Importance of optimizing income tax and loan goals

business loan and income tax

Income tax return filing is one of the top priorities for every business intending for proper compliance. The importance of income tax filing is well known by businessmen who wish to expand their business with bank financing. The best practice for income tax filing is not tax saving alone, but also making the best suitable for the bank loan.

Optimizing Income tax return filing with financing goals

The income tax return is considered one of the primary documents for a business loan application, it serves as proof of income earned by the business. Better net income results in better loan appraisal and credibility, and optimize tax saving goal with financing goal by using a better provision that will enhance loan appraisal and loan eligibility. The income tax act had given relaxation to small businesses to file an income tax return under the presumptive income scheme, so in this case a business owner who aims only to save tax will declare only 8% or 6% under the presumptive taxation scheme u/s 44AD. Consider a situation of a good business earning an actual net profit of 15 % and declaring only 8% as net profit as per 44AD will lack credibility due to low net total income.

Example :

Year 1 : 

Turnover: Rs.50,00,000.

Net profit as per Section 44AD – 50,00,000 X 8 % – 4,00,000.
Actual Net profit  @ 15 %                        – 7,50,000.

Year 2 : 

Turnover: Rs.6,00,000.

Net profit as per Section 44AD -,00,000 X 8 % – 4,80,000.
Actual Net profit  @15%                          – 9,00,000.

Year 2 : 

Turnover: Rs.75,00,000.

Net profit as per Section 44AD – 50,00,000 X 8 % – 6,00,000.
Actual Net profit   @ 15%                       – 11,25,000.

While calculating loan eligibility, banks generally calculate the average income for the last three financial years below

Average income as per option 1 (using maximum benefit under 44AD)= (4,00,000 + 4,80,000 + 6,00,000) / 3 = Rs.4,93,333.

Average income as per option 2 (with actual income)= (7,50,000 + 9,00,000 + 11,25,000) / 3 = Rs.9,25,000.

So comparatively you can see the difference in the two options, suppose a bank policy is to provide a loan with an EMI payable capacity of 40 % of the average total income then under option 1 maximum EMI payable capacity will be Rs.197333 per annum (Rs.4,93,333 X 40 %), whereas under option 2 it will be Rs.370000 per annum  (Rs.9,25,000 X 40 %).

What is the solution to solve this?

As a businessman, you should have better knowledge about your business, so it is your responsibility to decide whether there will be any requirement for a business loan in the next three years, if you consider a loan is a priority for business development then choose declaration of maximum income under option 2 so that your eligibility of loan amount will be considerably higher compared to option 1. Be prepared to pay enhanced taxes at the end of the financial year else you can deposit tax regularly each month to avoid a cash flow crunch at the end of the year, and it will also give a boost to declare high income.

Concept of higher interest in link to average Income

As we discussed above regarding the eligibility percentage of 40% of some banks, there will also be banks that provide 60 % of average income at a higher interest rate. This is the main trap of banks and most businessmen fail to analyse this fact, businessman with option will go for the bank providing a 60 % loan with a higher interest rate, and businessman with option 2 will go for 40 % eligibility and pay lesser interest for same loan amount for a same number of years. If we fail to pay the right amount of tax, we will end up paying more than double the tax saved in the form of higher interest.

Chain process of business growth

The right business will develop its business with a line of credit facilities and develop its business over years rapidly, and it will also have improved cash flow because of reduced EMI. A business that is focused only on tax saving end up paying a major portion of profits towards higher interests and again paying low taxes and rapidly avails loans with higher interest rates. So we can conclude this section by saying focus on long-term growth goals by availing low-interest rates.

Wide choice of financial institutions for peace of mind

If you have solid financials most banks will welcome you with a red carpet for loans with reduced interests, nationalized banks which are having conservative approval policies will provide loans for good financials. If you are getting loans from nationalized banks, it will be very beneficial in terms of other charges and the EMI collection process. Loans from nationalized banks will give you peace of mind in times of cash crunch because they won’t pressure you much compared to private banks in case you fail to pay even one EMI.