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Section 44AD(2)

What the Income Tax Act, 1961 reads?
 
"Any deduction allowable under the provisions of sections 30 to 38 shall, for the purposes of sub-section (1), be deemed to have been already given full effect to and no further deduction under those sections shall be allowed:
 
Provided that where the eligible assessee is a firm, the salary and interest paid to its partners shall be deducted from the income computed under sub-section (1) subject to the conditions and limits specified in clause (b) of section 40."
 
Our Analysis
 
It implies the following: –
i. No deduction u/s 35AD for any capital expenditure incurred by the assessee for specified business,
ii No carry-forward of depreciation u/s 32 or business loss, (except in cases covered by 44AD(5))
iii. No weighted deduction for contribution to research institutes, etc.
 
Q- In case of partnership firms where 44AD is applicable, how to compute Salary and Interest payable to partners u/s 40b?
 
  • As per the provisions of section 44AD(2), the deduction u/s 40b in respect of remuneration and interest to partners is allowable.
 
  • The interest to partners can be credited by preparing a Memorandum Capital Account of Partners where no books are maintained. Whereas where books are maintained the same can be credited as per the balance in capital account as per the books so maintained.
 
  • As regard remuneration, the deemed income @ 8% of Turnover or higher income, as reduced by Interest paid to partners shall be deemed to be the BOOK PROFIT for the purpose of 40b and Salary can be calculated accordingly. (Because such income @ 8% or higher income, is nothing but deemed income form business as per this section and the same is before allowances under section 40b.)
 
Example no. 1

 

–          Turnover of assessee – Rs. 50 Lakhs
–          Income @ 8% – Rs. 4 Lakhs & Actual Income as per records of assessee is Rs. 4.5 Lakhs (after                 deducting current depreciation as per books of Rs. 5 Lakhs). Assessee declares Income of Rs. 4.5             Lakhs as per books as income u/s 44AD of the Act.
–          Unabsorbed Depreciation brought forward – Rs. 10 Lakhs
–          Unabsorbed Business Loss brought forward – Rs. 10 Lakhs.
 
Comment on the set off of brought forward loss and depreciation and its carry forward to subsequent years.
 
Answer
First of all it is worth considering that set off of brought forward unabsorbed business loss is governed by section 72 of the Act.
 
Whereas set off of brought forward depreciation is governed by section 32 (2) of the Act and as per section 32 (2) of the act, brought forward depreciation gets merged with and forms part of current depreciation.
 
◊As regards the set of brought forward business loss is concerned the same is available to the assessee as a reduction in Income in Order to arrive at the Gross Total Income of the assessee. (Reliance can be placed on Universal Cargo v/s CIT (Cal.) 165 ITR 209.)
 
◊ Whereas, unabsorbed depreciation is not akin to business loss. Hence set off of the same is not permissible. (Reliance can be placed on Universal Cargo v/s CIT (Cal.) 165 ITR 209.)
 
Here, in the given example total depreciation as per section 32 including brought forward depreciation as per section 32(2) comes to Rs. 15 Lakhs.
 
However, as per section 44AD(2), all deductions u/s 30 to 38 shall be deemed to have been given full effect to and no further deduction under those section shall be allowed.
 
So technically and legally speaking, the assessee cannot take set off of unabsorbed depreciation against income as per section 44AD of the Act.
 
(Here no set off or deduction for depreciation in the current year is not an issue that requires due consideration.)
 
What is annoying indeed is the words “full effect” and “no further deduction under those sections shall be allowed”.
 
Does this mean that, the unabsorbed Depreciation of Rs. 10 Lakhs is reduced to “NIL” in the current year under consideration and hence the same cannot even be carried forward?
 
The answer is YES, because legally the language of section is very clear and unambiguous. But logically, this sounds unjust. But, it has been rightly said that what may be Logical may not necessary be Legal always and vice versa.
 
Look at the anomalous nature of the provision. On one hand assessee is paying tax on deemed income u/s 44AD, whereas on the other hand, the assessee is losing the benefit of brought forward depreciation of earlier years. This leads to double jeopardy. The provision seems to be arbitrary to this extent.