A Costly Mistake: Filed Under 44AD Instead of 44ADA and Claimed a Full Refund? Now Brace for Audit and Penalties

The presumptive taxation scheme under the Income Tax Act aims to make it easier for small businesses and professionals to comply with tax laws. However, a simple mix-up between its key sections, 44AD and 44ADA, can lead to serious issues. Many taxpayers, particularly freelancers and professionals, mistakenly file their returns under Section 44AD, which is for businesses, instead of the correct Section 44ADA for professionals. This error often results in inflated and incorrect refund claims, which raises red flags for the Income Tax Department and can lead to audits, scrutiny, and heavy penalties.

This blog explains why this mistake occurs, the serious consequences, and what you should do if you find yourself in this difficult situation.

Understanding the Key Difference: Section 44AD vs. 44ADA

To appreciate the seriousness of the error, it's important to understand who each section applies to.

Section 44AD is for Businesses: This section applies to resident individuals, Hindu Undivided Families (HUFs), and partnership firms (excluding LLPs) engaged in eligible businesses. It allows them to declare a presumptive income of 8% of their total turnover or gross receipts (6% if received through digital means). The turnover limit for this section is up to ₹3 crores, provided 95% of receipts are digital.

Section 44ADA is for Professionals: This section is specifically for resident individuals or partnership firms (excluding LLPs) earning income from professions listed under Section 44AA(1). This includes lawyers, doctors, engineers, architects, accountants, technical consultants, and other recognized professionals. Under this scheme, professionals can declare 50% of their total gross receipts as income. The gross receipts limit for this section is up to ₹75 lakhs if 95% of receipts are online.

The Key Mistake: A professional, such as a software consultant with gross receipts of ₹22,00,000, must file under Section 44ADA. Their presumptive income would be 50% of ₹22,00,000, which equals ₹11,00,000. However, if they mistakenly file under Section 44AD and declare 8% as their profit (₹1,76,000), their taxable income becomes much lower. This often leads them to claim a full refund of the Tax Deducted at Source (TDS), which quickly alerts the tax authorities.

How the Income Tax Department Finds the Error

The Income Tax Department has upgraded its systems. AI-based tools can easily spot mismatches between the data you provide and what they have on file. Here’s how they catch errors:

• TDS Mismatch: Clients of professionals typically deduct TDS under Section 194J (Fees for Professional or Technical Services). When you file your return under Section 44AD (for business), the system flags a mismatch between the income reported in your Form 26AS/TIS (professional fees) and the section under which you've filed your ITR (business income).
• Unusually Low Profit & High Refund: Claiming a full refund on your TDS while reporting a profit as low as 6% or 8% on professional receipts raises suspicion. It suggests your profit margin is much lower than the 50% standard set for professionals under the presumptive scheme.

The Domino Effect: Serious Consequences and Penalties

Once the discrepancy is flagged, expect more than just a notice. The consequences can be financially damaging.

1. Scrutiny Notice: You will likely receive a notice from the department, possibly under Section 139(9) for a defective return or under Section 142(1) or 143(2), asking for an explanation of the discrepancies.
2. Mandatory Audit Requirement: If a professional reports profits lower than the 50% required under Section 44ADA, they will no longer enjoy the benefits of the presumptive scheme. They must maintain proper financial records and undergo an audit under Section 44AB.
3. Penalty for Not Undergoing an Audit (Section 271B): Failure to get the required tax audit done can lead to a penalty under Section 271B. The penalty can be 0.5% of the total sales, turnover, or gross receipts, up to a maximum of ₹1,50,000.
4. Repayment of Wrongly Claimed Refund with Interest: Any refund amount that was claimed incorrectly must be repaid to the department. This will include interest under Section 234D on the excess refund.
5. Penalty for Erroneous Refund Claim: You may face a penalty of 20% on the amount of the refund that was wrongfully claimed.
6. Penalty for Under-reporting of Income: The Assessing Officer may impose a penalty for under-reporting income, which can be 50% of the tax payable on the under-reported portion.

What to Do If You’ve Made This Mistake

Receiving a notice from the tax department can be overwhelming, but ignoring it is not an option. Here’s a step-by-step guide on how to handle the situation:

• Do Not Panic, But Act Quickly: Read the notice carefully to understand the issue raised by the department. You usually have a limited time, often 15 days, to respond.
• Consult a Chartered Accountant: This situation is not one to navigate alone. The complexities of tax laws, audits, and penalties require professional help. A CA can assist you in formulating an appropriate response and guide you through the next steps.
• File a Revised/Rectified Return: If you can still revise your return, do so immediately under the correct section (44ADA). Declare the correct presumptive income (50%) and pay any outstanding taxes along with interest.
• Respond to the Notice: You must submit a detailed response to the notice online through the e-filing portal. Your response should acknowledge the error and outline the corrective actions taken (i.e., filing of a revised return and payment of taxes).
• Comply with the Audit: If you declared profits lower than 50% and now need an audit, work with your CA to complete the audit and file the report.

Prevention is Better Than Cure

To avoid this costly mistake in the future, always ensure:

• You correctly identify the nature of your income—whether it’s from business or a profession.
• You choose the right section of the presumptive taxation scheme.
• You verify the details in your ITR with your Form 26AS and Annual Information Statement (AIS).
• When in doubt, seek the advice of a tax professional before filing your return.

Filing an income tax return is a serious responsibility. A seemingly small error can lead to significant financial consequences. Being diligent and seeking professional help can save you from a difficult situation with the tax authorities.

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