JAMIA MILLIA ISLAMIA

Faculty of law

Project

Profits and gains of any business or profession

Tax Law

Submitted to: Dr. Ekramuddin Sir

Submitted by: Faisal Hassan

BA.LLB (Self-finance) 6th Semester

Batch: 2017 - 2022

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 INDEX

SERIAL TOPIC PAGE

NUMBER NUMBER
1. Acknowledgement 3

2. Introduction 4

3. Business and profession 5

4. Profits and gains 6

5. Method of accounting 7

6. Rent, rates, taxes, repairs and insurance for buildings 8

7. Current repairs 8

8. Deduction in respect of expenditure on specified business 9

9. Bad debts 10

10. Transfer to special reserve 10

11. General deductions 11

12. Case laws 12

13. Conclusion 17

14. References 18

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ACKNOWLEDGEMENT

I would like to express my special thanks of gratitude to my teacher Dr. Ekrammuddin who gave me the golden
opportunity to do this wonderful project on the topic “Profits and gains of any business or profession”, which also
helped me in doing a lot of research and I came to know about so many new things. I am really thankful to her.

Secondly, I would also like to thank my parents and friends who helped me a lot in finalizing this assignment
within the limited time frame.

-Faisal Hassan

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INTRODUCTION

Profits and gains of any business or profession carried on by the assessee at any time during the previous year. Any
compensation or other payment due to or received by any person:

1. In connection with the termination of his management or the modification of the terms and conditions relating
thereto;
2. In connection with the termination of his office or the modification of the terms and conditions relating thereto;
3. In connection with the termination of the agency or the modification of the terms and conditions relating thereto

Income derived by a trade, professional or similar association from specific services performed for its members. Profits
on sale of a license is granted under the Imports (Control) Order, 1955. Cash assistance 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. Any
profit on the transfer of the Duty Entitlement Pass Book Scheme. Any profit on the transfer of the Duty Free
Replenishment Certificate. 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, under an agreement for—
not carrying out any activity in relation to any business; or
 not sharing any know-how, patent, copyright, trade-mark, license, franchise or any other business or commercial right
of similar nature or information or technique
any sum received or receivable on account of any capital asset 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.

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BUSINESS AND PROFESSION

The term 'business' is defined to include any — trade, commerce, manufacture, or any adventure or concern in the
nature commerce or manufacture.
The definition is not exhaustive, it covers even an occupation carried on by a person with a view to earning profit.
Profit motive - The word "business" would mean some real, substantial and systematic or organised course of activity
with a set purpose which would normally be profit motive.

Trade:
Trade primarily means the exchange of goods for goods or goods for money.
It would also signify that it is a kind of repeated activity in the nature of business carried on with a profit motive.

Commerce:
If a person purchases goods with a view to sell them at profit, it is an ordinary case of trade and If such transactions are
repeated on a large scale, it is called commerce.
In determining a case of trade or commerce, in crucial issue is that of investment.
One has to take into account the nature of the assets, the occupation of assessee, the frequency and volume of
transactions etc. to distinguish trading from commercial activity.

Manufacture
Manufacture is the making of articles or materials by physical labour or mechanical Power.
The essence of manufacturing is that something is produced or brought into existence which is different from that out
of which it is made, in the sense that the thing produced is by itself commercial commodity which is capable as such of
being sold or supplied. Means an activity that original article or thing resulting in transformation of the object or article
or thing having a different name, character and use.

Any adventure in the nature of trade, commerce or manufacture

The following guiding principles would apply while deciding as to whether a transaction of purchase or sale forms an
adventure in the nature of trade or an investment –
The commodity purchased plays an important role in deciding whether a person is indulging in an adventure in the
nature of trade or is making an investment.

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Whether the transaction is an isolated one or forms part of a series of transactions showing a tendency to indulge in
trade.
The fact that the property bought has been sold within a short time does not by itself indicate that the transaction is in
the nature of trade.
If the property purchased is capable of yielding income, then again the inference will be that an investment was
intended to earn income and is not an adventure in the nature of trade.

Profession
The expression ‘profession’ has been defined in section 2(36) of the Act to include any ‘vocation’.
According to generally accepted principles the meaning of the term ‘profession’ involves the concept of an occupation
requiring either intellectual skill or manual skill controlled and directed by the intellectual skill of the operator.
A profession is normally associated with the exercise of intellectual or technical equipment resulting from learning or
service. Profession involves occupation requiring purely intellectual or manual skill

PROFITS AND GAINS

The tax is upon income, profits or gains; it is not a tax on gross receipts. The profit of a trade or business is the surplus
by which the receipts from the trade or business exceeded the expenditure necessary for the purpose of earning those
receipts. As accounting year is a self-contained year, taxable profit is the profit accrued or arising in that year.
Anticipated or potential profits or losses, which may occur in future, are not considered for arriving at taxable income
of a previous year.

Income from illegal business

• The income-tax law is not concerned with the legality or illegality of business or profession. The income of illegal
business or profession is not exempt from tax.

Business Loss
1. The business losses can be allowed as deduction only if the following conditions are satisfied –
2. The loss should be revenue in nature;
3. The losses should be incurred during the previous year;
4. The loss should be incidental to the business or profession carried on by the assessee;
5. The loss not be notional or fictitious.

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 6. The loss should have been actually incurred and not merely anticipated to incur in future; and there should not
be any, direct or indirect, restriction under the Act against the deductibility of such loss.

Instances of Losses deductible from Business Income

1. Loss of stock-in-trade due to destruction by Fire
2. Loss of stock-in-trade by an act of God,
3. Loss of stock-in-trade due to theft,
4. Loss on account of advances given to employee’s welfare co- operative stores which becomes irrecoverable,
5. Loss of Cash due to theft, Depreciation in funds kept in foreign currency due to exchange fluctuation,
6. Loss incurred due to devaluation of rupee in foreign country which is being utilized in course of business,
7. Loss due to embezzlement by an employee,Loss incurred on account of insolvency of banker with which
current account is maintained,
8. Loss incurred due to sale of lands acquired from a business- debtor in satisfaction of debt
9. Loss on account of non-recovery of advances given by assessee-company to its 100% subsidiary company,
10. Loss arising from sale of securities held in the regular course of business,
11. Loss arising due to non-realization of the loan advanced to the importer,
12. Loss of cash and securities in a banking company on account of dacoity,
13. Loss incurred due to forfeiture of deposits made for residential accommodation of employees of the assessee-
company

Instances of Losses NOT deductible from Business Income

1. Loss of advances made for setting up a new business which ultimately could not be started
2. Depreciation of funds kept in foreign currency for capital purpose
3. Loss arising from non-recovery of tax paid by an agent on behalf of the non-resident
4. Anticipated future losses
5. Loss relating to any business or profession discontinued before the commencement of previous year
6. Loss of security deposit made to obtain selling agency
7. Provision made by assessee in respect of non-performing assets

METHOD OF ACCOUNTING
Income chargeable under the head – “Profits and gains of business or profession” or “Income from other sources” shall
be computed in accordance with either :
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 1. Cash system of accounting
2. Mercantile system of accounting
Notwithstanding anything to the contrary contained in Section 145, the valuation of Purchase and sale of goods and
inventory for the purposes of determining the income chargeable under the head "Profits and gains of business or
profession" shall be in accordance with the method of accounting regularly employed by the assesses and
further adjusted to include the amount of any tax, duty, cess or fee actually paid or incurred by the assessee to bring the
goods to the place of its location and condition as on the date of valuation.

RENT, RATES, TAXES, REPAIRS AND INSURANCE FOR BUILDINGS1

In respect of rent, rates, taxes, repairs and insurance for premises, used for the purposes of the business or profession,
the following deductions shall be allowed —
where the premises are occupied by the assessee-
 as a tenant, the rent paid for such premises; and further if he has undertaken to bear the cost of Current Repairs to the
premises, the amount paid on account of such repairs;
 otherwise than as a tenant, the amount paid by him on account of current repairs to the premises;
 any sums paid on account of land revenue, local rates or municipal taxes
 the amount of any premium paid in respect of insurance against risk of damage or destruction of the premises.

CURRENT REPAIRS
The expression 'current repairs' means expenditure on buildings, machinery, plant or furniture which is not for the
purpose of renewal or restoration but which is only for the purpose of preserving or maintaining an already existing
asset and which does not bring a new asset into existence or does not give to the assessee a new or different advantage.
'Current repairs' means repairs undertaken in the normal course of user for the purpose of preservation, maintenance or
proper utilization or for restoring it to its original condition. 'Current repairs' aim to restrict the allowance to
expenditure incurred for preservation and maintenance of the asset in its current state of its working. it does not include
expenditure incurred on any improvement or an addition to the asset. It would be only the repairs for its use during the
current year and not the repairs arising for its use over past years.
In respect of repairs and insurance of machinery, plant or furniture2 used for the purposes of the business or profession,
the following deductions shall be allowed-

1
Section 30
2
Section 31
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 1. The amount paid on account of current repairs;
2. The amount of any premium paid in respect of insurance against risk of damage or destruction thereof.
3. The amount paid on account of current repairs shall not include any expenditure in the nature of capital
expenditure

DEDUCTION IN RESPECT OF EXPENDITURE ON SPECIFIED BUSINESS 3

“Specified Business” means –

Lying and operating a cross-country natural gas or crude or petroleum oil pipeline network for distribution, including
storage facilities being an integral part of such network, Building and operating, anywhere in India, new hotel of 2 star
or above category as classified by central government ,Building and operating, anywhere in India, a new hospital with
at least 100 beds for patients, Developing and building housing project under a scheme for slum re-development or
rehabilitation framed by central government or state government as the case may be. From the above examples it can
be said that the business should be specifically mentioned then only will it be able to fall in this category.

Deduction Available
The expenditure incurred, wholly and exclusively, for the purposes of any specified business, shall be allowed as
deduction during the previous year in which he commences operations of his specified business.

Conditions need to be fulfilled to avail deduction

1. The business is not set up by splitting up, or the reconstruction, of a business already in existence
2. The business is not set up by the transfer to the specified business of machinery or plant previously used for any
purpose
3. Such Business is owned by a company formed and registered in India has been approved by the Petroleum and
Natural Gas Regulatory Board

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Section 35AD
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BAD DEBTS 4
Bad Debts is allowable subject to following conditions –
1. There must be a debt.
2. Debt must be incidental to business or profession of the assesee.
3. Debt must have been considered in computing business Income Allowed only if, debt considered as income of
previous year or earlier year
4. Debt must have been written off in books of accounts of the assessee.
5. If ultimate recovery of debt is more than the estimated bad debt, the difference is charged to tax. If it is less the
difference allowed in the year of recovery.
6. Bad debt discontinued business not allowed.
7. Bad debt allowable in the hands of successor in certain cases.

TRANSFER TO SPECIAL RESERVE5

Provision Applicable to

1. Approved financial corporation (including Public co., and Govt. co.) providing long-term finance for industrial
or agricultural development or development of infrastructural facility in India.
2. Approved public company providing long term finance for construction or purchase of residential houses.

Amount of deduction

An amount not exceeding 20 % of the profits derived from the aforesaid business of providing long term finance
(computed under section 28 before making this deduction) carried to a special reserve account created (and
maintained) by the aforesaid financial corporation/public company is deductible.
However, the aggregate of the amounts carried to such reserves from time to time exceeds twice the paid up share
capital and genera' reserves, no allowance is made in respect of such excess.

4
Section 36(1)(vii)
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Section 36(1) (viii)
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GENERAL DEDUCTIONS6
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".
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.
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.
Under residual head, the deduction of business expenditure is allowed in the following manner –
1. It is not an expenditure of the nature described in sections 30 to 36 of the Act
2. It is not in the nature of capital expenditure or personal expenses of the assessee
3. It is laid out or expended wholly and exclusively for the purposes of the business
4. 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
5. 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

Capital Expenditures
Any expenses/initial expenses incurred for acquiring or bringing into existence an asset or advantage of enduring
nature, or for substantial replacement of an existing, asset is a capital expenditures.

Wholly and Exclusively

The word 'wholly' refers to quantum of expenditure. The word 'exclusively' refers to the motive, objective and purpose
of the expenditure and gives jurisdiction to the taxing authorities to examine these matters.

For the purpose of business

The words 'for the purpose of business' would mean for the purpose of keeping the trade going and making it pay. The
expression 'for the purpose of business' is wider in scope than the expression 'for the purpose of earning profits'. Its
range is wide; it may take in not only the day-to-day running of a business but also the rationalization of its
administration and modernization of its machinery.
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Section 37
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CASE LAWS
CASE: Rural Electrification Corporation Ltd., 7

SUMMARY: The main object of the applicant, a public sector undertaking, was to provide long-term finance,
primarily to State Electricity Boards, for the purpose of transmission, distribution and generation of electricity to
enable industrial, agricultural and infrastructure development.

 The applicant was filing income-tax returns right from the beginning and the Department had all along, in
the past, allowed deduction under section 36(1)(viii) of the Income-tax Act, 1961, in respect of the special
reserve created and maintained for providing long-term finance for industrial or agricultural development or
development of infrastructure.

 For the assessment year 2004-05, the applicant credited Rs.170.85 crores as “swapping premium” received
and claimed deduction thereon under section 36(1)(viii). “Swapping premium” was a scheme under which
long-term finance given at a higher percentage of interest was converted to a lower rate of interest.

 The applicant itself had declared the swapping premium receipt in its balance-sheet as “Other income” and
not income from lending operations. The Assessing Officer held that the applicant forfeited the claim for
allowance of deduction under section 36(1)(viii) in respect of the “swapping premium”.

 The Commissioner (Appeals) agreed with the Assessing Officer. The applicant appealed to the Appellate
Tribunal but withdrew the appeal. Meanwhile, the applicant obtained permission of the Committee on
Disputes to pursue the matter before the Authority.

The Authority ruled that the applicant was an eligible entity, i.e., a financial corporation as laid down in section
36(1)(viii).

1. That the applicant was engaged in the business of providing long-term finance to its clients for rural
electrification which paved the way for industrial, agricultural and infrastructural development. The
availability of electricity contributed significantly to the overall development of the country including that
of industry, agriculture and infrastructure. The provision of electricity was essential for modernization and
growth of agriculture and also catered to the requirements of industry including small and medium
industries, agro-industries, Khadi and village industries, etc. The applicant had been providing finance for
industrial and agricultural development and, keeping in view these very goals, the Government of India had

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(2009) 308 ITR 321 (AAR)
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 granted approval to the applicant for deduction under section 36(1)(viii). The applicant could be said to be
engaged in providing long term finance for industrial and agricultural development in India.
2. That the long-term loan financed by the applicant to its clients in the beginning had not been tampered with
on rescheduling of the interest and no fresh loan agreements had also been drawn.
3. That clause (e) of the Explanation to section 36(1)(viii) defined long-term finance as “any loan or advance
where the terms under which moneys are loaned or advanced provide for repayment along with interest
thereon during a period of not less than five years”. In this case, the loans had been advanced in the
beginning for five years and those loan amounts had not undergone any change, so the period of five years
had to be counted from the date of advancing the initial loans and not from the date of rescheduling the
interest rates.
4. That the “swapping premium” was nothing but discounted interest and had “originated” in the long-term
finance initially advanced. The premium was actually traced to the original source and was not a step
removed from the business of providing long-term finance. No fresh agreement had been entered into for
advancing long-term financing and the one-time measure for rescheduling the interest had been actuated by
business expediency. The swapping premium was simply a compensation received for agreeing to a lesser
amount as against a higher fixed rate of interest initially fixed. The business of providing long-term finance
was the immediate and effective source of the swapping premium received.
5. (vi) That the swapping premium could not be termed as compensation for breach of contract because
neither party had breached the contract. The disclosure of the swapping premium in the balance-sheet as
“Other income” instead of business income was also immaterial since entries in the books of account are
not determinative of the true character of a receipt.
6. That, therefore, the applicant was entitled to deduction under section 36(1)
7. in respect of the swapping premium received.

CASE: Shriram Pistons and Rings Ltd. v. CIT 8

SUMMARY: The “good work reward” that was given by the assessee to some employees on the recommendation
of senior officers of the assessee did not fall in any of the categories of bonus specified under the industrial law.
There was nothing to suggest that the good work reward given by the assessee to its employees had any relation to
the profits that the assessee may or may not make. The reward had relation to the good work done by the employee
during the course of his employment and at the end of the financial year on the recommendation of a senior officer
of the assessee, the reward was given to the employee. Consequently, the “good work reward” could not fall within
8
(2008) 307 ITR 363 (Del.)
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the ambit of section 36(1)(ii) of the Income-tax Act, 1961. The “good work” reward was allowable as business
expenditure under section 37(1) of the Act.

CASE: CIT v. Solapur Dist. Co-Op. Milk Producers and Process Union Ltd. 9

SUMMARY: The assessee-societies were federal milk societies and their members were primary milk cooperative
societies. The business of the assessee was to purchase milk from its members and other producers of milk at the
rate, i.e., similar to both the members and outside milk producers and sell the milk to various parties. The rate of
purchase price was fixed by the board of the assessee-societies. The purchase price was linked to the fat content of
milk and also varied according to seasons. For instance, the rate for purchase of milk in the lean season was
different from the flush seasons.

The assessee-societies fixed the rate of processing of milk at the beginning of the year on the basis of the price
declared by the Government of Maharashtra and the price which other buyers paid to the vendors. These rates were
revised from time to time. It was made always clear that the rates were provisional and the final milk rate
difference was determined in the month of March every year and the difference was paid subsequently in the
following year.

The primary milk society also in turn made payment of the final rate difference to the individual milk producers
around Diwali. The assessees claimed deduction of the final rate difference. The Assessing Officer refused to
exclude the final rate difference paid from the total amount paid by the assessee. The Commissioner (Appeals)
upheld the order. The Tribunal allowed the appeal and allowed deductions of the final rate.

The High Court held that the amount to be paid was not out of the profits ascertained at the annual general meeting.
It was not paid to all shareholders. The amount which was the subject-matter was paid to members who supplied
milk and in some case also to non-members.

The payment was for the quantity of milk supplied and in terms of the quality supplied. The commercial
expediency for payment of this price was the market conditions and the need to procure more milk from the
members and non-members to the assessee.

Therefore, the amount paid could not be said to be dividend to the members or shareholders or payment in the form
of bonus as bonus also had to be paid from the accrued profits. It was deductible.

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(2009) 315 ITR 304 (Bom.)
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CASE: CIT v. Geoffrey Manners and Co. Ltd. 10

SUMMARY: The assessee incurred expenditure on film production by way of advertisement for the marketing of
products manufactured by it. The Assessing Officer disallowed the expenses incurred by the assessee for
promotion films, slides, advertisement films and treated it as capital expenditure.

The Commissioner (Appeals) held that the films were in the form of advertisement whose life term could not be
ascertained. Therefore, they could not be held as capital expenditure. The Tribunal upheld the order of the
Commissioner (Appeals). The High Court held that if the expenditure is in respect of an ongoing business of the
assessee and there is no enduring benefit it can be treated as revenue expenditure. If the expenditure is in respect of
business which is yet to commence then it cannot be treated as revenue expenditure since the expenditure is on a
product yet to be marketed. Hence, the expenditure incurred in respect of promoting ongoing products of the
assessee was revenue expenditure.

CASE: CIT v. Hero Cycles P. Ltd 11

SUMMARY: The assessee claimed expenditure of Rs. 73,180 on purchase of motors and certain other items of
machinery. The Assessing Officer rejected the claim for treating the amount as revenue expenditure on the ground
that the items purchased by the amount were not spare parts but independent items and the amount had, thus, to be
treated as capital expenditure.

On appeal, the plea of the assessee that most of the items purchased were electric motors for replacement of
existing machinery, was upheld. The Tribunal affirmed the order and held that occasional replacements were
necessary having regard to the machinery installed.

The High court held that the Tribunal was right in law in allowing expenditure of Rs.73,180 shown by the assessee
in the machinery repairs account as revenue expenditure.

10
(2009) 315 ITR 134 (Bom.)
11
(2009) 311 ITR 349 (P&H)
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CASE: CIT v. Hoshiari Lal Kewal Krishan 12

SUMMARY: The assessee claimed deduction of Rs. 31,433 paid as fine for belated payment of the excise duty
instalment. This was disallowed by the Assessing Officer as well as the appellate authority but the Tribunal
allowed it.

The Supreme Court in Prakash Cotton Mills P. Ltd. v. CIT [1993] 201 ITR 684, observed that whenever any
statutory impost paid by an assessee by way of damages or penalty or interest is claimed as an allowable
expenditure under section 37(1) of the Income-tax Act, the assessing authority is required to examine the scheme
of the provisions of the relevant statute providing for payment of such impost notwithstanding the nomenclature of
the impost as given by the statute, to find whether it is compensatory or penal in nature.

The authority has to allow deduction under section 37(1) of the Income-tax Act, wherever such examination
reveals the concerned impost to be purely compensatory in nature.

Hence, in the present case, the High Court held that it had been clearly found that though termed as fine, the
payment was not in the nature of punishment but was by way of compensation. The payment was deductible.

12
(2009) 311 ITR 336 (P&H)

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CONCLUSION

As we have seen different heads of income and their provision related to set off and carry forward, we can say that
loss should be set off inter source in the same AY and if still there is a loss then only inter head set off is allowed.
After completing first two steps only if any loss remains then it will be carrying forward and will set off in next AY
under the same head of income and not different head. But there still exception to it for example Losses in
Speculation Business can only be set off against the same head for that particular AY.
It provides the method for computing income under the head profits and gains from business or profession. The
method of accounting regularly employed by the assessee is relevant for the purpose of computing such income.
While sections 30 to 37 specify the various allowances or deductions available, section 40, 40A and 43B specify
explicitly as to what is not allowable as deduction. Passive versus active user - The user of the asset should be
understood in a wide sense so as to embrace passive as well as active user. If a machine is kept ready for use at any
moment in a particular factory, the machinery can be said to be “used” for the purpose of the business which earns
profits, although in fact it has not worked during the year. Assets used partly for business purposes - Undersection
38(2) where any building, machinery, plant or furniture is not exclusively used for the purposes of the business or
profession, the deduction under section32(1) shall be restricted to a fair proportionate part thereof which the
Assessing Officer may determine, having regard to the user of such building, machinery, plant or furniture for the
purposes of the business or profession.

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REFERENCES

Books
1. Singhania, Vinod K., Direct Taxes: Law And Practise, (New Delhi: Taxmann Publications Ltd.,
50th Edition, 2013)

Statutes
1. INCOME TAX ACT, 1961

Articles
1. https://archive.india.gov.in/business/taxation/profit_gains.php
2. http://incometaxmanagement.com/Pages/Tax-Ready-Reckoner/GTI/Business-Profession/CONTENT-
Income-Under-the-Head-Business-Profession.html

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