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Thursday, March 17, 2016

How the Presumptive Scheme Taxes More Than the Actual Profits

Finance Bill 2016 has introduced section 44ADA to extend presumptive tax scheme to professionals. Opinions remain divided on whether 50% is too high a rate. Another implication of it has stumped partnership firms, where taxable profits end up more than the actual profits!

There appears to be an error in setting the 50% rate, particularly in view of the fact that partners’ remuneration and interest u/s 40(b) will be treated as if they are already allowed. In other words, 50% of gross receipts will be assumed to be taxable profits after giving effect to all expenses, including those mentioned in section 40(b).

Section 40(b) provides for maximum remuneration and interest for a working partner as follows:

(a) on the first Rs. 300,000 of the book-profit or in case of a loss: Rs. 150,000 or @90% of the book-profit, whichever is more;

(b) on the balance of the book-profit: @60% of the book profit

Book profit is net profit after all expenses, but before remuneration and interest. 

Let us assume Rs. 5,000,000 as gross receipts for a professional partnership firm in a year. Taxable income as per section 44ADA will be Rs. 2,500,000. We will do reverse calculations to arrive at the profits so taxed.

In INR
Book Profit
Rate
Remuneration
Net Profit
300,000
90%
270,000
30,000
6,175,000
60%
3,705,000
2,470,000
       6,47,5000

3,975,000
2,500,000

The book profit, in this case, adds up to an amount more than the gross receipts!
 
Now, what would happen if the recommended rate of 33.33% given by the Income Tax Simplification Committee (Ch. Justice R.V. Easwar) was included? Taxable income as per section 44ADA would be Rs. 1,666,500.
In INR

Book Profit
Rate
Remuneration
Net Profit
300,000
90%
270,000
30,000
4,091,250
60%
2,454,750
1,636,500
4,391,250

2,724,750
1,666,500

In this case, the book profit (before partners’ salaries) is 87.8% and remuneration is 54.5% of the gross receipts, which appears fair for both the assessee and the exchequer.

This issue definitely needs immediate attention, failing which presumptive tax for professionals will lose its practical application.

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