The small business community is usually a discontented lot when it comes to budget announcements by the government. This time though was a little different. The UPA government took significant measures in Budget 2009 to simplify the direct tax code for individuals, entrepreneurs and small businessmen.

Under the proposed changes, businesses with revenues of up to Rs 40 lakh will now have the option to declare income at 8% of their turnover (see illustration) and also be exempt from compliance procedures such as maintaining books of accounts. Moreover, they will be allowed to pay the entire tax liability from their businesses only at the time of filing tax returns, and not in advance.

Over 10 million MSMEsthat fall in the sub-Rs 40 lakh turnover bracketstand to gain from this announcement, which is being seen as a boost to entrepreneurship in the country. "It will rid a large number of businesses from harassment by income tax authorities and reduce paperwork to a great extent," says Anil Bhardwaj, secretary general of the Federation of Indian Micro and Small & Medium Enterprises (FISME).

In a recent poll by FISME across 60 such firms, two-thirds of the respondents believed that the new proposal would benefit them.

"The government understands that there is a need to ease pressure on small businesses," agrees Vikas Vasal executive director, KPMG. Most small entrepreneurs get caught in a vicious cycle of non-compliance due to a number of reasons, which in turn hinders growth.

For instance, when a small business owner needs funding to grow his business, he turns to his bank. If he hasnt been filing tax returns, his loan application is rejected. To file a tax return, he needs to maintain books of accounts, get them audited and pay advance tax, all of which comes at a considerable cost. To save on these costs, if he defers these regulatory requirements, hes strapped for bank lending. That's where the new proposal could help.

"The idea behind this proposal is to expand the tax net by encouraging voluntary compliance by small businesses, says Aseem Chawla, tax partner at Amarchand Mangaldas. According to an estimate, only 10% of the Indian population pays direct taxes. Targeting the rest of the population is very difficult and so voluntary compliance is the only way out.

"If the government keeps the tax rate to a bare minimum and the compliance also to a minimum, there is a possibility that these non-taxpaying entities might come forward to file their tax returns," says Vasal.

The proposed new section 44AD in the Income Tax Act seeks to estimate the income of a business assessee whose total turnover does not exceed Rs 40 lakh, at 8% of the total turnover or gross receipts in the previous year. The amendment will take effect from 1st April, 2011 and will apply only to an individual, Hindu undivided family and partnership firm and not a limited liability partnership firm.

There are a number of businesses under Rs 20 lakh turnover for whom the income (at 8% of turnover) does not fall in the tax bracket, yet they must maintain books of accounts. But if they subscribe to the new regime, they could easily file their tax returns without having to maintain books of accounts.

Also, when entering into a partnership, tax returns add to the credibility of the business. Anil Gupta, proprietor of Lakhnavi Chiken Art, a clothing store in Delhis Dilshad Garden area is only too happy to exercise this option.

With a turnover of Rs 12 lakh, Gupta spends close to Rs 15,000 a year to maintain his books of accounts and towards chartered accountant (CA) fees. "Given this option of paying at the rate of 8% of turnover, will rid us of a lot of the headache and expense," says Gupta.

Chawla cautions that this proposal will work only if the income tax assessee does not face harassment from tax authorities like before. "The financials declared by firms under section 44AD should be accepted by the tax authorities without any questions. The governments intention is fair but this can work only if implementation is honest," says Chawla.

There are other apprehensions too. Some of the small business owners ET spoke with contend that assuming income at 8% of turnover may not be practical since in these recessionary times profits levels have dropped to the 3-5% range.

So while very small businessesthose below the Rs 20 lakh bracketmay take the option those with higher revenues say 8% is cutting it too close. "The 8% rate takes into account all the cost savings accruing from not having to maintain books of accounts and not paying advance tax," says Vasal.