Section 44AD of Income Tax Act: Complete Guide, Eligibility, and Benefits

For small business owners, taxes might feel more like a hurdle than a duty, often filled with complex filings, endless paperwork, and costly audits. To ease such burdens and to encourage small businesses, the Indian government added Section 44AD in the Income Tax Act of 1961.

Section 44AD offers a simplified tax scheme that eliminates complex taxation procedures and boosts ease of doing business. This article examines the presumptive tax scheme under Section 44AD, including who can opt for it, its benefits, and other associated factors. 

• Section 44AD of the Income Tax Act is a presumptive taxation scheme for small businesses with turnover up to ₹2 crore, extended to ₹3 crore if 95% of receipts are digital. It allows businesses to declare income at 6% for digital transactions or 8% for cash, without maintaining detailed books or requiring an audit.

• The benefits of Section 44AD include simplified tax filing for small businesses, exemption from maintaining detailed books of accounts, and no audit requirement. It also encourages digital transactions, lowers compliance burden, and offers protection from scrutiny if used consistently for five years.

• Section 44AD applies to resident individuals, Hindu Undivided Families (HUFs), and partnership firms (excluding LLPs) engaged in eligible businesses, with a turnover up to ₹2 crore (extended to ₹3 crore if 95% of receipts are digital). It does not apply to professionals who fall under Section 44AA(1), businesses engaged in commission, brokerage, or agency services.

• Section 44AD offers simplified tax filing, but it has key limitations. Businesses cannot claim actual expenses, making it unsuitable for high-cost operations. It excludes professionals and commission-based income, applies only if turnover is within ₹2-3 crore, and restricts re-entry for five years once opted out, along with audit requirements in certain cases.

Section 44AD of Income Tax Act is a provision that benefits small businesses with its presumptive taxation structure. It applies to businesses with a turnover of up to Rs. 2 crores or those with a turnover of Rs 3 crores but whose annual cash receipts are within 5% of their total revenue.

Presumptive taxation basically means that businesses have to pay tax based on presumed income. They are also not required to maintain books of accounts and their profit is calculated as a percentage of their turnover, usually 6% or 8%, depending on the nature of receipts. 

According to Section 44ADA, a subsection of 44AD, professionals, such as doctors, lawyers, freelancers, with a turnover of Rs. 50 lakh or Rs. 75 lakh in case 95% of receipts are through online mode. 

According to the Income Tax Act of 1961, the tax to be paid under Section 44AD is calculated at 8% of annual turnover if transactions are in cash or 6% in case of digital transactions. The condition here is that the actual turnover should be Rs. 2 crores or Rs. 3 crores (if 95% of receipts are through digital modes). 

The above provision is applicable to every type of business with this specific turnover, except those mentioned in the Section 44AE of the Income Tax Act. 

Taxable profits and gains are the income a person or business earns that must be reported and taxed. This includes money made from business operations, selling assets, or earning returns on investments. 

In simple terms, it’s a profit made by a business or a person on which they must pay tax to the government. For businesses, it’s usually the profit left after subtracting allowed expenses, deductions, and credits from the total revenue. Capital gains from selling capital assets like property, jewellery, shares, or even digital assets are also taxed based on set rules under Income Tax Act. 

Section 44AD is particularly beneficial for small businesses as it reduces their compliance burdens significantly. Let’s have a look at its key features with the help of this table

The main aim of Section 44AD of the Income Tax Act is to simplify compliance and reduce the tax burden on small businesses. It fulfils the following objectives:

1. Make tax filing easier

This scheme is designed to make tax filing simpler for small taxpayers. It cuts down on the paperwork by removing the need to keep detailed records or go through complicated audits.

2. Increase the scope of compliance

Because the process is easier, more small business owners, shopkeepers, and freelancers are likely to start paying taxes. This helps grow the number of people contributing to the country’s tax collection.

3. Reduce workload for tax officers

With fewer detailed checks needed for small taxpayers, tax officers can focus more on catching big frauds and serious tax evasion cases.

4. Save money for small taxpayers

Small businesses don’t have to spend a lot on hiring accountants or paying for audits. This helps them save money and use it for growing their business instead.

In the budget of 2023, the government amended Sections 44AD and 44ADA to revise the taxation limits. Let’s clarify these limits with the help of this table.

These revised turnover limits are subject to the condition that cash receipts do not exceed 5% of the total turnover of the financial year. In other words, 95% of total receipts are received through digital modes.

The businesses and individuals who can opt for the presumptive taxation scheme under Section 44AD include:

• An individual who is a resident of India
• Resident Hindu Undivided Families (HUF)
• Resident partnership firms (excluding LLP firms)

An additional condition these entities must satisfy is that they must have an annual turnover of less than Rs. 2 crore or Rs. 3 crore (whichever is applicable).

Section 44AD is applicable to select categories of entities as discussed above. However, there’s an exception to this taxation system. As per Section 44AE of the Income Tax Act, businesses engaged in plying, leasing, or hiring of goods carriages are not included in the presumptive taxation of Section 44AD. 

Moreover, businesses or individuals who qualify the turnover threshold of the presumptive taxation scheme but refuse to claim benefits under the scheme have to maintain books of accounts and get them regularly audited by a chartered accountant. 

The taxable income for professionals included in Section 44ADA who choose to claim benefits under Section 44AD is 50% of their total earnings. The condition to claim the benefit in this case is a turnover of less than Rs. 50 lakh or Rs. 75 lakh (whichever is applicable)

When you opt for Section 44AD, there's no need to maintain detailed accounting, and it also lowers the overall cost and effort involved in filing income tax returns. Here are the key benefits associated with Section 44AD:

1. Simplified tax filing

Taxpayers opting for Section 44AD are not required to maintain detailed books of accounts as normally required under the Income Tax Act. This provision is very useful for businesses that might not have the resources to handle complicated accounting tasks.

2. Fixed rate of income declaration

Income is calculated as a fixed percentage of the total turnover:

• 6% for receipts through digital modes (like bank transfers, UPI, cards, etc.)
• 8% for receipts made in cash

This makes the return filing process simple, with no need to prepare detailed profit and loss accounts.

3. Lower compliance burden

Since detailed accounting is not required, businesses can save money on hiring accountants or purchasing accounting software. This also helps businesses that operate with low margins.

Additionally, when businesses have to maintain fewer records, they can save time on paperwork and focus more on running and growing their business operations.

4. Tax-related benefits

Under the presumptive tax scheme, it is presumed that 92% or 94% of the total turnover is spent on business expenses, depending on the mode of receipt of its income. This assumed expense can often be higher than the actual expenses incurred, which lowers the taxable income.

Taxpayers under Section 44AD are usually not subject to penalties for shortfall or delay in advance tax payments, provided they meet the other conditions of the scheme. So, the risk of penalties under Sections 221 and 222 of the Income Tax Act is also minimized. 

5. Promote digital transactions

Businesses that earn their income through digital payments can benefit from a lower presumptive tax rate of 6%, instead of the usual 8%. This, in turn, encourages businesses to adopt cashless methods.

6. Long-term benefit for consistent filers

If a taxpayer opts for Section 44AD and continues to declare income under this scheme for five consecutive years, the declared income for that period is generally not questioned by the Income Tax Department. 

Certain categories of businesses and individuals are barred from claiming benefits under Section 44AD. These include taxpayers earning income from brokerage settlements, those mentioned in Section 44AA(1) of IT Act, and the ones whose business proceedings involve complex revenue collection. Let’s take a detailed look at this. 

• Businesses or taxpayers who earn their income from commissions and brokerage agreements. The reason behind this is to eliminate entities whose income is not associated with sales volume, such as insurance agents or brokers. 

• Professionals mentioned under Section 44AA(1) of the Income Tax Act. Such professionals can be medical professionals, engineers, architects, accountants, lawyers, interior decorators, technical consultants, or any other notified profession by the CBDT. These are not included because they are mostly service providers and their income is not based on sales or turnovers, which can be represented by a percentage. 

• Agency businesses that usually involve complicated revenue architecture that is unsuitable for a flat rate assumption of income.

If you're a small business owner opting for the presumptive taxation scheme under Section 44AD, your income is calculated as a fixed percentage of your total turnover, which can be 8% for cash transactions and 6% for digital receipts. Now let’s try to understand this with an example.

Imagine you run a small retail business and your annual turnover is as follows:

• Total turnover for the financial year: Rs. 40,00,000
• Out of this, Rs. 25,00,000 was received in cash
• The remaining Rs. 15,00,000 was collected via digital modes (like UPI, card, or bank transfer)

In this case, your tax calculation will be:

1. Income from cash receipts:

8% of Rs. 25,00,000 = Rs. 2,00,000

2. Income from digital receipts:

6% of Rs. 15,00,000 = Rs. 90,000

Your total taxable income under Section 44AD: Rs. 2,00,000 (cash) + Rs. 90,000 (digital) = Rs. 2,90,000

So, if you choose to file under Section 44AD, your declared income will be ₹2,90,000, and tax will be calculated based on this amount.

When you are applying for the benefits under Section 44AD, the first thing is to confirm your eligibility and then understand the consequences of using the benefits since you can’t opt out of it for the next five years. Next, be ready with all the financial documents and statements that’ll be required during the process, such as bank statements, invoices, ITRs, and gross receipts. 

Given below is a step-by-step procedure that small businesses can follow to apply for the benefits under Section 44AD:

Step 1: Confirm eligibility

Before choosing Section 44AD, you should meet the following conditions:

• You must be a resident individual, partnership firm (not LLP), or HUF.
• Your business should not fall under professional services listed in Section 44AA(1), such as legal, medical, or engineering.
• Your annual turnover or gross receipts should not exceed Rs. 2 crore or Rs. 3 crore (if 95% of receipts are through digital modes)
• Your business income should not come from commission or brokerage services.

Step 2: Understand the implications  

It’s important to know the implications of using Section 44AD:

• You are not required to maintain books of accounts.
• Once you opt in, you must continue with the scheme for the next five financial years to avoid audit requirements.
• If you exit the scheme before completing five years, you may lose the option to re-enter during the next five consecutive years. 

Step 3: Prepare financial information

To begin filing:

• Compute your presumptive income as per the turnover.
• Ensure your turnover matches your invoices and bank statements.
• Keep records of all receipts and sales for reference.

Step 4: File income tax return using ITR-4

Use the Sugam ITR-4 form to report income under Section 44AD:

• Mention your total turnover or gross receipts.
• Declare presumptive income using the applicable percentage.
• Fill in other relevant details as per the form instructions.

Step 5: Submit and verify your return

After filling the ITR:

• Submit your return electronically through the Income Tax Department’s e-filing portal.
• Verify your return using Aadhaar OTP, EVC (Electronic Verification Code), or by sending a signed ITR to the CPC office in Bangalore.

Step 6: Maintain records

Though detailed accounting is not mandatory:

• Maintain simple records like daily sales summaries, receipts, and invoices.
• These can help support your declared turnover if the Income Tax Department raises any queries.

Step 7: Perform annual review

Each year:

• Check if you still meet the eligibility criteria.
• Assess whether continuing under Section 44AD is beneficial based on your income and expenses.
• If your turnover crosses ₹2 crore or actual expenses are higher than presumed income, consider switching back to the regular tax scheme after the five-year period.

While Section 44AD provides ease of tax compliance and is beneficial for small businesses, it comes with several important limitations. Understanding these drawbacks is essential before choosing to adopt the presumptive taxation scheme. These limitations include:

1. No option to claim actual expenses

Under Section 44AD, the income is presumed to be 8% or 6%, regardless of actual business expenses incurred. This can be a disadvantage for businesses with high operational costs, as they cannot claim deductions beyond the presumptive percentage. As a result, their taxable income may be overstated compared to actual profits.

2. Restricted to certain types of businesses

This scheme is applicable only to eligible businesses and not to professionals such as doctors, lawyers, architects, engineers, or accountants, as defined under Section 44AA(1). It also excludes income from commission or brokerage. Therefore, professionals and agents cannot take advantage of this scheme.

3. Turnover limits

Section 44AD can only be used if the business’s total turnover or gross receipts during the financial year do not exceed ₹2 crore (₹3 crore if 95% of receipts are digital). This turnover cap excludes many medium-sized enterprises from availing the benefits, even if they would otherwise qualify based on business type.

4. Restriction on re-entry after opting out

Once a taxpayer opts for Section 44AD and later decides to opt out, they are barred from using the scheme for the next five financial years. Additionally, if during any of these five years, the taxable income is more than the basic exemption limit, the business is required to maintain books of accounts and get them regularly audited as per normal provisions of the Income Tax Act.

The presumptive taxation scheme under Section 44AD of the Income Tax Act offers significant benefits to small businesses. It eases the burden of maintaining detailed books of accounts by providing a simplified way to declare income, which, in turn, encourages tax compliance.

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