Whither Tax Audit and Presumptive Taxation
“The Finance Act, 2021 increased the threshold limit for applicability of the provisions of section 44AB(a) of the Income Tax Act, 1961 from five crore rupees to ten crore rupees, w.e.f. 1-4-2021. The Memorandum accompanying the relevant Finance Bill, 2021 explained the purpose of the amendment as to incentivise non-cash transactions to promote digital economy and to further reduce compliance burden of small and medium enterprises. Notwithstanding what is stated in the Memorandum, the author feels that the above amendment is a part of a larger strategy to render the provisions of sections 44AB and 44AD of the Act futile in case of assessees having income from business. Moreover, a distinction is made between an assessee carrying on business and others. Read on…”
1 Historical Background & Declared Legislative Intent
Tracing the history of the introduction of the provisions relating to compulsory audit and presumptive scheme of taxation contained in sections 44AB and 44AD of the Income-tax Act, 1961 (“the Act”), respectively, and certain recent amendments, it is opined that the scope and coverage of these two sections are being reduced in a phased manner. The assessees having income from business would no longer be able to claim profits lower than presumptive rate by getting their accounts audited and furnishing the audit report. The declared aims for introduction of these provisions would, thus, be negated.
2 Overview & Evolution of the Presumptive Taxation Scheme
The Finance Act, 1994 inserted sections 44AD and 44AE in the Act:
- Section 44AD: Inserted with a view to providing a method of estimating income from the business of civil construction or supply of labour for civil construction work.
- Section 44AE: Inserted with a view to providing a method of estimating income from the business of plying, hiring, or leasing trucks owned by a taxpayer, owning not more than ten trucks.
The scheme, when introduced, was optional and an assessee could claim that his income in respect of the abovementioned business was lower than the specified estimate of income, i.e., the presumptive rate. In such a case, he was subjected to compulsory scrutiny. But initially, he was not required to get his accounts audited. Later, the requirement of compulsory scrutiny was removed and in lieu thereof, the requirements of audit and furnishing of audit report were imposed.
Taxpayer-Friendly Reforms by the Finance Act, 1997
Realising the benefit of the presumptive provisions, the Finance Act, 1997 introduced key amendments to make the scheme more popular:
- It removed the requirement of compulsory scrutiny.
- It settled the controversy regarding allowability of deduction for salary and interest paid by a partnership firm to its partners in favour of the taxpayers.
- It introduced section 44AF in the Act providing similar presumptive benefits to retail traders (estimating income at 5% of gross turnover).
The benefits of the presumptive taxation scheme were further extended to all businesses by the Finance (No. 2) Act, 2009 w.e.f. 1-4-2011, except in case of income from profession, commission, brokerage, and agency.
3 The Department’s Shifting Approach: Restrictive Amendments (1998 to 2016)
The approach of the Department to the scheme has been changing since its introduction. Beginning from 1-4-1998, a series of steps were taken contrary to its declared beneficial objects so far as small traders are concerned:
Amended sections 44AD, 44AE and 44AF w.e.f. 1-4-1998 providing that an assessee could claim his income to be lower than the deemed profits and gains only on the condition that books of account are maintained under section 44AA(2) and the assessee gets accounts audited and furnishes audit report under section 44AB.
Substituted section 44AD to enlarge coverage to all businesses (except profession, commission, brokerage, agency), but substantially enhanced the presumptive deemed profit rate from 5 per cent to 8 per cent of gross turnover/gross receipts.
- Disallowance of Partner Remuneration/Interest: No deduction allowed for salary, remuneration, interest, etc. paid to partners as per clause (b) of section 40 while computing income under section 44AD.
- Five-Year Lock-In & Disqualification Penalty (Section 44AD(4)): Where an assessee declares profit under 44AD and subsequently opts out in any of the next five consecutive assessment years, he is barred from claiming section 44AD for the subsequent five assessment years.
- Advance Tax: The assessee was required to pay advance tax.
4 Right to Adopt Lower Than Presumptive Rate: Pre- vs. Post-2017 Regime
Position Prior to 1-4-2017
Although sub-section (1) of section 44AD mandated that the specified percentage of gross receipts or gross turnover shall be deemed to be profits, sub-section (5) thereof, starting with a non-obstante clause, provided that an eligible assessee (i.e. a small trader) could claim that his profits and gains from eligible business are lower than the presumptive rate, subject to maintaining books under 44AA and furnishing tax audit report under 44AB.
Substitution by Finance Act, 2016 w.e.f. 1-4-2017
The Finance Act, 2016 substituted sub-section (5) of section 44AD w.e.f. 1-4-2017. The words “who claims that his profits and gains from the eligible business are lower than the profits and gains specified in sub-section (1)” appearing in the existing sub-section were deleted and replaced by the words “to whom the provisions of sub-section (4) are applicable”. Consequently, sub-section (5) no longer overrides sub-section (1) to enable a small businessman to claim lower profits simply by getting audited!
Numerical Illustration: Operation of Section 44AD(4)
An eligible assessee claims to be taxed on presumptive basis under section 44AD for Assessment Year 2017-18 and offers income of INR 8 lakh (or INR 6 lakh depending upon digital transactions) on turnover of INR 1 crore. For two succeeding Assessment Years 2018-19 and 2019-20, he offers income in accordance with section 44AD.
However, in the third assessment year 2020-21, he offers income of INR 4 lakh on turnover of INR 1 crore. Thus, he has not offered income in accordance with section 44AD for five consecutive assessment years.
Case of a New Assessee
Section 44AD(4) applies strictly to an assessee who had declared profit under 44AD in an earlier year and subsequently opted out. Therefore, sub-section (4) does not apply to a person who starts a business and is assessed for the first time; in the first year of his operation, he does not fall within the disqualification of section 44AD(4).
5 Interplay with Section 44AB & Discrimination Against Business Assessees
An assessee can get his accounts audited under section 44AB only if his case falls within one of its specific clauses:
Applies to a person carrying on business whose turnover exceeds INR 1 crore (or INR 10 crore if 95% digital transactions). Crucially, clause (a) contains no provision enabling an assessee below the threshold to get audited to claim lower profits!
Clause (d) specifically empowers a professional under section 44ADA to get accounts audited and declare profits lower than presumptive rates (50%).
Clause (e) mandates audit only where the provisions of sub-section (4) of section 44AD are applicable and income exceeds the basic exemption limit. It does NOT enable a regular businessman to claim lower profits unless he is serving the sub-section (4) penalty period!
The Resulting Legal Dilemma: Two Contrary Views
As regards the issue of claiming profits lower than the presumptive rate by maintaining required books of account without audit under section 44AB, two contrary views emerge:
6 Conclusion & Critical Policy Questions
A person carrying on a business is no longer allowed to claim profits lower than the presumptive rate by getting his accounts audited under section 44AB.
It is pertinent to ask whether, in the absence of enabling provisions, an assessee can claim profits lower than presumptive rates and if so, how. If it is held that a small trader must declare his profits at presumptive rates as provided in sub-section (1) of section 44AD, there would be injustice to him. If he claims profits lower than presumptive rates by maintaining the prescribed accounts and is subjected to scrutiny to prove the same, he faces immense hardship, and the entire declared legislative purpose of introducing the presumptive scheme is lost.