Profits and Gains of Business or Profession
Weightage: Unit 3 of Chapter 3 of ICAI's Paper 3 Section A — the heaviest single unit in the paper's largest chapter. Almost every full-length problem in Section A includes at least a component from this head.
The starting point: profit as per books, adjusted
Business income is not computed from first principles for each problem. It starts from net profit as per the profit and loss account, prepared under ordinary commercial accounting, and is then adjusted: items debited in the books but not deductible under the Act are added back; items allowable under the Act but not debited, or debited at a different figure, are deducted; and income credited in the books but not taxable under this head, or not taxable at all, is deducted, while income taxable under this head but not credited is added.
This adjustment format is not optional presentation — it is how ICAI's own suggested answers are laid out, starting with "Net profit as per P&L account" and working through additions and deductions to "Income from Business/Profession," and reproducing it earns marks independently of getting every adjustment right.
Depreciation — section 32
The block of assets
Depreciation is not computed asset by asset. Assets are grouped into blocks, each block comprising assets of the same nature attracting the same rate of depreciation. All plant and machinery attracting 15% form one block; all buildings attracting 10% form another; and so on. The written down value of the block, not of any individual asset, is what depreciation is calculated on.
Computing WDV of the block
Depreciation for the year is then a percentage of this closing figure, subject to the half-rate rule: where an asset is put to use for less than 180 days in the year of acquisition, depreciation on the value of that addition is restricted to 50% of the normal rate for that year (full rate in subsequent years). This restriction applies to the value added during the year, computed proportionately where the block contains a mix of long-held and newly acquired assets.
Where the block ceases to exist — all assets sold and proceeds exceed opening WDV plus additions — no depreciation is allowed and the excess is a short-term capital gain. Where the block's WDV becomes negative or nil but assets remain in the block (sale proceeds exceed the block value but assets remain), the deficit is a short-term capital gain and the block continues with a nil WDV for future depreciation on any further additions.
Additional depreciation
Available for new plant and machinery (not second-hand, not office appliances, not vehicles, not items eligible for 100% deduction) acquired and installed by an assessee engaged in manufacture or production, or in the business of generation, transmission or distribution of power, at 20% of actual cost (10% where put to use for less than 180 days, with the balance 10% allowed in the immediately succeeding year), in addition to normal depreciation.
Deductions expressly allowed — sections 30 to 37
Rent, rates, taxes, repairs and insurance for premises used for business (section 30); similarly for plant, machinery and furniture (section 31).
Depreciation (section 32, above).
Expenditure on scientific research (section 35), with enhanced weighted deductions available for specified categories of research expenditure.
Preliminary expenses (section 35D), amortised — deductible in five equal annual instalments, subject to a cap expressed as a percentage of the project cost or of capital employed (for companies).
General deduction — section 37(1). Any expenditure, not being expenditure 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, is allowed. This is the residual, catch-all provision, and the phrase "wholly and exclusively" — not merely "reasonably" or "partly" — is the operative test that most disputes under this section turn on.
Explicit exclusion. Expenditure incurred for a purpose which is an offence or which is prohibited by law is deemed not to have been incurred for the purposes of business or profession and is not deductible — this is the statutory response to businesses attempting to claim bribes, illegal payments or expenditure on prohibited activities as ordinary business costs.
Expressly disallowed — sections 40, 40A and 43B
Section 40(a) — payments requiring TDS
Where tax is deductible at source on specified payments (interest, commission, brokerage, rent, royalty, fees for professional or technical services, or payments to a resident contractor or sub-contractor) and such tax has not been deducted, or having been deducted has not been paid within the prescribed time, 30% of the expenditure is disallowed for a payment to a resident. For a payment to a non-resident where tax was deductible and was not deducted or not paid, the disallowance is of the entire amount (100%) of the expenditure.
This distinction between the 30% and 100% disallowance, and between resident and non-resident payees, is examined precisely because candidates conflate the two.
Subsequent deduction and payment. Where the tax is deducted or paid in a later year, the disallowed expenditure is allowed as a deduction in that later year.
Section 40A(2) — payments to related parties
Where an assessee incurs expenditure for goods, services or facilities and the payment is made to a specified related person (relative, or a person having a substantial interest in the business), and the Assessing Officer is of the opinion that the expenditure is excessive or unreasonable having regard to the fair market value of the goods, services or facilities, the excess over what is reasonable is disallowed.
Section 40A(3) — cash payments
Where an assessee incurs any expenditure in respect of which a payment or aggregate of payments made to a person in a day, otherwise than by account payee cheque, account payee bank draft or electronic clearing system, exceeds ₹10,000 (₹35,000 for payment to a transport operator for plying, hiring or leasing goods carriages), 100% of such expenditure is disallowed.
Section 43B — deductions only on actual payment
Certain statutory liabilities — tax, duty, cess or fee under any law; employer's contribution to provident fund, superannuation fund or any other employee welfare fund; bonus or commission to employees; interest on loans from specified financial institutions, banks or NBFCs; and leave encashment liability of employees — are deductible only in the year of actual payment, notwithstanding that the assessee follows the mercantile (accrual) system of accounting.
The proviso relief. If the payment is made on or before the due date of filing the return of income under section 139(1), the deduction is allowed for the year in which the liability was incurred, even though actual payment occurred after the year end. This effectively gives the assessee until the return filing due date, not merely the financial year end, to make the payment without losing the year's deduction.
Employee's contribution to PF and similar funds is governed separately (section 36(1)(va)): it must be deposited by the due date under the relevant welfare legislation itself, not merely by the return filing due date — the section 43B proviso relief does not extend to the employee's own contribution collected by the employer, and this is a point of frequent confusion, since the two provisions look similar but carry materially different deadlines.
Presumptive taxation
Section 44AD — eligible business
An eligible assessee (resident individual, HUF or partnership firm other than an LLP) carrying on an eligible business (any business except plying, hiring or leasing goods carriages under section 44AE, and except an agency or commission business) with turnover or gross receipts not exceeding ₹2 crore (a higher threshold of ₹3 crore applies where cash receipts do not exceed 5% of total receipts) may declare profits on a presumptive basis at 8% of turnover (6% for receipts through banking channels or digital modes), without maintaining detailed books of account or being subject to audit purely on that ground.
No further deduction for business expenses is available once income is declared under this presumptive scheme — the declared percentage is deemed to already account for all expenses.
Exit consequence. An assessee who has opted for section 44AD and later declares profit below the presumptive rate, if his total income exceeds the basic exemption limit, must maintain books of account and get them audited.
Section 44ADA — professionals
A resident individual, HUF or partnership firm (other than LLP) engaged in a specified profession (legal, medical, engineering, architectural, accountancy, technical consultancy, interior decoration and certain others) with gross receipts not exceeding ₹50 lakh (₹75 lakh where cash receipts do not exceed 5%) may declare profits at 50% of gross receipts, with the same no-further-deduction consequence.
Section 44AE — goods carriages
An assessee owning not more than 10 goods carriages at any time during the year, engaged in the business of plying, hiring or leasing them, may declare presumptive income at a prescribed rate per vehicle per month (differentiated by vehicle type and tonnage for heavy goods vehicles), regardless of actual profit or loss.
Compulsory maintenance of books and tax audit
Section 44AA prescribes when books of account must be maintained: specified professions must maintain prescribed books where gross receipts exceed a threshold in any of the three immediately preceding years; other businesses and professions must maintain books adequate to enable the Assessing Officer to compute total income, where income or turnover exceeds prescribed limits.
Section 44AB prescribes when accounts must be audited by a chartered accountant: broadly, where turnover of a business exceeds a prescribed threshold (with a higher threshold available where cash transactions are minimal), or gross receipts of a profession exceed a prescribed threshold, or where an eligible assessee under the presumptive schemes declares profit below the presumptive rate and total income exceeds the basic exemption limit.
The business versus other-heads boundary
Two boundary questions recur across problems and are worth stating explicitly.
Business income versus capital gains. Where an asset is held as stock-in-trade, its sale generates business income; where held as a capital asset (investment), its sale generates capital gains. The same type of asset — shares, land — can produce either depending on the assessee's intention and pattern of dealing, which is a question of fact examined through frequency of transactions, holding period, the assessee's stated business, and how the asset was treated in the books.
Business income versus income from other sources. Interest, rent or dividend earned is ordinarily taxed under Other Sources, unless it is genuinely part of the assessee's business operations — interest earned by a banking business, or rental income where letting out property is itself the assessee's business (as opposed to an incidental letting of a surplus asset).
