Chargeability/Scope/Meaning of Income under the head “Profits and Gains of Business and Profession” under Section 28 to 44D has been explained with practical examples for the AY: 2022-23 & 2023-24.
|A. Income from sources other than speculation business
|1. Net profit/loss as per Profit and Loss Account
|2. Additions and deduction of amounts which have not been adjusted in the Profit and Loss Account in accordance with sections 28 to 44C
|3. Balance after adjustments (1 + 2)
|4. Interest and remuneration from the firm
|5. Chargeable income from business/profession (other than speculation business (3 + 4)
|B. Speculation business
|6. Net Profit/loss from speculation business (after adjustments in accordance with sections 28 to 44C, if necessary)
|7. Brought forward speculation loss adjusted with income at item 6
|8. Balance speculation profit (6 – 7)
|9. Total of amount at items 5 and 8
|10. Other brought forward loss from business/profession, if any, set off with the income at item 9.
|11. Balance income (8 – 9)
The word ‘Business’ is defined in section 2(13) to include any trade, commerce or manufacture or any adventure or concern in the nature of trade, commerce or manufacture.
The word business has a wider content than the word trade, commerce or manufacture. The activities which constitute carrying on of business need not necessarily consist of activities by way or trade, commerce or manufacture or activities in the exercise of a profession or vocation. They may even consist of rendering services to others. The definition of business being an inclusive definition and not being exhaustive, is indicative of extension and expansion and not restriction.
Section 2(13) defines business to include “any adventure or concern in the nature of trade, commerce or manufacture.” The word ‘business’ is generally understood as systematic and organised course of activity or conduct with a set purpose. But an isolated transaction can also be considered as business. The requirement is that it must have an element of trade.
It involves the idea of an occupation requiring purely intellectual skill or manual skill on the basis of some special learning. There should be some special qualification of a person apart from skill and ability, which is required in carrying on any activity which could be considered as a profession. This could be having education in a particular system either in a college, university or institute or it may be even by experience.
It refers to any activity on which a person spends a major part of his time in order to earn his livelihood.
The distinction between business, profession or vocation is however not material because the income from all these activities is taxable under the same head i.e. ‘Profits and gains of business or profession’.
The following Incomes shall be chargeable to income-tax under the head “Profits and gains of business or profession”
(i) the profits and gains of any business which was carried on by the assessee at any time during the previous year;
(ii) any compensation or other payment due to or received by, —
(a) any person in connection with termination/modification of his agreement for managing the whole or substantially the whole of the affairs of an Indian company or any other company;
(b) any person holding an agency in India for any part of the activities relating to the business of any other person at or in connection with the termination or modification of the terms of the agency. e.g., B was the distributor of a company for entire Northern India. During 2021-22, the company has modified the contract of agency and in future B will be the distributor only for Delhi. In lieu of such modification, the company compensates B with ₹5,00,000. Such amount of ₹5,00,000 received by B, although capital receipt but shall be taxable as business income;
(c) any person for or in connection with the vesting in the Government, or in any corporation owned by or controlled by the Government, under any law for the time being imposed, of the management of any property or business;
(d) any compensation received or receivable by any person, by whatever name called, at or in connection with—
— the termination or
— the modification of the terms and conditions
of any contract relating to his business shall be taxable as business income.
In other words, compensation received or receivable by any person, whether revenue or capital, in connection with the above, shall be taxable as business income.
(iii) income derived by a trade, professional or similar association from specific services performed for its members. This is an exception to the general principle that a surplus arising to mutual association cannot be regarded as income chargeable to tax;
(iv) export incentives which include:
(a) profits on sales of import licences granted under Imports (Control) Order on account of exports,
(b) cash assistance, by whatever name called, received or receivable against export,
(c) duty drawbacks of Customs and Central Excise duties,
(d) any profit on the transfer of the Duty Entitlement Pass Book Scheme,
(e) any profit on the transfer of the Duty-Free Replenishment Certificate;
(v) the value of any benefit or perquisite, whether convertible into money or not, arising during the course of the carrying on of any business/profession. e.g. the value of rent-free residential accommodation secured by an assessee from a company in consideration of the professional services as a lawyer rendered by him to that company, will be assessable in the hands of the assessee as his income under the head “Profits and Gains of Business or Profession”.
Further, the assessee may receive a car, air conditioner, motor cycle or any other article on achieving a sales target; the value of this article constitutes perquisite taxable as profits or gains from business or profession. Similarly, Free Air tickets received by the assessee for achieving a target shall be perquisites;
(vi) any interest, salary, bonus, commission or remuneration due to or received by a partner of a firm from the firm in which he is a partner. However, where any interest, salary, bonus, commission or remuneration by whatever name called, or any part thereof has not been allowed to be deducted under section 40(b), in the computation of the income of the firm, the income to be taxed shall be adjusted to the extent of the amount disallowed.
In other words, suppose a firm pays interest to a partner at 18% simple interest p.a. amount to ₹2,70,000. The allowable rate of interest is 12% p.a. Hence the excess 6% paid will be disallowed in the hands of the firm. Since the excess interest has been taxed in the hands of the firm, the same will not be taxed in the hands of the partner. The amount of interest taxable in the hands of the partner shall be ₹1,80,000 (Calculated @ 12% p.a.) instead of ₹2,70,000;
(vii) any sum whether received or receivable in cash or in kind under an agreement for: —
(a) not carrying out activity in relation to any business or profession; or
(b) not sharing any know-how, patent, copyright, trade-mark, licence, franchise or any other business or commercial right of similar nature or information or technique likely to assist in the manufacture or processing of goods or provision for services.
However, the above clause (a) shall not apply where any sum, whether received or receivable, in cash or kind, on account of transfer of the right to manufacture, produce or process any article or thing or right to carry on any business or profession, which is chargeable under the head “Capital gains”;
(viii) any sum received under a Keyman Insurance Policy including the sum allocated by way of bonus on such policy;
(ix) the fair market value of inventory as on the date on which it is converted into, or treated as, a capital asset determined in the prescribed manner [Clause (via) inserted w.e.f. A.Y. 2019-20].
(x) any sum, whether received or receivable, in cash or kind, on account of any capital asset (other than land or goodwill or financial instrument) being demolished, destroyed, discarded or transferred, if the whole of the expenditure on such capital asset has been allowed as a deduction under section 35AD. [Section 28(vii)]
|Where speculative transactions carried on by an assessee are of such a nature as to constitute a business then such speculative business shall be deemed to be distinct and separate from any other business. However, trading in derivatives carried out in a recognised stock exchange shall not be regarded as a speculative transaction.
It provides that the fair market value of inventory as on the date on which it is converted into, or treated as, a capital asset determined in the prescribed manner shall be chargeable to tax as business income.
Clause (i) of section 28 is the main clause dealing with the charge of profits and gains of a business in general. On an analysis of clause (i) five ingredients are found to emerge:
(a) there should be a business or profession;
(b) the business or profession should be carried on by the assessee;
(c) the business or profession should be carried on for some time during the previous year;
(d) the charge is in respect of the profits and gains of the previous year of the business or profession; and
(e) the charge extends to any business or profession carried on.
Under section 28, the income is chargeable as profit of the business, only if the business is carried on by the assessee at any time during the previous year. It is, however, not necessary that the business is carried out throughout the previous year or till the end of the previous year. Hence the year in which the business income is assessable is relevant. Also relevant is the question, whether the business is set up or commenced in the year of account. When the assessee does not carry on business at all, section 28 cannot be applied and the amount that he receives cannot bear the character of profits of a business.
There are, however, six exceptions to the above rule. In these cases, certain receipts are taxable as ‘Income from business’ even though no business is being carried on by the assessee in the year of receipt.
(i) Recovery against any loss, expenditure or trading liability earlier allowed as a deduction [Section 41(1)].
(ii) Balancing charge in case of electricity companies [Section 41(2)].
(iii) Sale of capital asset used for scientific research [Section 41(3)].
(iv) Recovery against bad debts [Section 41(4)].
(v) Amount withdrawn from Special Reserve [Section 41(4A)].
(vi) Receipt of discontinued business under cash system of accounting [Section 176(3A), (4)].
It is obvious that business profit cannot be computed without allowing a business loss. A trading loss of business is deductible in computing the profit earned by the business even though there is no specific provision in the Act for allowance thereof.
Such trading losses can be claimed as a deduction provided the following conditions are satisfied:
(a) It should be a real loss and not notional or fictitious.
(b) It should be a loss on revenue account and not on capital account.
(c) It must have actually arisen and been incurred, not merely anticipated as certain to occur in future.
(d) It should be one that is incidental to the carrying on of the business and must arise or spring directly from or be incidental to the carrying out of an operation of the business.
(e) There should be no prohibition in the Act, express or implied, against the deductibility thereof.
In the following cases, it has been held that the loss is incidental to business and is deductible in computing the income chargeable under this head:
(i) loss on account of embezzlement by an employee is allowed as deduction in the previous year in which such embezzlement is discovered.
(ii) loss of stock-in-trade by fire and other natural calamities or due to negligence of the employees.
(iii) loss on account of robbery or theft provided it is in the course of business and incidental to the trade whichever trade it is.
(iv) loss caused on account of fluctuations in exchange rate at the time of remitting the money for purchase of raw material.
(v) loss caused by non-recovery of advances made in course of business, provided it is a trading loss. e.g. advance money paid to a supplier for supply of raw material who does not supply the goods.
(vi) loss caused due to breach of contract for delivery of goods by either party.
(vii) loss of raw material, finished goods in transit.
(viii) loss caused by forfeiture of security deposits given at the time of submission of tenders for supply of goods.
(ix) loss by the failure of bank in which money is deposited.
(x) loss of stock in trade due to enemy action.
(xi) Any loss incurred due to non-recovery of advance given to salvage the capital, if it is in the revenue field, is an admissible deduction.
(i) Loss sustained before the business is commenced e.g. the pre-incorporation losses of the business taken over by a company cannot be claimed by the company.
(ii) Losses incurred in the closing down of the business.
(iii) Loss incurred due to damage, destruction, etc. of capital assets.
(iv) Loss which is not incidental to the carrying on of the business of the assessee.
(v) Loss due to sale of securities held as investments as it will be a capital loss and not the business loss.
(vi) Loss caused by forfeiture of advance given for purchase of capital assets.
(vii) Violation of law is not a normal incident of trade and an expense incurred by way of penalty for infraction of laws is not deductible as business loss.
(viii) Trading loss due to loss of goods in transit in normal course of business.
For purposes of taxation, there should not be, and indeed there is no distinction made between legal and illegal business. Profits from an illegal business are subject to tax just as from a legal business.
9. Cases where income from certain business is Not Taxable under the head ‘Profits and Gains of Business’
Where an assessee is carrying on a business of owning and letting out of residential houses, the income derived by him, from such letting, shall be taxable under the head ‘Income from house property’ and not as business income. However, if residential houses/flats are let out to the employees for efficient conduct of assessee’s own business and letting of house properties is not the main business of the assessee but is subservient and incidental to the main business, income from such letting shall be taxable as business income.
An assessee who is carrying on a business of dealing in shares and securities and earns income by way of dividend on such business assets shall be taxable, in respect of the dividends, under the head ‘Income from other sources’ and not under this head.
Any winning from Lotteries, Races, etc. are taxable under the head ‘Income from Other Sources’ even if, it is derived as a regular business activity.
As specified heads of income have been specified for income from these three activities, therefore, they have to be taxed under those heads only.
Section 29 states that profits and gains of business or profession, chargeable to income tax u/s 28, shall be computed in accordance with the provisions contained in sections 30 to 43D. It may be added here that the provisions of sections 44 to 44D have also to be considered in this context as they make certain special provisions regarding the computation of profits and deduction of expenditure in certain cases.
(i) Expenditure should have been incurred during the previous year.
(ii) Expenditure should be incurred for the purpose of the business.
(iii) No deduction is allowable in respect of a discontinued business.
(iv) Expenses incurred before the setting up of a business are not allowed.
In cases where the assessee provides for any contingent liability like bad debts, sales tax, etc. which have not arisen during the previous year but are only anticipated to arise in the future, no deduction is allowable. Deduction can be claimed only when the expenditure or the loss has been actually incurred during the previous year.
The terms “Loss” and “Expenditure” have distinct meanings and are defined as follows in the Webster New World Dictionary:
(a) Loss — the damage, disadvantage, etc. caused by losing something.
(b) Expenditure — an expending/a spending or using of money.
Business losses are different from expenditure and shall be allowed as deduction by computing the profits or gains under the head ‘Profits and gains of business or profession’ u/s 28. The scheme of allowing business expenses while computing the profits or gains under the head ‘Profits and gains of business or profession’ is as under:
(a) expenses which are expressly allowed (Sections 30 to 37);
(b) expenses which are specifically disallowed (Section 40);
(c) expenses or payments not deductible in certain cases (Section 40A).
(1) Income to be computed either on the basis of cash or mercantile system of accounting [Section 145(1)]
Income chargeable under the head “Profits and gains of business or profession” or “Income from other sources” shall, subject to the provisions of section 145(2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee.
(2) Central Government empowered to notify income computation and disclosure standards [Section 145(2)]
The Central Government may notify, in the Official Gazette from time to time, income computation and disclosure standards to be followed by any class of assessees or in respect of any class of income.
The Central Government vide Notification No. 87/2016, dated 29.9.2016 has notified certain Income Computation and Disclosure Standards to be followed by all assessees.
(3) Assessing Officer empowered to make assessment in the manner provided under section 144 in certain cases [Section 145(3)]
(i) Where the Assessing Officer is not satisfied about the correctness or completeness of the accounts of the assessee, or
(ii) Where the method of accounting provided in section 145(1) has not been regularly followed by the assessee, or
(iii) Where income has not been computed in accordance with the standards notified under section 145(2), the Assessing Officer may make an assessment in the manner provided in section 144.
(1) The Central Government vide Notification No. 87/2016, dated 29.9.2016 has notified the following Income Computation and Disclosure Standards to be followed by all assesses (other than an individual or a Hindu undivided family who is not required to get his accounts of the previous year audited in accordance with the provisions of section 44AB), following mercantile system of accounting for the purposes of computation of income chargeable to tax under the head “profit and gains of business or profession” or “income from other sources”:
A. Income Computation and Disclosure Standard, I relating to accounting policies
B. Income Computation and Disclosure Standard II relating to valuation of inventories
C. Income Computation and Disclosure Standard III relating to construction contracts
D. Income Computation and Disclosure Standard IV relating to revenue recognition
E. Income Computation and Disclosure Standard V relating to tangible fixed assets
F. Income Computation and Disclosure Standard VI relating to the effects of changes in foreign exchange rates
G. Income Computation and Disclosure Standard VII relating to government grants
H. Income Computation and Disclosure Standard VIII relating to securities
I. Income Computation and Disclosure Standard IX relating to borrowing costs
J. Income Computation and Disclosure Standard X relating to provisions, contingent liabilities and contingent assets
The above notification shall apply to the assessment year 2017-18 and subsequent assessment years.