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CAN LOWER PROFIT BE DECLARED U/S. 44AD OF IT ACT DESPITE HIGHER ACTUAL PROFITS EARNED

INTRODUCTION : The section 44AD of the Income tax Act (hereinafter referred to as “Act”) is one of the most important sections which comes in to use most frequently. There is a misconception / issue regarding the interpretation of the provisions of this section, regarding declaration of profits at minimum 8% / 6% rate even though the actual net profit earned is more. In this article an attempt has been made to discuss the above issue and to arrive at logical conclusion.

ISSUE REGARDING DECLARATION OF PROFIT HIGHER THAN 8% / 6%

In cases where section 44AD is applicable, the net earnings from the business has been deemed to be 8% / 6% of gross receipts / turnover of the business. However, at the same time, the assessee has been given an option that he may claim and declare higher earnings from above business, instead of minimum deemed earnings of 8% / 6%. In this regard, the related part of section 44AD is mentioned as below :

Profits Earned

“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” :

MISCONCEPTION / ISSUE – It is frequently asked that as per section 44AD, it is mandatory to declare only minimum net profit of 8% / 6%. The declaration of higher profits is only optional and not mandatory. Therefore, in cases where the actual net profit earned is more than 8% / 6%, then can in the return only minimum required 8% / 6% be declared.

For example – turnover Rs. 80 lakhs, net profit Rs. 40 lakhs and minimum (say 8%) required to be declared is Rs. 6.4 lakhs. Then whether minimum net profit of Rs. 6.4 lakhs can be declared in the return instead of actually earned net profit of Rs. 40 lakhs. It is also further frequently asked that at the same time whether the above actual net profit of Rs. 40 lakhs can be credited to the capital account and can be utilized against investment in assets etc. shown in the balance sheet.

CONSIDERABLE POINTS – In this regard, the following points are important for consideration –

(1) The section 44AD is mainly based on the presumption that the books of accounts have not been maintained and as such actual net profit is not known. Therefore, net profit is to be estimated. Thus, a reasonable net profit percentage of 8% / 6% has been prescribed.

(2) But if actual net profit is known (as in the above example – Rs. 40 lakhs above), it means some working / books of account have been maintained on the basis of which the above higher net profit has been determined. Thus, the basic reason for providing estimation of net profit at 8% / 6% in the Act may not exist in such cases.

(3) In such a situation, in the personal opinion of the author, the basic principle of the taxation i.e., “real income should be taxed” may come in to play and accordingly, the provisions of section 44AD may be applied in such cases considering the above principle.

(4) More clearly it can be said that, if the actual net profit has been computed and has been credited to the capital account and has been utilized against assets shown in balance sheet, then it may be prudently considered that “a sum higher than the 8% or 6% has been indirectly claimed to have been earned by the assessee”. Alternatively, it may be prudently said that the earning of higher net profit can be deemed to have been claimed by the assessee.

(5) If higher net profit has been computed and credited to capital account, then even if minimum net profit of 8% / 6% is declared in return, it may not have any sense. Because, in such a situation, the Income tax department may not accept lower profit declared in the return and may proceed to tax the higher profit credited in capital account. Further, due to same, the assessee may also have to face many other problems, initiation of penalty proceedings etc. during scrutiny assessment / reassessment etc.

(6) Further, the author has not seen any judicial decision supporting the view that lower net profit can be declared in the return despite higher net profit actually earned, computed and utilized.

(7) Now let us consider that what may be the correct, logical and reasonable interpretation of the provision regarding optional declaration of the higher profit. According to the author, the provisions regarding declaration of higher profits optionally may be “in the form of a facility”, so that where assessee estimates / actually computes that the real business profit is more, he can utilize the above facility and may declare higher actual profit. The above provisions may not be in the form of a mean to declare and pay tax on lower profits even though the higher actual profits have been earned and utilized.

(8) There is one more aspect of the provision that declaration of higher profit is optional i.e., –

(a) if 8% / 6% profit is declared by the assessee in ITR, then the assessing officer (“AO”) may not interfere with the same and may not assess higher profits (except only when the assessee himself has computed on record / avail benefit of higher profits) ; or

(b) If more than 8% / 6% profit is declared by the assessee (say for example 10%), then also the AO may not interfere and assess further higher profit (say for example 12%), except only when the assessee himself has computed on record / avail benefit of further higher profits (say 12% in present example) ; or

(c) If more than 8% / 6% profit is declared in ITR in one year (e.g., say 10% in year “A”) and only 8% / 6% profit is declared in ITR in another year (say in year “B”), then also the AO may not interfere and assess higher profit (10% in above example) in the year “B” in which only 8% / 6% profit is declared in ITR (except only when the assessee himself has computed on record / avail benefit of higher profits in year “B”).

(9) Let us consider one more situation where (a) the actual net profit earned is more than 8% / 6% ; and (b) net profit is declared in ITR at 8% / 6% rate ; and (c) higher net profit is not credited in capital account. In such situation also it is advisable to declare real profits because later on, when extra net profits will be utilized in acquiring assets etc. then the investment in them may be unexplained and the assessee may have to face additions U/s. 69 etc. on detection of the same by the Income tax department.

CONCLUSION : Thus, in the opinion of the author, (a) net profit of 8% / 6% may be declared in ITR when no books of account are available and actual net profit has not been actually computed ; or (b) where actual net profit has been computed but the same is below 8% / 6% and the assessee has not opted out of the section 44AD scheme ; and (c) actual net profit should be declared in ITR where net profit has been computed / estimated at amount more than 8% / 6%. This may save the assessee from unnecessary litigation with the department and from consequential adverse conditions / problems. The interpretation of the provisions of section 44AD should be made prudently, logically and reasonably considering the intention of the legislature and basic principles of the Income tax i.e., tax on real income etc.

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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. Before taking any action relevant to the above topic, it is advised that the user may please refer relevant Act, Rules etc.

(Republished with amendments)

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5 Comments

  1. Shrinath says:

    If we need to declare actual profit only, why should we need to use 44AD ?. No one can make exactly 6% or 8% profit. I think finance ministry should come out clearly and inform what is exactly expected. If they want real profit to be declared, then I suggest, they can scrape this provision. Is it not possible to ask Finance Ministry and clarify this issue instead every one imagining according to their will and wish. ?

  2. Nem Singh says:

    Presumptive income tax provisions are to help the assessee and grant exemption from maintenance of specific records like bills, vouchers etc but nowhere has provided that despite earning higher income, declare lower one. Need to read the relevant provision:
    “a sum equal to eight per cent of the total turnover or gross receipts of the the assessee in the ………. or, as the case may be, a sum higher than the aforesaid sum claimed to have been earned by the eligible assessee” thus if the earning is higher that the prescribed percentage then the higher one should be declared means the income should be equal to the personal drawings of the year plus savings of investment if any made out of the current year.

    1. Shrinath says:

      Please read the order from ITAT, Income Tax Appellate Tribunal – Bangalore M/S. Kokkarne Prabhakar, … vs Income Tax Officer, Ward – 3(2), … on 11 September, 2020
      1 IN THE INCOME TAX APPELLATE TRIBUNAL
      BENGALURU BENCH, BENGALURU
      BEFORE SHRI CHANDRA POOJARI, AM
      ITA No.1239/Bang/2019
      Assessment Year: 2013-14
      It is clearly stated that once you are eligible to file return under 44AD, section 68, 69 cannot applied.

  3. ACS says:

    It seems that the view taken by Author is Conservative View, as Income Tax Department (ITD) has to use the same Yardstick for Both type of Assessee i.e. If ITD is allowing assessee (having Net Profit less than prescribed %) to get away with by declaring the prescribed % of Net Profit, then it should also allow the assessee (Having Net Profit more than prescribed %) to follow the same Yardstick and get away with declaring the Prescribed % of Net Profit.

    Further, NO WHERE in the said section it is mentioned that the Net Profit shall be % of Minimum Net profit Prescribed or Actual Net Profit, Whichever is Higher??

    So, either kind of the Assessee can take the benefit of declaring Net Profit @ prescribed percentage as provided in the said section.

  4. s baskar says:

    if anyone declared his income is 25% or 30 % under sec 44 AD – can he deduct his expenses from the income declared under 44 AD . ( if he use old tax regime ) # if yes how much is the maximum limit for the expenses = 30 % or 50 % from the declared profit .
    kindly reply .
    good luck

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