Profits and Gains from Business or Profession - 3 | Commerce & Accountancy Optional Notes for UPSC PDF Download

Specific Disallowances under the Income Tax

The Income Tax Act specifies certain expenses that are disallowed when computing income under the "Profits and gains of business or profession" head. These disallowances are outlined in Sections 40, 40A, and 43B, and they take precedence over any provisions in Sections 30 to 37. Here's a breakdown of these specific disallowances:

• Interest, Royalty, and Fees for Technical Services Paid Outside India or to Non-Residents (Section 40(a)): This section disallows expenses for interest, royalty, or fees for technical services when the Tax Deducted at Source (TDS) is not deducted or not paid before the due date specified under section 139(1). However, if the TDS is deducted in a subsequent year or paid after the due date, the sum will be allowed as a deduction in the year of such deduction or payment.
• Payment/Credit to Residents without TDS (Section 40(a)(ia)): If TDS is not deducted or deposited on time for interest, commission, rent, technical/professional fees, royalty, or contract payments to residents, the expenditure is disallowed to the extent of 30% of the payable sum.
• TDS Default for Non-Resident Salary (Section 40(a)(iii)): No deduction is allowed if TDS is not deducted for salaries paid to non-residents or outside India.
• Fringe Benefit Tax, Income Tax, Wealth Tax (Section 40(a)): These taxes, including penalties, fines, and interest, are not deductible.
• Tax on Non-Monetary Perquisites Paid by Employer (Section 40(a)(v)): Such taxes are not deductible.
• Salary/Interest Paid by a Firm to its Partners (Section 40(b)): Deduction is allowed for interest on capital or loan of partners only if mentioned in the partnership deed. Salary, bonus, commission, or remuneration paid to working partners is allowed as deduction if per the partnership deed or as per specified limits.
• Salary/Interest Paid by an AOP to its Members (Section 40(ba)): Non-deductible.
• Excessive Unreasonable Payments to Relatives/Interconnected Concerns (Section 40A(2)): Payments exceeding fair market value or legitimate business needs are disallowed.
• Disallowance for Expenditure Exceeding Rs. 10,000 Paid Otherwise Than by Cheque/Draft (Section 40A(3)): Expenditure exceeding Rs. 10,000 (or Rs. 35,000 for certain cases) paid in cash is disallowed, except for specific exemptions listed in Rule 6DD.
• Provision for Gratuity (Section 40A(7)): Not deductible unless it's from an approved gratuity fund.
• Employer’s Contribution to Non-Recognized Fund or Trust (Section 40A(9)): Not deductible, except for contributions to recognized provident funds, statutory provident funds, approved superannuation funds, or approved gratuity funds.
• Certain Deductions to be Allowed Only on Actual Payment (Section 43B): Deduction for certain expenditures is allowed only if paid during the previous year, regardless of when the liability was incurred. These include tax, duty, cess, contributions to provident or superannuation funds, bonuses, commissions, interest, leave payments, and payments to the Indian Railways.

Deemed Profits Chargeable To Tax

The following receipts are subject to taxation:

Recovery against any deduction [Section 41 (1)]:

• If a deduction was granted to the taxpayer in a prior year for a loss, expenditure, or trading liability, and in the current year, they receive a refund of that loss or expenditure or benefit from the cessation of the trading liability, this amount is considered taxable income for the previous year. 
• This applies even if the business is no longer in operation in the year of recovery or in cases of amalgamation/demerger, where it is taxable for the successor. For example, if a taxpayer paid Rs.1,00,000 as sales tax in the previous year 2021-22 and claimed it as a deduction, and then receives a Rs.10,000 refund in June 2022 due to a court decision, that Rs.10,000 is taxable in the year 2022-23.

Sale of assets used for scientific research [Section 41 (3)]:

• If an asset used for scientific research is sold without being used for another purpose, the net sale price or the cost of the asset (whichever is less), which was previously allowed as a deduction under section 35, is treated as business income of the year in which the asset is sold. 
• Any capital gain (sale price - original cost) is subject to capital gains provisions. This applies even if the business is no longer in existence in that previous year.

Recovery of bad debts [Section 41 (4)]:

• If an amount was claimed and allowed as a bad debt, and it is subsequently recovered, it is treated as income of the year in which it is recovered. The business may or may not continue in that previous year.

Amount withdrawn from specific reserve created and maintained by certain financial institutions [Section 41 (4A)]:

• If an amount is withdrawn from a reserve subsequently, it is considered profits and gains of business and profession and is chargeable to tax as income of that previous year.

Recovery after discontinuance of business or profession [Section 176 (3A)]:

• Any sum received after the discontinuance of the business or profession is deemed to be profits and gains of business and profession and chargeable to tax as the income of that previous year.

Maintenance Of Books Of Account Becomes Compulsory

• A person engaged in certain professions, as detailed in Section 44AA(1) of the Income Tax Act, such as legal, medical, engineering, architectural, accountancy, technical consultancy, interior decoration, authorized representation, film artistry, company secretarial services, and information technology, or any other profession as specified by the board in the official Gazette, is required to maintain a set of books and documents that enable the assessing officer to compute their total income according to the Act's provisions. 
• Rule 6F outlines the specific books to be maintained, including a cash book, journal, ledger, carbon copies of bills, and original bills or vouchers for expenses under fifty rupees. In the case of medical professionals, they must also keep a daily case register in Form No 3C and an inventory of drugs, medicines, and consumable accessories used for their profession. These books should be kept at the principal place of business and maintained for six years from the end of the relevant assessment year.
• There are exceptions to this rule. If the gross receipts in the specified profession do not exceed Rs. 1,50,000 in any of the three years immediately preceding the previous year, or if the total receipts in a newly established specified profession are not expected to exceed Rs. 1,50,000, maintaining books is not mandatory. However, in such cases, the person must still maintain books of account to enable the assessing officer to compute their total income.

For individuals in non-specified professions (Section 44AA(2)), they must maintain books of account in the following cases:

• If their total income from business or profession exceeds Rs. 1,20,000 or their total sales/gross receipts/turnover exceed Rs. 10,00,000 in any of the three years immediately preceding the relevant previous year, they must keep and maintain books of account and other documents.
• The monetary limits for individuals and Hindu Undivided Families (HUFs) have been increased from Rs. 1,20,000 to Rs. 2,50,000 and from Rs. 10,00,000 to Rs. 25,00,000, respectively.
• If their business or profession is newly established and their total income is likely to exceed Rs. 1,20,000 or their total sales/gross receipts exceed Rs. 10,00,000 during the relevant previous year, they must keep and maintain books of account and other documents.
• If their profits and gains from business or profession fall under sections 44AE, 44BB, and 44BBB, and their business income is claimed to be lower than the income computed under these sections on an estimated basis.
• If the provisions of section 44AD(4) apply and their income exceeds the maximum amount not chargeable to income tax in any previous year, they must keep and maintain records.

Failure to keep and maintain books of account and not retaining them for the prescribed period will result in a penalty of Rs. 25,000 under Section 271A.

Compulsory Audit of Accounts

The following individuals are required to undergo a mandatory audit by a chartered accountant under Section 44AB:

• A person conducting a business if the total sales/turnover/gross receipts in business exceed Rs.2 crore.
• A person carrying out a profession if the gross receipts in the profession exceed Rs.50 lakhs.
• If the profits and gains from business are considered to be profits and gains under sections 44AE, 44BB, and 44BBB, and the business income claimed is less than the income computed under these on an estimated basis.
• If an individual covered under section 44AD or 44ADA claims that the profits from business or profession are lower than the income computed under these sections and if their income exceeds the exemption limit.
• If the provisions of section 44AD(4) are applicable to any person, and their income exceeds the maximum amount not chargeable to income tax in any previous year.

The audit report must be uploaded on or before the due date for furnishing the return of income under Section 139(1).

Estimated Income Method For Computing Business Income In Certain Cases

Computation of Income on Estimated Basis in the Case of Taxpayers Engaged in a Business [Section 44AD]

This scheme applies to individuals, Hindu Undivided Families (HUF), and partnership firms who are residents but excludes companies, Limited Liability Partnerships (LLP), Associations of Persons (AOP), or Bodies of Individuals (BOI).

The following are not eligible for benefits under this scheme:

• Individuals engaged in specific professions as outlined in Section 44AA(1),
• Individuals earning income in the form of commission or brokerage,
• Individuals engaged in agency business,
• Individuals involved in plying, hiring, or leasing goods carriages as per section 44 AE,
• Taxpayers availing deductions under section 10 AA or section 80-IA to 80RRB.

The deemed profits and gains of the business are 8% of the total turnover or gross receipts in the previous year or a higher sum claimed to have been earned by the eligible assessee. This 8% rate can be reduced to 6% (presumptive rate) if the total turnover or gross receipts are received by an account payee cheque, account payee bank draft, or through the electronic clearing system via a bank account during the previous year or before the due date specified in Section 139(1).

• No deductions are allowable under sections 30 to 38.
• The Written Down Value (WDV) of any asset is deemed to be calculated as if the eligible assessee had claimed and been allowed the deduction for depreciation for each relevant assessment year. Salary and interest to partners are not deductible.
• Advance tax must be paid on or before 15th March during each financial year.
• Those who opt for this scheme are exempt from maintaining books of account.
• If profits are declared under this scheme for five consecutive previous years relevant to the previous year, and if the assessee declares profit not in accordance with Section 44 AD (1), then they will not be eligible to claim the benefit of Section 44 AD for the five assessment years subsequent to the assessment year relevant to the previous year in which the profit was not declared in accordance with the provisions of section 44 AD (1).

Computation of Income on Presumptive Basis [Section 44ADA]

Any assessee who is a resident and engaged in a profession referred to in Section 44AA(1) such as legal, medical, engineering, architectural, accountancy, technical consultancy, interior decoration, authorized representative, film artist, company secretary, and information technology, or any other profession as notified by the Board in the official Gazette.

• Gross receipts from the profession do not exceed Rs.50 lakhs.
• If the above two points are satisfied, the income of the assessee shall be calculated on an estimated basis at a sum equal to 50% of the total gross receipts.
• The assessee can voluntarily declare higher income in the income tax return.
• No deductions are allowable under sections 30 to 38.

The WDV of any asset is deemed to be calculated as if the eligible assessee had claimed and been actually allowed the deduction for depreciation for each relevant assessment year.

• Salary and interest to partners are not deductible.
• If the assessee declares his income to be lower than the deemed profits and gains as above, he has to maintain books of account as per section 44AA, if his total income exceeds the exemption limit and get his books audited as per section 44AB.

Computation of Income in Case of Business of Plying, Hiring, or Leasing Goods Carriages [Section 44AE]

• This section applies to assesses carrying on the business of plying, hiring, or leasing goods carriages and do not own more than 10 goods carriages at any time during the previous year.
• For heavy goods vehicles (more than 12 MT gross vehicle weight), the income is equal to Rs 1,000 per tonne per gross vehicle weight or unladen weight for every month or part of a month during which the heavy goods vehicle is owned by the assessee in the previous year or the amount actually earned, whichever is higher.
• For vehicles other than heavy goods vehicles, the profits and gains of each carriage shall be computed at Rs.7,500 for every month or part of the month during which the goods carriage is owned by the assessee in the previous year or the amount claimed to have been actually earned by the vehicles, whichever is higher.
• No further deductions except salary and interest to partners are allowed.
• If the assessee declares his income to be lower than the deemed profits and gains as above, he has to maintain books of account as per section 44AA, if his total income exceeds the exemption limit and get his books audited as per section 44AB.