Tag: Tax Planning Strategies

Profit and Gains of Business or Profession (PGBP) represent another important head of income under the Indian Income Tax Act, 1961. This head encompasses earnings derived from business activities, including trade, commerce, manufacturing, professions, vocation, or any other activity undertaken with a profit motive. Understanding the tax treatment of PGBP is essential for businesses, professionals, freelancers, and self-employed individuals.

In view of Section 2(13), business includes any:

(a) Trade

(b) Commerce

(c) Manufacture

(d) Any adventure or concern in the nature of trade, commerce or manufacture. It covers every facet of an occupation carried on by a person with a view to earning profit.

• The word “business” is one of large and indefinite import and connotes something which occupies attention and labour of a person for the purpose of profit.
• Business arises out of commercial transactions between two or more persons. One cannot enter into a business transaction with oneself.

As per section 2(36), profession includes vocation. As profits and gains of a business, profession or vocation are chargeable to tax under the head “Profits and gains of business or profession”, distinction between “business”, “profession” and “vocation” does not have any material significance while computing taxable income. What does not amount to “profession” may amount to “business” and what does not amount to “business” may amount to “vocation”.

Business Incomes Taxable under the head of ‘Profit and Gains of Business or Profession’ (Section 28).

Under section 28, the following income is chargeable to tax under the head “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(ii);
• Income derived by a trade, professional or similar association from specific services performed for its members;
• The value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession;
• Any profit on transfer of the Duty Entitlement Pass Book Scheme;
• Any profit on the transfer of the duty free replenishment certificate;
• Export incentive available to exporters;
• Any interest, salary, bonus, commission or remuneration received by a partner from firm;
• Any sum received for not carrying out any activity in relation to any business or profession or not to share any know-how, patent, copyright, trademark, etc.;
• fair market value of inventory as on the date on which it is converted into, or treated as, a capital asset determined in the prescribed manner;
• Any sum received under a Keyman insurance policy including bonus;
• any sum received (or receivable) in cash or kind, on account of any capital asset (other than land or goodwill or financial instrument) being demolished, destroyed, discarded or transferred, if the whole of the expenditure on such capital asset has been allowed as a deduction under section 35AD;
• Income from speculative transaction.

Business Income Not Taxable under the head ‘Profit and Gains of Business or Profession’

In the following cases, income from trading or business is not taxable under section 28, under the head “Profits and gains of business or profession”:

• Rental income in the case of Dealer in Property:

Rent of house property is taxable under section 22 under the head “Income from house property”, even if property constitutes stock-in-trade of recipient of rent or the recipient of rent is engaged in the business of letting properties on rent.

• Dividend on Shares in the case of a Dealer-in-Shares:

Dividends on shares are taxable under section 56(2)(i), under the head “Income from case of a dealer-in-shares other sources”, even if they are derived from shares held as stock-in-trade or the recipient of dividends is a dealer-in-shares. Dividend received from an Indian company is not chargeable to tax in the hands of shareholders (this rule is subject to a few exceptions).

• Winnings from Lotteries, etc.

Winnings from lotteries, races, etc., are taxable under the head “Income from other sources” etc. (even if derived as a regular business activity).

• Interest received on Compensation or Enhanced Compensation:

Such interest is always taxable in the year of receipt under the head “Income from other sources” (even if it pertains to a regular business activity). A deduction of 50 % is allowed and effectively only 50 % of such interest is taxable under the head “Income from other sources”.

Profits derived from the aforesaid business activities are not taxable under section 28, under the head “Profits and gains of business or profession”. Profits and gains of any other business are taxable under section 28, unless such profits are exempt under sections 10 to 13A.

Mode of Taxation on Certain Incomes (Section 145B)

Section 145B has been inserted by the Finance Act, 2018. It is applicable from the assessment year 2017-18 onwards. It provides mode of taxation of the following incomes:

1. Interest received by an assessee on compensation or on enhanced compensation, shall be deemed to be the income of the year in which it is received (however, it is taxable under section 56 under the head “Income from other sources”).
2. The claim for escalation of price in a contract or export incentives shall be deemed to be the income of the previous year in which reasonable certainty of its realization is achieved.
3. Assistance in the form of subsidy (or grant or cash incentive or duty drawback or waiver or concession or reimbursement) as referred to in section 2(24)(xviii) shall be deemed to be the income of the previous year in which it is received, if not charged to income tax for any earlier previous year.

Basic Principles for computing income Taxable under the head ‘Profit and Gains of Business or Profession’

1. Business or profession carried on by the assessee:

Business or profession should be carried on by the assessee.

2. Business or profession should be carried on during the previous year:

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 (not necessarily throughout the previous year). There are a few exceptions to this rule.

3. Income of previous year is taxable during the following assessment year:

Income of business or profession carried on by the assessee during the previous year is chargeable to tax in the next following assessment year. There are, however, certain exceptions to this rule.

4. Tax incidence arises in respect of all businesses or professions:

Profits and gains of different businesses or professions carried on by the assessee are not separately chargeable to tax. Tax incidence arises on aggregate income from all businesses or professions carried on by the assessee. If, therefore, an assessee earns profit in one business and sustains loss in another business, income chargeable to tax is the net balance after setting off loss against income. However, profits and losses of a speculative business are kept separately.

5. Legal ownership vs. beneficial ownership:

Under section 28, it is not only the legal ownership but also the beneficial ownership that has to be considered. The courts can go into the question of beneficial ownership and decide who should be held liable for the tax after taking into account the question as to who is, in fact, in receipt of the income which is going to be taxed.

6. Real profit vs. anticipated profit:

Anticipated or potential profits or losses, which may occur in future, are not considered for arriving at taxable income of a previous year. This rule is, however, subject to one exception: stock-in-trade may be valued on the basis of cost or market value, whichever is lower.

7. Real profit vs. Notional profit:

The profits which are taxed under section 28 are the real profits and not notional profits. For instance, no person can make profit by trading with himself in another capacity.

8. Recovery of sum already allowed as deduction:

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.

9. Mode of book entries not relevant:

The mode or system of book-keeping cannot override the substantial character of a transaction.

10. illegal business:

The income-tax law is not concerned with the legality or illegality of a business or profession. It can, therefore, be said that income of illegal business or profession is not exempt from tax.

Accounting Methods:

Taxpayers engaged in business or profession have the flexibility to adopt either the cash basis or the mercantile (accrual) basis of accounting for computing taxable income. Under the cash basis, income is recognized when received, and expenses are recognized when paid. Under the mercantile basis, income is recognized when earned, and expenses are recognized when incurred, irrespective of actual receipt or payment. Taxpayers are required to maintain proper books of accounts and records to support their accounting method.

Presumptive Taxation Scheme:

To simplify the tax compliance burden for small businesses and professionals, the Income Tax Act provides for a presumptive taxation scheme under Sections 44AD, 44ADA, and 44AE. Under these provisions, eligible taxpayers can declare income at a prescribed rate (usually a percentage of turnover or gross receipts) without maintaining detailed books of accounts. This scheme offers administrative relief and ensures a minimum level of tax compliance for small taxpayers.

Depreciation Allowance:

Businesses are allowed to claim depreciation on assets used for business purposes, such as machinery, equipment, vehicles, buildings, and intangible assets. Depreciation represents the gradual wear and tear, obsolescence, or loss in value of assets over time. The Income Tax Act prescribes depreciation rates for different categories of assets, and taxpayers can claim deductions for depreciation expenses while computing taxable income under PGBP.

Set-off and Carry-forward of Losses:

If a business or profession incurs a loss in a financial year, such loss can be set off against income from any other head of income, including salary, house property, capital gains, or other business income, in the same year. Any unadjusted loss can be carried forward for up to eight subsequent years and set off against income from the same head. However, losses from speculative business are subject to specific set-off and carry-forward restrictions.

Clubbing of income under the Indian Income Tax Act is a crucial concept aimed at preventing tax evasion and ensuring fair taxation. It essentially refers to the inclusion of certain incomes in the hands of someone other than the actual recipient or earner of that income. This provision is primarily intended to curb tax avoidance strategies wherein individuals may attempt to transfer their income to family members or related entities with lower tax liabilities.

Introduction to Clubbing of Income:

Clubbing provisions are laid out in Sections 60 to 64 of the Indian Income Tax Act, 1961. These sections outline situations where income, though earned by one person, is deemed to be the income of another person and taxed accordingly. The underlying principle is to prevent the misuse of legal entities or relationships to evade taxes.

Applicability of Clubbing Provisions:

Clubbing applies primarily in cases where there’s an attempt to transfer income without transferring the underlying asset or where income is diverted to a spouse, minor child, or any other person or entity. The provisions cover various scenarios, including income from assets transferred to spouse, minor child’s income, income from assets transferred to a person for the benefit of the spouse or minor child, etc.

Specific Provisions of Clubbing:

• Transfer of Assets to Spouse:

If an individual transfers assets to their spouse without adequate consideration, any income derived from such assets will be deemed to be the income of the transferor.

• Minor Child’s Income:

Income arising to a minor child from assets transferred by a parent (either directly or indirectly) is clubbed with the income of the parent who has higher taxable income.

• Transfer of Income without Transfer of Asset:

If a person transfers income without transferring the underlying asset, the income is clubbed with the income of the transferor. This provision prevents the practice of assigning income without transferring the ownership of assets.

• Income from Assets Transferred to a Person for the Benefit of Spouse or Minor Child:

If an individual transfers assets to another person for the benefit of their spouse or minor child, any income arising from such assets is clubbed with the income of the transferor.

Exceptions to Clubbing Provisions:

• Minor Child’s Income:

There are exceptions when the minor child’s income is not clubbed with the parent’s income, such as when the child has earned the income through manual work or any activity involving application of skill, knowledge, or experience.

• Assets Acquired Through Previous Year’s Income:

Income arising from assets acquired by a spouse or minor child with their own income (not from income clubbed in previous years) is not clubbed with the income of the transferor.

Implications of Clubbing Provisions:

• Tax Liability:

The income clubbed under these provisions is taxed in the hands of the transferor at the applicable tax rates.

• Compliance Requirements:

Transferors need to disclose such clubbed income in their tax returns and pay taxes accordingly.

• Penalties:

Non-compliance with clubbing provisions may attract penalties and legal consequences, including tax evasion charges.

Case Studies and Examples:

• Property Transfer:

If an individual transfers property to their spouse without adequate consideration, any rental income generated from that property will be taxed in the hands of the transferor.

• Investment in Minor Child’s Name:

If a parent invests in financial instruments in the name of their minor child, any income generated from those investments will be clubbed with the parent’s income for taxation purposes.