44ADA when your profit is more than 50%- An analysis

[tomwedding]

I am writing about what will happen when people invest surplus, undeclared profits( over 50% @burning___bush 44ADA or over 8% @burning___bush 44AD) and who were sent a notice for the same. I am attaching a case law sheet on this topic at the end. The reason this is important for personal finance is because if it is possible to freely invest the balance, it would lead to a substantial increase in the size of available pool of investments for Individuals.

Tl;dr:

1. Income tax department can not claim you have unexplained investments as you need to be maintaining books of accounts for that(It is how law is framed). DEMAT statement/ Bank statement is not books of accounts.
2. Income tax department can not claim that your actual profit is higher and hence more tax is payable. 8% or 50%(44AD or 44ADA) is your tax profit. Your actual profit may.
3. For DIY people who have been avidly researching this and other tax related topics, it will be hard for you to take anything coming from my mouth related to selling you tax services seriously, however, if you were to apply your hourly rate to the time you spent researching about taxes, what would be your annual cost? And with how much surety can you say that there is nothing that you don't know that you don't know? How has spending your time doing research helped you save money or make money compared to simply hiring a top notch CA?

Before we begin:

• Being "caught" with surplus money will essentially mean either of or a combination of two things:

1. You are caught with surplus assets (cash/ bank balances, MF/Equity, property etc.) leading to unexplained money or assets.
2. You are caught with personal expenditure which is greater than what is expected from someone earning your level of profit.

• Bank account statement or DEMAT statement is NOT books of accounts. They are simply statement of assets maintained in capacity of agent, debtor or creditor.(CIT vs. Bhaichand N. Gandhi)
• These cases will be only for 44AD(and not 44ADA) as that is the older section(1994 vs 2017), hence has material for research. However, the wording of both sections as to calculation of profits of taxpayer opting for the respective sections is same.

Let's get on to the juicy details:How can/ under which sections can addition be made:

1. Unexplained deposits in Bank( Section 68)
2. Unexplained money( Section 69A)
3. Unexplained/ partially explained investments(69 and 69B)

The language of those sections with regards to the subject matter they deal with is same. I am quoting Section 69 here that deals with unexplained investments. Other sections have same wording for the subject matter they deal in."Where in the financial year immediately preceding the assessment year the assessee has made investments which are not recorded in the books of account, if any, maintained by him for any source of income, and the assessee offers no explanation about the nature and source of the investments or the explanation offered by him is not, in the opinion of the Assessing Officer, satisfactory,the value of the investments may be deemed to be the income of the assessee of such financial year."The above mentioned section is what most of the freelancers are concerned about. ***Unexplained Investments.***Breakdown of the section(s):Let's say XYZ Pvt Limited has been declaring it's profits to be 50 lakhs for each year for the past 10 years, however, it invests Rs. 75 lakhs each year into mutual funds AND this catches the eye of Income Tax Department in one of the years, and it "rightfully" asks for an explanation and you fail to give a satisfactory reply, in which case, the Income for all the years will be recomputed and XYZ Private limited will have to pay taxes+ penalty+ interest on such recomputed profits.HOWEVER, the reason XYZ Private Limited could be convicted is because it was required to maintain Books of Accounts and it did not record this Investment properly.

As a freelancer, you are not required to maintain books of Accounts, hence, you can not be convicted under these sections.

This is not simply my opinion, but something that has been ruled by judiciary over and over.However, this also begs the question "What is books of Accounts?" And there is no answer to that(Ha! got you). However, there is an answer to what is NOT books of Accounts.

Demat statements and Bank statements are NOT books of Accounts. They are not maintained by you and they are not maintained for you. They are simply statements issued by the respective Banks and brokers/ depositories of your Balance available with them.And that is all. Or so you thought, that this will be another wall of text that leaves your core question

unanswered.

Your Actual profit is more than 6/8/50% ! Income tax department, if they ask you, you have no answer to it.

And here is the part 2:

As much as I could simply refer cases upon cases(link to my excel file below), the point is you want to hear from judiciary that what you are doing is fundamentally correct.

Hence, you should see Paragraph 10 of ITAT Chandigarh judgement on Nand Lal Popli vs DCIT- ITAT Chandigarh case.

The ITAT(Income tax judicial body) clearly states that 8%/50% is the presumed profit for tax purposes. The actual profit may be higher or lower than that.

Another Interesting case is that of Smt.Honey Rahulan, Alappuzha vs The Ito, Alappuzha where the Assesse had made investments and expenditures of Rs. 12 lakhs, while the profit declared during the year was merely 4 lakhs, however, the same was allowed by ITAT as well, citing Nand Lal Popli's case.Feel free to ask me any questions you have.

Link to my case law file

 

[jely]

@tomwedding Hey, thanks for the detailed article! But you didn’t mention what to do incase someone receives a notice?