Professional Documents
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Unit 5 Profits and Gains of Business or Profession Structure
Unit 5 Profits and Gains of Business or Profession Structure
Business or Profession
Unit 5 Profits and Gains of Business or Profession
Structure:
5.1 Introduction
Objectives
5.11 Depreciation
· Block of assets
· Methods of depreciation
· Additional depreciation
· Rates of Depreciation
· Unabsorbed depreciation
Self assessment Questions III
5.12 Summary
5.1 Introduction
Business means and includes any trade, commerce or manufacture or any adventure or
concern in the nature of trade, commerce or manufacture. It is not necessary that there
should be a series of transactions in a business and that it should be carried on
permanently. Even profit of an isolated transaction is also taxable under this head,
provided that it is a venture in the nature of business or trade. In this connection, it is
important that the intention of purchase or manufacture should be to sell at a profit
Profession means the activities for earning livelihood which require intellectual skill or
manual skill, e.g., the work of a lawyer, doctor, auditor, engineer and so on, are in the
nature of profession. Profession includes vocation. Vocation means activates which are
performed in order to earn livelihood, e.g., brokerage, insurance agency, music, dancing
etc. As the rules for the assessment of business, profession or vocation are the same, there
is no importance of making any distinction between them for income tax purposes.
Learning Objectives:
2. Tax is chargeable on the aggregate income from all businesses or professions carried
on by an assessee. The profits and gains of different business or professions carried on by
an assessee are not taxable separately; but tax is chargeable under one head on the
aggregate income from all businesses or professions carried on by the assessee. The
essence of this rule is that, if in a year he earns profit in one business and sustains loss in
the other, he can set-off his loss of one business against the profits of the other, and the
balance of amount shall be income of the assessee under this head.
3. Profits and Losses of speculation business are kept separate. if there is a loss in a
speculation business it can be set-off only against profits of speculation business and not
against profits of any other business.
5. Tax is payable on the income of every business or profession whether legal or illegal.
Expenses concerned with illegal business are to be allowed as deduction out of the
income earned from illegal business. However, penalties levied for violation of law and
expenses incurred in defense of criminal proceedings are not allowed.
6. General commercial principles to be kept in view while determining the real profits of
a business.
7. Sums previously allowed as deduction are taxable, if recovered during the previous
year e.g. bad debts recovered, disallowed earlier.
8. Only those expenses and losses are allowed as deductions which were incurred or
sustained during the relevant previous year.
9. These losses and expenses should be incidental to the operation of the business. Only
the expenses incurred in connection with the business of the assessee are allowed as
deductions.
10. If a business has been discontinued before the commencement of the previous year,
its expenses cannot be allowed as deduction against the income of any other running
business of the assessee.
11.There are some essential expenses though neither expressly allowed nor disallowed,
but are deductible while computing the profits of business or profession on the basis of
general commercial principles provided these are not expenses or losses of a capital
nature or personal nature.
12. Any expenditure incurred in consideration of commercial expediency is allowed as
deduction.
13. Deduction can be made from the income of that business only for which the expenses
were incurred. The expenses of one business cannot be charged against the income of any
other business.
14. The value of any benefit or perquisite, whether convertible into money or not, arising
from business or exercise of a profession is taxed under this head.
The Profit and Loss account prepared by the assessee may not be correct from the income
tax point of view, because:
· several such expenses are charged to it may be wholly or partly inadmissible under the
Income Tax Act,
· Some such incomes might be credited which are either neither taxable under the head
‘Profits and Gains of Business or Profession’ or nor taxable at all. Hence, this profit and
loss account has to be adjusted from the income tax point of view, so that the profit
taxable under the head “Business or Profession’ is determined correctly.
The following are the rules for adjustment of the Profit and Loss Account:
i. Those expenses or losses which are charged to Profit and Loss Account but are not
allowed under the Income Tax Act, should be added to the profit, as shown by the Profit
and loss Account prepared by the assessee. If any expense is partly disallowed, only the
disallowed part of it shall be added to the profit.
ii. If any admissible expenses are omitted from Profit and Loss Account, they should be
deducted from the above profit.
iii. If some taxable incomes are omitted from the Profit and Loss Account they should be
added to the above profit.
iv. If some such incomes have been credited to the Profit and Loss Account which are
either not taxable under the head ‘Business or Profession’ or are not taxable at all, they
should be deducted from the above profits.
(1) All taxable incomes under this head which relate to the previous year are aggregated.
(2) All admissible expenses under this head which relate to the previous year concerned
The following deduction is allowed in respect of rent, rates, taxes repairs and insurance
for premises used for the purpose of the business or profession.
(i) as a tenant, rent paid for such premises: and further if he has undertaken to bear the
cost of repairs to the premises, the amount paid on account of such repairs;
(ii) As a landlord, the amount paid by him on account of current repairs to the premises.
Current repairs are those repairs which are done to maintain the building.
Any sum paid on account of land revenue, local taxes or municipal taxes.
(b) The amount of any premium paid in respect of insurance against risk of damage or
destruction of the premises.
In respect of repairs and insurance of machinery, plant and furniture used for the
purposes of the business or profession the following deductions are allowable:
The amount of any premium paid in respect of insurance against risk of damage of
destruction of these assets.
Where the assessee himself carries on scientific research in relation to his own business
any revenue expenditure made by the assessee on scientific research during the previous
year shall be allowed in full.
Further, any such expenditure incurred during the three years immediately preceding the
commencement of the business on:
The aggregate of the expenditure so incurred shall be deemed to have been incurred in
the previous year in which the business commenced and shall be deductible in that
previous year.
If any capital expenditure has been incurred during the three years immediately preceding
the commencement of the business the aggregate of the expenditure so incurred shall be
deemed to have been incurred in the previous year in which the business commenced.
Where an assessee pays any sum to an employee in any previous year in connection with
his voluntary retirement, he shall be allowed a deduction of 20% of such expenditure for
each of five successive previous years beginning with the year in which the expenditure
was incurred.
1) Sums paid for social and scientific research to an approved university etc., is allowed
to the extent of 125% 0f sums paid.
3) Sums previously allowed as deduction are taxable if recovered during the previous
year.
· Insurance Premium, The amount of any premium paid in respect of insurance against
risk of damage or destruction of stocks or stores used for the purpose of business or
profession, is allowed as deduction.
· Insurance premium for Cattle paid by a federal milk co-operative society. The amount
of any premium paid by a federal milk co-operative society on the life of the cattle owned
by a member of a primary milk co-operative society affiliated to the federal milk co-
operative society is allowed as deduction.
· Bad debts.
It is a residuary section:
Under section 37(1), the following conditions should be fulfilled, in order that a
particular item of expenditure may be deductible under this head:
The following are the few examples of admissible general deduction under sec 37:
6) Contribution made to provident fund maintained for the benefit of employees under an
Act and with the previous approval of a state Government may not be allowable u/s 36(1)
(iv) but allowable u/s 37(1).
10) Insurance premium paid under a policy insuring its employees against injury or
against liability for compensation in respect of accident to its workmen.
19) Penalty paid by the assessee for saving from confiscation the good which he
purchased from a third party without knowing that they had been illegally imported.
23) Guarantee fee paid to he Government for loan obtained for purchase of machinery.
25) If an asseessee stand ss surety for the debt of another and it is usual in this trade to
guarantee debts, any payment made as a result of such guarantee may be allowed as a
business losss.
26) Professional tax levied by local authorities the payment of which is a necessary
condition for the carrying on the business within the area of a local authority.
27) Rebate granted by co-operative stores to their members on the value of the purchases
made by them.
28) The interest payable on arrear of cess is in the nature of compensation paid to the
Government of delay in the payment of cess and not as penalty, hence it is deductible.
Similarly, interest paid for delay in payment of municipal taxes is also allowable as
deduction.
30) Amount paid as damages to the Government Department for delay in the execution of
contracts was held to be allowable deduction, if the delay was inherent in the nature of
business carried on by the assessee.
31) Annual listing fee paid to Stock Exchange by public limited company is allowable.
32) Interest levied for failure to pay installment of the assets purchased on hire-purchase
basis is allowable.
36) Liability to pay debenture premium is to be spread over the years between date of
issue and date of redemption.
The following expenses are expressly disallowed by the Act while computing income
chargeable under the head’ profits and gains of business or profession’.
(i) Payments outside India. Royalty, fees for technical services, etc. which tax is
deductible at not been paid during the previous year or in prescribed time. shall not be
allowed as a deduction.
(ii) Payments to residents. any interest, commission or brokerage, fees for professional
services or feeds for technical and such tax has not been deducted or, after deduction.
· Salaries Payable outside India or to a non-resident, if tax has not been paid thereon nor
deducted at source.
· Payment to P.F., etc. Any payment to a provident or other funds shall not be allowed as
a deduction unless it is ensured that tax shall be deducted at source from any payment
made from the fund provided it is chargeable to tax
· Payments in cash: Any expenditure in respect of which payment is made exceeding Rs.
20,000 otherwise that by a crossed cheque drawn on a bank or by crossed bank draft will
be disallowed to the extent of 20%.Further, the limit of Rs. 20,000 applies to the payment
made to a party at a time and not the aggregate of the payments made to a party in the
course of a day.
· Capital expenditure.
· Any provision or transfer to reserve except transfer to reserves as provided in the Act.
· Any expenditure not incurred wholly and exclusively for the purposes of the business or
profession.
· Expenditure incurred to buy off competition, e.g., a sum paid by a company to a retiring
director or a managing agent in consideration of their agreement not to complete with the
company.
· Penalties paid by the assessee for infringement of law.
· Payments made by an assessee in the nature of sharing the profits to the sole selling
agents under an agreement are not deductible.
· Gift made on occasion of marriages in the families of friends and others with whom
assessee has business dealing cannot qualify as business expenditure even on grounds of
commercial expediency.
1) Drawings of proprietor.
The following deductions are allowable only on actual payment: Sec. 43B:
If the tax payer maintains books of accounts on mercantile basis, following expenses are
deductible on accrual basis, provided the payment is actually made on or before the
due date of submission of return of income.
(a) Any sum payable by the assessee by way of tax, duty, cess or fee
(b) Any sum payable by him as an employer by way of contribution to any provident
fund, superannuation fund or gratuity fund or any other fund for the welfare of
employees.
(c) Any sum payable to an employee as bonus or commission for services rendered,
where such sum would not have been payable to him as profit or dividends if it had not
been paid as bonus or commission.
(d) Any sum payable by the assessee as interest on any loan or borrowings from any
Public Financial Institution or a State Financial Corporation or a State Industrial
Investment Corporation.
(e) Any sum payable by the assessee as interest on any loan or borrowing from any
Public Financial Institution or a State Financial Corporation or a State Industrial
Investment Corporation
(f) Any sum payable by the assessee as interest to a scheduled bank on any loan or
advance from a scheduled bank.
If the amount is paid after the due date of furnishing the return, the deduction will be
allowed in the year of payment.
5.11 Depreciation
Depreciation means a diminution in the value of assets due to wear and tear,
obsolescence etc. caused by their use over a period of time. Its cost is spread over its life
by charging depreciation every year against the profits of business.
A. Tangible assets: (i) Building, (ii) Machinery or Plant, and (iii) Furniture.
Other assets such as investments, goodwill, etc., do not qualify for depreciation
allowance
Building means only the superstructure and does not include the land on which it is
constructed, as the land does not depreciate by use. Building includes roads, bridges,
culverts, wells and tube wells. The term ‘plant’ includes ships, vehicles, books scientific
apparatus etc.
(ii) It should be used for the purpose of the assessee’s business or profession.
The term ‘Block of Assets’ means a group of assets falling within a class of assets
comprising:
(ii) in any other case on any block of assets at the prescribed rates on the written-down
value of such block of assets.
In the case of an asset acquired and put to use in the business during the previous year,
only 50% of the normal depreciation will be allowed if it is used in the business for less
than 180 days during the previous year.
Tax Planning: As for as possible, the assessee should purchase and put to use the net
asset on which depreciation is allowed upto 2nd October in the previous year. This will
entitle to him full depreciation for the relevant previous year.
(a) in the case of asset acquired in the previous year the actual cost to the assessee; and
(b) In the case of assets acquired before the previous year, the actual cost to the assessee
less depreciation actually allowed to him.
(c) Depreciation is calculated on the block of asset instead of individual assets. In the
case of any block of assets, the written-down value shall be computed as under:
(i) The aggregate of the W.D.V. of all the assets falling within a ‘block’ which were
acquired during the previous year.
(ii) Add to it the actual cost of any asset falling in that block which was acquired during
the previous year.
(iii) The sum arrived at in (ii) shall be reduced by the moneys receivable together with
scrap value in regard to any asset falling within that block which is sold, discarded,
demolished or destroyed during the previous year. The amount of such reduction cannot
exceed the amount arrived at as per (ii) above. If it exceeds the written-down value will
be taken as nil.
(iv) The balance under (iii) shall be the W.D.V. for computation of depreciation for that
previous year.
If the full block of the assets is transferred and the monies payable is less than the
W.D.V. under (iii), the loss shall be treated as short term capital loss. When the money
payable in respect of a full block of assets or its part is more than written down value
under (iii), the excess shall be treated as short term capital gains.
On new plant or machinery (other than ships and aircraft), which has been acquired and
installed after 31.3.2005, by an assessee engaged in business of manufacture or
production of any article or thing, additional depreciation shall be allowed @ 20% @
10% if the asset is put to use for less than 180 days in the year in which it is acquired) of
the actual cost of it:
(a) any machinery or plant which, before its installation by the assessee, was used either
within or outside India by any other person; or
(b) any machinery or plant installed in any office premises or any residential
accommodation, including accommodation in the nature of a guest house; or
(d) any machinery or plant, the whole of the actual cost of which is allowed as a
deduction (whether by way of depreciation of otherwise) in computing the income
chargeable under the head “Profit and gains of business or profession” of any one
previous year.
=>Rates of Depreciation
Intangible Assets
=>Unabsorbed Depreciation
Depreciation allowance for a particular previous year is first deductible from the profits
and gains of the business or profession. If the profits and gains of the same business or
profession are insufficient for this purpose, the balance of the amount of current
depreciation allowance is deductible from the profits of any other business or profession
of the assessee. If the profits of any other business or profession are also unable to absorb
the whole amount of depreciation allowance, the balance of such allowance which
remains unabsorbed can be set-off against any other taxable income of the same year. If
still, the whole amount of current depreciation allowance is not deductible on account of
the insufficiency of the other taxable income, the remaining unabsorbed amount is called
“Unabsorbed Depreciation”.
If unabsorbed depreciation cannot be wholly set-off, the amount of depreciation not set-
off shall be carried forward to the following assessment year.
The unabsorbed depreciation shall be added to the depreciation allowance for the
following previous year or for the succeeding previous years till such time it is fully
deducted. In other words the unabsorbed depreciation shall be treated as part of the
current year’s depreciation.
Illustration
The following are the particulars of the assets of a limited company as on Ist April, 2008;
1.4.2008
Buildings: 10,00,000 8,10,000 10%
Bhagvan
The company sold the following assets during the financial year 2008-09
Queen
Compute the written-down value and the amount of depreciation for the Assessment year
2009-10. Assessee is entitled to additional depreciation on machinery on which
depreciation is allowable @ 15%.
Solution:
Tax planning
Capital assets may be purchased even on the last day to claim 50% of normal
depreciation. Business assets if are to be purchased during Sept. or Oct., one may see that
it is used for a minimum period of 180 days to claim full depreciation allowance. Since
no depreciation on the assets sold during the previous year is allowed, the sale of the
asset may be postponed to the beginning of the next year.
Illustration
The following is the profit and loss account of the United Plastic for the
P.Y. 2008-09
Rs. Rs.
To Op. Stock 30,000 By Sales 6,10,000
“ Purchases 1,59,000 “ Dividends (Gross) 6,000
“ Wages and Salaries 50,000 “ Rent from staff 7,000
quarters
“ Rent 20,000 “ Interest on Govt. 50,000
Securities
“ Reserve for bad 10,000 Closing. Stock 25,000
debts
Advertisement 5,000 Income from Smuggling 10,000
Depreciation on 5,000 “ Dividend from Foreign 2,000
Machinery Co. (net)
“ Wealth tax 7,000
“ Interest 7,000
You are required to compute taxable income for the assessment year 2009-10 after taking
into account the following information:-
Solution
Mr. Shantharam (age: 66 years), a resident individual, furnishes the following particulars
relevant for the assessment year 2009-10:
Profit and Loss Account for the year ending March 31, 2009
Rs. Rs.
Salary to staff 34,000 Gross profit 1,86,000
General expenses 48,000 Commission and 2,17,200
discount
Bad debts written off 15,000 Sundry receipts 43,000
Reserve for losses 2,000 Short-term profit on 31,000
sale of investment
Fire insurance premium 3,700
(office premises)
Advertisement 2,400 4,000
March 3,2007
Depreciation on plant and 28,000
machinery
Provision for outstanding 13,000
sales tax and excise duty
Net Profit 2,34,000
4,77,200 4,77,200
Other information:
4. Out of outstanding sales tax and excise duty, Rs. 3,000 is paid on July 10,2009 and Rs.
8,000 is paid on October 3, 2009. The balance is not paid as yet. Due date of filling return
of income is July 31,2009.
5. Income of Shantharm from company deposit is Rs. 12,000, which is not shown in the
above Profit and Loss Account.
Determine the taxable income and tax liability of Shantharam for the assessment year
2009-10.
Solution:
Notes:
· It is assumed that the evidence of payment of sales tax on July 10,2007 is submitted
along with return of income
Illustration
Mr. Nagaraja (age: 26 years), a leading tax consultant, who maintains books of account
on cash basis furnishes the following particulars of income and expenditure for the
assessment year 2009-10.
Receipt and Payment Account for the year ending March 31, 2009.
Rs. Rs.
Balance brought down 12,400 Purchase of a typewriter 6,000
Fees from clients: Car expenses 18,000
• 2009-10 2,30,500 Office Expenses 40,000
• 2008-09 11,500 Salary to staff:
• 2010-11 13,000 of 2009-10 32,000
Presents from clients 24,000 of 2010-11 11,000
Interest-free loan from a Expenses in respect of let out
client property
for purchase of a car 2,38,000 municipal tax: 2,000
Winnings from lottery 46,000 repairs: 1,000 6,000
insurance 3,000
Interest from UTI (received 12,000
on September 11,2008)
Car purchased on December 2,40,000
10,2008
Rent of a let out property 60,000 Repairs of office 12,000
Share of income from a 15,000 Interest on loan 10,000
firm
Income-tax payment 2,000
Life insurance premium 8,000
Balance carried down 2,77,400
6,62,400 6,62,400
Car is party used for official purposes (40%) and partly for private purposes (60%)
Determine the taxable income and tax liability of X for the assessment year 2009-10.
Solution:
Note: As books of account are maintained on the basis of cash system, income is taxable
on “receipt” basis and expenditure are deductible on “payment” basis.
Illustration
From the Profit and Loss Account of Sriram (age : 31 years) for the year ending March
31, 2009, ascertain his total income and tax liability for the assessment year 2009-10.
Rs. Rs.
General expenses 13,400 Gross profits 3,15,500
Bad debts 22,000 Commission 8,600
Advance tax 21,000 Brokerage 37,000
Insurance 600 Sundry Receipts 2,500
Salary to staff 26,000 Bad debt recovered (earlier 11,000
allowed as deduction
Salary to Sriram 32,000 Interest on debentures (i.e. 25,000
net amount Rs. 22,450 +
tax deducted at source: Rs.
2,550)
Interest on overdraft 4,000 Interest on deposit with a 13,000
company
Interest on loan to Mrs 42,000 (non-trade) (net interest :
Sriram Rs. 11,674 + tax deducted
at source: Rs. 1,326)
Interest on Capital of 23,000
Sriram
Depreciation 48,000
Advertisement 7,000
expenditure
Contribution to 13,000
employees recognised
provident fund
Net profit 1,60,600
4,12,600 4,12,600
Other information:
1. The amount of depreciation allowable is Rs. 37,300 as per the income-tax Rules. It
includes depreciation on permanent sign board.
2. Advertisement expenditure includes Rs. 3,000, being cost of permanent sign board
fixed on office premises.
3. Income of Rs. 4,500, accrued during the previous year, is not recorded in the profit and
Loss Account.
5. General expenses include (a) Rs.500 given to Mrs. Sriram for arranging a party in
honor of a friend who has recently come from Canada (b)
Rs. 1,000 being contribution to a political party.
6. Loan was taken from Mrs. Sriram for payment of arrears of income-tax.
Solution
Rs. Rs.
Net profit as per Profit & Loss Account 1,60,000
Add: Inadmissible expenses:
Expenses for arranging personal party 500
Contribution to a political party 1,000
Advance tax 21,000
Salary to Sriram 32,000
Interest on capital to Sriram 23,000
Interest on loan taken for payment of income-tax 42,000
Capital expenditure on advertisement 3,000
Excess depreciation (i.e. Rs.48,000-Rs. 37,300) 10,700 1,33,200
2,93,800
Add: Income not recorded in the Profit and Loss Account 4,500
Less: income credited to the Profit and Loss Account but
not chargeable under the head “profit and gains of
business or profession”.
Interest on debentures 25,000
Interest on company deposit 13,000 38,000
Business Income 2,60,300
COMPUTATION OF NET INCOME OF SRIRAM
Profit and gains of business or profession 2,60,300
Income from other sources (interest on debentures and 38,000
company deposit)
Gross total income 2,98,300
Less: Deductions under section 80C (payment of 6,000
insurance premium)
Deduction under section 80GGC (being contribution to a 1,000 7,000
political party)
Net Income 2,91,300
Tax on net income 14,130
Add: Surcharge Nil
Tax and surcharge 14,130
Add: Education cess (2% of tax and surcharge) + SHEC 424
at 1% of tax and surcharge
Tax 14,554
Less: Pre-paid tax (i.e., advance tax + tax deducted at 24,876
source) (21,000 + 2,550 + 1,326 )
Tax refund 10,322
1) Payment of Rs. 50,000 for purchase of materials in Bombay made in cash is deductible
only to the extent of Rs. ————–.
2) Excise duty of the year 2006-07 paid on 23rd April 2009 is deductible in the assessment
year ——–
3) Sales tax liability of 2008-09 paid on 23rd April 2009 is deductible in the assessment
year ———.
4) Depreciation for the asset purchased on 23rd Dec. 2008 is allowed to the extent of
————– during the previous year 2008-09
5.12 Summary
Business or profession head is the biggest source of revenue to the Govt. The
admissibility of expenditure as deduction is generally governed by the general principles.
Hence there are chances of claiming personal expenses as business expenses, outstanding
dues as expenses paid during the year. Hence restrictions are placed for some
expenditure, allowed to be deducted on payment basis only. This unit briefly explains as
to how a business or professional income can be calculated for tax purposes, in the light
of income tax provisions.
1. Mr. Vikas is a practicing accountant. He also took 40 lectures in a college at Rs. 100
per lecture. His receipts and payments a/c is given bellow:
Rs. Rs.
To bal b/d 9,500 By Office expenses 25,000
“ Audit Fees 1,60,000 “ Municipal taxes 500
“ Remuneration for 4,000 “ Personal expenses 5,000
lectures
“ Examiner’s fees 1,500 “ Membership fees 500
“ Interest on securities 1,550 “ LI Premium 2,000
“ Rent from LOP 3,000 “ Scooter Purchased 24,500
“ Royalty on a book 5,000 “ Scoter expenses 12,000
“ Balance c/d 1,15,050
1,84,550 1,84,550
a) Office expenses include Rs. 500 paid as typing charges for preparing manuscript of his
book.
d) Interest of securities includes Rs. 774 being interest on Tax Free Government
Securities.
2. What are the expressly disallowed expenses while computing income under the head’
profits and gains from business or profession?
3. State with reasons whether the following are admissible as deductions in the case of
business:
a) Wealth tax, b)income tax, c)expenses in connection with income tax proceedings, d)
advance income tax paid, e) sales tax.
4. Write a note on: Block of the assets, additional depreciation, and unabsorbed
depreciation.
SAQ I
1. True
2. False
3. True
4. False
SAQ II
1. Not allowed
2. Not allowed
3. Deductible
4. Deductible
SAQ III
1. NIL
2. 2009-10
3. 2009-10
Terminal Questions:
(Ans.: Income from house property: Rs. 1,750; Prof. income Rs. 1,32,662; other sources
Rs. 5,474; TTI: Rs. 1,31,636)
2. Refer to section 5.8
e) allowed