Goswami and Brothers Vs. Union of India and anr. - Court Judgment

P.P. Naolekar, J.

1. In this petition the prayer is made to quash theimpugned Circular No. 737, dated February 23, 1996 (see : [1996]218ITR97(All) ), issued by the Central Board of Direct Taxes (the CBDT) and theactions taken in pursuance thereof. The Central Board of Direct Taxesissued Circular No. 684, dated June 10, 1994 (see [1994] 208 ITR 8), toexplain the substance of the newly inserted provisions of Section 44AD ofthe Income-tax Act, 1961 (for short 'the Act' hereinafter). The circular hasbeen published in [1994] 208 ITR 8. In paras. Nos. 31 to 31.7 at page29, the meaning of the scope of Section 44AD has been explained as under(page.30):

'31.3: The rate of 8 per cent. is comprehensive. All deductions undersections 30 to 38 including depreciation, will be deemed to have been alreadyallowed and no further deduction will be allowed under these sections.' Thewritten down value will be calculated, where necessary, as if depreciation asapplicable has been allowed. In the case of firms, the normal deductions to the extent allowed under Clause (b) of Section 40 will be allowed.

31.6 The scheme is optional. A system of rebuttal has been provided, A person can claim that his income in respect of the abovementioned business is lower than the specified estimate of income. In such a case, he must produce necessary evidence to prove his case. Such a case will be scrutinised for regular assessment under Section 143(3).

32.2 The estimated income is comprehensive. All deductions under Sections 30 to 38 including depreciation, will be deemed to have been already allowed and no further deduction will be allowed under these sections. The written down value will be calculated, where necessary, as if depreciation as applicable has been allowed. In the case of firms, the normal deductions to the extent allowed under Clause(b) of Section 40 will be allowed.'

2. A subsequent impugned Circular No. 737, dated February 23, 1996 (see : [1996]218ITR97(All) ), was issued by the Central Board of Direct Taxes. It has been mentioned in the circular that a doubt has been raised as to whether deduction on account of salary/interest to the partners of a firm shall be admissible from the income estimated in accordance with Section 44AD and Section 44AE of the Act. The doubt has primarily arisen because of the erroneous clarification given in paras. 31.3 and 32.2 of Circular No. 684, dated June 10, 1994 (see [1994] 208 ITR 8). The following lines appearing in paras, 31.3 and 32.2 of Circular No. 684, dated June 10, 1994 (see [1994] 208 ITR 8), were deleted by the subsequent Circular No. 757, dated February 23, 1996 (see : [1996]218ITR97(All) ):

'In the case of firms, the normal deductions to the extent allowed under Clause(b) of Section 40 will be allowed.'

3. Taking recourse to the circular dated February 23, 1996, the income-tax authorities have reopened the assessments against the petitioner and in some of the matters, have issued fresh assessment orders.

4. By the Finance Act, 1997, a proviso to Sub-section (2) of Section 44AD has been added giving retrospective operation with effect from April 1, 1994, i.e., assessment year 1994-95, providing that where the 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. In view of the insertion of the proviso in the Finance Act to Sub-section (2) of, Section 44AD and giving it retrospective operation from April 1, 1994, Circular No,. 737, dated February 23, 1996 (see : [1996]218ITR97(All) ), deleting the words 'in the, case of firms, the normal deductions to the extent allowed under Clause(b) of Section 40 will be allowed' is clearly erroneous and cannot be permitted to stand.

5. Accordingly, the petition is allowed, Circular No. 737, dated February 23, 1996 (see : [1996]218ITR97(All) ), as above is quashed. As a result ofquashing of the circular dated February 23, 1996, now it will be incumbent on the Income-tax Officer to pass fresh orders and take appropriate steps in the matter of reassessment of the petitioner in accordance with law treating the circular dated February 23, 1996, as above as non-existent.