Set-off brought forward business losses against presumptive income
The idea of writing this article came to mind because of a query of a small-scale builder who is engaged in the construction of villas/duplexes and selling it to customers. His simple question was “Can I set off brought forward business losses of earlier years while declaring income from construction business under section 44AD in the current year?”
My instant reaction to him was “Wait” … Before giving a final opinion, I wanted to be assured by referring to the Income Tax Act. I referred to all the relevant sections including section 32, section 44AB, section 44AD, and section 72 and after reading all these sections I could say that the answer to this question is “Yes”. There is no restriction on setting off earlier year brought forward business losses against the current year’s presumptive income declared under section 44AD. I would rather say that this can be a good short-term tax planning mechanism for a builder or any other businessman in a particular situation. I would try to discuss this with an example later. First, we shall quickly brief the provisions of section 72 of the Income Tax Act, 1961.
Section 72 of the Income Tax Act
Carry Forward and set off of business losses
According to section 72 of the Act, where the loss under the head “Profit and Gains of Business or Profession” (other than the loss from speculation business and loss from a specified business referred to in section 35AD) could not be set off in the same assessment year because either the assessee had no income under any other head or the income was less than the loss, such loss which could not be set off in the same assessment year, can be carried forward to the following assessment year and it shall be set off against the profits and gains of business or profession.
Accordingly, there is no restriction under section 72 of the Act which disrespects the claim of brought forward business losses of the assessee against the presumptive business income declared under section 44AD. But we should also quickly read section 44AD before reaching any final conclusion. So please refer to section 44AD also as below.
Section 44AD of the Income Tax Act
Profits and Gains of business on presumptive basis
Notwithstanding anything contained in sections 28 to 43C, a sum equal to 8% or 6% (in certain cases) of the turnover or gross receipts or a higher amount, shall be deemed to be the profits and gains of such business chargeable to tax under the head “Profits and Gains of business or profession”.
Reading of the above provision also makes it clear that section 44AD overrides section 28 to section 43C but doesn’t interfere with the provisions of section 72 of the Act. As a result, set off of brought forward depreciation as per section 32 of the Act shall not be allowed against the income declared under section 44AD of the Act. However, set off of brought forward business losses shall be allowed against the presumptive income declared in the income tax return for the current year under section 44AD of the Act.
Take an example:
This example is based upon the query raised by the construction businessman (builder). Please read carefully…
In the Financial Year 2020-21 (AY 2021-22), Mr. Ram started a new construction business on 1st October 2020 in partnership with Mr. Shyam under the name M/s R.S. Builders. Both the partners infused an initial capital of Rs. 1.00 crore in the firm and purchased a plot for construction of 3 villas/duplexes. Land acquired Rs. 70 Lakhs. Construction expenses incurred till 31st March 2021 are Rs. 50 Lakhs. Suppose interest on capital eligible @ 12% is Rs. 6 Lakhs for F.Y. 2020-21 and allowable remuneration to partners is 1.50 Lakhs as per the Income Tax Act. The construction was not completed till year-end. However, the total construction period is estimated to be around 10 months.
Thus, the final figures for the F.Y. 2020-21 are:
- Construction WIP: Rs. 1.20 crores (including the cost of land)
- Gross Profit/ Loss for the Year: Nil (as no sale took place during the year)
- Net Loss: Rs. 750,000 (consisting of interest on capital & remuneration)
Note: The claim for interest on capital will not be affected in any manner by the proviso to section 36(1)(iii) “Interest on Borrowed Capital”. Further, ICDS-IX “Borrowing Costs” shall also not apply to the interest on capital Rs. 6 lakhs because ICDS-IX is applicable only in respect of cost incurred against the borrowings and not against the imputed cost of owner’s equity. Further, the construction of a villa/ duplex is not a ‘qualifying asset’ looking into construction tenure in terms of ICDS-IX.
Suppose, in the F.Y. 2021-22, the 3 villas are sold at Rs. 1.90 crores. In the FY 2021-22, the firm decides to opt for section 44AD while ITR filing and declared income @ 6% of Rs. 1.90 crores = Rs. 11,40,000. Net position will be:
Profit declared for FY 2021-22 u/s 44AD: Rs. 11,40,000
Less: Brought Forward business losses: Rs. 7,50,000
Net Income chargeable to tax: Rs. 3,90,000
Tax payable @ 31.20% Rs. 1,21,680
Thus, the construction firm needs to pay a tax of Rs. 1,21,680 on the overall turnover of Rs. 1.90 crores. This example might not stand true in all the cases and further, we will also have to look into the implications of section 44AD (4) of the Act in the future years.
Disclaimer: The article is contributed by CA Naveen Goyal and these are his personal views. Taxwink is not responsible for any losses or damages to any person on account of the information given in this article. Readers are therefore requested to act diligently and under consultation with any professional before applying the information contained in this article.
For any ITR filing online services connect at 9660930417
