Taxation

Income Tax on Profits and Gains of Business or Profession

Income Tax on Profits and Gains of Business or Profession

The word,’ business’ is defined under Section 2(13) of the Income Tax Act. According to it, business means any trade, commerce or manufacture or concern in the nature of trade, commerce or manufacture. The word ‘profession’ is described in Section 2(36) of the Income Tax Act. According to it, the profession includes vocation. For taxability purposes, Income Tax Act dissects the taxable income of an assessee into five different categories. Business profits come under the third category, head of income. The present article deals with detailed overview regarding this topic in reference to the Income Tax Act.

Five Categories of Heads of Income

Income from the assessee is divided into five categories, also known as the five heads of income under the Income Tax Act. This is done for the proper facilitation, convenience and for easy computation of taxes. It is also done for smooth and seamless cash flow. The five main heads of income under the Income Tax Act are mentioned below:-

  • Income from Salary

The income under the salary head involves an individual’s or an employee’s advanced salary, basic wages, pension, commission, gratuity, annual bonus etc.

This head includes the rental income that an individual or a landlord derives from the rent and by giving his house on lease. This includes the income derived from both commercial and residential properties.

  • Income Derived from Profits and Gains of Business or Profession

This head includes all sorts of income that an individual earns from carrying a business or a profession. This also includes salaries, bonuses and profits earned from a business organisation’s partnership.

  • Income from Capital Gains

It includes the transfer and sale of any capital gains as an investment. It is taxable under the head of capital gains.

  • Income from Other Sources

Any income which does not follow under any of the above-mentioned income heads falls in the income from other sources. This category includes income from lottery, gambling, gaming etc.

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What is Business Income or Profit In reference To the Income Tax Act

Business income is nothing, but it is the sum of the profits that are earned from carrying out any business or profession. This profit deduced from carrying out any business is taxable under the head of profits and gains of business or profession. It can be calculated using a simple formula.

Total Revenue – Total Expense = Profit / Income that is Taxable from Business

Business Income Taxable under Income Tax Act

Business profits are defined under Section 28 of the Income Tax Act. According to this section,

  • Any profit organs from carrying out any business or profession come under the head of profits and gains of business or profession.
  • Any benefit or perk or a perquisite arising from carrying out any business or profession comes under the income head of profits and gains of business or profession.
  • Any type of interest, salary, commission or remuneration will be taxable under this head.
  • Sums or profits received under the agreement of forbearance or non-compete agreement, trademark, and copyright agreements are taxable under the head of profits and gains of business or profession.
  • Sums received under Keyman Insurance Policy are taxable under the head of profits and gains of business.
  • Income derived by trade or a profession related to specific services.

According to Section 29 of the Income Tax Act 1961, all the incomes mentioned under section 28 of the Income Tax Act shall be charged in accordance with the provisions and rules laid out from Section 30 to Section 43D of the Income Tax Act, 1961.

Cases in Which the Taxpayer is Unable to Find the Type of Income in the Above List

There are certain cases in which an individual or a taxpayer is unable to identify the type of income mentioned under section 28 of the Income Tax Act, of 1961. In these cases following conditions or ways can be used to identify whether the income falls into the income head of profit and gains of business or profession or not.

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Section 28 lays down specific prerequisites that are needed for an income to fall under the income head category of profits and gains of business or profession. These conditions are given below:-

  • For fulfilling the criteria to come under the profits and gains of a business or a profession income head, it is mandatory for an individual to carry a business or a profession.
  • The business should be carried on by an assessee for some time during the financial year.
  • The income charge should be in respect of the profits and gains that are derived from that business or profession in that particular financial year.
  • The charge should be related to that business or profession carried out by the assessee. The business or profession can be under the name of the taxpayer’s own name or someone else’s name.

However, the foremost and main point to determine whether income falls under the head of capital and gains of business or not is if a business or a profession was carried on by the assessee or the taxpayer at any time during the financial year. Though it is not necessary that the business or profession was continued throughout the financial year or till the end of it.

Exceptions to the Above-Mentioned Rule

Earlier in this article, we talked about the main or primary requirement for an income to be classified under the head of profits and gains of a business or profession as the existence of a business or profession. However, there are certain exceptions to this above-mentioned rule.

Following incomes fall under the income head of profits and gains of business or profession even if the business wasn’t carried on by the assessee or the taxpayer during the previous financial year. These are mentioned below:-

  • Recovery against any type of loss, trading liability or expenditure which was earlier allowed as a deduction.
  • Balancing charges in the case of electric companies.
  • The amount that is drawn from the special reserve, and the recovery against bed debts.
  • Receipts from the previous or discontinued business which was carried out by the employee.
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Business Income Not Taxable Under Income Tax Act

The following incomes are not taxable under Section 28 of the Income Tax Act 1961[1], under the income head of ‘profits and gains of business or profession’. These are mentioned below:-

  • Income deduced from the rent of house property is not taxable under this income head. It is taxable under the income from house property.
  • Dividends on shares in case of a dealer in shares are not taxable under the head of profits and gains of business or profession. These are taxable under income from other sources.
  • Prize money won from lotteries, gaming, and gambling are not taxable under the head of profits and gains of business or profession. These are taxable under the head of income from other sources.
  • The interest which is received upon compensation does not fall under this income head. It cannot be taxable under this particular head. This interest is taxable under income from other sources.

These are some of the incomes which are not taxable under the head of profits and gains of business or profession.

Conclusion

The article dealt with the specific income head mentioned under Section 28 of the Income Tax Act, 1961, i.e. ‘Income Tax on Profits and Gains of Business or Profession’. For the income to fall in this category, it is required for the existence of a business or profession. That business or profession should have been carried out by the taxpayer during a particular financial year. We also discussed exceptions to this above-mentioned rule.

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