This Article will simplifies the provisions of Section 44AD of the Income Tax Law, helping small business owners to understand how it affects his business if he opt out Section 44AD. We’ll explain the provisions of presumptive taxation scheme, what will happen if you opt out from this scheme, and when a tax audit becomes necessary. We’ll also cover special cases where you might still qualify for the scheme later.

Section 44AD (4): Five-Year Restriction for Opting Out

Under Section 44AD of the Income Tax Act, if a taxpayer chooses the presumptive taxation scheme, they are generally expected to adhere to it for a minimum period of five years. Here’s how it works:

– If a taxpayer has declared profits as per Section 44AD for any given year, they must continue to do so for the next five assessment years.

– Should the taxpayer decide to opt out of this scheme during these five years, they will be barred from re-entering the scheme for the following five assessment years.

Key Implication: This rule effectively locks the taxpayer into the presumptive taxation scheme for six years (one year within the scheme and five years outside if they opt out).

Section 44AD (5): Mandatory Audit and Maintenance of Accounts

When a taxpayer exits the presumptive taxation scheme under Section 44AD and their total income exceeds the basic exemption limit, they are required to:

1. Maintain detailed books of accounts as stipulated under Section 44AA(2).
2. Get these accounts audited and submit the audit report as required under Section 44AB.

The basic exemption limits are as follows:

– ₹2,50,000 for individuals below 60 years.

– ₹3,00,000 for senior citizens (60 years and above).

– ₹5,00,000 for super senior citizens (80 years and above).

Important Note: Rebate under Section 87A is relevant only after crossing the basic exemption limit, and thus does not impact the applicability of Section 44AD(5). If the taxpayer’s income exceeds the exemption limit, they must comply with tax audit requirements.

Illustrative Case Study

To clarify, let’s consider a hypothetical taxpayer, Mr. X, whose business income varies over the years:

ASSESSMENT YEAR	TURNOVER	RATE OF PROFIT	WHETHER TOTAL INCOME MORE THAN EXEMPTION LIMIT	WHETHER SECTION APPLICABLE			REMARKS
				44AA	44AB	44AD
2018-19	3.00 Crore	7%	Yes	Yes	Yes	No	A
2019-20	1.20 Crore	9%	Yes	No	No	Yes	B
2020-21	85 Lacs	5%	Yes	Yes	Yes	No	C
2021-22	75 Lacs	10%	Yes	Yes	Yes	No	D
2022-23	1.20 Crore	2%	No	Yes	Yes	No	E
2023-24	1.5 Crore	9%	Yes	Yes	Yes	No	F
2024-25	92 Lacs	6%	Yes	Yes	Yes	No	G
2025-26	95 Lacs	9%	Yes	Yes	Yes	No	H
2026-27	2.50 Crore	6%	Yes	Yes	Yes	No	I

A	Turnover exceeding Rs.1 Crore and hence, he is liable to keep books of account & Audit 44AB(a).
B	Since, Mr. X opted 44AD,he is not required to maintain books and not required to get audited u/s 44AB
C	Since, Mr. X   fails to opt sec 44AD.The benefit of section 44AD shall not be available to the assessee for A.Y. 2021-22 to 2025-26. Therefore he is liable to keep books of account &  Audit u/s 44AB(e).
D	Mr. X is liable to keep books of account & Audit u/s 44AB(e).
E	Mr. X is liable to keep books of account & Audit u/s 44AB(a). If his cash receipts is up to 5% of total receipts and his cash payments is up to 5% of total payments, then he is not liable to audit under sec 44AB(a). Further, he is not liable to audit u/s 44AB(e), as his total income is less than the basic exemption limit.
F	Mr. X is liable to maintain books of account and required to get them audited u/s 44AB(e).If his cash receipts is up to 5% of total receipts and his cash payments is up to 5% of total payments, even then he is liable to audit under sec 44AB(e), as the proviso to Sec 44AB(a), which provides exemption from audit is applicable only to sec 44AB(a) and not Sec 44AB(e)
G	Mr. X is liable to keep books of account & Audit u/s 44AB(e).
H	Mr. X is liable to keep books of account & Audit u/s 44AB(e).
I	Mr. X is liable to keep books of account & Audit u/s 44AB(a).

Analysis:

– In 2020-21, Mr. X failed to opt for Section 44AD, leading to an audit requirement under Section 44AB(e) from 2021-22 to 2025-26.

– By maintaining compliance, Mr. X avoids penalties but must fulfill the audit and accounting obligations for the years he is outside the presumptive taxation scheme.

Exceptions to Section 44AD(4) & 44AD(5)

There are situations where a taxpayer may not be eligible to opt for Section 44AD due to circumstances beyond their control, and these do not disqualify them from re-entering the scheme in subsequent years:

1. Ineligibility Due to High Turnover: If the taxpayer’s turnover exceeds ₹2 crores, they are automatically ineligible for Section 44AD. This does not count as an “opt-out” decision by the taxpayer, so they can return to the scheme once they meet the eligibility criteria again.

Example: Mr. X had a turnover of ₹74 Lakhs in FY 2019-20 and opted for Section 44AD. In FY 2020-21, his turnover increased to ₹2.5 crores, making him ineligible. He was required to get his accounts audited but could return to Section 44AD in FY 2021-22, provided he meets the eligibility conditions.

2. Commission Income: If a taxpayer earns commission income, they cannot opt for Section 44AD. This rule applies automatically, and the taxpayer can re-enter the presumptive scheme in subsequent years when they no longer have commission income.

Example: Mr. X earned a commission in FY 2020-21, making him ineligible for Section 44AD. However, if he no longer earns commission income in subsequent years, he can return to the presumptive taxation scheme.

Conclusion

Section 44AD provides significant benefits under presumptive taxation, but it comes with strict conditions. Taxpayers must understand the long-term commitments and the potential need for audits if they step outside this framework. However, certain automatic disqualifications like high turnover or commission income do not permanently lock a taxpayer out of the scheme, allowing flexibility in subsequent years.

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Disclaimer: The information provided in this article is for general informational purposes only and does not constitute legal, tax, or financial advice. While every effort has been made to ensure the accuracy of the content, tax laws and regulations are subject to change, and their application can vary based on specific circumstances. We recommend that readers consult with a qualified tax expert or financial advisor for personalized advice and to ensure compliance with the most current laws and regulations. The author and publisher are not responsible for any errors or omissions or for any losses or damages that may result from reliance on this information.