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There is a misconception in the mind of business as well as the professional community that if a person opts the provisions of presumptive taxation, then he is free to enjoy the difference between the actual profits and the presumptive profits. It is to be noted that the provisions of presumptive taxation are enacted to facilitate computation of total income and filing of return of income. It does not give a license to the assessee to declare lower income despite the assessee having a higher income. The law is not creating a privileged class out of such assessees, but only is providing a window of concession for a limited purpose. It is to be noted that whenever the law provides any concession for its rigors, the observance and satisfaction of the qualifying criteria are presumed and section 44AD would not operate to curtail the scope of section 2(24) read with section 5 of the Act. The assessee must keep in mind that where they admittedly earn a higher income, they would be liable to be assessed on that basis and presumptive profits shall have no application. The assessee is legally bound to return higher income if the same is higher than the benchmark given. To understand this concept, first of all, we have to study the relevant portion of the section 44AD and 44ADA which are relevant.

44AD. (1) ............................. a sum equal to eight percent 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.......................................

44ADA(1) ............................. a sum equal to fifty percent of the total gross receipts of the assessee in the previous year on account of such profession or, as the case may be, a sum higher than the aforesaid sum claimed to have been earned by the assessee........................................

44AE. (2) For the purposes of sub-section (1), the profits and gains from each goods carriage,—

Presumptive Taxation Does Not Create a Privileged Class of Taxpayers

(i) being a heavy goods vehicle, shall be an amount equal to one thousand rupees per ton of gross vehicle weight or unladen weight, as the case may be, for every month or part of a month during which the heavy goods vehicle is owned by the assessee in the previous year or an amount claimed to have been actually earned from such vehicle, whichever is higher;

(ii) other than heavy goods vehicle, shall be an amount equal to seven thousand five hundred rupees for every month or part of a month during which the goods carriage is owned by the assessee in the previous year or an amount claimed to have been actually earned from such goods carriage, whichever is higher.

From the study of the above three sections, one thing is apparent that under section 44AD and Section 44ADA, an assessee can declare the presumptive profits or an higher amount of profits as claimed by the assessee. These two profits may be less than the actual profits. In this context we must understand that under presumptive taxation there are three kinds of profits- Firstly presumptive profits, secondly the profits claimed to have been earned by the assessee and thirdly the actual profits of the business. If the assessee declares minimum presumptive profit then he is not required to maintain books of accounts and get them audited. But if we see the provisions of section 44AE, which gives only two options to the assessee which is- presumptive profits or actual profits- whichever is higher.. The lawmakers have very rightly enacted the provisions of section 44AD and section 44ADA with the words “as claimed to have been earned by assessee”. If the lawmakers had used the words actual profits-as given in section 44AE then the purpose of section 44AD and section 44ADA shall be defeated because to compute the actual profits the assessee must maintain books of accounts. However, it can be easily seen that the phrase, “whichever is higher” is absent in the amended section 44AD which is a distinctive feature of the amended section 44AE. In sec 44AD and sec 44ADA the word “or as the case may be” which has been defined in legal lexicon as ‘whichever the case may be’.

 

Meaning of words ‘claimed to have been earned by the eligible assessee’

The section has been amended for the benefit of the assessee and the words claimed to have been earned by the eligible assessee. By the introduction of these words in section 44AD(1), the legislature shows his intention to accept specified income as returned income even if higher sum is earned by eligible assessee unless it is claimed by assessee in his Income Tax Return. The word “Claim” signifies the right of assessee to the extent to opt between actual profits and presumptive profits. It is further to be noted that to claim the profits upto presumptive rate is the right of the assessee and if the actual profits are more than the presumptive profits then it is an obligation of assessee to declare the actual profits to the department. In other words, the scheme of presumptive taxation provides both right- to the extent of presumptive profits and obligation to the extent of actual profits. It cannot be said that if an assessee who has opted for presumptive taxation is not free to enjoy the gap between presumptive profits and actual profits. The distinction between right and obligation is very necessary here. The language of section 44AD(1) requires claims to have been made by an assessee for returning higher income. If there is no claim made by assessee in return for higher income, there is no higher income. The assessee, who has opted presumptive taxation system, is under no obligation to explain individual entry of cash deposit in bank unless such entry has no nexus with gross receipts

Example: Mr. Sham is carrying on business. The Turnover is Rs.90 Lacs. The profit as per his books or calculation is Rs.9 Lacs. However, he opts to return the income under section 44AD @ 8% i.e. Rs.7.20 lacs. Now a question arises regarding the power of AO to assess the difference of Rs.1.8 lacs as undisclosed income. In this case Mr. Sham has claimed the income of Rs.7.20 lac as in his return of income as his claim. The assessee is free to exercise this option at his will. Legally he is given the option by the statute and such an option cannot be equated with obligation cast upon the assessee. There is a definite difference between OPTION and OBLIGATION and an option granted to the assessee cannot be construed to be his obligation when his actual income is more than 8% of Turnover. The AO cannot make any addition on this count as there is no provision under the Act permitting him to make such addition. Further, the words used are “higher income claimed to have been earned by the assessee”. It is to be clarified that if the assessee has not made a claim in the return of Income regarding any higher income, it implies there is no claim for higher Income made by assessee. AO cannot claim that the assessee has earned higher income, because under the statue, he is not entitled to do so. Another pertinent point is that if 8 per cent of gross receipts are 'deemed' income of the assessee, the remaining 92 percent are also 'deemed' expenditure of the assessee. Meaning thereby that actual expenditure may not be 92 percent of gross receipts, only for the purposes of taxation, it is considered to be so. To take it further, it can be said that the expenditure may be less than 92 percent or it may also be more than 92 percent of gross receipts. It means that the assessee has incurred the expenditure of 92 percent for earning the presumptive profits of 8 percent. The point to be noted is that 92 percent has been expanded and this amount is neither saved nor invested. AO can make addition if he is having sufficient evidence that the difference between actual profits and presumptive profits have been invested.

Now let us understand the applicability of this section under the following cases:

Case 1. When Actual profits is less than Presumptive Profits

In this case if the assessee wants to opt for the actual profits then he has to maintain books of accounts and get them audited. On the other hand if the assessee opts for presumptive profits then he is not required to maintain books of accounts.

Now, a question arises that if an assessee opts for presumptive taxation, when the actual profits are less than presumptive profits, then the actual profit will be added in the capital account of the assessee. In this context it is to be noted that he has opted the provisions of presumptive taxation to avoid the maintenance of books of accounts and its audit. His capital account will be credited with the actual profits earned by him during the year. The reason is very simple that the system of presumptive taxation does not override the system of actual accounting. Presumptive taxation is a method to compute the profits and gains in a simpler manner for taxation purposes and not for maintenance of books.

 

Example: Mr. A has turnover of Rs.1.2 Cr for the FY 20-21 and his actual profits is Rs.5,20,000. But in such a case his presumptive profit will be 9,60,000. The assessee opts for presumptive taxation and declares his income @8%. In his books of accounts, the profits amounting to Rs.5,20,000/- will be credited to the capital account. Though he will declare profits of Rs.9,60,000 in his return of income, the profits in books will be Rs.5,60,000 only.

CASE 2: When Actual profits are more than Presumptive Profits

There may be situation when assessee is earning profit more than presumptive taxation profits. In such a situation if an assessee declare profit under presumptive tax then @ 8% or 6% as the case maybe, AO can assess correct income on the basis of investment if they have sufficient documentary evidence which may be available during survey, search & assessment proceeding. AO can bring to tax the higher income in such cases.

In this case, there will be two situations which will depend on whether the assessee is maintaining books of accounts or not. If he is maintaining books of accounts, then he is obliged to declare actual profits which are higher than the profits at presumptive rate. He cannot take the benefit of declaring lower profits, in spite of higher actual profits in books of accounts.

Second situation is where the assessee is not maintaining books of accounts. In this case, the assessee has the option to declare profits at the presumptive rate or higher profits than that. Since, the books of accounts are not maintained, actual profits would not be available. The rates specified under sections- 6% or 8% or 50% are the benchmarks. The assessee can claim higher profits than these rates. If assessee declares profits at the rate of 10% of receipts, also implies that 90% of the receipts have been expended (ITAT Chandigarh in case of NandPopli vs DCIT). The AO cannot question the expenditure upto 90% of receipts. However, some taxpayers are of the view that If they declare their savings and investment more than the amount of profits declared in their return. If the assessee has declared profits at the rate of 10% of receipts, he can deposit or make investment upto 10% of receipts only. The reason being, the assessee has claimed that he has expended 90% of the receipts. The AO cannot question the expenditure upto 90%, but he has right to assess the investment over and above the declared profits as income.

Example: A doctor has gross receipts of Rs.45 Lacs. He has declared profits u/s 44ADA amounting Rs.24 Lacs. In actual, he has earned Rs.30 Lacs. He invested Rs.30 Lacs in an FDR. Whether he can claim that he has deposited the actual profits and the AO has no right to question since he has declared profits under presumptive scheme.

The assessee cannot make investment of more than the declared profits. If he has declared 24 Lacs as profits, also implies that he has expanded Rs.21 Lacs (Rs.45 Lacs – Rs.24 Lacs). In this case, the AO can make an addition of Rs.6 Lacs. Further, the assessee should have declared 30 Lacs as his profits, since the actual profits are known and are higher than the presumptive profits.

Almost similar issue was dealt by Ahmedabad bench of ITAT in the case of Shivani Builders Vs. ITO [2007] 295 ITR (AT) 281.

The relevant paragraphs of the order reproduced below brings out the import of the presumptive sections which we are discussing:

It is, thus, clear that the law envisages all the three situations by laying down appropriate procedure for all of them, i.e., the assessee disclosing a higher, lower, or an amount equal to the presumptive income (reckoned at the rate of 8 percent of the turnover). - In the instant case, the assessee contended to have declared its income at the presumptive rate, being covered by the provisions of section 44AD, of which, clearly, there was no doubt, it being engaged in the civil construction of residential flats. The provision of section 44AA i.e., with regard to mandatory maintenance of books of account, would apply to an assessee engaged in such business, only, if the assessee chooses to be taxed at lower than the presumptive rate of 8 per cent, which is clearly in the nature of a, and the only, concession accorded by the statute to the relevant class of assessees, to which assertion of the assessee, there could be no doubt, it being statutorily recognized/ enacted.

However, where the assessee, despite the said concession, chooses to maintain the books of account, preferring to rely thereon for various other purposes, both apart from and under the Act, it cannot ignore the book results and claim to be entitled to a lower presumptive rate of income than that revealed by such books. The law does not accord a privileged status to the assessee engaged in this line of business but only, considering the vagaries that attend thereto, draws a higher bar for the purpose of maintenance of books, i.e., than that normally obtains under section 44AA.

As such, it cannot be said that though the assessee, admittedly, earns more, he would still be liable to be assessed to income-tax at a lower income by virtue of the said concession.

Section 44AD would not operate to curtail the scope of income as defined under section 2(24), read with section 5, so that where the assessee admittedly earns a higher income, the character of which as income is undoubted, it would be liable to tax on that basis, that is, on the basis of real income, even as held by the Commissioner (Appeals).

The assessee’s plea of the said interpretation as amounting to be penalizing it for the maintenance of its books, was wholly misconceived; the act of paying tax on the basis of income earned cannot, by any stretch of imagination, be considered as amounting to being penalized; the law is not creating a privileged class out of such assessees, but thereby only is providing a window of concession for a limited purpose.

From the above discussion, the following points can be concluded

  1. An assessee filing the return of income is under an obligation to offer its correct and true income in accordance with the provisions of the Act.
  2. The presumptive scheme of taxation allows taxpayers to offer income higher than the prescribed rate. In short, it is the minimum rate u/s 44AD that has to be considered and higher income option is open for the taxpayers which has to be used if taxpayers have higher income.
  3. The powers of the AO are very wide & exhaustive. AO can assess correct income on the basis of investment if they have sufficient documentary evidence which is very much possible during survey, search & assessment proceeding. AO can bring to tax the higher income in such cases
  4. Though the presumptive scheme of taxation is introduced with an aim to relieve the taxpayers form the requirements of maintaining the books of accounts, however, it doesn’t not relieve the taxpayers from justifying its investment sources. In short, it may not be taken as a permission to show lower income even if taxpayers are earning higher income.
  5. The concept of making disclosure in the ITR forms with respect to few Balance Sheet data in income tax returns seems to have been introduced with this concept only.
  6. Not offering true or correct income may even result in the application of section 69, 69A or section 69C of the Act if the investment or the expenditure is in excess of the returned income.
  7. Section 44AD does not give a license to the assessee to declare lower income despite the assessee having a higher income.
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