5 Year Restriction under Section 44AD of Income Tax Act, 1961

Introduction: The Section 44AD of the Income Tax Act contains special provisions for computing profits and gains of a business on presumptive basis. According to this section the profits and gains from eligible businesses carried by an eligible assesse are required to be computed at least at the rate of 8% / 6% of the total turnover / gross receipts. However, the assessee can declare lower profit by maintaining books of account etc. as required under section 44AA and by furnishing audit report as required under Section 44AB.

Earlier there was freedom for the assesses to choose every year that whether to declare profit for that year at the presumptive rate of 8% / 6% or to declare lower profit by maintaining books and furnishing audit report. For example, In the assessment year 2013-14 the net profit is declared at the presumptive rate of 8% and in the next assessment year 2014-15, the net profit is declared at the rate of 5% (by maintaining books of account and furnishing audit report). Thereafter, in the assessment year 2015-16 again net profit is declared at the rate of 8% on presumptive basis.

Now, vide Finance Act, 2016, a new sub section (4) has been inserted in the section 44AD with effect from 01.04.2017 i.e., from the Assessment Year 2017-18. This sub section has put some restrictions on the frequent switch over between “declaring profits on presumptive basis” and “declaring lower profits by maintaining books and furnishing audit report” in different years.

Also Read- Is Tax Audit Necessary in every case where Section 44AD is applicable but Net Profit is less than 8% / 6%

SUB SECTION (4) OF SECTION 44AD :

The provisions of sub section (4) are 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).

AN EXAMPLE GIVEN IN MEMORANDUM EXPLAINING THE PROVISIONS OF THE FINANCE BILL 2016 :

For example, an eligible assessee claims to be taxed on presumptive basis under section 44AD for Assessment Year 2017-18 and offers income of Rs. 8 lakh on the turnover of Rs. 1 crore. For Assessment Year 2018-19 and Assessment Year 2019-20 also he offers income in accordance with the provisions of section 44AD. However, for Assessment Year 2020-21, he offers income of Rs.4 lakh on turnover of Rs. 1 crore. In this case since he has not offered income in accordance with the provisions of section 44AD for five consecutive assessment years, after Assessment Year 2017-18, he will not be eligible to claim the benefit of section 44AD for next five assessment years i.e. from Assessment Year 2021-22 to 2025-26.

AN ANALYSIS OF ABOVE 5 YEAR’S RESTRICTION :

There is no complete restriction on switch over between the two options. The restriction is only a partial restriction.

This restriction is analyzed for four different situations :

(a) Entry to section 44AD presumptive basis to a complete outsider ;

(b) Exit from section 44AD presumptive basis by the existing beneficiary ;

(c) Re entry to section 44AD presumptive basis to an assessee who had left section 44AD before completing 6 years ;

(d) Re entry to section 44AD presumptive basis to an assessee who had left section 44AD after completing 6 years ;

ENTRY TO SECTION 44AD TO A COMPLETE OUTSIDER :-

An assessee who is presently maintaining books of accounts and furnishing audit report i.e., not declaring net profit at the rate of 8% / 6% on presumptive basis can enter Section 44AD at any time and can start computing net profit on presumptive basis. There is no restriction of 5 years on his entry to Section 44AD.

For example : An assessee who has maintained books and furnished audit report for the Assessment Year 2017-18 can enter Section 44AD and declare net profit at the rate of 8% / 6% without maintaining books etc. for the Assessment Year 2018-19.

Similarly, an assessee who was previously an “ineligible assessee” now becomes “an eligible assessee” or an assessee who has newly started an eligible business can also enter section 44AD presumptive basis without 5 year’s restriction.

EXIT FROM SECTION 44AD BY THE EXISTING BENEFICIARY:-

Similarly, an assessee presently computing net profit @ 8% / 6% can exit Section 44AD at any time and can offer less than 8% / 6% by maintaining books and furnishing audit report. There is no restriction of 5 years on his exit from section 44AD.

For example, an assessee who has declared net profit at the presumptive rate of 8% / 6% for the Assessment Year 2017-18 can exit section 44AD and declare net profit at the rate lower than 8% / 6% by maintaining books of accounts and furnishing audit report for the Assessment year 2018-19.

RE-ENTRY TO SECTION 44AD PRESUMPTIVE BASIS TO THE ASSESSEE WHO EXITED SECTION 44AD:-

The 5 year’s restriction is only regarding re entry of an assessee who had left section 44AD presumptive basis. The restriction as to re entry is also not full restriction. It is a partial restriction. There may be two type of such assesses i.e., (a) those who had made exit from section 44AD before continuously completing at least 6 years under presumptive basis of section 44AD ; and (b) those who had made exit from section 44AD after continuously completing at least 6 years under presumptive basis of section 44AD. The above restriction is only regarding the assesses mentioned in point no. (a) above.

RE ENTRY TO AN ASSESSEE WHO HAD COMPLETED AT LEAST 6 YEARS UNDER SECTION 44AD BEFORE EXITING :

An assessee who has continuously computed net profit at the presumptive rate of 8% / 6% at least for the 6 years can exit Section 44AD at any time and can offer less than 8% / 6% by maintaining books and furnishing audit report. He can also re enter section 44AD at any time and can again start declaring profit at the rate of 8% / 6% on presumptive basis. There is no 5 year’s restriction regarding re entry of such assessee to presumptive basis under section 44AD. He can re enter section 44AD at any time after exit from it.

For example : If an assessee continuously computes net profit @ 8% / 6% for the assessment year 2017-18, 2018-19, 2019-20, 2020-21, 2021-22 and 2022-23 and then exit Section 44AD for the Assessment Year 2023-24 then he can re enter section 44AD presumptive basis from Assessment Year 2024-25 itself without waiting for 5 years thereafter.

RE ENTRY TO AN ASSESSEE WHO HAD NOT COMPLETED AT LEAST 6 YEARS UNDER SECTION 44AD BEFORE EXITING :

An assessee who has not continuously computed net profit at the presumptive rate of 8% / 6% at least for the 6 years can exit can exit Section 44AD at any time and can offer less than 8% / 6% by maintaining books and furnishing audit report but he cannot re enter section 44AD till next five assessment years. The restriction of 5 year’s is only regarding re entry of such assessees. He can re enter section 44AD only after waiting for the next five assessment years.

Example : – The example given in memorandum explaining provisions of Finance Bill (as mentioned above) covers this situation.

AN IMPORTANT ISSUE REGARDING TRANSITIONAL PERIOD :

The above sub section (4) has been inserted from Assessment Year 2017-18. Now there is an important issue regarding transitional period that :

(a) whether the continuous period completed under section 44AD prior to the Assessment Year 2017-18 will be considered for computing the above mandatory period of 6 years or not ; or

(b) that the above period of 6 years will be computed from the Assessment Year 2017-18 and onwards only.

For example : If an assessee has continuously computed net profit @ 8% / 6% from (or before) the assessment year 2011-12, 2012-13, 2013-14, 2014-15, 2015-16 and 2016-17 and then he exit deemed basis under section 44AD for the Assessment Year 2017-18 then whether the continuous period completed under section 44AD prior to the Assessment Year 2017-18 will be considered or not. Whether he can re enter section 44AD presumptive basis from Assessment Year 2018-19 itself or the period before the Assessment Year 2017-18 will be ignored and the period of 6 years under section 44AD will have to be completed from Assessment Year 2017-18 (or onwards) only. There is no mention / clarification in this regard by the CBDT. However, the author is of the opinion that it will be logical to consider the continuous period completed under section 44AD prior to the Assessment Year 2017-18 also. The plain reading of sub section (4) is also implying the same view.

Disclaimer: The information contained in the above article are solely for informational purpose after exercising due care. However, it does not constitute professional advice or a formal recommendation. The author do not owns any responsibility for any loss or damage caused to any person, directly or indirectly, for any action taken on the basis of the above article.