Profits and Gains of Business or Profession
Introduction
Income from business or profession is taxable under the head “Profits and Gains of Business or Profession” (PGBP) as per Chapter IV, Part D of the Income-tax Act, 1961. The business income shall be computed in accordance with the method of accounting regularly followed by the taxpayer. For the purpose of computation of business income, a taxpayer can follow either mercantile system of accounting or cash basis of accounting. This chapter contains provisions for regular and presumptive methods of income computation.
Computation of Income
- Normal Provisions:
- Income includes revenue and specified capital receipts.
- Deductions allowed for revenue, specific capital expenditures, depreciation, payment-based expenses, and condition-based expenses.
- Additions include non-allowable capital and revenue expenditures.
- Presumptive Scheme:
- Applicable to small and medium enterprises.
- Income is computed as a percentage of gross receipts/turnover.
- Specified deductions may be allowed.
Speculative Business
Introduction
A speculative business arises from speculative transactions, which are settled otherwise than through actual delivery. Such transactions are deemed speculative businesses under the Income-tax Act.
Key Concepts
Speculative Transaction:
- Defined under Section 43(5) as contracts for the purchase or sale of any commodities, including stocks and shares, that are periodically or ultimately settled other than by actual delivery or transfer of the commodity or scrips.
- The intention of the parties is immaterial; it is the method of settlement that determines the speculative nature.
Exclusions from Speculative Transactions:
- Hedging Transactions:
- Contracts entered to mitigate future price fluctuation risks in raw materials, inventory, or securities.
- Losses/profits from hedging are treated as business losses/profits.
- Derivatives Trading:
- Share derivatives: Transactions in recognized stock exchanges are not speculative if registered with SEBI and time-stamped.
- Commodity derivatives: Transactions in recognized exchanges are exempt unless the commodity transaction tax is unpaid (not applicable to agricultural derivatives).
- Jobbing or Arbitrage by Exchange Members:
- Transactions to safeguard losses in the ordinary course of business for members of forward or stock exchanges.
Conditions for Exemption:
- Transactions must occur in recognized stock exchanges fulfilling Rule 6DDA (shares) or Rule 6DDC (commodities).
- Contract notes must include client identity, PAN, and be time-stamped.
Adventure in Nature of Trade
Introduction
Under Section 2(13) of the Income-tax Act, 1961, an adventure in the nature of trade includes transactions with elements of trade, commerce, or manufacture. Identifying whether income qualifies as business income, capital gains, or other income is significant due to differing tax rates and computation methods.
Key Features
- Continuity Not Mandatory:
- A single or isolated transaction can be deemed an adventure in the nature of trade if it bears elements of trade, even without continuity.
- Essential Elements:
- Intention to Resell:
- Transactions made solely for resale at a profit are business activities.
- Resale under changed circumstances does not qualify unless intended at purchase.
- Connection to Business:
- Transactions linked to an assessee’s usual business, even indirectly, may constitute an adventure in the nature of trade.
- Quantity of Purchase:
- Large-scale purchases, not for personal use or pride of possession, may indicate trade.
- Alterations:
- Significant alterations or conversions of a commodity before resale suggest business activity.
- Organizational Setup:
- Concerns with adequate business organization for activities align with trade or commerce.
Deemed Business Profits
Introduction
Income chargeable under the head Profits and gains of business or profession includes profits from a business carried on at any time during the previous year. Certain receipts are deemed to be business profits even if the business is no longer in existence, where deductions were allowed in earlier years against the related items.
Receipts Deemed as Business Profits
Recovery Against Loss or Expenditure [Section 41(1)]
Where a deduction was allowed in any earlier year in respect of loss, expenditure or trading liability, and the assessee subsequently obtains any amount or benefit by way of remission or cessation, such amount or benefit is taxable as business income in the year of receipt, even if the business is not in existence.
Balancing Charge [Section 41(2)]
Applicable to tangible assets of electricity undertakings using the straight-line method of depreciation. If the asset is sold, discarded, demolished or destroyed and the money payable plus scrap value exceeds its written-down value, the excess (to the extent of earlier depreciation allowed) is taxable as balancing charge. Any amount exceeding the sum of written-down value and depreciation allowed is taxable as short-term capital gain. These rules apply even if the business is no longer carried on.
Intangible assets are not covered. Balancing charge does not apply where the asset is sold in the same year it was first put to use; such surplus is taxable as short-term capital gain.
Sale of Asset Used for Scientific Research [Section 41(3)]
If an asset acquired for scientific research is sold without being used for other purposes, the lower of the sale proceeds or the deduction allowed is taxable as business income. Excess over cost is taxable as capital gains. If such asset is later used for business, its actual cost is reduced by the deduction allowed. Provisions apply even if the business is not in existence.
Sale includes exchange or compulsory acquisition; sale proceeds include insurance, salvage or compensation money.
Recovery of Bad Debt [Section 41(4)]
Where a bad debt allowed as a deduction is subsequently recovered, any excess of recovery over the amount previously allowed is taxable as business income in the year of recovery, irrespective of the existence of business.
Withdrawal from Special Reserve [Section 41(4A)]
Banks, housing finance companies and financial institutions allowed deduction under Section 36(1)(viii) are taxed on any amount withdrawn from the special reserve account, to the extent deduction was previously allowed. Taxability applies even if the business is not in existence.
Adjustment of Losses Lying Unabsorbed
Where the assessee’s business has ceased and non-speculative business losses arise in the year of cessation, such losses may be set off against income deemed as business profits under these provisions, except income taxed as balancing charge.
Recovery Against Deduction
Introduction
Any amount or benefit received by an assessee in respect of a loss, expenditure or trading liability for which deduction was allowed in earlier years is taxable as income in the year of such receipt.
Conditions for Taxability
Taxability arises when:
- A deduction was allowed in an earlier year for a loss, expenditure or trading liability; and
- In the current year, the assessee obtains any amount or benefit towards such item by way of remission, cessation or recovery.
The amount or benefit so obtained is taxable as business income in the year of receipt.
In Case of Succession
Where a business is succeeded by another person through inheritance or otherwise, and the successor receives an amount or benefit relating to a deduction allowed to the predecessor, such amount is taxable in the hands of the successor.
In Case of Business Restructuring
If an amalgamated company receives an amount relating to a deduction allowed to the amalgamating company, it is taxable in the hands of the amalgamated company.
Similarly, in a demerger, recovery relating to deductions of the demerged company is taxable in the hands of the resulting company.
In case of reconstitution of a partnership firm, any benefit relating to deductions allowed to the predecessor firm is taxable in the hands of the successor firm.
In Case of Unilateral Write-off
If an assessee or successor writes off a trading liability unilaterally in the books of account, such write-off is deemed to be remission or cessation of liability. The amount written off is taxable as business income in the year of write-off.