INCOME UNDER THE HEAD" PROFITS AND GAINS OF BUSINESS OR PROFESSION AND COMPUTATION "

INCOME UNDER THE HEAD “PROFITS AND GAINS OF BUSINESS OR PROFESSION “AND ITS COMPUTATION.

Under section 28 , the following income is chargeable to tax under the head “ Profits and gains of business or profession”

a.     Profits and gains of any business or profession

b.     Any compensation or other payments due to or received by any person specified in section 28(ii)

c.      Income derived by a trade, professional or similar association from specific services performed for its members.

d.     The value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession.

e.     Any profit on transfer of the duty free replenishment certificate.

f.       Any profit on the transfer of the Duty Entitlement Pass Book Scheme.

g.     Export incentive available to exporters.

h.     Any interest, salary, bonus, commission or remuneration received by a partner from firm.

i.        Any sum received for not carrying out any activity in relation to any business or not to share any know how , patent, copyright, trademark etc.

j.       Any sum received under a Keyman insurance policy including bonus.

k.     Any sum 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 applicable from the assessment year 2010-11 onwards

l.        Profit and gains of managing agency

m.  Income from speculative transaction.

In view of section 2(13) business includes any (a) trade, (b) commerce, (c) manufacturer or (d) any adventure or concern in the nature of trade, commerce, or manufacture.  Though the definition is not exhaustive, it covers  every facet of an occupation carried on by a person with a view to earning with a view to earning profit. Production of goods from raw material, buying and selling of goods to make profit and providing services to others are different forms of “business”, profits arising therefrom are, therefore, chargeable to tax under the head “ Profits and gains of business or profession”. The term “business” is a word of wide import and in fiscal statutes in must be constructed in a broad rather than a restricted sense.

Business income not taxable under the head “ Profit and gains of business or profession 

                      In the following cases, income from trading or business is not taxable under section 28, under the head “ Profits and gains of business or profession” :-

1.     Rental income in the case of dealer in property – Rent of house property is taxable under section 22 under the head “ Income from house property” even if property constitutes stock in trade of recipient of rent or the recipient of rent is engaged in the business of letting properties on rent.

2.     Dividend on shares in the case of a dealer in shares – Dividends on shares are taxable under section 56(2) (i), under the head “ Income from other sources “, even if they are derived from shares held as stock in trade as the recipient of dividends is a dealer-in –shares. However, dividend received from an Indian company is not chargeable to tax in the hands of shareholders.

3.     Winnings from lotteries, etc – Winnings from lotteries, races, etc. are taxable under the head “Income from other sources “ (even if derived as a regular business activity.)

One has to keep in view the general commercial principles while determining real and true profits of a business or profession. For instance, capital receipts are not taxable. Profits can arise only out of a trading receipt. Even if a transaction is on trading or revenue account, only its profit element is taxable and not the entire receipt.

TRADING LOSS

 Trading losses of revenue nature incurred in carrying out the business are deductible, if they are incidental to the operation of business. This rule is applicable even if it is not specially coded anywhere under the Act. A trading loss is allowable as deduction while computing business income only in the year in which it is incurred. Moreover, in order to avail deduction of trading loss, it should have been incurred by the assessee in the character of a trader and the same should fall on him in that character. As capital receipts are not chargeable to tax as business income , capital losses are not deductible while computing under the head “ Profit and gains of business or profession “. In other words, business losses can be allowed as deduction only if the following conditions are satisfied :

1.     Losses should be revenue in nature.

2.     Losses should be incurred during the previous year.

3.     Losses should be incidental to the business or profession carried on by the assessee.

4.     It should not be notional or fictitious.

5.     It should have been actually incurred and not merely anticipated to incur in future.

6.     There should not be any, direct or indirect , restriction under the Act against the deductibility of such loss.

Instances of losses deductible from business income:-

1.     Loss of stock in trade as a result of enemy action, or arising under similar circumstances.

2.     Loss of stock in trade due to destruction by an act of God.

3.     Loss arising on account of failure on the part of the assesses to accept delivery of goods.

4.     Depreciation in funds kept in foreign country for purchase of stock in trade.

5.     Loss due to exchange rate fluctuations of foreign currency held on revenue account.

6.     Loss arising from sale of securities held in the regular course of business.

7.     Loss of cash and securities in a banking company on account of dacoity ( may be after banking hours )

8.     Loss incurred on realisation of amount advanced in connection with business.

9.     Loss of security deposited for the purposes of acquisition of stock in trade.

10.   Loss due to forfeiture of a deposit made by the assesses for properly carrying out of contract for supply of commodities.

11.   Loss on account of misuse by an employee.

12.   Loss incurred due to theft or burglary in factory premises during or after working hours.

13.   Loss of precious stones or watches of a dealer while bringing them from business premises to his house.

14.   Loss arising from negligence or dishonesty of employees.

15.   Loss incurred on account of insolvency of banker with which current account is maintained by the assessee.

16.   Loss incurred due to freezing of the stock in trade by enemy action.

17.   Loss incurred by a sugar manufacturing company by foregoing advance made to sugarcane growers who used to sell sugarcane crop exclusively to the company.

18.   Loss on account of non recovery of advances given by the assesses company to its 100 percent subsidiary company.

19.   Loss incurred by a holding company which has guaranteed a loan taken by its subsidiary company.

Instances of losses not deductible from business income

1.     Loss which is not incidental to trade or profession, carried on by the assesses.

2.     Loss incurred due to damage, destruction etc. of capital assets.

3.     Loss incurred due to sale of shares held as investment.

4.     Loss of advances made for setting up of a new business which ultimately could not be started.

5.     Depreciation of funds kept in foreign currency for capital purposes.

6.     Loss arising from non-recovery of tax paid by an agent on behalf of the non resident.

7.     Anticipated future losses.

8.     Loss relating to any business or profession discontinued before the commencement of previous year.

9.     Loss arising as a result of capture and subtraction of illegal stock in trade is allowable as a business loss against income from illegal business.”

What is the scheme of business deductions / allowances?

Section 28 defines various income which are chargeable to tax under the head “ Profits and gains of business or profession”. Section 29 permits deductions and allowances laid down by sections 30 to 43D while computing profits or gains of a business or profession. Loss of revenue nature, which is incidental to business, is allowable as deductions while computing taxable business income, even though it is not codified specially under any of these sections, Section 40, 40A, and 43B give a list of expenses which are not deductible.

It will be useful if we keeps in view the following principles governing admissibility of these deductions under section 30 to 43D:-

1.     Onus of proof: - It is the responsibility of the assessee to prove that a particular deduction is admissible in his case.

2.     Allowances are cumulative: - The allowances laid down under sections 30 to 37 are cumulative and not alternative. For example, if a particular expense is expressly dealt with by a particular section, its admissibility under the residual section 37 cannot be denied unless the particular section prohibits any allowance under any other provision.

3.     Expenditure should relate to the previous year;- It is necessary to claim deduction that the expenditure should relate to the previous year. In order to ascertain whether the expenditure relates to the relevant previous year or not, one has to examine method of accounting generally adopted by the assessee. If the assessee keeps his books of account on the basis of mercantile system, expenses of the previous year would be deductible irrespective of the fact whether they are actually paid during the previous year or not. If the assessee, on the other hand, keeps his books of account on the basis of cash system, expenses actually paid during the previous year are deductible, whether or not they are in respect of previous year. The rule described is however, subject to one exception.

4.     Business should be carried on during the previous year:- In order to avail deduction of expenditure , it is necessary that the business in respect of which expenses are incurred, should be carried on by the assessee during the previous year. If the business has been closed or discontinued before the commencement of the previous year, no deduction in respect of such discontinued business is permissible while computing taxable income of the previous year from other sources. Section 41 and 176 bring into charge certain receipts relating to a business or profession, not in existence during the previous year.

5.     Expenditure should have been incurred in connection with assessee’s business: -An expenditure is allowable as deduction in computation of taxable income only if it is incurred for the purpose of assessee’s own business. For example, parent company cannot be allowed a deduction in respect of an expenditure incurred for the benefit of its subsidiary company even if it is a wholly owned subsidiary company.

6.     Benefit of expenditure may extend to somebody else:- If the expenditure is incurred primarily in connection with assessee’s own business. It would still be allowed as deduction even if it endured to the benefit of someone else. For example, insurance premium, repairs and other expenditure incurred on leased out business assets are deductible from the income of the lesser; even though the expenditure endures to the benefit of the lessee.

7.     Benefit of expenditure may extend beyond the relevant previous year:- It is not necessary that benefit of the expenditure should be limited to the previous year in which the expenditure is incurred. A revenue expenditure incurred during the previous year is deductible even if benefit of expenditure is extended beyond the year of expenditure.

8.     No allowance in respect of exhaustion of wasting assets:- No deduction is admissible in respect of diminution or exhaustion of the capital asset from which income is derived. Wasting assets such as mines and quarried, timber bearing land, leasehold interest are capital assets and their diminution or exhaustion in value represents capital loss which is not allowable as deduction, as the Act permits deduction of revenue loss.

9.     No allowance in respect of expenditure incurred before the setting up of a business:- In the case of a new business the first previous year commences on the date when the business or profession is set up. Expenditure incurred prior to setting up of a business falls outside the previous year. Section 28 applied only in respect of business carried on during the previous year. As consequences, expenditure incurred before setting up of a business would not be deductible, while computing income of the previous year. However, there is sometimes a time lag between setting up a business and its actual commencement. Expenditure incurred after setting up of a business may be allowed as deduction under section 30 to 37, even if it is incurred before the actual commencement of business.

10. Exception :- To the aforesaid general rule that expenditure incurred before setting up of a business is not permissible as deduction, some exceptions are provided. If business is commenced by promoters of a company before its incorporation, tax incidence on profit earned during pre incorporation period, falls on the company and in arriving at  taxable profit, expenditure incurred during pre incorporation period is allowable as deduction. Three more instances when expenditure incurred before setting up of a business are allowable as deductions are found in sections 35A, 35D and 35E.

11.  No allowance in respect of non assessable business:- Section 28 applies only in respect of business profits which are assessable  under the Income Tax Act. Therefore, the question of deduction of expenditure under section 30 to 37 arises only if profits of a business are assessable to tax under the Act. For example, if the assessee carries on a non taxable business such as agricultural income in India, then no deduction on account of expenditure relating to such non taxable business can be claimed.

12.  Expenditure relating to illegal business:- As said earlier, profits of illegal business are chargeable to tax. In arriving at chargeable profits, ordinary business expenditure incurred in carrying on an illegal business is allowable as deduction. However, infringements of law including breaches of obligations are not ordinary incidence of business and penalty or damages paid in connection with such infringement do not constitute expenditure, wholly and exclusively laid out for the business of the assessee ; such expenses are , therefore , not deductible.

13.  No allowance in respect of anticipated losses:- Under the present scheme of the Act anticipated loss cannot be deducted, though the loss is certain. In other words, a loss which is neither suffered nor incurred in the previous year is not deductible against the actual receipts of the year. The only exception to this rule is that stock in trade may be valued at cost or market value whichever is lower.

14.  No deduction in respect of depreciation of investment:- A deduction in respect of depreciation of investment in shares and securities is not allowable.

15.  Relevance of distinction between capital and revenue expenditure:- The question whether the expenditure is capital expenditure or revenue expenditure is relevant only in the case of expenditure falling under sections 30,31 and 37 (1) which expressly exclude the items of the nature of capital expenditure from being allowed as permissible deduction. However, expenditure falling under other section may fall either under the category of capital expenditure or revenue expenditure.

 What are specific deductions under the Act?

    Section 30 to 37 cover expenses which are expressly allowed as deduction while computing business income, sections 40, 40A and 43B cover expenses which are not deductible. The following expenses are expressly allowed as deductions against profits and gains of business or profession:

1.     Rent, rates, taxes, repairs and insurance for building (Sect 30):- Under the section 30, the following deductions are allowed in respect of rent, taxes, repairs and insurance for premises used for the purpose of business or profession :

a.     The rent of premises, the amount of repairs (not being capital expenditure), if he has undertaken to bear the cost of repairs (this is applicable if the assessee has occupied the property as a tenant)

b.     The amount of current repairs (not being capital expenditure ) if the assessee has occupied the premises otherwise than as a tenant.

c.      Any sum on account of land revenue, local rates or municipal taxes and

d.     Amount of any premium in respect of insurance against risk of damage or destruction of the premises.

·        Applicable to section 43B:- Land revenue , local rates or municipal taxes are deductible subject to the conditions as specified by section 43B .

·        Judicial rulings:- The following judicial ruling one should keep in view – If an assessee takes premises on lease for carrying on a business or profession and agrees to pay arrears of rent of previous tenant, such arrears of rent cannot be deducted, whether arrears of rent are paid under legal obligation or voluntarily.

           A fluctuating item like a share in profit cannot be treated as rent.

           Painting the outside of a house is repair.

2.     Repairs and insurance of machinery, plant and furniture (Sect 31):- The expenditure incurred on current repairs not being capital expenditure and insurance in respect of plant, machinery and furniture used for business purposes is allowable as deduction under section 31.

·        “ Current “ can not be interpreted to mean petty. The section does not say anything about the magnitude of the expenditure. However, the expenditure should not be capital expenditure.

      3) Depreciation allowance (Sect 32):- Depreciation shall be determined according to the provision of section 32.

      4) Investment allowance (Sect 32A)- Investment allowance is not available.

      5) Investment deposit account scheme (Sect 32AB) :- Deduction under section 32AB is not available form the assessment year 1991-92 onwards.

     6)  Tea / coffee / rubber development account (Sect 33AB):- An assessee can claim deduction under section 33AB as per following conditions :-

           a)  The assessee must be engaged in tea, coffee , or rubber plantation.

           b) It must make a deposit in “special account”.

           c) The deposit should be made within specified time limit.

           d) The accounts of the assessee should be audited.

     7) Site restoration fund (Sect 33ABA) :- An assessee can claim deduction under section 33ABA as follows:-

          a) The assessee must be engaged in production of petroleum / natural             gas in India.                               

          b) The assessee has an agreement with the Central Government.

          c) It must make a deposit in “special account”.

          d) The deposit should be made within specified time limit.

          e) The accounts of the assessee should be audited.

    8) Reserves for shipping business ( Sec. 33AC ) :- No deduction under section 33AC is available from the assessment year 2005-06.

    9) Expenditure on scientific research (Sec 35) :- The term “scientific research “ means any activity for the extension of knowledge in the fields of natural or applied sciences including agriculture, animal husbandry or fisheries”. With a view to accelerating scientific research, section 35 provides tax incentives.

   10) Expenditure on acquisition of patent rights and copyrights (Sec 35A ):- For claiming deduction under section 35A, the following conditions should be satisfied :-

           a) The know-how, secret formula, designs and specifications are either patent rights or copyrights.

           b) The expenditure is of capital nature.

           c) The expenditure is incurred on acquisition of the patents right / copyrights.

           d) Patents rights / copyrights are used for the purpose of business or profession of the taxpayer

           e)  The capital expenditure is incurred prior to April 1, 1998.

           If all the aforesaid conditions are satisfied, then deduction is available under section 35A.

          If all the aforesaid conditions are not satisfied then –

a)     In respect of capital expenditure incurred on or after April 1, 1998 one can claim depreciation under section 32.

b)    In respect of any other capital expenditure, no deduction is available.

c)     In respect of revenue expenditure, one can claim deduction under section 37 (1).

   11 ) Expenditure on know –how ( Sec 35 AB ) :- If expenditure on acquisition of      technical know how is incurred after March 31,1998, depreciation is available under section 32. Now a days no deduction is available under section 35AB.

  12 ) Expenditure of telecom licence fees  ( Sec 35 ABB ) :- the provisions of section 35ABB are given below conditions :-

a)     The expenditure is capital in nature.

b)    It is incurred for acquiring any right to operate telecommunication services.

c)     The expenditure is incurred either before the commencement of business or thereafter at any time during any previous year.

d)    The payment for the above has been actually made to obtain licence.

       13) Expenditure on eligible projects or scheme (Sec 35 AC) ;- Deduction is available under section 35AC for promoting social and economic welfare or uplift of the public.

       14) Deduction in respect of expenditure on specified business ( Sec 35AD ) :- Section 35AD has been inserted with effect from the assessment year 2010-11 to provide for investment linked tax incentive.

        15) Payment to association and institutions for carrying out rural development programmes (Sec 35CCA ) :- Section 35CCA provides deduction of sums paid by an assessee to

            a)  any association or institution to be used for carrying out any programme of rural development approved before March 1, 1983. ( Sec 35CCA (1) (a) )

           b) an association or institution which has its object the training of persons for implementation of a rural development programme approved before March 1, 1983 (sec 35CCA (1) (b) )

          c) the National Fund for Rural Development set up by the Government.(sec 35CCA (1)(c) )

         d) the National Urban Poverty Eradication Fund set up and notified by the Central Government.

      16) Amortisation of preliminary expenses (Sec 35D );- Certain preliminary expenses are deductible under section 35D.