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Contents

Introduction.3-4
Meaning of Business {Section 2(13)}..3
Meaning of Profession {Section 2(36)}...4
Profits and Gains from Business or Profession.5-22
Methods of Accounting and Accounting Standards (Section 145
and 145A).5
Income Taxable under Business or Profession (Section 28)6-9
Aggregation of Profits...9
Computation of Profits and Gains of Business or Profession
(Section 29)10
Deductions Expressly Allowed (Section 30 to 37)...11-17
General Deduction (Section 37).13-15
Deduction in respect of Bad Debt {Section 36(1)(vii) and
36(2)}..15-17
Leading Cases18
Recent Case-laws..19-21
Conclusion....22-24
Bibliography.25

Introduction
Meaning of Business {Section 2(13)}
The term business has been defined in Section 2(13) of the Income Tax Act 1961
but the definition is merely an inclusive one. According to the definition business includes
any trade, commerce, or manufacture or any adventure or concern in the nature of trade,
commerce or manufacture. The word business in section 2(13) has a very broad meaning.
The definition is not exhaustive. It covers every facet of an occupation carried on by a person
with a view to earning profits. Business arises out of commercial transactions between two or
more persons. Business cannot be carried on with oneself. Business includes trade, commerce
and manufacture. Trade, commerce, or manufacture is easy to understand but considerable
difficulty arises in interpreting adventure or concern in the nature of trade, commerce or
manufacture.
In Mazagaon Dock Ltd. V. C.I.T.1, it was held that the term business is a word of
wide import and in a fiscal statute it must be construed in a broad sense rather than a
restricted sense.
Business includes any adventure in the nature of trade, commerce or manufacture. In G.
Venkatswami Naidu & Co. v. C.I.T.2, it was held that when Section 2(13) refers to an
adventure in the nature of trade, it clearly suggests that the transaction cannot be properly be
regarded as trade or business. It has some of the features that make up trade or business but it
is not all of them. In C.I.T. v. Sutlej Cotton Mills Supply Agency Ltd.3 It was held that a single
transaction of purchase and sale outside the assessees line of business may constitute an
adventure in the nature of trade.
The word business in its commercial sense implies an element of continuity. But according
to above mentioned definition of business as given in section 2(13) the Income-Tax law
does not require that there should be a series of transaction provided that such transaction can
be termed to be an adventure or concern in the nature of trade, commerce or manufacture.
1 (1958) 34 ITR 368 (SC)
2 (1959) 35 ITR 594 (SC)
3 (1975) 100 ITR 706 (SC)
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In order to be an adventure in the nature of trade etc. the transaction in question need not
possess all the elements of trade or business but some of them must be present. Thus a single
plunge may be enough provided it is clearly demonstrated that the plunge is made in the
waters of trade. In Indramani Bai v. C.I.T.4, wives of two brothers, who were partners in a
firm which dealt with bullion, purchased land out of money allegedly raised by selling silver.
The assessees then carved out the land into plots and sold them individually within few
months. It was held that in such circumstances shortness of the time gap between the two was
indicative of the transaction being an adventure in the nature of trade and not investment.

Meaning of Profession {Section 2(36)}


According to Section 2(36) profession includes vocation. Thus, section 2(36) does not state
what profession means; it only states that profession includes vocation. According to Oxford
dictionary, profession means a vocation or calling, esp. one that involves some branch of
advanced learning or science. Profession means an occupation requiring either purely
intellectual skill or if any manual skill, as in painting and sculpture or surgery, which is
controlled by the intellectual skill of the person. Examples of profession are medicine, law,
auditing, engineering, architecture, painting, sculpture, etc. Vocation means the work in
which a person is more or less regularly employed usually, but not necessarily, for earning
livelihood and which requires some special fitness or sense of duty. Vocation is analogous to
calling, meaning the way in which a man passes his life. It is the activity upon which a person
spends major portion of his time. For example, writing of books and contributing of articles
to periodicals and magazines constitute the vocation of an assessee.
The distinction between business, profession and vocation is not important as the rules for
assessment are the same.

4 (1993) 200 ITR 594 (SC)


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Profits and Gains from Business or


Profession
Methods of Accounting and Accounting Standards (Section 145 and 145A)
Income chargeable under the head Profits and gains of business or profession or Income
from other sources shall be computed in accordance with the method of accounting regularly
employed by the assesse. In any case where the accounts are correct and complete to the
satisfaction of the Assessing officer, but the method employed is such that in the opinion of
the Assessing Officer, the income cannot properly be deduced therefrom, then the
computation shall be made upon such basis and in such manner as the Assessing Officer may
determine.
With effect from April 1, 1997 the following section has been substituted, vide
Finance Act, 1995.
Section 145(1) provides that income chargeable under the head Profits and gains of
business or profession or Income from other sources shall, subject to the provisions of
sub-section (2) be computed in accordance with either cash or mercantile system of
accounting regularly employed by the assesse.
Section 145(2) and 145(3) were introduced by the Finance Act, 1995. According to
Section 145(2) the Central Government may notify in the Official Gazette from time to time
accounting standards to be followed by any class of assessees or in respect of any class of
income.
Section 145(3) provides that where the Assessing Officer is not satisfied about the
correctness or completeness of the accounts of the assesse or where the method of accounting
provided in sub-section (1) or accounting standards as notified under sub-section (2), have
not been regularly followed by the assesse, the Assessing Officer may make an assessment in
the manner provided in Section 144.
In Sanjeev Woollen Mills v. C.I.T.5, it was held that consistent method of accounting is
the first condition of applicability of Section 145. Choice of method of accounting regularly
5 (2005) 13 SCC 307.
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employed lies with the assesse. Department of Revenues is bound thereby and can interfere
only if by that method real income, profit and gains cannot be arrived at.

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Income Taxable under Business or Profession (Section 28)


According to Section 28 the following incomes are chargeable to income-tax under the head
Profits and gains of business or profession.
1. Profits and gains of business and profession {Section 28(i)}:- Under clause (i) the
profits and gains of any business or profession which was carried on by the assessee at any
time during the previous year are chargeable to income-tax under this head.
In C.P. Pictures Ltd. v. C.I.T., the assessee was carrying on the business of exhibition
of motion pictured in its own cinema house. It executed a lease agreement in 1953 for a term
of 5 years at a monthly rent of

2000/- with an option to the lessee to renew it for a further

period of 5 years. According to the agreement the assessee leased its premises to the lessee
for the purpose of exhibiting motion pictures. The premises included out-houses, restraunts,
cycle stands, furniture, fixtures, machineries and goods with which cinema house was fully
equipped. The lessee was bound, under the lease, to regularly check the projection and sound
equipment and lesser had the right to inspect the conditions of the equipment. The lessee was
bound to replace the all worn out parts by only genuine parts of original manufacturer. The
head operator and his assistants were to be persons approved by the lessor and the lessee was
not entitled to dismiss or transfer the operators without the written approval of the lessor. The
Supreme Court, on the facts and circumstances of the case, held that the income which the
assessee received from the lease of the cinema house and its equipments was business
income. The Court said: It can be taken as well settled that a mere circumstance that the
commercial asset, which was being used by the assessee and exploited for his business, and is
capable of being so used, has been let out by him temporarily to stranger will not amount to
cessation of the business activity by the assessee.
2. Compensation or other payments due to or received by any person specified in
Section 28(ii):- Clause (ii) of Section 28 takes within the fold of business income, any
compensation or other payment due to or received by
a) 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 or the modification of the terms and conditions relating thereto;
b) Any person, by whatever name called, managing the whole or substantially the whole
of the affairs in India of any other company, at or in connection with the termination
of his office or the modification of the terms and conditions relating thereto;
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c) 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 or the modification of the terms and conditions relating
thereto;
d) Any person, for or in connection with the vesting in the Government, or in any
corporation owned or controlled by the Government under any law for the time being
in force, of the management of any property or business.
Thus certain compensation receipts are also chargeable under the head Profits and gains
of business or profession. The compensation receipts mentioned are those for the loss of
office or cessation of the business.
3. Income of trade or professional association from specific services {Section
28(iii)}:- Under Section 28 income derived by a trade, professional or similar association
from specific services performed for its members is taxable. Thus here again by fiction of
law the surplus in the hands of a mutual association has been made table in certain
circumstances. The term specific services means conferring on the members some
tangible benefit which would not be available to them unless they paid specific fees
charged for such benefit. Income not arising from specific services is not taxable like
entrance fees or members periodic contribution.
4. Profits on sale of a licence {Section 28(iiia)}:- The profits on sale of a licence granted
under the Imports (Control) Order, 1955, made under the Imports and Exports (Control)
Act are taxable as income.
5. Cash assistance {Section 28(iiib)}:- Cash assistance (by whatever name called)
received or receivable by any person against exports under any scheme of the government
of India is taxable as income.
6. Duty of customs or excise repaid or repayable {Section 28(iiic)}:- Any duty of
customs or excise repaid or repayable as drawback to any person against exports under
the Customs and Central Excise Duties Drawback Rules, 1971 is taxable as income.
7. Value of any benefit or perquisite {Section 28(iv)}:- The value of any benefit or
perquisite, whether convertible into money or not, arising from business or the exercise of
a profession is chargeable to income-tax under the held Profits and gains of business or
profession. For example gift to a doctor by a patient in addition to the doctors fees for
curing the patient is taxable as a revenue receipt in the hands of the doctor.
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8. Interest, salary etc. received by a partner {Section 28(v)}:- Any interest, salary,
bonus, commission or remuneration, by whatever name called, due to, or received by, a
partner of a firm from such firm shall be chargeable to income-tax. However where any
interest, salary, bonus, commission or remuneration, by whatever name called, or any part
thereof has not been allowed to be deducted under clause (b) of Section 40, the income
under this clause shall be adjusted to the extent of the amount not so allowed to be
deducted.
9. Sun received or receivable under an agreement {Section 28(va)}:- Any sum,
whether received or receivable, under an agreement for(a) not carrying out any activity
in relation to any business; or (b) not sharing any know how, patent, copyright, trade
marl, 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, shall be chargeable to income-tax. However sub-clause (a) clause
shall not apply to
i.

Any sum, whether received or receivable, in cash or kind, on account of transfer


of the right to manufacture, produce or process any article or thing or right to
carry on any business, which is chargeable under the head Capital gains;
Any sum received as compensation, from the multilateral fund of the Montreal

ii.

Protocol on Substances that Deplete the Ozone Layer under the United Nations
Environment Programme, in accordance with the terms of agreement entered into
with the Government of India.
Explanation to the section provides as follows:
i.

agreement includes any arrangement or understanding or action in concert

A. Whether or not such arrangement, understanding or action is formal


or in writing; or
B. Whether or not such arrangement, understanding or action is intended

ii.

to be enforceable by legal proceedings;


service means service of any description which is made available to
potential users and includes the provision of services in connection with
business of any industrial or commercial nature such as accounting, banking,
communication, conveying of news or information, advertising, entertainment,
amusement, education, financing, insurance, chit funds, real estate,
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construction, transport, storage, processing, supply of electrical or other


energy, boarding or lodging.
10. Sum received under a Keyman insurance policy {Sectionn 28(vi)}:- Any sum received
under a Keyman insurance policy including the sum allocated by way of bonus on such
policy is chargeable to income-tax. Keyman insurance policy, as per Section 10(10-D) means
a life insurance policy taken by a person on the life of another person who is or was the
employee of the first mentioned person or is or was connected in any manner whatsoever
with the business of the first mentioned person.
11. Sum received or receivable on account of any capital asset {Section 28(vii)}:- 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 or transferred, if
the whole of the expenditure on such capital asset has been allowed as a deduction under
Section 35 AD, is chargeable to income tax.
12. Speculation business (Explanation to Section 28):- According to Explanation 2 to
Section 28 if the assessee carries on speculative transaction of such a nature as to constitute a
business, such speculation business shall be deemed to be distinct and separate from any
other business. According to Section 73, speculative loss can be set off only against
speculative profit and not against profits from any other business. For the purposes of this Act
the expression speculative transaction has been defined by Section 43(5) as a transaction
in which a contract for the purchase or sale of any commodity including stocks and shares, is
periodically or ultimately settled otherwise than by the actual delivery or transfer of the
commodity or scrips.

Aggregation of Profits: In C.I.T. v. P.M. Mathuraman Chettiar6, it was held that though
the profits of each distinct business may have to be computed separately the tax is chargeable
not on the separate income of every distinct business but on the aggregate of the profits of all
business carried on by the assessee.

Computation of Profits and Gains of Business or Profession (Section 29)


Under Section 29 the profits and gains of business or profession shall be computed in
accordance with the provision contained in Sections 30 to 43-D. Sections 30-37 contain the
deductions which are expressly allowed while Sections 40 and 40-A provide those expenses
6 (1962) 44 ITR 710.
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which are expressly disallowed. The list of deduction enumerated in Sections 30 to 37 is not
exhaustive. An item of loss or expense incidental to business may be deducted in computing
the profits and gains of business, even if it does not fall within any of these sections, because
the tax is on profits and gains, properly so called and computed, as said earlier, on ordinary
commercial principles. If an assessee receives during the previous year any sum connected
with business, which during any preceding year was allowed as a deduction while computing
the taxable profits of that year, will be taxable as business income during previous year.
In C.I.T. v. R.B. Rungta & Co.7, it was held that claiming of deductions under a wrong
head or section will not disentitle the assessee from getting the relief under the proper head to
which the relief belongs. In Plantation Corpn. of Kerala v. C.I.T.8, it was held that deductions
have to be allowed even if there are insufficient profits in the previous year.
The trading losses which are incurred carrying out of the business and are incidental to
operation are deductible in computing the profits and gains of a business provided they are
not of capital nature and there is no provision against it, express or implied. In Devi Films
Pvt. Ltd. v. C.I.T.9, it was held that a trading loss is not allowable in the year in which it is
incurred and if it is not allowed in the relevant year then it will not be eligible for deduction
in any subsequent year. The burden of proving the losses is upon the assessee. Some of the
usually occurring types of trading losses are:-i.
ii.
iii.
iv.
v.

Loss of stock-in-trade
Loss through embezzlement of employee or agent
Loss of robbery or theft
Loss incurred as a surety
Loss for non-performance of a trading contract

7 (1963) 50 ITR 233.


8 (1969) 73 ITR 23.
9 (1970) 75 ITR 301.
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Deductions Expressly Allowed (Section 30 to 37)


The following deductions are expressly allowed under Section 30 to 37, as against the losses
or other expenses, as stated earlier, which may be claimed in accordance with commercial
expediency or generally accepted accounting principles:
1. Rent, rates, taxes, repair and insurance of buildings (Section 30)
2. Repair and insurance of plant, machinery and furniture (Section 31)
3. Depreciation (Section 32 and 34)
4. Investment allowance (Section 32A)
5. Investment deposit account (Section 32AB)
6. Development rebate and development allowance (Sections 33, 33-A and 34)
7. Tea, coffee and rubber development accounts (Section 33AB)
8. Site Restoration Fund (Section 33ABA)
9. Reserve for shipping business (Section 33AC)
10. Rehabilitation allowance (Section 33B)
11. Expenditure on scientific research (Section 35)
12. Expenditure on acquisition of patent rights or copyrights (Section 35A)
13. Expenditure on know-how (Section 35AB)
14. Expenditure on obtaining licence to operate telecommunication services (Section
35ABB)
15. Expenditure on eligible projects or schemes (Section 35AC)
16. Deduction in respect of expenditure on specified business (Section 35AD)
17. Expenditure by way of payment to associations and institutions for carrying out rural
development programmes (Section 35CCA)
18. Expenditure by way of payment to associations and institutions for carrying out
programmes of conservation of natural resources (Section 35CCB)
19. Amortisation of certain preliminary expenses (Section 35D)
20. Amortisation of expenditure in case of amalgamation or demerger (Section 35DD)
21. Amortisation of expenditure incurred under voluntary retirement scheme (Section
35DDA)
22. Deduction for expenditure on prospecting etc. for certain minerals (Section 35E)
23. Other deductions (Section 36)
(i) Insurance of stocks and stores used for the purposes of business or
profession.
(ia) Insurance on the life of the cattle owned by a member of milk co-operative
society.
(ib) Insurance on the health of employees by the assessee.
(ii) Bonus or commission to employee.
(iii) Interest on borrowed capital.
In Munjal Sales Corp. v. C.I.T.10, it was held that the claimant assessee must establish not
only that it was entitled to claim deduction for interest paid on borrowed capital for business
10 (2008) 3 SCC 185.
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under Section 36(i)(iii) nut also that it was not disentitled thereto on account of applicability
of Section 40(b)(v). Thus Section 40(b)(v) puts limitation on the deduction under Sections 30
to 38.
(iiia) the pro rata amount of discount on a zero coupon bond.
(iv) Contribution to recognised provident fund or approved superannuation
fund.
(iva) Contribution towards a pension scheme.
(v) Contribution to an approved gratuity fund.
(va) Contribution to any provident fund or superannuation fund set up under
the provisions of Employees State Insurance Act.
(vi) Deduction in respect of dead or useless animals.
(vii) Deduction in respect of bad debt or part thereof which is written off as
irrecoverable in the accounts of the assessee for the previous year.
(viia) Provision for bad and doubtful debts made by a bank.
(viii) Deduction for special reserve created by approved financial institutions.
(ix) Expenditure on promotion of family planning.
(x) Contribution to a public financial institution for a fund specified under
Section 10(23E). This clause has been omitted by the Finance Act, 2007 (w.e.f.
1-4-2008).
(xi) Any expenditure by the assessee, on or before April 1, 1999 but before 1 st
day of April 2000, to make the computer system a Y2K Compliant Computer
System.
(xii) Any expenditure (not being in the nature of capital expenditure) incurred
by a corporated, constituted or established by a central, state or provisional Act
for the objects and purposes authorised by the Act.
(xiii) Any amount of banking cash transaction tax paid.
(xiv) Any sum paid by a public financial institution by way of contribution to
such credit guarantees fund trust for small industries.
(xv) An amount equal to the securities transaction tax (inserted by the Finance
Act, 2008 w.e.f. 1-4-2009).

General Deduction (Section 37)


Section 37 provides for deduction in respect of residuary business expenses. The deduction
under Section 37(1) is available in respect of any expenditure which is neither an expenditure
described in Sections 30 to 36 and Section 80VV nor expenditure in the nature of capital
expenditure nor personal expenses of the assessee.
Section 37 is reproduced below:

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37. General--(1) Any expenditure (not being expenditure of the nature described in
sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of
the assessee), laid out or expended wholly and exclusively for the purposes of the business or
profession shall be allowed in computing the income chargeable under the head Profits and
gains of business or profession.
Explanation.For the removal of doubts, it is hereby declared that any expenditure
incurred by an assessee for any purpose which is an offence or which is prohibited by law
shall not be deemed to have been incurred for the purpose of business or profession and no
deduction or allowance shall be made in respect of such expenditure. [Explanation added by
the Finance Act, 1998 w.e.f. 1.4.1962]
(2) Omitted w.e.f. 1-4-1998.
(2B) Notwithstanding anything contained in sub-section (1), no allowance shall be made in
respect of expenditure incurred by an assessee on advertisement in any souvenir, brochure,
tract, pamphlet or the like published by a political party.
(3) to (5) Omitted w.e.f. 1-4-1998.
Section 37(1) is a residuary section. In order to claim deduction under this section, the
following conditions should be satisfied:
1.
2.
3.
4.
5.
6.

The expenditure should not be of the nature described under sections 30 to 36.
It should not be in the nature of capital expenditure.
It should not be personal expenditure of the assessee.
It should have been incurred in the previous year.
It should be in respect of business carried on by the assessee.
It should have been expended wholly and exclusively for the purpose of such business.
The expression for the purposes of the business is wider in the scope than the
expression for the purposes of earning profits. If a payment is made or expenditure
is incurred for the purposes of the trade of the assessee, it is deductible even if it may
bring benefit to a third party.11 In C.I.T. v. Walchand & Co. Ltd.12, it was held that the
reasonableness of the expenditure has to be judged from the point of view of the
businessman and not of the revenue. The rule that increased remuneration can only be
justified if there be corresponding increase in t 242he profits of the employer is

11 C.I.T. v. Chandulal Keshavlal & Co. (1960) 38 ITR 601 (SC).


12 (1967) 64 ITR 381 (SC).
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errorness. In Dr. T.A. Qureshi v. C.I.T., it was held that loss on account of seizure of
heroin from the assessee-doctors possession was not a case of business expenditure.
Business losses are allowed on ordinary commercial principles in computing profits.
7. It should not have been incurred for any purpose, which is an offence or is prohibited
by any law.
If an assessee is penalised is penalised under one Act, he cannot claim that the amount
is deductible against his income under another Act, because that will frustrate the
entire object of imposition of penalty.
In Rajasthan State Warehousing Corporation v. C.I.T.13, it was held that where the
business of the assessee was one and indivisible and yielding both taxable and non-taxable
income, the entire amount expended in accordance with Section 37(1) and not only the
portion thereof referable to taxable income would be deductible. The Supreme Court laid
down the following principles for deductions under different heads:
i.

If income of an assessee is derived from various heads of income, he is


entitled to claim deduction permissible under the respective head whether or

ii.

not computation under each head results in taxable income;


If income of an assessee arises under any of the heads of income but from
different items e.g. different house properties or different securities etc., and
incomefrom one or more items alone is taxable whereas income

from

the

other item is exempt under the Act, the entire permissible expenditure in
iii.

earning the income from that head is deductible; and


When an assessee is carrying on business in various ventures and some among
them yield taxable income and the others do not, the question of allowability
of the expenditure under Section 37 of the Act will depend on:
a. fulfilment of requirements of that provision noted above; and
b. on the fact whether all the ventures carried on by him constituted one
indivisible business or not;
if they do the entire expenditure will be a permissible deduction but if they
do not the principle of apportionment of the expenditure will apply.

Deduction in respect of Bad Debt {Section 36(1)(vii) and 36(2)}


According to the provisions of Section 36(1)(vii) and 36(2) the following conditions must be
satisfied for the allowance of a claim for bad debt:
13 (2000) 242 ITR 450(SC): AIR 2000 SC 972.
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1. A bad-debt presupposes the existence of a debt and if there was never a relationship of
debtor and creditor no allowance can be claimed for bad-debts. Unless there was an
admitted debt owing to the assessee no deduction can be claimed.
2. The debt which is claimed as bad must be in respect of the business and arising out of
the operation of the business carried on by the assessee in the relevant accounting
year. No deduction is allowed for a bad debt of a business which has been
discontinued before the commencement of the accounting year.14
3. The debt must have been taken into account in computing the income of the assessee
or represent money lent in the ordinary course of the business of banking or money
lending which is carried on by the assessee.
4. The debt must have become bad or irrecoverable during the relevant accounting year.
The assessee will not be able to claim allowance of debt as bad simply by writing it
off in books if it has not actually become irrecoverable.15
5. The debt must have been written off as irrecoverable in accounts of the assessee for
the relevant accounting year. In Vijaya Bank v. C.I.T., it was held that closure of
individual account of each debtor in books of assessee is not necessary; reduction in
loans and advances account or debtors on asset side of balance sheet to the extent of
provisions for bad and doubtful debts is sufficient to constitute actual write-off
entitling to deduction under Section 36(1)(vii).
6. If the amount of final recovery and the amount allowed as bad debt in respect of a
debt falls short of the amount of such debt, such deficiency is further deductible in the
year of final recovery {Section 36(2)(ii)}. On the other hand, if the amount of final
recovery and the amount allowed as bad debt exceed the amount of such debt, such
excess is chargeable as profit of the relevant accounting year in which such recovery
is made {Section 41(4)}.
7. The deduction relating to a bad debt in the case of a bank to which clause (viia)
applies shall be limited to the amount by which such bad debt exceeds the credit
balance in the provision for bad and doubtful debts account made under clause (viia).
The bad debts to the extent of provision for bad and doubtful debts shall be debited to
the provision for doubtful debts account in the previous year.
8. The debt should be of revenue nature and not of capital nature.
As per judgment of Catholic Syrian Bank Ltd. v. CIT16, it was held that It is useful to notice
that in the proviso to Section 36(1)(vii), the explanation to that Section, Section 36(1)(viia)
14 Indian Aluminium Co. Ltd. v. C.I.T., (1971) 79 ITR 514 (SC).
15 Vithaldas v. C.I.T. (1981) 130 ITR 95 (Guj.).
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and 36(2)(v), the words used are provision for bad and doubtful debts while in the main part
of Section 36(1)(vii), the Legislature has intentionally not use such language. The proviso to
Section 36(1)(vii) and Sections 36(1)(viia) and 36(2)(v) have to be read and construed
together. They form a complete scheme for deductions and prescribe the extent to which such
deductions are available to a scheduled bank in relation to rural loans etc., whereas Section
36(1)(vii) deals with general deductions available to a bank and even nonbanking businesses
upon their showing that an account had become bad and written off as irrecoverable in the
accounts of the assessee for the previous year, satisfying the requirements contemplated in
that behalf under Section 36(2). The provisions of Section 36(1)(vii) operate in their own
field and are not restricted by the limitations of Section 36(1)(viia) of the Act.
Burden of proof is on assessee - Bad debt is claimed as an allowance by the assessee and,
therefore, the burden is on him to show that he had no reasonable expectations of recovering
it at the time he wrote it off or that there was no ray of hope at all on which he could rely for
recovering the amount from his debtor at the time he wrote off the debt.17

16 (2012) 343 ITR 270 (SC).


17 Jadavji Narsidas & Co. v. C.I.T., [1963] 47 ITR 411 (Bom.)
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Leading Cases
C.I.T. v. Ahmedabad Cotton Company Ltd.18
If the amount paid is found to be a penalty or something akin to penalty due to the fact
that the amount paid by the assessee was in exercise of the option conferred upon him
under the very law/scheme concerned, then one has to regard such payment as
business expenditure of the assessee, allowable under Section 37 as an incident of
business laid out and expended wholly and exclusively for the purposes of the
business.
C.I.T. v. Jalan Trading Co. (P) Ltd.19
The aim and object of the expenditure would determine the character of the
expenditure. The source or the manner of payment would be of no consequence. In
this case the amount of

7,93,837/- paid by the assessee to the firm in pursuance of

the instrument of assignment was held to be of capital nature and thus not deductible
under the Income-tax Act.
B.D. Bharucha v. C.I.T.20
The assessee found that a balance of

80,759 was irrecoverable from the film

distributors and he accordingly wrote it off as a bad debt in the ledger account. He
was entitled to claim the said amount as a bad debt under Section 36(1)(vii) and the
loss suffered by him was held not a loss of capital nut a revenue loss.
Kamla Cotton Co. v. C.I.T.
There was sufficient reason for the assessee to have written off the claim as bad debt
at the relevant time. The enforcement of any right or remedy against the debtor was
suspended under an Act.
EIMCO-KCP (P) Ltd. v. C.I.T.21
Pre-incorporation contribution of know-how by a promoter, paid by allotting equity
shares: the value of the shares allotted to the foreign company equal to the value of
the know-how supplied by it, held, not deductible under Section 37 of the Income-tax
Act, 1961.

18 (1994) 205 ITR 163.


19 (1985) 155 ITR 537 (SC).
20 (1967) 3 SCR 238.
21 (2000) 2 Scc 729: (2000) 242 ITR 659.
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Recent Case-laws
Rajchandra Capital Services P. Ltd. v. Asst. CIT22
The entire amount of debt, i.e., inclusive of the value of shares and securities traded in
for and behalf of the clients, would constitute a debt and, thus, qualify as a trade debt
even in terms of section 36(2), irrespective of the method of accounting being
followed whereby only the commission/brokerage income for the services rendered
forms part of the operating/income statement of the assessee, or of only the said
amount having been returned and brought to tax as income on incurring the debt.
M/s. Kostub Investment Ltd. v. C.I.T.23
There can be no doubt that the burden of showing that expenditure would be wholly
and exclusively for the purpose of business under Section 37(1) is upon the assessee
and that personal expenditure cannot be claimed as business expenditure but having
regard to the circumstances of this case, the Court was of the opinion that the
expenditure claimed by the assessee to fund the higher education of its employee to
the tune of 23,16,942/- had an intimate and direct connection with its business, i.e.
dealing in security and investments. It was, therefore, appropriately deductible under
Section 37(1). In short, expenditure on foreign education of employee (son of
director) is deductible if there is business nexus.
C.I.T. v. Shri Shreyas S. Morakhia24
Section 36(2)(i) provides that a deduction on account of a bad debt can be allowed
only where such debt or part thereof has been taken into account in computing the
income of the Assessee of the previous year in which the amount of the debt is written
off. The Assessee is a stock broker who engages in transactions of sale and purchase
of shares for his clients. The bill raised on the client reflects the rate, quantity and
total value of the shares transacted as well as the brokerage, apart from the Security
Transaction Tax and the service tax. The brokerage from the transaction of the
purchase of shares has been taxed in the hands of the Assessee as its business income.
Once that is so, it is evident that within the meaning of Section 36(2)(i) the debt or
part thereof has been taken into account in computing the income of the Assessee. The
debt comprised of the value of the shares transacted and the brokerage payable by the
22 MANU/IU/0233/2014; Decided on: 26-02-2014.
23 2013 (8) TMI 662.
24 [2012] 342 ITR 285 (Bom).
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client. The brokerage as well as the value of the shares constituted a part of the debt
due to the Assessee since both arose out of the same transaction. The fact that the
liability to pay brokerage arose at a point in time anterior to the liability to pay the
value of the shares transacted makes no material difference to the position. As the
brokerage from the transaction of the purchase of shares had been taxed in the hands
of the Assessee as business income, the debt or part thereof has been taken into
account in computing the income of the Assessee and the requirements of Section
36(1)(vii) read with Section 36(2) were satisfied. Accordingly, question of law as
formulated answered in the affirmative and in favour of the Assessee.
Shri Hemant Surana v. I.T.O.25
Commissioner of Income-tax (Appeal)/CIT(A) allowed claim of Assessee of set off of
loss on ground that Explanation below Section 37(1) of Act was attracted only in case
of any expenditure and not in event of loss. Hence this appeal was filed. The
Appellate Tribunal found that Assessee, chartered accountant, incurred loss of
`3,11,85,809/- in business of trading in shares - Explanation below Section 37(1) of
Act laid down that any expenditure incurred by an Assessee for any purpose which is
an offence or which is prohibited by law shall not be deemed to have been incurred
for purpose of business and no deduction or allowance shall be made - It was well
settled that said explanation was applicable only to an expenditure and not to a loss In instant case, CIT(A) concluded that Assessee was a Chartered Accountant by
qualification but not in practice, having surrendered certificate of practice and that
provisions of clause 11 of First Schedule referred to by A.O., were applicable only to
Chartered Accountants in practice, and were therefore, not applicable to Assessee However, revenue had not placed any material controverting those findings of facts of
recorded by CIT(A) - Therefore, findings of CIT(A) was justified - Revenue's Appeal
dismissed.
TVS Finance and Services Ltd., Jayalakshmi Estates v. The Joint Commissioner of
Income Tax Special Range XI26
Assessee finance company had shown amount as bad debts representing the write off
made on principal portion as per RBI norms on asset classification and provisioning.
It submitted that since the amount written off as bad debts represented money lent to
the business of banking or money lending that was carried on by the assessee, it
25 MANU/ID/0122/2012; Decided on: 24.02.2012
26 [2009]318 ITR 435 (Mad).
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cannot be disputed that this advance would not fulfil the condition provided for in the
first part of Clause (i) of Section 36(2) and, therefore, it has to be allowed as a
deduction. Department found that since the assessee was neither doing the business of
banking nor money lending and since the assessee had not offered the amounts to tax
this year or any other year, the assessee cannot claim write off. Held: On the plain
language of Section 36(1)(vii), the debt cannot be allowed as a 'bad debt'. It may be
that the assessee committed an inadvertent mistake. One cannot go by notions of
equity in tax matters. Making a provision is not the same thing as writing off of a debt
as irrecoverable." In case, the debts are shown as written off on the basis of the
formula given by the RBI, writing off of the debt as bad debt requires judgment on the
part of the person carrying on the business but in this case the debts evidently have
been "written off" merely on the basis of the RBI norms and nothing more. Therefore,
the debts in question having not been written off as irrecoverable in its books of
accounts for the previous year relevant to the assessment year, same could not be
allowed as bad debts on the plain language of Section 36(1)(vii).

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Conclusion
Under the Income Tax Act, 'Profits and Gains of Business or Profession' are also subjected to
taxation. The term "business" includes any (a) trade, (b) commerce, (c) manufacture, or (d)
any adventure or concern in the nature of trade, commerce or manufacture. The term
"profession" implies professed attainments in special knowledge as distinguished from mere
skill; "special knowledge" which is "to be acquired only after patient study and application".
The words 'profits and gains' are defined as the surplus by which the receipts from the
business or profession exceed the expenditure necessary for the purpose of earning those
receipts. These words should be understood to include losses also, so that in one sense 'profit
and gains' represent plus income while 'losses' represent minus income.
After completing this assignment, I came to the conclusion that the following types of income
are chargeable to tax under the heads profits and gains of business or profession:

Profits and gains of any business or profession


Any compensation or other payments due to or received by any person specified in

section 28 of the Act


Income derived by a trade, profession or similar association from specific services

performed for its members


Profit on sale of import entitlement licences, incentives by way of cash compensatory

support and drawback of duty


The value of any benefit or perquisite, whether converted into money or not, arising

from business
Any interest, salary, bonus, commission, or remuneration received by a partner of a

firm, from such a firm


Any sum whether received or receivable in cash or kind, under an agreement for not
carrying out any activity in relation to any business or not to share any know-how,
patent, copyright, franchise, or any other business or commercial right of similar

nature or technique likely to assist in the manufacture or processing of good


Any sum received under a keyman insurance policy
Income from speculative transactions.

In the following cases, income from trading or business is not taxable under the head "profits
and gains of business or profession":-

Page | 21

Rent of house property is taxable under the head "Income from house property". Even
if the property constitutes stock in trade of recipient of rent or the recipient of rent is

engaged in the business of letting properties on rent.


Deemed dividends on shares are taxable under the head "Income from other sources".
Winnings from lotteries, races etc. are taxable under the head "Income from other
sources".

Profits and gains of any other business are taxable, unless such profits are subjected to
exemption.
I would like to highlight some general principles as well governing the computation of
taxable income under the head "profits and gains of business or profession: Business or profession should be carried on by the assessee. It is not the ownership of
business which is important, but it is the person carrying on a business or profession,
who is chargeable to tax.
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. This income is taxable during the following assessment year.
Profits and gains of different business or profession carried on by the assessee are not
separately chargeable to tax i.e. tax incidence arises on aggregate income from all
businesses or professions carried on by the assessee. But, profits and loss of a
speculative business are kept separately.
It is not only the legal ownership but also the beneficial ownership that has to be
considered.
Profits made by an assessee in winding up of a business or profession are not taxable,
as no business is carried on in that case. However, such profits may be taxable as
capital gains or as business income, if the process of winding up is such as to involve
the carrying on of a trade.
Taxable profit is the profit accrued or arising in the accounting year. Anticipated or
potential profits or losses, which may occur in future, are not considered for arriving
at taxable income. Also, the profits, which are taxable, are the real profits and not
notional profits. Real profits from the commercial point of view, mean a gain to the
person carrying on the business and not profits from narrow, technical or legalistic
point of view.
The yield of income by a commercial asset is the profit of the business irrespective of
the manner in which that asset is exploited by the owner of the business.

Page | 22

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.
Modes of book entries are generally not determinative of the question whether the
assessee has earned any profit or loss.
The Income tax act is not concerned with the legality or illegality of business or
profession. Hence, income of illegal business or profession is not exempt from tax.

Page | 23

Bibliography
Books referred:
B.B. Lal, Income Tax, Pearson, Dorley Kindersley (India) Pvt. Ltd., 2010.
Dr. V.K. Singhania & Dr. Monica Singhania, Students Guide to Income
Tax, Taxmann Publications Pvt. Ltd., 2009.
N. Hariharan, Income Tax: Law and Practice, 4th ed., McGraw-Hill, Vijay
Nicole Imprints Pvt. Ltd., 2009
N.A. Palkhivala & B.A. Palkhivala, The Law and Practice of Income Tax,
8th ed., vol. 1.

Web Articles referred:


Business Knowledge Resource Online, Sources of Income: Income from
Profits & gains of business or profession
<http://business.gov.in/taxation/profit_gains.php >
Income From Business/Profession
<http://www.vazecollege.net/staffprofile/commercejunior/Unit_6Business
_IncomePDF.pdf>
The Institute of Chartered Accountants of India, Profits and Gains of
Business or Profession
< http://www.icai.org/resource_file/19170sm_dtl_finalnew_cp6a.pdf >
Mensa Commerce Classes, Profits And Gains of Business or Profession
<https://www.wirc-icai.org/material/business%20&%20profession
%20theory-AY0910.pdf>

Article referred:

Dipesh Shah, Bad Debts & Provisions of Bad Debts, CA Club India, CCI
Online Coaching, 2012.

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