[2023] 153 taxmann.

com 487 (Article)

[2023] 153 [Link] 487 (Article)

Date of Publishing: August 21, 2023

Whether Tax Audit is Required in Case Business Profit is Less Than 6% or 8% ?

ANKET S DODYA
Partner, MGDS & [Link] Accountants

After successful conclusion of the Income tax return (ITR) phase for FY 2022-23, professionals now have
geared up in the Audit phase. However, this year in particular, there had been excessive concerns about
applicability of audit in one peculiar case i.e.

Whether tax audit is required for a business merely because profit is less than 6% or 8%, even when proper
books of accounts are maintained, turnover is within the prescribed limit of section 44AB and other
provisions of section 44AB are not attracted?

In author's opinion as on date, tax audit is NOT required in such case merely on account of profit being less
than prescribed percentage ! A detailed discussion is made hereinbelow as to how Tax Audit is not attracted
in such case.

CHRONICALS OF SECTION 44AD :

In order to analyze the audit provisions, it is pivotal to understand the entire genesis of section 44AD from
the inception till date.

It is pertinent to note that from 1994 till 1999, there was no provision for audit by assessee, in case he
disclosed profit lesser than 8%. Only with F.A. 1999, the provision of such audit was introduced. Further,
provisions of section 44AD (introduced in 1994) were not opened for all businesses for almost 17 years and
only in the year 2011, the said provisions were made applicable to almost all the businesses (eligible
businesses). This radical shift in the provisions of section 44AD unfurled the beneficial provisions to widest
range of businesses. However, in principle the audit provisions carved in the section 44AD remained intact
since inception in 1999 till 2017 and only vide F.A. 2016 there was radical shift in the audit provisions too.

Therefore, audit provisions till 1.4.2017 and after that have to be read independently as there are
substantial changes in the provisions. This sacred line of separation appears to have been blurred, without
getting its due importance resulting in debate over audit applicability.

Audit provision in section 44AD till 2011 read as under :

 …[(6) Notwithstanding anything contained in the foregoing provisions of this section, an assessee may
claim lower profits and gains than the profits and gains specified in sub-section (1), if he keeps and
maintains such books of account and other documents as required under sub-section (2) of section 44AA
and gets his accounts audited and furnishes a report of such audit as required under section 44AB.

There was slight difference in the phraseology of audit provision after 2011 till 2017 but in principle they
remained same. As section 44AD mandates for audit under special circumstances, corollary provision must
also exist in section 44AB which compliments audit provisions in line with section 44AD. The same read as
under:

(..d) carrying on the business shall, if the profits and gains from the business are deemed to be the profits
and gain s of such person under section 44AD and he has claimed such income to be lower than the profits
and gains so deemed to be the profits and gains of his business and his income exceeds the maximum
amount which is not chargeable to income-tax in any previous year.

Till 2017, above provisions remained more or less similar. Therefore, like an age old customary ritual, the
law got embedded into the veins of professional as an undisputed fact that audit is mandatory in case profit
is lesser than 6/8%.

INCEPTION OF THE DEBATABLE ISSUE :

The entire thread of debate whether audit is required when profit is lesser than 6/8% begins from loose
ended terminology of section 44AB. Although intention of above clause was to simply put in place audit
provision in line with the provisions mentioned in section 44AD, however the drafting of clause had been as
such that it had potential to drift the interpretation in unintended direction.

The above provisions of section 44AB if approached with literal interpretation, mandates audit 'ONLY' in
case when assessee opts to report its profit under the 'deeming' provisions of section 44AD 'and' that too
lesser than the prescribed limit. That means if assessee has 'derived' the profit on actual basis by
maintaining books of account as against 'deemed' profit, then audit provision won't be attracted. This
argument holds the ground strongly when provision of section 44AB are read independently and in
isolation from the provisions of section 44AD. However, both sections are to be read together to achieve
the desired objective of Taxman. If so, then 44AD mandates audit irrespective of the fact whether or not
assessee disclose profit in 44AD. It states if assessee desires to claim profit at lesser rate than the prescribed
rate then audit is to be done. This can be substantiated from the fact that the audit provisions in 44AD
begins with the phrase 'notwithstanding anything contained in foregoing provisions of section 44AD'. The said
interpretation can be more convincingly digested when audit provision of section 44AD pertaining to period
upto 2011 are read. As already extracted above, the provision clearly prescribes that, if assessee desires to
claim lesser profit then he can do so by maintaining books of accounts and undergoing audit. The same
provisions are borrowed in new section 44AD made effective from 2011, with slightly different
phraseology. Thus, from 2011 till 2017 also, audit was required in case assessee claims to have earned
lesser profit than the prescribed limit.

For the sake of argument even if some heed is paid to the school of thought that 44AB prescribes audit
ONLY in case of 'deemed profit' being less than 6/8% percent then one should keep in mind that, any such
interpretation which makes the law redundant/otiose is not tenable in eyes of law. This is because, it is
impossible to disclose 'deemed' profit at lesser than the prescribed rate. The moment conditions of 44AD
are not met i.e. profit is supposedly to be claimed lesser than 6/8%, maintenance of books of accounts
become mandatory with audit and 'deemed' profit gets converted into 'actual/derived' profit. Thus, claiming
deemed profit at lesser rate is not possible at all and so question of audit 'only' if deemed profit are lesser
than 6/8% does not arise.
However, law is not the same since 2017. If one borrows the audit implication from erstwhile law without
interpreting the new provisions, then obviously it shall follow the age old settled presumption of audit.
However, young professionals reading the present law, find it very hard to digest as to how audit provisions
are attracted in case profit is less than 6/8 %. Clearing the air around the issue.

W.e.f. section 44AB, the updated audit provision simply provide that audit would be required if 44AD(4) is
attracted. There are multiple conditions mentioned in 44AD(4) that are to be simultaneously satisfied for
enabling audit provision.

44AD(4) : An eligible assessee must declare profit for any previous year in accordance with the provisions
of section 44AD 'and' he declares profit not in accordance with the provisions of sub-section (1) in any 5
succeeding years then…

This is the climacteric part of the discussion to conclude whether or not audit is required from 2017,
considering the live provisions of law. As stated above, unlike previous audit provisions of section 44AD,
the present audit provision clearly provides that audit would be applicable only if 'eligible assessee' do not
'declare' the profit in accordance with 44AD that too during the prescribed period. This simply means if
assessee 'opts out' of the 44AD scheme then audit would trigger. There is absolutely no exclusive carving of
mandatory audit if profit falls less than 6/8%.

For instance, say in the very first year of business, the profit is 5%. In such cases the first part of the audit
provision does not get attracted at all i.e. declaration of profit in any previous year in accordance with section
44AD, as the said year itself is the very first year. Therefore, in absence of qualification of first mandatory
part of the audit provision, entire audit provisions i.e. section 44AD (4) and (5) are not applicable. Similarly,
if he continues to declare such lower profits in succeeding years, still audit won't be mandated as he never
ever opted the presumptive scheme in any previous year.

On contrary if in any year, assessee opts in presumptive scheme and in next year even if he declares 60%
profit but by maintaining books of accounts and opting out of presumptive scheme, still audit would be
attracted as the new provision do not link the audit with profit percentage but simply based upon the fact of
entry and exit from presumptive scheme within the stipulated period.

Only in case, 44AD was opted previously and in any year before 5 years assessee discloses profit less than
6% by maintaining books of accounts he would be liable for audit. However, audit would be attracted not
for the fact that he disclosed profit lesser than 6% but for the fact that, for doing so he had to opt out of the
scheme.

In FAQs and flyers issued by department, the above audit provisions are clearly mentioned as applicable in
case assessee 'opts out' of the presumptive scheme in any year within 5 years bracket.

Thus, w.e.f. 2017 according to the revamp audit provisions mentioned in section 44AD(4) there is
absolutely no exclusive reference of declaration of profit lower than 6% to attract audit. Such understanding
further gets strength from the fact that, wherever in other presumptive provisions Taxman felt the need for
audit to be linked to profit percentage, the law remained same i.e. in case of 44ADA the audit provisions are
linked with the profit disclosure being lesser than the prescribed rate. Similarly in case of 44AE,44BB or
44BBB the audit provisions are directly linked with lower disclosure of the profit unlike audit provisions of
section 44AD which are clearly linked with opting out of the scheme after opting in. Thus, the total overhaul
or revamping of the audit provision in 44AD from 2017, has completely delinked the audit provision from
lower profits criteria and linked it to opting out of the scheme alone for whatsoever reason.
Thus if one follows audit blindly due to profit being lesser than 6 %, then he might be defeating the true
intent of the new audit provision in 44AD. Although, over compliance is not bad, it might lead to
unnecessary trouble when under the guise of over compliance one is availing additional benefit i.e. to say,
Department may take a stand that audit is conducted when audit was not required at all and thereby the
return was file beyond the prescribed regular date of filing return (non audit case) attracting all provisions
of belated filing of return including and not limited to disallowance of carrying forward of losses, if any.

Thus, applicability of audit is to be vividly checked before skidding on archaic assumption of audit
applicability which are purely based upon archaic law.'

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