Profits and Gains from Business or Profession

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

IntroductionMeaning 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.[footnoteRef: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. [1: (1958) 34 ITR 368 (SC)]

Business includes any adventure in the nature of trade, commerce or manufacture. In G. Venkatswami Naidu & Co. v. C.I.T.[footnoteRef: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.[footnoteRef: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. [2: (1959) 35 ITR 594 (SC)] [3: (1975) 100 ITR 706 (SC)]

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. 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.[footnoteRef: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. [4: (1993) 200 ITR 594 (SC)]

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.

Profits and Gains from Business or ProfessionMethods 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.[footnoteRef:5], it was held that consistent method of accounting is the first condition of applicability of Section 145. Choice of method of accounting regularly 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. [5: (2005) 13 SCC 307.]

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 bya) 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;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.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 toi. 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;ii. Any sum received as compensation, from the multilateral fund of the Montreal 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 concertA. Whether or not such arrangement, understanding or action is formal or in writing; orB. Whether or not such arrangement, understanding or action is intended to be enforceable by legal proceedings;ii. 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, 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 Chettiar[footnoteRef:6], 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. [6: (1962) 44 ITR 710.]

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 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.[footnoteRef: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.[footnoteRef:8], it was held that deductions have to be allowed even if there are insufficient profits in the previous year. [7: (1963) 50 ITR 233.] [8: (1969) 73 ITR 23.]

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.[footnoteRef: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:-- [9: (1970) 75 ITR 301.]

i. Loss of stock-in-tradeii. Loss through embezzlement of employee or agentiii. Loss of robbery or theftiv. Loss incurred as a suretyv. Loss for non-performance of a trading contract

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.[footnoteRef: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 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. [10: (2008) 3 SCC 185.]

(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 1st 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: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. The expenditure should not be of the nature described under sections 30 to 36. 2. It should not be in the nature of capital expenditure. 3. It should not be personal expenditure of the assessee. 4. It should have been incurred in the previous year. 5. It should be in respect of business carried on by the assessee. 6. 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.[footnoteRef:11] In C.I.T. v. Walchand & Co. Ltd.[footnoteRef: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 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. [11: C.I.T. v. Chandulal Keshavlal & Co. (1960) 38 ITR 601 (SC).] [12: (1967) 64 ITR 381 (SC).]

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.[footnoteRef: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: [13: (2000) 242 ITR 450(SC): AIR 2000 SC 972.]

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 not computation under each head results in taxable income; ii. If income of an assessee arises under any of the heads of income but from different itemse.g. different house properties or different securities etc., and incomefrom one or more items aloneis taxable whereas incomefrom the other item is exempt under the Act, the entire permissible expenditure in earning the income from that head is deductible; andiii. 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; andb. 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: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.[footnoteRef:14] [14: Indian Aluminium Co. Ltd. v. C.I.T., (1971) 79 ITR 514 (SC).]

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.[footnoteRef:15] [15: Vithaldas v. C.I.T. (1981) 130 ITR 95 (Guj.).]

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. CIT[footnoteRef:16], 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) 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. [16: (2012) 343 ITR 270 (SC).]

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.[footnoteRef:17] [17: Jadavji Narsidas & Co. v. C.I.T., [1963] 47 ITR 411 (Bom.)]

Leading Cases C.I.T. v. Ahmedabad Cotton Company Ltd.[footnoteRef:18] [18: (1994) 205 ITR 163.]

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.[footnoteRef:19] [19: (1985) 155 ITR 537 (SC).]

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.[footnoteRef:20] [20: (1967) 3 SCR 238.]

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.[footnoteRef:21] [21: (2000) 2 Scc 729: (2000) 242 ITR 659.]

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.

Recent Case-laws

Rajchandra Capital Services P. Ltd. v. Asst. CIT[footnoteRef:22] [22: MANU/IU/0233/2014; Decided on: 26-02-2014.]

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.[footnoteRef:23] [23: 2013 (8) TMI 662.]

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. Morakhia[footnoteRef:24] [24: [2012] 342 ITR 285 (Bom).]

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 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.[footnoteRef:25] [25: MANU/ID/0122/2012; Decided on: 24.02.2012]

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 XI[footnoteRef:26] [26: [2009]318 ITR 435 (Mad).]

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 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).

ConclusionUnder 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":- 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. 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.

BibliographyBooks 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

IncomeFromBusiness/Profession

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

Article referred: Dipesh Shah, Bad Debts & Provisions of Bad Debts, CA Club India, CCI Online Coaching, 2012.Page | 21