income from the books, save a few and rare success stories. Creating a business is hardly passive. You need time to nurture it, run it, and take it to a point where it needs no more of you – and don’t let anyone make you believe otherwise.
The concept of building an asset for the longer term makes starting a business less risk than it sounds. The often quoted fact is that 99% of startups fail. But 99% of people who play cricket don’t become as good as Sachin Tendulkar; and fewer than 1% of people who write the CAT exam get into an IIM. Statistics alone don’t determine an outcome; especially not where you have the power to influence it.
Where owning a business doesn’t help:
Starting up on your own has a charm of its own, but the thrill wears off in a few years. What remains are benefits of taxes-after-expenses and the building of a long term asset; to me, these should really be what attracts people to starting up rather than the shallow feeling of importance that is attributed to being your own boss or (blech) attending board meetings. But in the days of sansanikhes khabar, you can’t but expect emotions to override everything.
* I don’t know what that means.