Analysis of Section 44AD Along with Apposite Provisions Of Income Tax Law And Practical Cases
In this article, author will try to clarify the haze amidst different opinions and interpretations of the Section 44AD and apposite provisions of Income Tax law.
This article will mainly focus on the throbbing aspects concerning provisions of Section 44AD which still maintain certain level of ambiguity.
Section 44AD of The Income Tax Act 1961 was introduced to ease the burden of small taxpayers, make them more tax compliant with minimal compliances and expand the tax base. Over the period it saw some significant changes, mostly after the advent of macro scale drive against black unearthed money and assets. Such period saw a great change with introduction of laws like The Prohibition of Benami Property Transactions Act, Income Disclosure Scheme, a historic event called ‘Demonetisation’. During that period, section 44AD also got amended with intent to reduce the abuse of this provision.
This discussion will focus on points of relevance which needs a clear understanding to take informed decisions and avoid any future litigation.
1. Provisions of Section 44AD used to have compulsory application on the tax payers subject to certain conditions prior to Assessment year 2017-18. But now, for claiming the benefit of this section,broadly businesses should fulfill the criteria of an ‘eligible business’ and ‘eligible assessee’ as provided in the explanation to this section.
2. Sub section (1) of Section 44AD overrides Section 28 to 43C which infers that where this section is applicable, afore said provisions relating to dominance of profits and gains from business or profession are deemed to be have been overruled.
But this has an exception in form of provision under Section 43B. Wording of Section 43B has been coined as “notwithstanding anything contained in any other provisions of the Act” which implies that it holds precedence over any other provision of Income tax act including provisions related to presumptive taxation (Section 44AD, 44ADA)
This interpretation is supported by a Tribunal judgement in case of Good Luck Kinetic v ITO (2015) 58 (Panaji).
3. Proviso to sub-section (1) of Section 44AD provides that where amount of turnover or gross receipt is received through specified banking channels as mentioned therein, profits @ 6% of such turnover or receipt which is received through the specified banking channels shall be deemed to be the income under the head Profits and Gains from Business or Profession.
Important point to consider herein, which is often overlooked, is that the amount of turnover or gross receipt received during the previous year or before the due date specified under sub-section(1) of section 139 in respect of that previous year shall be eligible for deeming rate of 6% on that part of turnover.Thus, even though books of accounts are maintained on accrual basis, taxability of such receipts will be determined on cash basis, received during the previous year or before the due date specified in Section 139(1). It is worth noting that where amount of turnover or gross receipt in relation to a previous year is received by any other mode or after the due date specified in Section 139(1), presumptive rate of income shall be 8% for that portion of turnover or gross receipts.
4. Omission of proviso to Sub-section (2) of Section 44AD vide Finance Act 2016 made it less favorable for partnership firms. After this amendment, salary and interest paid to partners will not be allowable as deduction from the income computed under sub-section (1) of section 44AD.
This had a drastic impact on taxability of partnership firms. The tax impact on their taxable income increased since no deduction of remuneration and interest paid to partners is now allowed.Thus, after such unfavorable change, many small firms which opted out of this presumption taxation scheme overlooked a corresponding amendment to sub section (4) and (5) of Section 44AD.
So, when firms opt out of this scheme, they have to mandatorily maintain books of accounts under section 44AA (2) (iv) and get them audited under clause (e) of section 44AB of the Income tax Act for next 5 assessment years irrespective of their income or turnover.
[Refer point 5 below for further discussion on Section 44AD (4) & (5)]
5. Now coming to the major amendments by Finance Act 2016 which changed the facade of this section-
1. Sub Section (4) of section 44AD was totally substituted with a new provision. Now, where an eligible assessee declaring profit in accordance with Section 44AD and for next 5 assessment years succeeding such previous years declares profits not in accordance to Sub section (1) to Section 44AD shall not be eligible to avail the benefit of this section for another five assessment years subsequent to assessment year in which assessee declares not in accordance to Section 44AD.
2. To synchronize provisions with the above amendment, Sub Section (5) of Section 44AD also got amended. It now implies that when an eligible assessee declares profits & gains not in accordance with Section 44ADi.e., provisions of Sub Section (4) of Section 44AD (above) applies to such assessee, they are mandatorily required to maintain books of accounts as required under Sub Section (2) of Section 44AA and get them audited as required under Section 44AB (e),if their total income exceeds the maximum amount not chargeable to tax.
To simplify these provisions, when assessee opts not to declare profit for any of the previous year in accordance with Section 44AD (but had declared income in accordance with Section 44AD in previous year)then for succeeding five assessment years relevant to such previous year, they shall mandatorily maintain books of accounts and get them audit if their total income exceeds the maximum amount not chargeable to tax.
3. Corresponding changes were also done in clause (iv) of sub section (2) of Section 44AA and clause (e) of section 44AB of the Income Tax Act 1961. Now, assessees to whom provisions of Sub section (4)of Section 44AD are applicable and their income exceeds the maximum amount not chargeable to tax in any previous year shall maintain books of accounts and get them audited mandatorily.
Thus, in light of above amendments, an eligible assessee carrying on eligible business, subject to other requirements of Section 44AD has following options while computing income chargeable to tax-
(A) Where the turnover exceeds one crore rupees but not more than two crore rupees and assessee opts not to compute income in accordance with sub section (1) of section 44AD shall get their accounts audited under clause (a) of Section 44AB.
(B) Where the turnover is below one crore rupees, assessee chooses not to compute income undersub section (1) of section 44AD, shall get their accounts audited by virtue of clause of (e) of Section 44AB.
(C) Where assessee started a new business then they have to choose their income computation options very carefully, especially looking into their future plans. For instance, if in first year they choose not to declare income as per Section 44AD then they should maintain books of accounts but there will no mandate to get such accounts audited if working within the four corners of section 44AB. Prior to A.Y. 2017-18 such option was not available and it was mandatory to maintain books of accounts and get them audited if income was declared below 8% of the turnover or receipts.
6. Comparative Chart of Section 44AD pre and post amendment 2016-
(i) Single rate of 8% was prescribed for computing income u/s 44AD
(ii) Salary& interest paid to partners was allowed.
iii) Provisions of advance tax were not applicable to eligible assessee
iv) Assessee who claimed income lower than 8% of the turnover and total income exceeds maximum amount not chargeable to tax was required to maintain books of accounts and get them audited.
v) Previously, limit of turnover to be an ‘eligible business’ was one crore rupees.
Deemed rate of 6% for receipts through specified banking channels and 8% for any other receipt.
Salary and interest paid to partners is not allowed as deduction now.
Provisions of advance tax apply to such assessees now [ Section 211]
Now, assessee who declares profit not in accordance with Section 44AD for any five assessment years succeeding the assessment year in which they claimed the benefit of Section 44AD shall get their accounts audited.
Limit of turnover has now been increased totwo crores rupees.
Thus, an eligible assessee engaged in eligible business can declare profits in accordance with Section 44AD if their turnover is below 2 crore rupees and who continue to avail the benefit for five assessment years relevant to the previous year succeeding the previous year in which such benefit is availed and thus, shall not be required to maintain books of accounts and get them audited.
7. Other relevant aspects: –
(A) Section 44AD shall not apply to-
– person carrying profession as referred to in subsection (1) of section 44AA.
This means professions other than mentioned in subsection (1) of section 44AA cannot opt the benefit of Section 44AD (or 44ADA) and shall be required to maintain books of accounts, though tax audit requirement will depend on the turnover [Refer Section 44AB(b) read with Section 44AB(d)];
– a person earning income in nature of commission or brokerage; or
– a person carrying on any agency business.
(B) Section 44ADA is much similar to pre-amended Section 44AD done by Finance Act 2016. Section 44ADA mentions that any person engaged in profession referred to in subsection (1) of Section 44AA shall maintain books of accounts as prescribed and get them audited under clause (d) of Section 44AB if they claim profits lower than 50% of the total gross receipts.
Here, we can also draw a fine conclusion that professions other than referred to in subsection (1) of Section 44AA shallhave to maintain books of accounts as Section 44ADA is not applicable to them.
[Refer Section 44AA read with Rule 6F]
(C) Many a times we come across a situation,especially in case of proprietorship firms where more than one business is carried on by the assessee. But, due to ignorance or whatsoever the reason be, they claim the benefit of section 44AD without looking in the fact that they might be carrying business in nature of commission or brokerage, agency business, or even profession as referred to in Section 44AA(1), which they are legally not entitled to avail due to provisions of subsection (6) of section 44AD.
Even though receipts of such ineligible business or profession might not be routed through books of accounts, whatever the reason be, or might be earned in personal capacity, still such assessee shall be ineligible to avail the benefit of Section 44AD.
This is simplified with the help of an example which is as follows:
Often architects/interior designers [profession referred in Section 44AA(1)] also supply material, labour, etc. under their own name or carry on such contractor business in addition to the profession referred above. So, in such cases,these persons cannot avail the benefit of Section 44AD for contractor business or for turnover from supply of material because they are also engaged in profession as referred above and such profession is outside the purview of this scheme as referred to in subsection (6) of section 44AD.
Same will be the case of doctors/medical professionals who are providing medical, nursing home, medical consultation (OPD) services and in addition to that are also carrying on business activities like medical supplies, charging room rent from their patients, etc.
Legal understanding: It is important to know the intent of the law makers.
If such professions or other specified businesses as referred in Section 44AD(6) were also provided, by way of an exception,in the definition of “eligible business” along with the business referred in Section 44AE, instead of subsection (6)then such professions and specified businesses would have been able to avail the benefit of Section 44AD in respect of businesses like contractor business, medical supplies, patient room rent, etc. as now it will also fall under “eligible business”
(D) Since, now government is trying to automate the tax processes, it will impact the implication of this section on the taxpayers. If provisions of Section 44AD, 44ADA, 44AB, 44AA are not properly and sincerely referred at the time of planning the taxes and filing of returns, intimations under section 143(1) will follow and such returns might be treated as defective and also result in scrutiny notices under section 143 or section 148.
(E) Tax Audit Limit under section 44AB is 2 crores rupees for assessees who opt for the benefit of Section 44AD. In other words, for such assessees limit is two crore rupees and for others limit is one crore rupees.
I hope this article answers your doubts & queries. Also, it majorly focuses on apprehensions of the tax professionals and tries to demystify them. In case of any query, please contact on the below mentioned email.
CA SHIVANSH MEHRA
DISCLAIMER: The views expressed in this article are strictly of the author. The contents are solely for informational purpose. It does not constitute professional advice or recommendation by the author. The author does not accept any liabilities for any loss or damage of any kind arising out of any information in this article nor for any actions taken in reliance thereon.