INCOME TAX

Admissibility of deduction on account of salary/interest to partners of firms opting for estimation of income under sections 44AD and 44AE sections 44AD and 44AE

Circular No. 737

Dated 23/2/1996

Sections 44AD and 44AE were inserted in the Income-tax Act, 1961, by the Finance Act, 1994, with effect from April 1, 1994. Section 44AD provides for a method of estimating income from the business of civil construction or supply of labour for civil construction work, where the gross receipts from the business do not exceed Rs. 40 lakhs. Section 44AE provides for a method of estimating income from the business of plying, hiring or leasing trucks owned by a taxpayer owning not more than 10 trucks. Both the schemes are optional.

2. Sub-sections (1) of section 44AD and 44AE clearly provide that the income shall be estimated at the prescribed percentage/basis without regard to the provisions contained in sections 28 to 43C of the Act. In other words, the income estimated in accordance with sections 44AD and 44AE takes care of various deductions, etc., admissible under the aforesaid sections.

3. A doubt has been raised as to whether deduction(s) on account   of salary/interest to the partners of a firm shall be admissible from the income estimated in accordance with sections 44AD and 44AE of the Act. The law is clear on this issue and no separate deduction is to be allowed under section 40(b) in such cases. The doubt has primarily arisen because of the erroneous clarification given in paras. 31.3 and 32.2 of the Explanatory Notes on provisions of the Finance Act, 1994 (Circular No. 684, dated 10th June, 1994 (see [1994] 208 ITR (St.) 8)). The relevant portion of the Explanatory Note reads as under  :_

"In the case of firms, the normal deductions to the extent allowed under clause (b) of section 40 will be allowed."

4. Clause (b) of section 40 lays down restriction on the deduction allowable on account of salary and interest to the partners and is not an enabling section for claiming deduction. The admissible deductions are specifically mentioned under sections 30 to 38 of the Income-tax Act. Hence, sections 44AD(2) and 44AE(3) only state this obvious position by way of clarification. However, in view of the non-obstante clause in sub-section  (1) of sections 44AD and 44AE, there is no ambiguity about the intention of the legislation in this matter and the provisions of the Act are quite clear. As already said above, the doubt has primarily arisen because of the error in the Explanatory Notes to the Finance Act, 1994. Therefore, for the sake  of clarity and removal of doubts in this regard, the following lines are deleted from paras. 31.3 and 32.2 of Circular No. 684, dated 10th June, 1994 (see [1994] 208 ITR (St.) 8) :_

"In the case of firms, the normal deductions to the extent allowed under clause (b) of section 40 will be allowed."

(Sd.) Aniruddha Kumar,

Under Secretary to the Government of India.