Income tax in India is computed under five heads, and one of the most intricate yet essential among them is the head of Profits and Gains from Business or Profession. This head encompasses all income derived from trade, commerce, manufacturing, professions such as legal or medical practice, and other business-related endeavors. In order to determine the tax liability of an assessee under this head, it becomes essential to compute the net income accurately. The net income or profit that is taxable under this head is not the gross income but is arrived at after allowing deductions of expenses that are incurred wholly and exclusively for the business or profession. The Income Tax Act, 1961, provides a detailed mechanism for determining these deductions through Sections 30 to 37. These provisions aim to ensure that tax is levied only on the real income, that is, income after reducing all legitimate business-related expenses.
Understanding the Legal Framework of Deductions
The statutory framework guiding the computation of income under the head PGBP is codified primarily in Sections 28 to 44DB of the Income Tax Act. However, Sections 30 to 37 specifically deal with expenses that are deductible while calculating such income. The underlying principle behind allowing these deductions is that an assessee should be taxed only on the profit that remains after incurring all necessary expenses related to running the business or profession. The expenditure must be genuine, must relate to the business, and must be incurred during the relevant previous year. Furthermore, such expenses must not be of a capital nature unless specifically provided, must not be personal, and must not be prohibited by law. These guidelines ensure that the claim of expenses is legitimate and that the deductions claimed are not excessive or fraudulent.
Section 30 Rent Rates, Taxes, Repairs, and Insurance for Buildings
Section 30 deals with the expenses related to buildings used for business or professional purposes. If a taxpayer uses a building for carrying on business or profession, the following expenses are deductible under this section: rent paid for the premises if the building is not owned by the assessee, municipal taxes or property taxes levied by local authorities, expenditure on repairs not being capital in nature, and insurance premiums paid to protect the building against risks such as fire or natural calamities. It is important to note that the deductions are allowed only if the building is used exclusively for the purpose of business or profession. If the building is used partially for personal purposes, then the deductions shall be proportionate to the extent it is used for business. Also, capital expenditures such as structural alterations or new constructions are not covered under this section.
Section 31 Repairs and Insurance of Machinery, Plant and Furniture
Section 31 allows deductions for expenditure incurred on the repairs and insurance of machinery, plant, and furniture used in the business. These assets are often essential for manufacturing, service delivery, or other operational aspects of the business. Expenditure on current repairs, which is not capital in nature, is allowable under this section. For example, the replacement of worn-out parts of machinery or the repainting of furniture qualifies as revenue repairs. However, if the expense results in a significant improvement or enhancement of the asset, it may be considered capital in nature and hence not deductible under this section. Additionally, the premiums paid to insurance companies to cover any damage or risk to these assets are also deductible. This ensures that businesses can maintain and protect their physical assets without being taxed on the amounts spent for such purposes.
Section 32 Depreciation on Tangible and Intangible Assets
Depreciation is one of the most significant deductions available under the Income Tax Act. Section 32 allows depreciation on tangible assets such as buildings, machinery, plant, and furniture, as well as on specified intangible assets like patents, trademarks, copyrights, and know-how. The depreciation must be calculated as per the rates prescribed under the Income Tax Rules. An important condition for claiming depreciation is that the asset must be owned, wholly or partly, by the assessee and must be used for the business or profession during the relevant previous year. If the asset is used for less than 180 days in a financial year, only half of the eligible depreciation is allowed. Additional depreciation is available for new plant and machinery acquired by manufacturing entities, subject to certain conditions. This section ensures that the cost of using fixed assets over time is accounted for, thereby presenting a true picture of the net profit.
Section 33AB Tea, Coffee, and Rubber Development Account
Section 33AB provides for a special deduction to assessees who are engaged in the business of growing and manufacturing tea, coffee, or rubber in India. Such assessees can claim a deduction for the amount deposited in a special account known as the Tea Development Account, Coffee Development Account, or Rubber Development Account with NABARD or a scheduled bank. Alternatively, expenditure incurred for development purposes as prescribed may also qualify. The maximum deduction allowable is the least of forty percent of the profits from such business or the amount deposited or spent. The scheme is intended to promote the development and modernization of these agricultural industries. However, there are specific conditions attached regarding utilization and withdrawal from such accounts, and failure to comply may result in withdrawal of the deduction and inclusion of the amount as income in subsequent years.
Section 33ABA Site Restoration Fund
Section 33ABA applies to assessees engaged in the business of prospecting for or extraction or production of petroleum or natural gas or both in India. Such businesses involve significant environmental risks and responsibilities. Therefore, to ensure that funds are available for restoration of the site once the exploration or production activity is over, the law permits a deduction for amounts deposited in a Site Restoration Fund. This fund must be established under a scheme framed by the Central Government and notified in the Official Gazette. The deduction allowed is the lower of the amount deposited or twenty percent of the profits from the eligible business. The withdrawal from such funds is also subject to strict regulation, and non-compliance may result in the reversal of the deduction. The objective of this provision is to enforce environmental responsibility among resource extraction industries.
Section 35 Expenditure on Scientific Research
Section 35 allows a wide range of deductions for expenditure on scientific research. The expenditure can be both capital and revenue in nature. If the research is related directly to the business carried on by the assessee, the full amount of expenditure incurred on such scientific research is deductible, even if incurred before the commencement of business, provided it is within three years before commencement. The expenditure must be certified and must be for in-house research facilities or for contributions to approved research associations, universities, or institutions. Payments to National Laboratories or Indian Institutes engaged in scientific research also qualify. The purpose behind this section is to promote innovation, research, and development in business and industry. However, deductions are not allowed for expenditure incurred on land, and any asset acquired for research must be used exclusively for that purpose. If it is sold later, the amount realized may be taxed under capital gains.
Section 35AD Deduction for Specified Businesses
Section 35AD allows a 100 percent deduction for capital expenditure incurred by an assessee on specified businesses. The list of specified businesses includes setting up and operating cold chain facilities, warehousing for agricultural produce, laying and operating cross-country pipelines, building and operating two-star or above hotels, and hospitals with at least one hundred beds. This deduction is available in the year in which the expenditure is incurred, provided the business is not set up by splitting up or reconstructing an existing business, and the asset is not used for any other purpose for eight years. The asset must also not be acquired through a related party or under a transfer covered by specific anti-avoidance provisions. Revenue expenditure is not covered under this section. The objective of Section 35AD is to incentivize investment in infrastructure and essential services by providing immediate tax benefits for capital investments.
Section 35CCC Agricultural Extension Project
Section 35CCC provides a deduction for expenditure incurred by an assessee on any agricultural extension project notified by the Board. Such projects are usually undertaken for the purpose of training farmers, creating awareness of modern techniques, or improving productivity and sustainability in agriculture. The deduction allowed is 100 percent of the expenditure incurred, provided the project is approved and is in accordance with the guidelines framed by the prescribed authority. This section aims to encourage businesses to contribute toward the advancement of agricultural practices in India. This provision is particularly beneficial for companies involved in agribusiness, agricultural inputs, fertilizers, pesticides, and seed production that run extension services as part of their operational activities.
Section 36 Specific Deductions Related to Business Expenditure
Section 36 covers a diverse array of business-related deductions. These include premiums paid for insuring the stock-in-trade, amounts paid as bonus or commission to employees, interest on capital borrowed for business purposes, and the employer’s contributions to recognized provident funds, approved superannuation funds, and employee state insurance. Also deductible are bad debts that were earlier included in the income and have been written off during the year. Deductions are also available for the amount transferred to a special reserve by certain financial institutions and for expenses incurred on promoting family planning among employees by companies. Additionally, discounts on debentures, preliminary expenses, and expenditure incurred on protecting or obtaining a patent or trademark are also covered under this section. Each of these expenses must satisfy the general conditions of being incurred wholly and exclusively for business and must not be capital or personal.
Depreciation Under Section 32
Depreciation is a crucial deduction under the head of Profits and Gains from Business or Profession. It allows the taxpayer to deduct the cost of wear and tear of assets used in the business. The assets should be owned wholly or partly and used for business purposes during the relevant previous year. The depreciation is allowed on tangible assets such as buildings, machinery, plant, and furniture, and on intangible assets such as know-how, patents, copyrights, trademarks, and licenses. The depreciation rate is prescribed under the Income Tax Rules. If the asset is used for less than 180 days in a year, only half of the depreciation is allowed. There is also an additional depreciation allowed at the rate of 20 percent on new plant and machinery acquired by manufacturing units, provided specific conditions are fulfilled. Depreciation is calculated on a block of assets basis rather than individually. The written-down value method is used except for undertakings engaged in generation or generation and distribution of power, which have the option to use the straight-line method.
Tea, Coffee, and Rubber Development Account Under Section 33AB
The deduction under Section 33AB is allowed to assessees engaged in the business of growing and manufacturing tea, coffee, or rubber in India. To claim this deduction, the assessee must deposit a specified amount in a development account maintained with the National Bank for Agriculture and Rural Development or with a scheduled bank. Alternatively, the amount can be invested in the acquisition of new plant or machinery. The amount of deduction shall be the lower of the amount deposited or invested, or forty percent of the profits derived from such business before making this deduction. The deduction is subject to several conditions, and the deposited amount must be used for development purposes as prescribed. If the amount is not utilized for the intended purpose or is withdrawn, it may be deemed as business income in the year of withdrawal.
Site Restoration Fund Under Section 33ABA
This deduction is available to an assessee carrying on the business of prospecting for or extraction or production of petroleum or natural gas in India. The deduction is allowed for the amount deposited in the Site Restoration Fund established by the Central Government. The maximum deduction allowed is the lower of the amount deposited or twenty percent of the profits from such business before claiming the deduction. The amount must be deposited before the due date of filing the return of income. Any withdrawal from the fund not used for site restoration purposes will be treated as business income in the year of withdrawal. The deduction aims to ensure that petroleum companies reserve funds for restoring the site after extraction activities cease.
Expenditure on Scientific Research Under Section 35
Scientific research expenditure is allowed as a deduction to encourage innovation and research in business operations. This deduction is available for both revenue and capital expenditure related to scientific research. The deduction can be claimed under three main categories. The first category is expenditure on scientific research related to the assessee’s business. The second category includes contributions to approved research associations, universities, colleges, or other institutions for scientific research. The third category includes contributions to companies engaged in scientific research. The entire capital and revenue expenditure incurred on scientific research related to the business is allowed as a deduction. However, the expenditure on land is not eligible for deduction. In the case of capital expenditure, the deduction is allowed in the year in which it is incurred, even if the asset is not used for business in that year. If the scientific research is not related to the assessee’s business, the deduction is limited to the amount paid during the year. The tax law also provides weighted deductions in certain cases, but such benefits are subject to changes by annual Finance Acts. The institutions or associations to which contributions are made must be approved and notified by the government.
Deduction for Specified Businesses Under Section 35AD
Section 35AD provides for a 100 percent deduction of capital expenditure incurred by an assessee on certain specified businesses. These businesses include setting up and operating a cold chain facility, a warehousing facility for agricultural produce, a cross-country pipeline network for natural gas, two-star or above category hotels, hospitals with at least one hundred beds, and slum redevelopment projects,, among others. The business should not be set up by splitting up or reconstructing an existing business. The business should also not be set up by using old plant and machinery beyond a specified limit. The expenditure should be capital in nature, not incurred on land, goodwill, or financial instruments. The deduction is allowed in the year in which the capital expenditure is incurred, even if the asset is not put to use in that year. However, the asset should be used exclusively for the specified business for eight years from the year of acquisition. If the asset is used for other purposes within this period, the deduction claimed earlier is deemed as business income in the year of such use. Section 35AD aims to promote investment in critical infrastructure and essential service sectors by offering a full deduction upfront instead of depreciation over the years.
Agricultural Extension Project Under Section 35CCC
This section allows a deduction for expenditure incurred on notified agricultural extension projects. The project must be undertaken by a scheme approved by the prescribed authority. The entire amount of such expenditure incurred in the previous year is allowed as a deduction. This provision is applicable to companies or other assessees who carry out projects for agricultural development. The primary objective is to encourage private participation in the dissemination of agricultural technology and practices among farmers. The projects may include soil testing, training programs, water management techniques, use of improved seeds and fertilizers, and sustainable farming methods. To avail of this deduction, the assessee must obtain approval from the prescribed authority and submit the required documents. The deduction is allowed only for the actual amount of expenditure incurred and not for any capital outlay on land or buildings used for such projects.
Skill Development Project Under Section 35CCD
Section 35CCD provides for a deduction of expenditure incurred by a company on any notified skill development project. The project must be notified by the central government and must comply with the prescribed guidelines. The entire expenditure incurred on such a project, excluding expenditure on land or buildings, is allowed as a deduction. The deduction is aimed at promoting the development of skilled manpower by encouraging companies to set up training programs and vocational education initiatives. This helps bridge the gap between industry requirements and available skill sets in the workforce. The company must maintain records and obtain approvals from the prescribed authorities to claim the deduction. The deduction is not available for expenses incurred on capital assets that are not directly related to the training or skill development activity.
Other Deductions Under Section 36
Section 36 covers a wide range of deductions that are directly related to the operation of a business or profession. One important deduction under this section is the insurance premium paid for stock in trade. This ensures that businesses can protect their inventory without the cost of insurance becoming a tax burden. Another key deduction is the bonus or commission paid to employees, provided it is not instead of profit sharing. This helps businesses compensate employees based on performance. Interest on borrowed capital used for business purposes is also deductible under this section, subject to certain conditions. Contributions to employee welfare funds such as Provident Fund, Superannuation Fund, and Employee State Insurance are deductible if paid before the due date. This provision ensures timely compliance with social security laws. Employers can also claim deductions for expenses related to employee welfare, such as leave encashment and gratuity, provided they meet the conditions laid down in the law. Bad debts written off in the books of accounts during the year are allowed as a deduction if the amount was earlier included in the income. In the case of banks and financial institutions, provision for bad and doubtful debts is also allowed within specified limits. Another notable deduction is the discount allowed on the issue of debentures, which is spread over the life of the debentures. This reflects the true cost of borrowing over the term. Companies are also allowed a deduction for expenditure incurred on promoting family planning among employees, though this is restricted to companies and subject to conditions. The wide scope of Section 36 ensures that genuine and routine business expenses are not taxed.
Section 35CCC Agricultural Extension Projects
Section 35CCC provides for the deduction of expenses incurred on agricultural extension projects. These projects are designed to educate and train farmers in improved farming techniques and practices. The expenditure must be incurred on a project notified by the central government. The deduction is allowed for the whole of the expenditure incurred. The condition is that the payment should be made to an approved institution engaged in agricultural extension services. This deduction promotes sustainable agricultural development and incentivizes businesses to contribute to rural growth.
Section 35CCD Skill Development Project
Section 35CCD provides for a deduction of expenses incurred by a company on any notified skill development project. This initiative aims to encourage businesses to invest in training and developing skilled manpower. The deduction is available to companies for expenditure (excluding land and buildings) incurred on such projects. The deduction allowed is 100 percent of the expense incurred. The project must be notified by the central government, and training must conform to the guidelines set by it. This provision helps in addressing the skill gap in various sectors and enhances employability.
Section 36 Allowable Expenses
Section 36 includes a wide array of specific deductions allowable under the head PGBP. These expenses must be incurred wholly and exclusively for the business or profession. The section plays a significant role in reducing the taxable income and thereby the tax liability of the assessee. Each category under this section has its conditions and limitations that must be fulfilled.
Insurance Premium on Stocks and Assets
Deduction is allowed for insurance premiumss paid to insure stock-in-trade and other assets used for business. The purpose of this deduction is to protect the business against potential losses arising from damage or destruction of goods. The expenditure must be incurred during the previous year and should relate to the assets used in business operations.
Insurance on the Health of Employees
The employer can claim a deduction for the premium paid to insure the health of employees under a scheme approved by the Insurance Regulatory and Development Authority. The deduction is available only if the payment is made by any mode other than cash. This provision supports employee welfare and encourages businesses to provide health benefits to their workforce.
Bonus or Commission to Employees
Any bonus or commission paid to employees is allowed as a deduction provided it is not paid instead of dividends or profits. The payment must be made for services rendered and should be reasonable. Excessive or unreasonable payments may be disallowed under the provisions of the Income Tax Act. The amount should be paid before the due date of filing the income tax return.
Interest on Borrowed Capital
Interest on capital borrowed for business purposes is deductible. The borrowed funds should be used for business or professional activities. If the borrowed money is diverted for personal use or non-business activities, the interest on such portion will not be deductible. In case of capital assets, interest paid before commencement of production is capitalized and included in the cost of the asset.
Employer’s Contribution to Provident and Other Funds
Contribution by the employer to recognized provident fund, approved superannuation fund, or pension schemes is allowed as a deduction if paid before the due date prescribed under the respective Acts. Late payment may result in the disallowance of the expense. These contributions must be made by the provisions of the respective fund regulations.
Employee’s Contribution to Provident Fund
Employee’s contribution received by the employer is also allowed as a deduction provided the same is deposited in the respective funds before the due date. If the employer fails to deposit the amount within the due time, the deduction will not be allowed. This encourages timely remittance of employee welfare funds and ensures financial security for workers.
Bad Debts Written Off
Bad debts that are written off in the books of account are allowed as a deduction if such debts were previously included in the total income of the assessee. The condition is that the bad debt must be related to business and must have been written off during the financial year. Provision for bad debts is not allowable. For banks and financial institutions, deduction is allowed even without writing off individual accounts under special provisions.
Provision for Bad and Doubtful Debts for Banks
Banks and certain financial institutions are allowed to claim a deduction for provisions for bad and doubtful debts. The deduction is restricted to a prescribed percentage of total income or the amount specified under the law. This is allowed in addition to the actual write-off of bad debts. The aim is to provide a cushion to financial institutions against future loan defaults.
Discount on Issue of Debentures
In the case of a discount on the issue of debentures, the deduction is allowed on a proportionate basis over the life of the debentures. The discount is treated as deferred revenue expenditure and amortized over the number of years the debentures are to remain outstanding. This ensures that the expenditure is matched with the income it helps to generate.
Expenditure on Family Planning
Only companies are allowed a deduction in respect of expenditure incurred for promoting family planning among employees. The expense may be capital or revenue in nature, but only revenue expenditure is fully deductible in the year incurred. Capital expenditure is allowed in equal installments over a period of five years. The deduction is aimed at supporting employee welfare initiatives and promoting responsible family planning.
Other Expenses Covered Under Section 36
Section 36 also includes other specific expenses like premiums for insurance against the risk of damage to crops, expenditure on the purchase and maintenance of animals used in business, and expenses related to training programs conducted for employees. Each of these deductions helps reduce the overall taxable profits, provided the expenses meet the requirements laid down under the Income Tax Act.
Section 37 General Business Expenditure
Section 37 serves as a residuary provision for claiming deductions that are not covered under any other specific section of the Act. It allows deduction for any expenditure not being capital expenditure or personal expenses, which is laid out or expended wholly and exclusively for business or profession. This section provides flexibility to claim deductions for routine business expenses.
Advertisement and Sales Promotion
Expenses incurred on advertisement and sales promotion are allowable under this section. This includes payments made to media agencies, costs of samples, promotional events, and other related costs. The expenditure should be reasonable and incurred during business operations.
Travelling and Conveyance Expenses
Business-related travel expenses, including airfare, hotel stays, and local conveyance, are allowed as a deduction. The travel must be for business purposes, and adequate documentation such as tickets and bills should be maintained to substantiate the claim.
Legal and Professional Charges
Fees paid to lawyers, accountants, consultants, and other professionals for services related to business are deductible. This includes services like audit, legal opinions, drafting agreements, tax advisory, and other professional services necessary for running the business.
Rent for Business Premises
If business premises are taken on rent, the rent paid is allowed as a deduction. The premises must be used for business purposes, and rent should be paid as per a valid agreement. Advance rent or refundable deposits are not deductible.
Repairs and Maintenance
Day-to-day repairs and maintenance expenses incurred for keeping business assets in working condition are allowed. This includes minor repairs to buildings, equipment, and other fixed assets. Major repairs that increase the life of the asset are considered capital expenditure and not allowed under this section.
Printing and Stationery
Expenditure on printing, stationery, and office supplies used in business operations is deductible. This includes letterheads, forms, diaries, pens, printer cartridges, and similar items necessary for running the business.
Telephone and Internet Expenses
Expenses on telephone and internet services used for business communication and operations are allowed as a deduction. If the services are used partly for personal purposes, only the business-use portion is allowed.
Electricity and Water Charges
Electricity and water expenses incurred for running business operations are allowed as deductions. The services must be consumed for business activities and paid for during the relevant financial year.
Subscription and Membership Fees
Membership fees for trade associations, chambers of commerce, and subscriptions to professional journals and databases are allowable under this section. The memberships must be related to the business activities.
Office Maintenance
Routine maintenance of office premises including cleaning, pest control, minor renovations, and other serservicess deductible. The expenditure must be incurred to keep the office operational and must be reasonable.
Training and Development
Expenses incurred on training programs for employees to upgrade their skills or enhance their productivity are allowed as deductions. This may include fees paid to external trainers, course material, and travel expenses for attending training sessions.
Software Subscription and License Fees
Payment made for software licenses and subscriptions that are used for business purposes is allowed as a deduction. The software must not be enduring. If the benefit is expected to last more than a year, the expenditure may be treated as capital.
Entertainment Expenses
Reasonable entertainment expenses incurred for business are allowable. This includes business lunches, client meetings, and hospitality provided during business negotiations. Lavish or personal expenses are not allowed.
Vehicle Running and Maintenance
Expenses related to fuel, servicing, repairs, and insurance of vehicles used for business purposes are deductible. If the vehicle is used partly for personal purposes, only a proportionate deduction is allowed.
Salary and Wages
Payments made to employees for services rendered are deductible. This includes basic salary, dearness allowance, overtime, and other benefits paid as part of the employment agreement.
Rent for Equipment and Machinery
Rent paid for hiring equipment, tools, and machinery used in business operations is allowed as a deduction. The hire charges must be reasonable and paid as per the agreement.
Miscellaneous Expenses
Other expenses which do not fall under specific heads but are necessary for the conduct of business can also be claimed under this section. The test is whether the expenditure is wholly and exclusively for business and is not capital or personal.
Expenditure Not Allowed Under Section 37
Expenditures which are prohibited by law, incurred for illegal purposes, or penal are not allowed. These include penalties, fines, illegal gratification, and payments made in contravention of any law. The expenditure must also not be capital in nature or related to personal use.
Disallowances Under Section 40
Section 40 specifically outlines expenses that are not deductible despite being business-related. This section overrides the general deduction provisions under sections 30 to 38. It includes certain payments made by a firm to its partners, tax payments, and payments where TDS provisions are not complied with. If an assessee fails to deduct or deposit tax at source as required, such expenses can be disallowed while computing business income. In the case of a partnership firm, any salary, bonus, commission, or remuneration paid to a partner is not deductible unless authorized by the partnership deed and is within the prescribed limits. Also, if a firm pays interest to partners, it should not exceed 12 percent per annum, and it must be according to the partnership deed. Similarly, any income tax paid or wealth tax paid is disallowed. Disallowances under this section emphasize the importance of compliance with procedural tax provisions.
Disallowances Under Section 40A
Section 40A deals with expenses or payments not deductible in certain circumstances. It primarily covers disallowance for excessive or unreasonable payments and cash transactions. If any expenditure is found to be excessive or unreasonable about the fair market value of the goods, services, or facilities provided or the legitimate needs of the business, it may be disallowed. Under section 40A(3), any payment over Rs. 10,000 made in cash to a person in a day is disallowed unless it falls under the specified exceptions. The objective behind this provision is to encourage payments through banking channels and reduce the circulation of unaccounted money. However, exceptions exist where payments in cash are allowed, such as in rural areas where banking facilities are not available or in emergencies like natural calamities. Businesses are required to maintain proper documentation and justification for such payments to avoid disallowance. Section 40A(2) also deals with payments to related persons and allows the assessing officer to scrutinize such payments for fairness.
Deductions Based on Actual Payment Under Section 43B
Section 43B provides for deductions only on an actual paymenirrespectiveve of the method of accounting followed. Even if the assessee follows the mercantile system of accounting, certain expenses are allowed only when they are paid. These include statutory dues like taxes, duties, cess, contributions to employee welfare funds, and interest on loans from public financial institutions. The deduction is allowed in the year in which the payment is made, irrespective of the year in which the liability was incurred. However, if the payment is made before the due date of filing the return, then the deduction is allowed in the year of accrual itself. This section ensures the timely payment of statutory dues and avoids the accumulation of unpaid liabilities. Examples include the employer’s contribution to the provident fund, tax liability, and interest payable to public institutions. This provision safeguards the interests of employees and ensures that government dues are paid promptly.
Expenses Disallowed Due to Violation of Law
Any expenditure incurred for an act that constitutes an offence or is prohibited by law is not allowable under the Income Tax Act. This includes penalties or fines imposed by law, bribes, illegal gratification, and protection money. If an expenditure is incurred in contravention of any statutory provision or public policy, it will be disallowed. Courts have consistently upheld that expenditure incurred for illegal purposes cannot be claimed as a business deduction. For instance, if a business pays a fine for violating environmental laws or transport regulations, such fines cannot be deducted. Similarly, any amount paid as a bribe to secure a contract or expedite business processes is not allowable. This reinforces the legal and ethical framework within which businesses must operate. Expenditures must be legitimate and within the boundaries of the law to qualify as deductible.
Capital vs Revenue Expenditure
Understanding the difference between capital and revenue expenditure is essential while computing income under the PGBP head. Revenue expenditure is deductible in the year in which it is incurred, provided it is wholly and exclusively for business. Capital expenditure, on the other hand, is not deductible immediately but may be eligible for depreciation or amortization under specific provisions. Capital expenditure results in the acquisition of assets or a lasting benefit for the business. For example, the purchase of land or machinery is capital in nature and not deductible as a business expense, although depreciation on machinery is allowed. In contrast, expenses like repairs, rent, salaries, and utilities are revenue in nature and deductible. The line between capital and revenue expenditure is sometimes blurred, particularly in cases of extensive repairs or renovations. The nature, purpose, and benefit of the expenditure help determine its classification.
Personal Expenses and Drawings
Expenses that are ersonal expenses are under any head of income. In the case of sole proprietorships and partnerships, any personal expense incurred by the proprietor or partner cannot be claimed as a business deduction. This includes personal travel, household expenses, family medical bills, or insurance premiums not related to the business. Similarly, drawings by a proprietor or partner, whether in cash or kind, are not business expenses. They are treated as an appropriation of profits and not as deductions. Maintaining a clear distinction between business and personal expenses is essential for accurate computation and compliance. Proper segregation also ensures that the financial statements present a true and fair view of the business performance.
Accounting Method and Taxability
The method of accounting employed by the assessee plays a crucial role in the recognition of income and expenditure. Businesses can adopt either the mercantile system or the cash system of accounting, subject to consistency and compliance with accounting standards. Under the mercantile system, income and expenses are recognized when they accrue, not when cash is received or paid. Under the cash system, income and expenses are recognized only when received or paid. The choice of accounting method affects the timing of recognition of income and deductions. However, certain deductions like those under section 43B are allowed only on an actual payment basis, even if the mercantile system is followed. Assessees are required to follow the same accounting method regularly to ensure comparability and reliability of financial statements. Any change in the method of accounting must be justifiable and disclosed.
Importance of Documentation and Audit
Proper documentation is essential for claiming deductions under PGBP. This includes invoices, bills, vouchers, bank statements, agreements, and tax payment challans. These documents support the genuineness and accuracy of business transactions. In the case of certain businesses exceeding specified turnover thresholds, a tax audit is mandatory under section 44AB. The audit report must be filed along with the income tax return, including particulars of deductions claimed and disallowances made. Auditors are also required to report any non-compliance with tax provisions. The tax audit ensures accuracy in reporting, encourages discipline in financial management, and facilitates smoother assessments. Non-maintenance of books of accounts or failure to get accounts audited may attract penalties and increased scrutiny.
Presumptive Taxation and Deduction Restrictions
Small businesses and professionals can opt for presumptive taxation schemes under sections 44AD, 44ADA, and 44AE. Under these schemes, income is computed on a presumptive basis, and assessees are not required to maintain detailed books of accounts. However, once the presumptive income is declared, no further deductions under sections 30 to 38 are allowed. This simplifies compliance but restricts the ability to claim actual business expenses. The presumptive schemes are optional and beneficial for businesses with low margins or limited accounting capabilities. Once opted for, the scheme must be followed for a continuous period to avoid penalties. These schemes are particularly useful for freelancers, transporters, and small retail businesses.
Impact of Goods and Services Tax (GST)
GST has a significant impact on business accounting and tax deductions. Input tax credit on GST paid on purchases can be claimed against GST liability on sales, thereby reducing the net tax burden. However, GST paid on certain expenditures like motor vehicles, food and beverages, or personal consumption is not eligible for input tax credit. Businesses must reconcile GST returns with income tax returns to ensure consistency. Any mismatch may lead to scrutiny or disallowance of deductions. Proper maintenance of GST invoices, return filings, and reconciliation statements is critical. GST compliance also impacts the overall tax planning and working capital of the business.
Conclusion
Computing income under the head Profits and Gains from Business or Profession involves a careful understanding of deductible and non-deductible expenditures. The Income Tax Act provides a comprehensive framework under sections 30 to 37 for claiming business expenses, while sections like 40, 40A, and 43B outline specific disallowances. The general principle is that only those expenses which are incurred wholly and exclusively for the business and are not capital or personal are allowed as deductions. Accurate classification, documentation, and compliance with legal provisions are essential for effective tax planning and audit readiness. Businesses must maintain transparency in transactions, avoid artificial arrangements, and align their tax practices with regulatory requirements. A clear understanding of tax deductions not only ensures compliance but also contributes to efficient financial management and profitability.