Advance tax payment is an integral part of the taxation policy in India. It compels taxpayers to make estimates of their income and pay advance taxes for a fiscal year. While as much as it helps the government in recovering tax, it affects one’s or company’s cash flow massively. This article discusses the effect of advance tax payment on cash flow, the way it crosses paths with instruments like tax-saving FD interest rates.
What Is Advance Tax Payment?
Advance tax payment is the payment of your income tax in installments during the year, rather than year-end payment to pay your dues. It is mandatory if your overall tax liability is more than ₹10,000 in a year, as per the Income Tax Act, 1961. It is for salaried individuals, freelancers, business persons, and companies whose income is not subject to the TDS.
The advance tax payment date is segmented by the government as follows:
1. 15th June: 15% of the tax liability.
2. 15th September: 45% of the tax liability.
3. 15th December: 75% of the tax liability.
4. 15th March: 100% of the tax liability.
Late payment of advance tax incurs a penalty and interest under Section 234B and 234C of the Income Tax Act.
Cash Flow Impact of Advance Tax Payment
One of the most glaring consequences of advance tax payment is that it drains your liquid funds, which could else be utilized for working capital, investment, or as a precaution in some emergency situation.
Cash Flow Staggering
Let us assume you have to remit ₹3,00,000 towards taxes on a particular financial year based on your estimated income. Instead of remitting it at the financial year end, you stagger your payments as shown:
– 15th June: ₹45,000 (15% of the tax liability).
– 15th September: ₹1,35,000 (45% of the tax liability).
– 15th December: ₹75,000 (75% aggregate tax liability).
– 15th March: ₹45,000 (100% aggregate tax liability).
The staggered format affects the timing of your cash outflow. Even though staggered payments seem appealing because it splits the amount of obligation into portioned amounts, companies and individuals ultimately get pinched by reduced liquidity when the times are critical. For example, during peak holiday periods or during its key operating cycle, advance tax payments can strain cash balances.
Assuming ₹3,00,000 is set aside to make advance tax. That can be invested elsewhere, for example, tax-saving fixed deposits. Tax-saving FDs yield an interest of 5.5% to 7% annually based on the time period and bank.
Let’s calculate how ₹3,00,000 could grow on a one-year FD at various rates of interest:
1. At 5.5% Interest: ₹3,00,000 x 5.5% = ₹16,500 interest earned.
2. At 6.5% Interest: ₹3,00,000 x 6.5% = ₹19,500 interest income.
3. At 7% Interest: ₹3,00,000 x 7% = ₹21,000 interest income.
(approximate income before tax deduction).
This, however, going towards advance tax payment robs you of the opportunity to earn this interest for the duration provided.
Operational Cash Flow
Advance tax payments would render working capital inconvenient for firms, especially if revenues or profits are cyclical in nature. As earnings are only estimates, prepaying advance tax on doubtful revenues in most cases leads to underpayment or overpayment, both of which have repercussions.
– Overpayment: There is no instant application of prepaid advance tax until it is refunded, tying up working capital unnecessarily.
– Advance tax shortfall invites penalties, adding extra burden to finance.
Advance Tax Payments and Tax Filing Notices
Importance of adherence to advance tax is where mismatches would lead to tax filing notices. Tax filing notices are issued by the Income Tax Department if mismatches are observed in tax declarations, payments, or audit reports.
By religiously remitting pre-paid taxes, the taxpayers reduce the likelihood of receiving such notices by leaps and bounds. However, proper control of cash flow becomes crucial to ensure normal payments are made without disrupting normal financial matters.
Mitigation Strategies
Tax Projections
Advance Tax payment on the basis of good forecast of income for the financial year. Proper projections allow individuals and firms to allocate funds dynamically and achieve tax payment outgo-returns from investment harmony. Quarterly updating of projections is to be preferred in order to escape cash flow deficit or over-charging of liquidity.
Use of Interest-Free Loans
Businessmen opt for products such as interest-free working-capital loans or line-of-credit facilities in order to maintain unbroken cash flow on advance tax payment due dates. Disposal of discretionary savings may be an option for individuals to cover short-term liquidity gaps.
A Dual Impact: Tax-Saving FD vs. Tax Payments
As discussed above, taking advantage of tax saving fd interest rates is a way of getting the best out of saving taxes. General taxpayers usually end up comparing the benefits of investing in it with the need to fulfill advance tax obligations. For instance:
For instance, if you deposit ₹1,50,000 in a tax-saving FD that earns a 6% interest. You pay ₹1,50,000 as advance tax at the same time. The FD would earn you an amount of ₹9,000 after a year. But the liquidity benefit realized by paying the tax may exempt you from the penalty but will lose out on the ₹9,000 of interest it could have earned.
Conclusion
Advance tax payments greatly change cash flow patterns of individuals as well as companies both. While on one hand they spread tax burden over a phase of the financial year, reducing the burden at the end of the year, they also tie liquid funds that would otherwise have been utilized for investment or business purposes.
With investment options like tax-saving FDs with favorable rates of interest, tax-payers generally have responsibilities and opportunities. As one can see from this article, every tax-paper has to keep his/her own cash situation in mind while estimating income, handling liquid funds, and calculating advance tax payment.
Summary
Advance tax is a compulsive statutory requirement for Indian tax payers having an overall annual tax liability of more than ₹10,000. Tax payers must pay tax in advance in every quarter of a year. The system discourages delays in taxation but is detrimental to cash flow as it forces taxpayers to forgo liquidity periodically. Companies, freelancers, and salary earners typically face the hardship of settling these payments along with the business and investment expenses.
For instance, ₹3,00,000 advance tax deprives the possibility of interest earnings that could be earned by tax-saving fixed deposits (FDs) yielding 5.5% to 7%. Secondly, flawed assumptions on the estimates can lead to overpayment or underpayment and deplete the cash cushions.
Disclaimer:
This article provides general guidance on payment of advance tax and its implication on cash flows. Investors need to analyze all the risks, calculation, and alternatives thoroughly before making any financial decision in the Indian capital market. Professional advice is advisable for particular recommendations.