This article is written by Jaya Vats, a practising advocate, Delhi. In this article, the author provides a detailed study of Section 44AD of the Income Tax Act. The article provides an in-depth analysis of the objective, calculation of tax, amendments, and limitations of Section 44AD along with its relevance.

It has been published by Rachit Garg.

Introduction

In India, income tax is a type of tax that is paid to the government based on one’s earnings/profits. The government then uses the tax revenue to fund different public services, infrastructure development, defence spending, and subsidies, among other welfare reasons. While it is obligatory to pay taxes if you earn a particular amount of money each year, there are methods to lower your tax burden and take advantage of tax-saving strategies.

The Income Tax Act of 1961 is a legislative framework that establishes the rules and regulations that regulate taxes in India. According to the Income Tax Department of India’s official website, the Income Tax Act has 23 chapters and 298 sections. The Income Tax Act is divided into many parts, each of which deals with a particular area of taxes in the country. To alleviate the financial burden of maintaining taxes, the Government of India has implemented a number of taxation initiatives. Section 44AD is a taxation plan under which persons such as company owners and small-scale firms are exempted from auditing their account books in order to file taxes.

Recent changes in the Union Budget 2022 include those earning less than Rs. 50 Lakhs being eligible for Section 44AD benefits. If a person owns a small business and must report any income to the government, the terms of Section 44AD of the Income Tax Act (1961) come into motion.

Section 44AD of Income Tax Act, 1961

The Government of India included a simple process to minimize the tax load and provide relief to taxpayers from tax compliance requirements. Section 44AD of the Income Tax Act establishes a mechanism of presumptive taxation. Businesses that use the presumptive taxation scheme are exempt from keeping normal books of accounts.

A presumptive income plan allows an assessee to disclose their income at a specified rate under the Income Tax Act. Section 44AD is one of such a scheme’s sections. This saves a significant amount of time and the associated compliance costs. Small taxpayers with less than 2 crores of revenue are not needed to keep their books of accounts under Section 44AD of presumptive taxation, and their earnings are deemed to be 8% of their turnover. Profits credited digitally or through a bank will be regarded at 6% instead of 8% for cash receipts when claiming benefits under this plan. If a person chooses presumptive taxation, he will not be able to deduct costs under Sections 30 to 38.

Objectives of Section 44AD of Income Tax Act

Some of the key goals of Section 44AD under the Presumptive Taxation Scheme are as follows:

• To make the tax system easier to understand
• To ease the strain of compliance
• To make it easier for small business owners to do business.
• To achieve a balance between small businessmen and small professionals (as defined under Section 44AD).

Applicability of Section 44AD of Income Tax Act

Section 44AD applies to all types of companies, with the exception of those that include the leasing, plying, or renting of commodities because these enterprises come within the restrictions of Section 44AE, the taxpayer cannot claim deductions under Section 44AD. Individual assessees, Hindu Undivided Families (HUFs), and partnerships who are Indian residents are able to claim deductions under Section 44AD. However, limited liability partnerships (LLPs) are not covered by this Section 44AE provision.

Any assessee who desires to submit his or her income tax returns under Section 44AD may do so at a rate of 8% or higher. If he or she chooses not to submit returns under this section and has earnings that are less than 8% of total turnover, the individual will be obliged to keep books of accounts and have them audited by a licensed Chartered Accountant.

Section 44AD does not apply to assessees who practise any of the professions listed in Section 44AA. Assessees who work for an agency or earn money through commissions or broker agreements are likewise unable to claim deductions under this clause.

Eligibility criteria of Section 44AD of Income Tax Act

According to Section 44AD, income is assumed to represent 8% of total firm turnover. Assessees having a gross yearly income of more than Rs 2 crores will have to pay the income tax in accordance with the standard tax regulations and will be exempt from Section 44AD’s advantages.

When an assessee files for Section 44AD, he or she cannot claim the costs and depreciation deductions permitted under Sections 30 to 38. The government also provides incentives of upto 8% of gross revenue to enterprises that conduct transactions online. 

Section 44AD Income Tax Act is available to the following taxpayers:

• Individuals or businesses that provide professional services
• Firms that form partnerships (excludes limited liability partnership firms)
• Hindu unbroken families
• Lawyers, physicians, technical consultants, interior designers, engineers, architects, and chartered accountants are examples of professionals.
• Professionals/companies with gross revenue of less than Rs 1 crore in the preceding fiscal year
• Individuals who did not claim any deductions under Sections 10A, 10AA, 10B, 10BA, 80HH, or 80RRB during the tax year.

Individuals and corporations in the following categories are not eligible for tax deductions under Income Tax Section 44AD:

• Individuals who own brokerage businesses, agencies, or earn a commission-based income
• People who work in the professions as specified in Section 44A (1)
• Businesses with a gross or total turnover of more than Rs 2 Crores
• Non-resident Indians and foreigners foreigners residing in India
• Individuals who have previously filed for tax breaks under Sections 10A, 10AA, 10B, and 10BA during the assessment year

Calculation of tax under Section 44AD of Income Tax Act

Section 44AD is a presumptive taxation scheme in which income is determined on the basis of 8% of turnover (6% in the case of digital receipts and payments) and the taxpayer is given a break for failing to keep books of account. 

For our better understanding let’s assume you are Mr. Verma and your supplies shop has a yearly revenue of Rs 90 lakhs. You can therefore take advantage of Section 44AD and avoid performing time-consuming paperwork by filing under the presumptive taxation scheme. Section 44AD applies to small and medium-sized firms that have not claimed any tax deductions under Sections 10A, 10AA, 10B, or 10BA during the assessment year.

The gross annual turnover rate of your firm that you disclose under this system is an estimate that equates to 8% of your gross annual earnings. Under this arrangement, you might claim a larger or lower yearly gross turnover rate than your presumed income as a business owner. Mr. Verma’s yearly presumptive tax would be around 7.2 lacs in his firm, which generated Rs 90 lakhs last year (8 percent of Rs 90 lacs).

Features of Section 44AD of Income Tax Act

Following are the features of Section 44AD:

• The assessee’s tax under Section 44AD is determined at 8% of the individual’s gross turnover for the fiscal year, provided that his or her gross sales is less than Rs 1 crore. According to the Budget for 2022-2023, this ceiling has been raised to Rs 2 crore.
• The rate of 8% has been reduced to 6% in order to promote digital transactions and encourage companies to accept digital payments. As a result, assessees who take digital payments might regard their considered total revenue to be 6%. This only applies if the amount of such turnover or gross revenues are received by account payee cheque or account payee bank draught, Credit Card, Debit Card, Net Banking, IMPS, UPI, RTGS, or NEFT.
• The assessee who chooses the program would be excused from keeping books of accounts.
• With the exception of those referred to in Section 44AE, the provisions of this section apply to any company or profession.
• Income determined under this section is liable to taxes in line with the Income Tax Act’s slab rates.
• Assessees who claim deductions under this provision will not be able to claim any further expenditure or depreciation, with the exception of any interest or payments given to partners.
• The qualifying assessee must pay the entire amount of advance tax on or before March 15th.
• If an assessee chooses the presumptive scheme and declares profits in accordance with the scheme, but does not disclose earnings for five consecutive assessment years, he will be ineligible to claim the benefit of the provisions for the next five assessment years, beginning with the year in which profits were not proclaimed in accordance with the scheme.

Presumptive income tax scheme

The Income Tax Act’s Section 44 ADA is a section created under the presumptive taxation scheme, which took effect on April 1, 2017. It was created to assist small firms and professionals in employing a simplified taxation system with a lower compliance load. Provisions 44AE and 44AD, which were established earlier, are the additional sections included in the presumptive taxation plan. Profits can be declared as a proportion of total turnover (sales) or gross revenues under presumptive taxation regimes. These disclosed gains are considered the assessee’s business income. A taxpayer who has chosen the program is not required to keep full records of accounts. Likewise, under Section 44ADA, small taxpayers are not required to keep books of accounts, and earnings are determined as a proportion of total sales.

According to the Income-tax Act of 1961, businessmen and professionals are required to keep regular books of accounts. In addition, they must have their finances audited and file income tax forms (ITRs). However, the presumptive taxation scheme (PTS) was created to provide assistance to small taxpayers.

PTS income is determined on a presumptive basis, as the acronym implies. Income is estimated on a presumptive basis for a person adopting section 44AD (businessman) at the rate of 8% of the qualified business’s turnover or gross revenues for the year. Section 44AD, however, was changed with effect from the assessment year 2017-18 to state that income shall be computed at a rate of 6% instead of 8% where turnover/gross receipt is received by an account payee cheque or an account payee bank draught, or by use of an electronic clearing system through a bank account or by any other electronic channel.

Similarly, if a professional (as defined in section 44ADA) wishes to adopt PTS, income will be estimated on a presumptive basis, i.e., at a rate of 50% of the profession’s total gross revenues. However, both entrepreneurs and professionals can voluntarily reveal more than the necessary proportion of their company or professional income and still file their returns under PTS.

Benefits

The fundamental advantage of PTS is that taxpayers are not required to keep detailed records of accounts. In addition, whereas most people must pay advance tax in four installments, those who choose the presumptive taxation plan under sections 44AD/44ADA must pay the whole amount of advance tax in one installment on or before March 15.

Considerations Before Choosing PTS 

Once you submit your income under PTS, you must use the same method for the next five years. If an assessee fails to do so in a given year, he will be barred from filing a PTS return for the next five years, and he will also be compelled to have his accounts audited in that year if his income exceeds the maximum amount that is not payable to tax. Before claiming the advantage of this section, it is preferable to first study the provision. When completing your tax returns through PTS, you must utilize the relevant income-tax form. A person must select between ITR forms 3 and 4. If you use the incorrect form, your refunds will be invalid.

Section 44AB of Income Tax Act

The provisions of Section 44AB of the Income Tax Act apply to tax audits conducted under the Income Tax Audit. A tax audit is a review of a taxpayer’s financial records. The purpose of the audit is to check that the taxpayer’s books of accounts and other records have been properly kept. In addition, the books of accounts should accurately reflect the taxpayer’s earnings. During the tax audit, the person in charge of issuing the tax audit report should check to determine if the assessee has met certain requirements such as filing income tax returns, accurately specifying claims and income tax deductions, and so on. A tax audit is a procedure used to detect and prevent fraudulent tax activities. 

Section 44AB allows for an income tax audit of an individual’s accounts in the following circumstances:

• Individuals whose overall income or turnover for the fiscal year exceeds the taxable limit, regardless of their turnover in previous fiscal years
• Individuals whose personal income is less than the taxable limit but whose business income exceeds the taxable limit
• In exceptional circumstances where the individual’s income does not exceed the taxable limit but the Assessing Officer needs the individual’s accounts to be audited. The Assessing Officer can only do this by issuing an order under Section 142(2A) of the Income Tax Act.

Anybody who fails to get their accounts audited will face the following penalties:

• 0.5 percent of overall company sales or 0.5 percent of total professional receipts in the current fiscal year
• A total of Rs 1,50,000

The lesser of the aforementioned will be imposed as a penalty.

Section 44ADA of Income Tax Act

Section 44ADA is a specific provision that allows small professionals to calculate their earnings and gains in certain circumstances. Section 44ADA was enacted to expand the streamlined presumptive taxes regime to certain professionals. Previously, the presumptive tax plan was only available to small businesses. The presumptive taxation method decreases the regulatory load on small businesses and enhances the ease of doing business. Profits are expected to be 50% of gross revenues under the presumptive taxation regime. 

Section 44ADA establishes a straightforward way of taxes for small professions. Section 44ADA of the Income Tax Act of 1961 provides for the presumptive taxation of income and gains derived from professions listed in Section 44AA(1). Section 44ADA is exclusively available to selected professions with yearly gross earnings of less than Rs 50 lakh.

Any professional’s income under this section is regarded to be 50% of total gross revenues for the year, as they are normally thought to incur few costs. This method does not require experts to keep books of accounts. However, if they allege that their income is less than 50% of their gross revenues and their total income exceeds the basic exemption ceiling, they are ineligible for Section 44ADA classification.

Amendments to Section 44AD of Income Tax Act

Under Section 44AD, there are particular provisions for company earnings and losses. They are as follows:

• Assets related to sub-section (1) should be included in tax computations and eligible for deductions according to the appropriate assessment years.
• If the assessee owns a business, interest and payments paid to partners will be deducted from the computed income.
• Businesses that file tax returns under Sections 44AA and 44AB are not eligible for the provisions listed in Section 44AD. During computations, they must disregard the gross receipts and monetary limits established by this section.

Benefits of Section 44AD of Income Tax Act

When claiming tax deductions under the Section 44AD scheme, a person obtains a variety of advantages. The most important are:

• If an individual is filing for Section 44AD, there is no need to pay any advance tax.
• If a person runs a partnership firm, they can deduct interest and salary paid to partners up to a certain amount, as long as the individual stays within the restrictions provided as under Section 40(b).
• There is no need to keep a book of accounts. Under this arrangement, an individual is not required to keep a record of financial transactions, statements, or audit its accounts.

Limitations of Section 44AD of Income Tax Act

The following is a list of the constraints based on Section 44AD:

• Under this approach, income is calculated on a presumptive basis. Section 44AD was created to make it easier for small business owners to pay their taxes.
• There are no disallowances mentioned in Sections 40, 40A, or 43B.
• Individuals are required to pay advance tax by the 15th of March or by the end of the fiscal year.
• The pay-as-you-earn model governs presumptive tax deductions, and businesses typically pay the Internal Revenue Service in installments.
• The written down value method of asset depreciation must be used for deductions made under this programme.
• Interest income, inventory value, customer advance payments, retention money, and property, plant, and equipment sales all contribute to gross receipts are not considered. 

Significant case laws

In the case of Kangiri Contractor v. ITO, (2011), the facts of the case show that the assessee’s firm had a turnover of Rs. 6.21 Crores and the assessee had kept good books of account, i.e, they were thoroughly audited and were devoid of any unfavourable remarks from the auditors. 

The main issues before the Income Tax Appellate Tribunal in Jodhpur were that the profit rate of 8% under Section 44AD is to be applied where the assessee does not keep books of account and the turnover is less than Rs. 1 Crore and that the provisions of Section 44AD were not applicable in the instant case. 

The Court held that the fact that the assessee destroyed the books of account, etc., after completing the scrutiny assessment and thus could not produce them before the Commissioner did not disprove the facts that those books of account were maintained and audited, were produced before the Assessing Officer, and were verified by the Assessing Officer. As a result, the Commissioner’s decision to impose a net profit rate of 8% was not justified. It was also decided that if the assessee’s net profit rate of 8.15 percent covered all additions, any additional additions made by authorities below that rate must be erased.

Before getting into details of the next case, one must understand the concept of assessment of on-money. The assessment on-money is proof of cash received that has been precisely recorded in diaries and records. It is frequently discovered and confiscated in situations involving builders and developers. The proof is usually deemed very strong if it includes particular facts such as the dates of receipt, the amount received in cash and by check, the property for which the money was received, and the people who made the payments, among other things. In most cases, the assessee additionally makes disclosures based on the results of the search and survey. Such searches and surveys are usually hailed as huge triumphs by the Investigation Wing, and assessments are conducted to tax the assessee’s on-money receipts as income.

In the case of Shivani Builders v. The Income-Tax Officer, 2005, the assessee firm signed into a building deal on a fixed fee with two associations. It was entitled to recover the cost of any additional work done in the completed apartment(s). During a survey activity undertaken at the assessee’s premises, one of its partners acknowledged collecting on-money outside the usual book of accounts and guaranteed that the same would be reported as clear revenue in the assessee’s books. The assessee did not include the challenged amount in its gross receipts for the relevant assessment year; instead, it returned its income based on a presumptive rate of 8% on the increased turnover as opposed to its net profit as shown in its profit and loss statement.

The main issue before the court was that the assessment officer lacked the authority to determine if returned income exceeds 8% of gross revenues. The assessee submitted an income tax return pursuant to Section 44AD, stating a net profit of 9.56 percent of the entire transaction value. On the basis of the aforementioned declaration of partner, the Assessing Officer added the full ‘on money’ to the assessee’s reported income.

The Income Tax Appellate Tribunal of Ahmedabad held that because there was no material with the department to make the ‘on money’ addition and the assessee had shown income of more than 8% of the total sale consideration, no addition of ‘on money’ to the assessee’s income could be made when working under section 44AD. The court further ruled that when the law makes a concession for its purposes, the compliance and fulfillment of the qualifying criteria is assumed, and section 44AD would not operate to limit the extent of Section 2(24) read with Section 5. As a result, when an assessee obtains a larger income, he or she is subject to be assessed on that basis, and Section 44 AD is inapplicable.

In the case of Abhi Developers v. ITO, 2007, the assessee was a partnership firm engaged in the civil construction sector. The company built flats and stores that were sold to various parties. During the course of the survey, two diaries were discovered, one of which belonged to the assessee. The receipt of ‘on money’ was documented in this journal. The turnover was Rs. 6.21 crores, and the assessee had kept proper books of account that had been audited and were devoid of any negative remarks from the auditors.

The main issue before the court was whether, while calculating an assessee’s income under section 44AD, the Assessing Officer does not have the authority to assess anything in excess of returned income if return income exceeds 8% of total receipt/sale consideration.

The Income Tax Appellate Tribunal of Ahmedabad held that simply because the assessee destroyed the books of account, etc., after completing the scrutiny assessment and could not be produced before the Commissioner, would not disprove the facts that those books of account were maintained and audited, were produced before the Assessing Officer and were verified by the Assessing Officer. As a result, the Commissioner’s decision to impose a net profit rate of 8% was not justified.

Conclusion

Every firm must keep track of its profit and loss statements, formal books of accounts, and other papers that are used to determine its tax liability. However, with the implementation of Section 44 AD of the Income Tax Act, they are excluded from reviewing the books of accounts and are assigned a rate based on the slabs under the Presumptive Taxation Scheme. A person can now apply for Section 44AD directly online, by accessing the Income Tax Department’s website, or through a CA or any private agency. This provision will eventually save a huge amount of time and the associated compliance costs.

FAQ’s

What is turnover under section 44AD of Income Tax Act?

Individuals , HUFs or partnership firms to be eligible for opting for presumptive income u/s 44AD should not have turnover more than Rs 2 crore.

Is it necessary for a person to keep books of account in accordance with Section 44AA if I use the presumptive taxation system of section 44AD?

No.

If a professional uses the PTS, how should they calculate my taxable business income?

As a professional, if a person uses PTS, your taxable income will be 50% of your turnover or revenues. For example, if an individual receives Rs.48 lacs in receipts or has a yearly turnover of Rs.48 lacs, they must disclose taxable profits equal to 50% of such turnover, i.e. Rs.24 lacs.

References

1. https://khatabook.com/blog/section-44ad/ 
2. https://scripbox.com/tax/section-44ad-of-income-tax-act/
3. https://www.kotaklife.com/insurance-guide/savingstax/section-44-ad
4. https://www.bankbazaar.com/tax/section-44ad.html
5. https://icmai.in/upload/Taxation/DT/PPT/Opportunities-Cost-Accountants.pdf

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