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:

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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: CA Naresh Jakhotia

In order to encourage ease of doing business, the Government has introduced section 44AD in the Income Tax Act – 1961 which provides for computation of Profits and gains of business on presumptive schemes. This presumptive scheme of taxation is applicable only to resident individuals/HUF, partnership firms. Other classes of taxpayers like AOP, LLP, Company etc cannot take the benefit of presumptive taxation u/s 44AD. Further, presumptive scheme under section 44AD can be opted only if the turnover is not exceeding Rs. 2 Crores.

As per the section 44AD, Profit & Gains of business is deemed @ 8% of the gross turnover (Higher sum as may be declared by the assessee but not lower). The rate of 8% can be replaced by 6% for the receipt by way of digital mode i.e., receipt is by way of cheque, RTGS, paytm, BHIM, etc. If a person offers income @ 8% or 6% as discussed above then such person is not required to maintain the books of accounts.

Presumptive scheme of taxation was introduced in the Income Tax Act – 1961 as a relief measure i.e., to provide a relief to the small taxpayers from the requirements of maintaining the books of accounts, vouchers, supporting, etc. However, the way the amendment has been carried out in this section, it has become a penal provision rather than a relief providing provision.

Let us read more about it by revisiting section 44AD first which reads as under:

Special provision for computing profits and gains of business on presumptive basis.

 44AD. (1) Notwithstanding anything to the contrary contained in sections 28 to 43C, in the case of an eligible assessee engaged in an eligible business, a sum equal to eight per cent of the total turnover or gross receipts of the assessee in the previous year on account of such business or, as the case may be, a sum higher than the aforesaid sum claimed to have been earned by the eligible assessee, shall be deemed to be the profits and gains of such business chargeable to tax under the head “Profits and gains of business or profession” :

[Provided that this sub-section shall have effect as if for the words “eight per cent”, the words “six per cent” had been substituted, in respect of the amount of total turnover or gross receipts which is received by an account payee cheque or an account payee bank draft or use of electronic clearing system through a bank account during the previous year or before the due date specified in sub-section (1) of section 139 in respect of that previous year.]

(2) Any deduction allowable under the provisions of sections 30 to 38 shall, for the purposes of sub-section (1), be deemed to have been already given full effect to and no further deduction under those sections shall be allowed.

(3) The written down value of any asset of an eligible business shall be deemed to have been calculated as if the eligible assessee had claimed and had been actually allowed the deduction in respect of the depreciation for each of the relevant assessment years.

[(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).

(5) Notwithstanding anything contained in the foregoing provisions of this section, an eligible assessee to whom the provisions of sub-section (4) are applicable and whose total income exceeds the maximum amount which is not chargeable to income-tax, shall be required to keep and maintain such books of account and other documents as required under sub-section (2) of section 44AA and get them audited and furnish a report of such audit as required under section 44AB.

(6) The provisions of this section, notwithstanding anything contained in the foregoing provisions, shall not apply to—

 (i)  a person carrying on profession as referred to in sub-section (1) of section 44AA;

(ii)  a person earning income in the nature of commission or brokerage; or

(iii)  a person carrying on any agency business.

Explanation.—For the purposes of this section,—

(a)  “eligible assessee” means,—

 (i)  an individual, Hindu undivided family or a partnership firm, who is a resident, but not a limited liability partnership firm as defined under clause (n) of sub-section (1) of section 2 of the Limited Liability Partnership Act, 2008 (6 of 2009); and

(ii)  who has not claimed deduction under any of the sections 10A, 10AA, 10B, 10BA or deduction under any provisions of Chapter VIA under the heading “C. – Deductions in respect of certain incomes” in the relevant assessment year;

(b)  “eligible business” means,—

 (i)  any business except the business of plying, hiring or leasing goods carriages referred to in section 44AE; and

(ii)  whose total turnover or gross receipts in the previous year does not exceed an amount of [two crore rupees].

One can fairly ascertain the complexity involved by reading the above section as it. Let us analyze it further.

  1. First Issue:
    Section 44AD is applicable if the turnover is not exceeding Rs. 2 Cr subject to the conditions that such assessee offers minimum of 8% or 6% of the turnover as income. In short, now there are three  limits of turnover for tax audit u/s 44AB for tax audit : –
    a) Rs. 1 Cr for AOP, LLP, Companies &
    b) Rs. 2 Cr for Resident  Individual/HUF/ Firm
    c) Rs. 1 if the profit offered for taxation is less than 8% or 6% of the turnover.It may be noted that the AOP, LLP, Companies as covered by (a) above will not be required to get the tax audit report u/s 44AB even if their income is less than 8% or 6% so long as their turnover is less than Rs. 1 Crore. Let us consider a case of a business of X whose turnover is Rs. 90 Lakh and have a profit of say Rs. 5 Lakh.

If X is a limited company then tax audit would not be mandatory as section 44AD is not applicable in such cases and the provision of section 44AB is also not applicable as the audit limit in such case is Rs. 1 Cr.

However, if X is an individual then the audit would be mandatory even if the turnover is less than Rs. 1 Cr.

Is it a relief measure? Is it providing ease of business? Is it not penalizing small taxpayers whom section 44AD was supposed to offer the benefit? Why the discrimination is there when the companies, AOP etc can offer the income without tax audit u/s 44AB, why the individual/firm/ HUF are subject to tax audit.  Is it not penalizing the one class & nature of taxpayers and favoring the other class of taxpayers?

  1. Second Issue:
    Section 44AD was amended few years back with sub section 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).

The crux of above amendment is

  1. If a person has opted for section 44AD in any one year and he has not continued offering the income thereafter continuously for 5 subsequent years then such person cannot offer income under section 44AD in subsequent 5 years.It means that if a person has opted for a presumptive scheme of taxation u/s 44AD in any one year then he has to remain in the umbrella of section 44AD for the next 5 years. If he goes out of the umbrella of section 44AD in any one of the subsequent 5 years then such person cannot take the shelter in the umbrella of section 44AD for next 5 years thereafter (i.e., such person has to remain out of Section 44AD for 6 years in continuation)

    Is  it logical? Is it relief provision for the taxpayers? Is it not penalizing the small taxpayers which may have a turnover of say Just Rs. 10 Lakh or 20 Lakh or even Rs. 1 in subsequent years.  Is it the frustration of the law maker which is getting reflected in drafting such provision? What one can say on this provision?

  2. Third Issue:
    It has one more hidden meaning which is not discussed elsewhere so far. What if a person has already taken the shelter of section 44AD for 6 years and decides to opt out of section 44AD in the 7thYear?First let us read again carefully section 44AD (4) which says that 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…..

    It means that if a person has continuously remained in the umbrella of section 44AD for 6 years then such person is not hit by the sub section (4) to section 44AD at all. Section 44AD(5) contains the word

    “…..and he declares profit for any of the five assessment years relevant to the previous year succeeding such previous year….”

    The restriction & bar of 6 years for re-entering back in the umbrella of section 44AD would arise only if the person has NOT opted for a presumptive scheme of taxation u/s 44AD for a continuous 6 years period.

    In short, if a person has already offered the income for 6 years or more than such person would not be hit by the provision of 5 years of continuous audit. In such cases, a person can make free entry & free exit on one subsequent occasion.

    Let us consider a case of Mr. X, as under:

S.No. Financial Year Turnover Actual Income Income Offered Opted for presumptive scheme of taxation
1 2012-13 90 Lakh 5.10 Lakh 7.20 Lakh Yes
2 2013-14 90 Lakh 5.10 Lakh 7.20 Lakh Yes
3 2014-15 90 Lakh 5.10 Lakh 7.20 Lakh Yes
4 2015-16 90 Lakh 5.10 Lakh 7.20 Lakh Yes
5 2016-17 90 Lakh 5.10 Lakh 7.20 Lakh Yes
6 2017-18 90 Lakh 5.10 Lakh 7.20 Lakh Yes
7 2018-19 90 Lakh 5.10 Lakh 5.10 Lakh No
8 2019-20 90 Lakh 5.10 Lakh 7.20 Lakh Yes

In the above case, Mr. X has already completed the cycle of 6 years of presumptive scheme of taxation in the FY 2017-18. So, if he opts out of section 44AD in the FY 2018-19 then he can enter back in the umbrella of section 44AD in the FY 2019-20 without hitting the bar placed in sub section (4) to section 44AD. However, if in the FY 2020-21, Mr. X again wants to opt out of section 44AD applicability then he will be hit by the sub section (4) and may not be able to opt for a presumptive scheme of taxation u/s 44AD again for the next 5 years. In such cases, in the FY 2021-22, even if the profit offered for taxation is higher than the rate of 6% or 8%, still the option of offering income u/s 444AD will not be there with Mr. X. In short, in such case, even if the profit offered for taxation is higher than 8% or 6% in the FY 2021-22, even then audit would be mandatory due to operation of section 44AD(5) read with 44AD(4).

However, to drawn this 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 reads.

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 the conclusions that 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 sixth year, seventh year or subsequent year so long as (a) income offered for taxation is less than the prescribed percentage of section 44AD(1) and (b) 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 all such cases, 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 audit is carried out. It refers to section 44AB (a) to (e) only. It don’t refer to the proviso to section 44AB. ITR forms & audit report need to be amended to incorporate the reference to the proviso as well.

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 above case. This view could further be supported by the fact that the procedure for filing of 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 levy of late filing fee for delayed filing of TDS return prior to 2015.
My view:
The return processing is system driven. If one file the return without uploading the audit report in such cases, notices from CPC is 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.

 4. Fourth Issue:
Another interesting area of the presumptive scheme of taxation u/s 44AD is with regard to its applicability only if the “income is exceeding the maximum amount which is not chargeable to income-tax.

In short, if the income of the person is below the basic exemption limit or if there is a loss then the audit (i.e., tax audit u/s 44AB) pursuant to section 44AD would not be mandatory as sub section (5) to section 44AD clearly provides for it and reads as under:

(5) Notwithstanding anything contained in the foregoing provisions of this section, an eligible assessee to whom the provisions of sub-section (4) are applicable and whose total income exceeds the maximum amount which is not chargeable to income-tax, shall be required to keep and maintain such books of account and other documents as required under sub-section (2) of section 44AA and get them audited and furnish a report of such audit as required under section 44AB.

Above view of non-mandatory nature of audit in above cases is further affirmed by section 44AD wherein clause (e) reads as under:
(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,
Readers may refer article titled “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/

With all above discussion, can we say that presumptive scheme of taxation has been introduced to provide ease of business to the small businessmen?

Hope Lawmakers know the purpose of introducing the presumptive scheme of taxation & ensures that the law is kept simple. It is clear that the new direct tax code is not going to be there. However, existing law certainly needs to be simplified. Hope some policy makers take a call on this article.

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