Circular No. 737

Sections 44AD and 44AE l Civil Construction Business/transport Business

What this is

Circular No. 737 was issued by the Central Board of Direct Taxes on 23 February 1996. Its subject is Sections 44AD and 44AE l Civil Construction Business/transport Business.

What it does

Holds that no separate deduction for salary or interest to partners is allowable from income estimated under section 44AD or section 44AE. Sub-section (1) of each section estimates income at the prescribed percentage or basis without regard to sections 28 to 43C, so the estimate already absorbs the deductions those sections allow, and clause (b) of section 40 is a restriction on deduction and not an enabling provision. To end the confusion the Board deletes from paragraphs 31.3 and 32.2 of Circular No. 684, dated 10-6-1994, the sentence 'In the case of firms, the normal deductions to the extent allowed under clause (b) of section 40 will be allowed.'

Why it was issued

A doubt had been raised on the point, and the Board traces it to an erroneous clarification in its own explanatory notes on the Finance Act, 1994.

Who it reaches

Partnership firms in civil construction or supply of labour for civil construction opting for section 44AD
Firms plying, hiring or leasing not more than ten trucks opting for section 44AE
Partners drawing salary or interest from such firms
Assessing Officers computing presumptive income of firms

The provisions it speaks to

Left, the provision of the Income-tax Act, 1961 as the instrument itself names it. Right, the section of the Income-tax Act, 2025 that the department’s own concordance maps it to — which is where the same ground is now covered.

Under the 1961 Act	Now
s.28	s.26, s.66
s.40	s.35, s.66
s.44AD	s.58
s.44AE	s.58

The instrument, as the Board published it

The words below are the department’s own, reproduced from its published text. Where the department’s copy carried a publisher’s notes after the instrument, those are not reproduced.

SECTIONS 44AD AND 44AE l CIVIL CONSTRUCTION BUSINESS/TRANSPORT BUSINESS
413. Whether deduction(s) on account of salary/interest to partners of firm shall be admissible from income estimated in accordance with sections 44AD and 44AE
1. Sections 44AD and 44AE were inserted in the Income-tax Act, 1961, by the Finance Act, 1994, w.e.f. 1st April, 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-section (1) of sections 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 Explanatory Notes on provisions of the Finance Act, 1994 (Circular No. 684, dated 10-6-1994) (see Volume 4). 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 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 :
‘In the case of firms, the normal deductions to the extent allowed under clause (b) of section 40 will be allowed.’
Circular : No. 737, dated 23-2-1996.

What to watch

It works by amending an earlier circular: paragraphs 31.3 and 32.2 of Circular No. 684, dated 10-6-1994, lose the offending sentence.
The presumptive schemes are optional; the bar on the section 40(b) deduction bites only if the firm opts in.
The thresholds recited are those of the sections as inserted by the Finance Act, 1994 with effect from 1st April, 1994 -- gross receipts up to Rs. 40 lakhs for section 44AD and not more than ten trucks for section 44AE. Both sections have since been rewritten in terms this text does not carry.
The reasoning turns on the non obstante clause in sub-section (1); sub-sections 44AD(2) and 44AE(3) are read as merely stating the obvious.

Where you meet it

In an assessment where a firm returns presumptive income under section 44AD or 44AE and separately claims partners' remuneration and interest, and in the appeal that follows the disallowance.

An example

Ours, not the Board’s: a worked case built from the rule the instrument sets, to show how it falls out.

A firm of civil contractors with gross receipts of Rs. 30 lakhs opts for section 44AD and returns the prescribed percentage of receipts as income. It then claims Rs. 2 lakhs of partners' salary and interest against that figure. On this circular the claim fails: the estimate is already net of everything sections 28 to 43C would have allowed.

On the same provision

Other instruments in this library that name the same provision of the 1961 Act. They are not necessarily still operative, and a later one may have replaced an earlier one without saying so.

Circular No. 12/2022 — Guidelines for removal of difficulties under sub section 2 of section 194R of the income tax act 1961 16 June 2022
Notification No. 42/2018 [F. No. 370142/05/2018-TPL] / SO 4213(E) — MINISTRY OF FINANCE (Department of Revenue) (CENTRAL BOARD OF DIRECT TAXES) NOTIFICATION New Delhi, the 30th August, 201 30 August 2018
Notification No. 71/2017 [F.No. 187/13/2015(ITA.I)] / SO 2320(E) — 2 the Gazette of INDIA : Extraordinary [Part Ii—sec. 3(ii)] 25 July 2017
Notification No. 40/2017 [F. No.173/429/2016-ITA-I ] / SO 1621(E) — Ministry of Finance 18 May 2017
Notification No. 100/2016/ F. No. 173/429/2016-ITA-I] / SO 3290(E) — Ministry of Finance 25 October 2016
Circular No. 8/2009 — Section 194J of the Income-tax Act, 1961 - Deduction of tax at source - Fees for professional or technical services - Ap 24 November 2009

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A circular binds the department, not you and not a court. The Board issues a circular to its own officers. An assessee may hold the department to a circular that helps him; the department cannot hold an assessee to one that hurts him, and the Tribunal and the courts decide the law for themselves.

Source: the Income Tax Department’s own published text — its page for this instrument.