In the earlier issues of presumptive scheme of taxation u/s 44AD, we have discussed few complexities involved.

The same can be read at

1. “5 Years Mandatory audit rule u/s 44AD is not applicable if the person has already offered income continuously for 6 years u/s 44AD” at https://thetaxtalk.com/2020/07/24/5-years-mandatory-audit-rule-u-s-44ad-is-not-applicable-if-the-person-has-already-offered-income-continuously-for-6-years-u-s-44ad/
2. “Audit not compulsory even if income offered for taxation is less than 8% or 6% u/s 44AD” at https://thetaxtalk.com/2018/08/08/section-44ad/

After the column, another query was raised by few readers as to the applicability of section 44AD scheme of taxation in case of assessee having first year of operation in business. Whether the audit would be mandatory if the assessee has started the business and in the first year, such assessee want to offer the income u/s 44AD at lower than the rate prescribed in section 44AD @ 8% or 6%? The question is very much relevant & need to be evaluated by reading the provision of section 44AB first and linking it with section 44AD thereafter.

To be more precise let us frame the issue with an example. Mr. X has started in the FY 2019-20 and has a turnover of Rs. 90 Lakh and actual profit of Rs. 5 Lakh only. It is lower than the rate prescribed u/s 44AD.

Whether audit of Mr. X would be compulsory for the FY 2019-20 which is the first year of his business income?

Section 44AB of the Income Tax Act – 1961 reads as under:

Audit of accounts of certain persons carrying on business or profession.

44AB. Every person,—

(a)  carrying on business shall, if his total sales, turnover or gross receipts, as the case may be, in business exceed or exceeds one crore rupees in any previous year ⁸⁹[***]:

⁹⁰[Providedthat in the case of a person whose—

(a) aggregate of all amounts received including amount received for sales, turnover or gross receipts during the previous year, in cash, does not exceed five per cent of the said amount; and

(b)  aggregate of all payments made including amount incurred for expenditure, in cash, during the previous year does not exceed five per cent of the said payment,

this clause shall have effect as if for the words “one crore rupees”, the words “five crore rupees” had been substituted; or]

(b)  carrying on profession shall, if his gross receipts in profession exceed fifty lakh rupees in any previous year; or

(c)  carrying on the business shall, if the profits and gains from the business are deemed to be the profits and gains of such person under section 44AE or section 44BB or section 44BBB, as the case may be, and he has claimed his income to be lower than the profits or gains so deemed to be the profits and gains of his business, as the case may be, in any previous year; or

(d)  carrying on the profession shall, if the profits and gains from the profession are deemed to be the profits and gains of such person under section 44ADA and he has claimed such income to be lower than the profits and gains so deemed to be the profits and gains of his profession and his income exceeds the maximum amount which is not chargeable to income-tax in any previous year; or

(e) carrying on the business shall, if the provisions of sub-section (4) of section 44AD are applicable in his case and his income exceeds the maximum amount which is not chargeable to income-tax in any previous year,

get his accounts of such previous year audited by an accountant before the specified date and furnish by that date the report of such audit in the prescribed form duly signed and verified by such accountant and setting forth such particulars as may be prescribed :

Provided that this section shall not apply to the person, who declares profits and gains for the previous year in accordance with the provisions of sub-section (1) of section 44AD and his total sales, turnover or gross receipts, as the case may be, in business does not exceed two crore rupees in such previous year:

Provided further that this section shall not apply to the person, who derives income of the nature referred to in section 44B or section 44BBA, on and from the 1st day of April, 1985 or, as the case may be, the date on which the relevant section came into force, whichever is later :

Provided also that in a case where such person is required by or under any other law to get his accounts audited, it shall be sufficient compliance with the provisions of this section if such person gets the accounts of such business or profession audited under such law before the specified date and furnishes by that date the report of the audit as required under such other law and a further report by an accountant in the form prescribed under this section.

Explanation.—For the purposes of this section,—

(i)   “accountant” shall have the same meaning as in the Explanation below sub-section (2) of section 288;

(ii)  “specified date”, in relation to the accounts of the assessee of the previous year relevant to an assessment year, means ⁹¹[date one month prior to] the due date for furnishing the return of income under sub-section (1) of section 139.

At the first instance, it may be noted that section 44AB require to carry out the audit in 5 situations covered in clause (a) to clause (e) only. The relevant clause for the purpose of our present discussion is clause (a) & clause (e) which reads as under:

Clause (a) –   carrying on business shall, if his total sales, turnover or gross receipts, as the case may be, in business exceed or exceeds one crore rupees in any previous year …

Clause (e) –  carrying on the business shall, if the provisions of sub-section (4) of section 44AD are applicable in his case and his income exceeds the maximum amount which is not chargeable to income-tax in any previous year,

Very clearly, the first clause is not applicable as his turnover is less than Rs. 1 Crore.

As far as clause (e) is concerned, it may be noted that it refers to section 44AD(4). Audit u/s 44AB(e) would be required only if the provision of sub-section (4) of section 44AD is hit and not otherwise.

For ease of understanding, section 44AD(4) reads as under:

(4) Where an eligible assessee declares profit for any previous year in accordance with the provisions of this section and he declares profit for any of the five assessment years relevant to the previous year succeeding such previous year not in accordance with the provisions of sub-section (1), he shall not be eligible to claim the benefit of the provisions of this section for five assessment years subsequent to the assessment year relevant to the previous year in which the profit has not been declared in accordance with the provisions of sub-section (1).

Reading section 44AD(4) again, one can easily drawn the following conclusions:

1. Section 44AD(4) gets a power only if the person has offered income u/s 44AD in any of the earlier year.
2. In short, 44AD(4) is powerless if the assessee is in its first year of business only.

Reading 44AD(4) & 44AB(e), taxpayers can draw a normal conclusion that audit is not compulsory u/s 44AD if the assessee is in its first year of business.

However, to draw these blanket conclusions may be totally erroneous and may not be in accordance with the spirit and explicit wording of the law as this conclusion could be drawn only if the proviso to section 44AB are not read.

The first proviso to section 44AB, after clause (a) to (e) reads as under:

Provided that this section shall not apply to the person, who declares profits and gains for the previous year in accordance with the provisions of sub-section (1) of section 44AD and his total sales, turnover or gross receipts, as the case may be, in business does not exceed two crore rupees in such previous year:

Above proviso is inserted to nullify the impact of 44AB (e) and enable one to draw following conclusions:

1. Audit u/s 44AB would not be applicable if
   a) the profit is declared in accordance with 44AD(1). It may be noted that section 44AD(1) refers to 8% or 6% only and
   b) turnover doesn’t exceed Rs. 2 Cr.

In totality, proviso to section 44AB clearly provides that the audit is mandatory, whether it’s a first year or subsequent year so long as the income offered for taxation is less than the prescribed percentage of section 44AD(1) and income is above the amount not chargeable to tax.

Drawing the Conclusions:

Though under section 44AB(e) read with section 44AD(4), audit is not compulsory in the first year of business whereas audit would be mandatory in such case pursuant to proviso to section 44AB.

However, there is a practical difficulty. While filing the return or even in the audit report, the question is asked as the clause in which the audit is carried out. It refers to section 44AB (a) to (e) only. It doesn’t refer to the proviso to section 44AB. ITR forms & audit reports need to be amended to incorporate the reference to the proviso as well.

Contrary views:

Whenever there is a controversy between two sections, the one which is latest will have an overriding effect over the earlier one. If this is so, one may draw an opinion that audit is not mandatory in the first year of business. This view could further be supported by the fact that the procedure for filing of a tax audit report is not providing for submitting the audit report under “first proviso to section 44AB” but only mentioned the clause (a) to (e) while uploading the audit report. Without any supportive mechanism to make the submission, the law cannot be enforced. This is the logical conclusion that was drawn in the late filing fee for delayed filing of TDS return prior to 2015.

My personal views:

The return processing is system driven. If one file returns without uploading the audit report in such cases, notices from CPC are going to be there. One may end up with repetitive litigation and filing of appeal would be the only alternative that would be left in such cases. The best approach could be to get the books of accounts audited and let the audit report be uploaded u/s 44AB(e) in all such cases.