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Profits and gains from any business, profession or vocation are chargeable to income tax. This head includes a wide ambit of income sources and hence it is no surprise that it accounts for a high percentage of the tax collected. Assesses can be individuals, partnerships, Hindu Undivided Families, Companies or Association of Persons. Income is computed based on sales as reduced by allowable expenses. Incomes can be even illegal, yet it would be subject to tax. Income from speculation is taxed separately. Loss from business can be set off against income over a period of several years, in accordance with relevant rules. The accounting method used can be either on cash or mercantile basis.
Incomes defined
According to the Income tax Act 1961, the following incomes are chargeable to tax under the head Profits and Gains of Business or Profession. The profits and gains of any business or profession, which was carried on by the assessee at any time during the previous year.
Any compensation or other payment due to or received by:
Any person, by whatever name called, managing the whole or substantially the whole of the affairs of an Indian company, at or in connection with the termination of his management; Any person, by whatever name called, 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 of the agency; Income derived by a trade, professional or similar association from specific services performed for its members; Profits on sale of a licence granted under the Imports (Control) Order, 1955, made under the Imports and Exports (Control) Act, 1947 (18 of 1947); Cash assistance (by whatever name called) received or receivable by any person against exports under any scheme of the Government of India; Any duty of customs or excise re-paid or re-payable as drawback to any person against exports under the Customs and Central Excise Duties Drawback Rules, 1971; Any profit on the transfer of the Duty Entitlement Pass Book Scheme, being the Duty Remission Scheme under the export and import policy formulated and announced under section 5 of the Foreign Trade Development and Regulation) Act, 1992 (22 of 1992); Any profit on the transfer of the Duty Free Replenishment Certificate, being the Duty Remission Scheme under the export and import policy formulated and announced under section 5 of the Foreign Trade (Development and Regulation) Act, 1992 (22 of 1992) ; The value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession; - Any interest, salary, bonus, commission or remuneration, by whatever name called, due to, or received by, a partner of a firm from such firm;
Any sum received under a Keyman insurance policy including the sum allocated by way of bonus on such policy; 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.
Expenses and Deductions
Sections from 30 to 37 detail the deductions that are available to be set off against profits from business or profession. Some of the allowable expenses are as follows:
Sec. 30: - Any rent, rates, taxes, insurance premiums paid by the assessee during the previous year in respect of the place for business purpose.
Sec. 31: - Any amount spent on repairs, insurance or hire charges, on plant, machinery, furniture.
Sec. 32: Depreciation on fixed assets like buildings, plant and machinery, furniture and other fixed assets is allowed. After 1, April, 1998, intangible assets like patents knowhow copyright, trademarks, licenses or any other right of business or commercial nature are also eligible for depreciation.
An important condition is that the asset must be put to use during the previous year for which depreciation is claimed. Further, the assets must be owned in full or in part by the assesse. Depreciation can be claimed even on assets bought under a scheme of hire purchase.
Depreciation can be classified into three parts:
Normal Depreciation
Additional Depreciation
Depreciation on SLM (straight line method) basis in case of electricity companies
Normal depreciation is provided on block of assets method on WDV (written down value) of the block as on every 31st March. Depreciation is provided in full for the whole year, except when an asset is bought and put to use for less than 180 days during the year, in which case only 50% is allowed. Unabsorbed depreciation can be set off against other heads except salary or can be carried forward to future years (subject to rules).
Sec 36:
Interest on borrowed capital, used for business Bonus or commission to employees: deduction subject to section 43B Discount on issue of zero coupon bonds to be allowed as deduction on pro-rata basis Employer's contribution to recognized provident fund or approved superannuation fund subject to section 43B Employer's contribution to approved gratuity fund subject to section 43B Insurance on health of employees by any mode other than cash Insurance premium on stocks
Other sections
Expenses of licenses to operate telecommunication services can be written off in equal installments over the useful period of the license
Expenses incurred prior to starting a business or preliminary expenses can be written off at 5% every year.
Further, under section 37(1) any expense that a normally prudent person will make for the purpose of his/her business and which can be related to the business can be deducted. The only condition is that it should have been spent wholly and exclusively for the purpose of business or profession.
Expenses not allowed
Expenses incurred by a particular business cannot be transferred to another business. Expenses incurred during a financial year cannot be used for setoff for any other year. Capital expenditure cannot be set off. All expenses must be of revenue nature. If expenses allowed in an earlier year are recovered, it will be subject to income tax. It is up to the assesse to show that any expenditure is permissible for deduction.
Special Provisions
Section 40A (2): - Assessing officer may disallow payments made to the assesse's relatives, if in his opinion it is in excess of market value.
Section 40A (3): - Any payment in cash exceeding Rs. 20000, or Rs.35000 in case of payment to a transporter engaged in plying, hiring, transporting etc., in a day will be disallowed.
Deduction under section 43b:- The following sums can be claimed only on actual payment before due date of filing:
Amounts payable by employer by way of contribution to provident fund or superannuation fund or any other employee benefit fund.
Amounts payable as bonus, commission to employees for services rendered.
Amounts payable by employer in lieu of leave salary to employee.
Amounts payable by way of tax, cess, duty or fee under any law and by whatever name called.
Amounts payable as interest on loan borrowed from public financial institutions or state financial institutions.
Amounts payable as interest on loan taken from scheduled bank including co-operative societies.
Maintenance of books of accounts - If in any of the three preceding years income exceeds Rs. 1, 20,000 or if gross sales exceed 10, 00,000, the assesse must maintain prescribed books of accounts. Audit of accounts is compulsory if gross receipts of a profession exceeds Rs. 25, 00,000 or in the case of a business Rs. 1, 00, 00,000.
Deemed Income/Presumptive income
If gross receipts of an eligible business does not exceed Rs. 2, 00, 00,000, assesses can declare 8% of such receipts as presumptive income. For specified professions like accountancy and interior decoration, if gross receipts does not exceed Rs. 50,00,000 assesses can declare 50% as income and pay the relevant tax.
Tax Shelter and Tax Holidays
Presently tax holiday is available under section 80IA, 80IB etc.
Under sections 80IA, profits and gains of industrial undertakings engaged in infrastructure development can claim 100% deduction from such business for a period of ten assessment years.
For undertakings engaged in the telecommunication sector, can claim 100% of the profits for the first five years and thereafter 30% for the next five years.
80 IB relates to enterprises other than those engaged in infrastructure. These enterprises can claim deduction which should be equal to the percentage and number years as may be specified in the act.
Tax planning tips
Some methods to reduce the incidence of taxation is given below.
Section 35(i), (ii), (iii) - Assesses can invest money in research activities which are related to their business with outside institutions. A weighted deduction of 175% of the actual expenditure is available. Similar deduction is available for monies given for research to Universities and other approved institutions, whether or not the research carried out is related to the assesse's business. If the money is given for social science and statistical research, then 125% deduction would be available.
Section 35(2AA)
A weighted deduction of 200% is available when money is given in response to a specific direction of a prescribed authority to National Laboratories, Universities, IITs, and specified persons approved by prescribed authorities.
Section 35(i) (iia)
A weighted deduction of 125% can be availed for money given to an Indian company engaged in scientific research, even if the research is not related to the assesse's business.
Further, capital expenditure incurred for the purpose of research can be debited in full to the profit and loss account and if profits are insufficient to absorb this, the excess can be set off against other heads of income and if any is still remaining, the unadjusted balance can be carried forward.
Stocks of raw materials, consumables and finished goods also play an important role in determining profits.
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