‘Profits and Gains of Business or Profession’-Taxability

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1. Business or Profession – Meaning & Definition 

(A) Business

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. 

Profits and Gains of Business or Profession-Taxability
Profits and Gains of Business or Profession-Taxability

Adventure in the nature of trade:

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. 

(B) Profession

Profession 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. 

(C) Vocation

Vocation 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’.

2. Incomes Taxable under the head ‘Profits and gains of business or profession’ [Section 28] 

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.

(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. 

(iii) income derived by a trade, professional or similar association from specific services performed for its members.

(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.

(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.

(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. 

(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

(x) any sum, whether received or receivable, in cash or kind, on account of any Capital Asses ( 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)]

3. Basic Principles for Computing income Taxable under the head ‘Profit and Gains of Business or Profession’

1.  Business or profession carried on by the assessee –

Business or profession should be carried on by the assessee.

2.   Business or profession should be carried on during the previous year –

Income from business or profession is chargeable to tax under this head only if the business or profession is carried on by the assessee at any time during the previous year (not necessarily throughout the previous year). There are a few exceptions to this rule.

3.   Income of previous year is taxable during the following assessment year –

Income of business or profession carried on by the assessee during the previous year is chargeable to tax in the next following assessment year. There are, however, certain exceptions to this rule.

4.   Tax incidence arises in respect of all businesses or professions –

Profits and gains of different businesses or professions carried on by the assessee are not separately chargeable to tax. Tax incidence arises on aggregate income from all businesses or professions carried on by the assessee. If, therefore, an assessee earns profit in one business and sustains loss in another business, income chargeable to tax is the net balance after setting off loss against income. However, profits and losses of a speculative business are kept separately.

5.   Legal ownership vs. Beneficial ownership –

Under section 28, it is not only the legal ownership but also the beneficial ownership that has to be considered. The courts can go into the question of beneficial ownership and decide who should be held liable for the tax after taking into account the question as to who is, in fact, in receipt of the income which is going to be taxed.

6.   Real profit vs. Anticipated profit –

Anticipated or potential profits or losses, which may occur in future, are not considered for arriving at taxable income of a previous year. This rule is, however, subject to one exception: stock-in-trade may be valued on the basis of cost or market value, whichever is lower.

7.   Real profit vs. Notional profit –

The profits which are taxed under section 28 are the real profits and not notional profits. For instance, no person can make profit by trading with himself in another capacity.

8.   Recovery of sum already allowed as deduction –

Any sum recovered by the assessee during the previous year in respect of an amount or expenditure which was earlier allowed as deduction, is taxable as business income of the year in which it is recovered.

9.   Mode of book entries not relevant –

The mode or system of book-keeping cannot override the substantial character of a transaction.

10. Illegal business –

The income-tax law is not concerned with the legality or illegality of a business or profession. It can, therefore, be said that income of illegal business or profession is not exempt from tax.

4. Incomes Not Taxable under the head ‘Profits and Gains of Business or Profession’ 

(1) Rent from House Property:

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. 

(2) Dividend 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. 

(3) Winning from Lotteries, Races, etc.:

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. 

5. General principles for allowability of Deductions for computing Income from Business or Profession 

(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. 

6. Losses and Expenditure – Meanings for Computing Income from Business or Profession

The terms “Loss” and “Expenditure” have distinct meanings and are defined as follows in the Webster New Word 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).

7. How to Compute the Income under the head ‘Profit and Gains of Business or Profession’

COMPUTATION OF INCOME FROM BUSINESS OR PROFESSION(Rs.)(Rs.)
Net Profit as per Profit and Loss Account
Add: Expenses debited to P & L A/c but not allowable,
(i) Capital expenses
(ii) Personal expenses
(iii) Charities and Donations
(iv) Income Tax / Wealth Tax
(v) Expenses disallowable u/s 40
(vi) Expenses Disallowable u/s 40A
(vii) Amounts transferred to Reserve A/c
(viii) Depreciation for separate consideration
(ix) Other expenses to be disallowed
(x) Expenses of income which is taxable under other heads of income,
(xi) Preliminary expenses in excess of permissible limits
Add: Amounts to be treated as income though not credited to P & L A/c
Less: Amount credited to P & L A/c but not to be Included under the head business income:
(i) Dividend income
(ii) Rental income (Taxable under the head ‘House properly’)
(iii) Bad debts recovered to the extent not allowed as a deduction earlier
(iv) Income-tax refund
(v) Capital gains (taxable under capital gains)
(vi) Gifts (not taxable being capital receipts)
(vii) Excise Duty/Customs Duty refund earlier not allowed as deduction
Less:
(i) Expenses which are allowable but have not been debited to P & L A/c.
(ii) Depreciation allowable as per Income-tax rules
Profit or Gains of Business or Profession as per Income Tax

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