As trading and investing become more accessible day by day, many people are participating in the stock markets.
Now with this, many people are also earning profits and they are considering setting up an LLP or Sole Proprietorship for potential tax benefits.
Let us evaluate these options in terms of both compliance and taxation.
Sole Proprietorship
Trading in segments like F&O or intraday is considered a business activity.
Hence, even if you do not set up a separate entity, your trading income will be considered business income and taxed as per slab rates.
Further, in both these cases, you will be able to claim business-related expenses. Hence, forming a separate sole proprietorship may not achieve much when taxes are considered. Taxes will be applicable at the same rate and expenses can be claimed even without forming a separate entity by just disclosing trading as your business income.
Here, the tax will be applicable at slab rates, which are different in old and new regimes.
Also, surcharge will be applicable if your income exceeds ₹50 lakhs. The surcharge rates are as follows:
10% of Income tax if total income > Rs.50 lakh
15% of Income tax if total income > Rs.1 crore
25% of Income tax if total income > Rs.2 crore
37% of Income tax if total income > Rs.5 crore
In Budget 2023, the highest surcharge rate of 37% has been reduced to 25% under the new tax regime.
So let’s say you make great profits and your income from trading business crosses ₹5 crores. In this case, the highest surcharge rate in the old regime would be 37% and the effective rate is 42.744% including 4% cess. However, under the new regime, the maximum surcharge is 25% making the effective rate 39% including cess.
Setting up an LLP for trading
First and foremost, the primary objective of an LLP cannot be trading, it could be a secondary objective. Now, if you want to set up an LLP, there are legal formalities that you will be required to fulfil.
In the case of a partnership or LLP, the tax liability will be calculated as follows:
The income earned by an LLP is taxed at a flat rate of 30%. Moreover, if the income exceeds ₹1Cr, a surcharge of 12% will also be applicable.
So, if we were to sum this up, if your LLP/ partnership firm earns an income of more than ₹1Cr, the net effective tax rate would be 34.94% including cess.
Now, one might argue that the effective tax rate in the case of an LLP or a partnership firm is lower than that in the case of a sole proprietorship.
Well yes, while there is a difference of approximately 5% in effective tax rates, setting up an LLP comes with various complications, primarily that you can’t set up trading as the primary objective of the LLP.
Now, this complication would not arise in the case of a partnership. You can form a partnership, but mostly within your family or close friends. Moreover, you can’t actively seek capital from outsiders to manage as once you start doing that, you’ll have to get an AIF registration.
Based on the above information, you can pick the better route for yourself. Make sure to consult with your legal advisor too.
If you have any further queries, ask ‘em below!