Profits and Gains of Business or Profession

Part D of Chapter IV is the engine room of the Income-tax Act. At 41 sections (Sections 26 through 66), it dwarfs every other part in volume, complexity, and commercial significance. This is the code that governs the taxation of every shopkeeper, manufacturer, trader, professional, partnership firm, and corporation in India. No other part of the Act generates as much litigation, as many assessment adjustments, or as much revenue.

The seven-layer architecture: The 41 sections are best understood as seven functional layers through which every item of business income and expenditure must pass. Layer 1 (Sections 26-27): Scope and charging — what is business income? Layer 2 (Sections 28-33): Specific allowable deductions — rent, repairs, employee welfare, bad debts, interest, depreciation. Layer 3 (Section 34): The general deduction and its absolute exclusions (capital, personal, illegal, CSR). Layer 4 (Sections 35-37): Disallowances that override even otherwise valid deductions (TDS failure, cash payments, payment-basis requirements). Layer 5 (Section 38): Deemed profits — recapture of previously allowed deductions. Layer 6 (Sections 39-43): The cost and WDV computation machinery — the mathematical foundation for depreciation and capital gains. Layer 7 (Sections 44-57): Specialised regimes — preliminary expenses, scientific research, investment-linked deductions, mineral prospecting, forex, telecom, construction contracts, insurance. Running parallel to these is the simplified track: presumptive taxation (S.58-61), accounts (S.62), and audit (S.63).

The cumulative filter: A deduction must survive every layer to be actually allowable. An expense may be genuinely incurred for business (passing S.34) but disallowed under S.35 because TDS was not deducted, or under S.36 because it was paid in cash. The layers operate cumulatively, not alternatively. A practitioner must test every material expense against all seven layers before claiming it. This chapter analyses each layer in sequence.

The accrual principle and its overrides: Business income is computed on the mercantile/accrual basis: income is recognised when the right to receive is established, and expenses when the liability to pay is incurred. This principle is subject to three major overrides: (a) Section 37 mandates payment-basis treatment for seven categories of expenses (taxes, PF contributions, leave encashment, etc.); (b) Section 38 deems certain amounts as income only when actually recovered; and (c) the Income Computation and Disclosure Standards (ICDS) notified under S.276(2) create specific accrual/recognition rules for categories such as construction contracts (S.57), forex (S.43), and government grants.

Structural fidelity: The business income provisions in the 2025 Act are the most faithful reproduction of the 1961 Act. The old Sections 28-44D are renumbered as Sections 26-66, but the substance is nearly identical. Depreciation (block assets, WDV, prescribed rates), disallowances (TDS, cash), deemed profits, and presumptive taxation are all carried forward without material change.

Notable changes: (a) S.37(2)(g) adds MSME payments to payment-basis list — with no return-due-date grace period. (b) Presumptive thresholds under S.58 incorporate the enhanced digital receipt limits (Rs.3Cr / Rs.75L) from Finance Act 2023. (c) S.57 codifies the percentage-of-completion method for construction contracts (previously under ICDS III). (d) S.53 introduces deemed full value of consideration for transfer of non-capital assets (land/building) at stamp duty value — previously applicable only to capital assets. (e) Goodwill exclusion from depreciable intangible assets, introduced from TY 2020-21, is now codified in S.33(12)(a)(ii)(G) read with S.2(17).

Section 26 is an expansive charging provision enumerating eleven categories of income chargeable under this head. It goes far beyond the ordinary meaning of ‘business profits’:

S.26(3) — Speculation as a separate business: When speculative transactions constitute a business, it is deemed distinct and separate from all other business. Losses of speculation business can only be set off against speculation profits (S.113), not against regular business income. The segregation is mandatory. ‘Speculative transaction’ is defined in S.2(101): a transaction settled otherwise than by actual delivery or transfer of the commodity or script. Exceptions: hedging transactions by traders, delivery-based transactions in shares through recognised stock exchanges, and eligible transactions in derivatives through stock exchanges.

S.26(4) — Residential rental override: Even if the assessee is in the business of letting properties, rental income from a residential house is taxable ONLY under ‘Income from house property.’ This prevents real estate companies from claiming business deductions (salary, interest, administration) against residential rental income. Commercial property rental may remain under this head where the letting is incidental to business or involves substantial services.

Section 27 — Method of computation: Section 27 mandates that income referred to in S.26 shall be computed as per Sections 28 to 60, ‘except section 58.’ This exception means presumptive taxation under S.58 operates as an alternative, self-contained regime, overriding the regular computational provisions. An assessee either computes under the regular regime (S.28-54) or the presumptive regime (S.58), not both simultaneously.

4C.4.1 The Two-Tier Deduction System

The Act creates a deliberate two-tier system. The first tier (S.28-33, S.44-48) provides SPECIFIC deductions for identified expenses. The second tier (S.34) provides a GENERAL residuary deduction. The distinction matters: specific deductions have their own conditions and limitations; the general deduction requires the expense to be non-capital, non-personal, and wholly and exclusively for business.

4C.4.2 Section 28 — Premises, Machinery, Plant, Furniture

Six deductions for premises and asset costs: (a) insurance premium against damage/destruction; (b) land revenue, local rates, municipal taxes; (c) rent for leased premises; (d) current repairs to owned premises (not capital); (e) repairs to leased premises where lessee bears cost; (f) current repairs to machinery/plant/furniture (not capital). S.28(2) mandates proportionate restriction for mixed-use (business + personal). The AO determines the ‘fair proportionate part.’ The distinction between ‘current repairs’ (deductible) and ‘capital improvement’ (not deductible but depreciable) is one of the oldest battlegrounds in tax law. Patching a leaky roof is current repair; adding a new floor is capital.

4C.4.3 Section 29 — Employee Welfare

Employer contributions to RPF, approved superannuation, NPS (up to 14% of salary for Central Government, 10% for others), approved gratuity fund are deductible within prescribed limits. The critical S.29(1)(e) requires that employee contributions (PF, ESI) received by the employer must be credited to the fund by the ‘due date’ under the relevant labour law — typically the 15th of the following month. The Supreme Court in Checkmate Services v. CIT (2022) held this date is an absolute deadline: late deposit by even one day results in permanent disallowance. The return-due-date grace period under S.37(3) does NOT apply to employee contributions under S.29.

4C.4.4 Section 31 — Bad Debts

Dual-track treatment: (a) Banking/financial institutions (S.31(1)): provision for bad debts is deductible (8.5% of income + 10% of rural advances for scheduled banks; 5% for foreign banks, PFIs, NBFCs); (b) All others (S.31(2)): actual write-off required — debt must be written off in accounts and must have been previously offered as income (or represent money lent in banking/money-lending business). TRF Ltd v. CIT (Supreme Court, 2010) established that mere write-off suffices — no obligation to prove the debt is actually bad. Any subsequent recovery is taxable as deemed profit under S.38(1)(d).

4C.4.5 Section 32 — Interest, STT, Zero Coupon Bonds, Special Reserves

This section consolidates several important deductions: (a) employee bonus/commission (not payable as dividend); (b) interest on business borrowings — with the critical proviso in S.32(b)(i) that interest for the period from borrowing to first use of asset must be CAPITALISED (added to the cost of the asset, not expensed); (c) credit guarantee fund contributions; (d) pro-rata discount amortisation for zero coupon bonds; (e) special reserves for financial institutions (PFIs, banks, HFCs — up to 20% of eligible business profits, aggregate cap of 2x paid-up capital + reserves); (k) STT and CTT — deductible if transactions are in the course of business and income is under this head. STT is deductible for stock traders but NOT for investors whose income falls under capital gains.

4C.4.6 Section 33 — Depreciation

Depreciation is the single largest deduction for capital-intensive businesses. The 2025 Act retains the block asset, WDV method:

The mandatory depreciation rule (S.33(7)): This is perhaps the most underappreciated provision. Many assessees historically deferred depreciation to more profitable years. S.33(7) eliminates this option: WDV reduces even if depreciation is not claimed. The assessee who fails to claim depreciation simply loses the deduction forever. The mandatory nature also impacts the unabsorbed depreciation carry-forward under S.33(11): if depreciation exceeds business profits, the excess is carried forward indefinitely and set off against any income in succeeding years.

Additional depreciation (S.33(8)-(9)): Available ONLY to manufacturers and power generators on NEW plant and machinery (never used, not office equipment, not vehicles, not ships/aircraft). This is a one-time benefit in the year of acquisition. The 20%/10% rate is on ACTUAL COST (not WDV). Conditions: first use must be by the assessee; asset must not be installed in office/residential premises.

‘Wholly and exclusively’ — the most litigated phrase: These words do not mean ‘necessarily.’ An expense is deductible even if not strictly necessary, provided it is for business (Sassoon J. David v. CIT, Supreme Court). But dual-purpose expenses (partly business, partly personal) are wholly disallowed unless the components can be clearly segregated — S.34(1) does not contemplate proportionate treatment for mixed-purpose expenses (unlike S.28(2)).

Three absolute exclusions (S.34(2)): (a) Expenditure for a purpose which is an offence or is prohibited by law — expanded under S.34(3) to include bribery (payments whose acceptance violates any law governing the recipient’s conduct), compounding of offences, and settlement of contraventions under notified laws. (b) CSR expenditure under S.135 of Companies Act, 2013 — deliberately excluded despite being a statutory obligation. However, if CSR spend independently qualifies as scientific research (S.45) or agricultural extension (S.47), those specific provisions may apply. (c) Political party advertisements.

4C.6.1 Section 35 — Amounts Not Deductible

Section 35 lists amounts NEVER deductible, overriding all other deduction provisions:

(a) Income tax, surcharge, cess: Tax is an appropriation of income, not a cost of earning it. Foreign tax for which credit is available under S.159/160 is also non-deductible (as the taxpayer gets relief through credit mechanism instead).

(b)(i) TDS failure on resident payments — 30% disallowance: If TDS is deductible on any sum payable to a resident and is not deducted or, after deduction, not paid by the return due date, 30% of the sum is disallowed. Reversal occurs in the year TDS is actually paid. If the payer is not treated as assessee-in-default under S.398(2) because the payee declared the income and paid tax, the payer is deemed compliant.

(b)(ii) TDS failure on NR payments — 100% disallowance: For interest, royalty, FTS, or any other sum chargeable under the Act payable outside India or to a non-resident/foreign company, the ENTIRE payment is disallowed if TDS is not deducted or not paid by the return due date. This is the most severe disallowance in the Act — it makes TDS compliance on cross-border payments an absolute imperative. A Rs.1 crore royalty payment without TDS results in full Rs.1 crore disallowance.

(e) Partner remuneration and interest: Five restrictions: (i) no deduction for remuneration to non-working partners; (ii) must be authorised by the partnership deed for the relevant period; (iii) aggregate working partner remuneration capped at Rs.3,00,000 or 90% of book profit (whichever higher) on first Rs.6L, plus 60% of balance; (iv) interest to partners capped at 12% p.a. simple interest; (v) where an individual is a representative partner, interest paid to the individual in personal capacity is excluded from the cap.

4C.6.2 Section 36 — Cash Payments and Related Party Restrictions

S.36(2)-(3) — Related party payments: The AO can disallow expenditure to ‘specified persons’ (relatives, directors, partners, AOP/HUF members, or 20%+ voting power/profit share holders) if excessive or unreasonable. This is a domestic transfer pricing provision.

S.36(4)-(8) — Cash payment disallowance: Any payment exceeding Rs.10,000 per person per day, made otherwise than by account payee cheque/draft/electronic mode, is FULLY disallowed. For goods carriage transport: Rs.35,000 threshold. S.36(5) extends to deferred liabilities: if an expense was deducted on accrual basis but payment is later made in cash above the threshold, the cash payment becomes deemed income. S.36(9) disallows marked-to-market losses except under ICDS.

4C.6.3 Section 37 — Payment-Basis Deductions

Section 37 overrides the accrual principle for seven categories of expenses. These are deductible ONLY when actually paid:

Section 38 is the recapture mechanism — it brings back into income amounts previously allowed as deductions or depreciation. Five categories: (a) benefit from cessation/remission of a trading liability, or recovery of previously deducted loss/expenditure; (b) balancing charge on asset disposal (sale price exceeds WDV, capped at original cost); (c) sale of scientific research asset exceeding deductions; (d) recovery of bad debts previously written off; (e) withdrawal from special reserves under S.32(e). These deemed profits are taxable even if the business has ceased (S.38(5)), and in the case of succession/amalgamation/demerger, the successor bears the liability (S.38(4)).

4C.8.1 Section 39 — Actual Cost

Section 39 determines actual cost for depreciation purposes. Basic rule: actual cost to the assessee, reduced by: (a) cost met by any other person; (b) GST input credit claimed; (c) excise/customs duty credit; (d) subsidy/grant/reimbursement relatable to acquisition. S.39(2): cash payments exceeding Rs.10,000/day for asset acquisition are excluded from actual cost — NO depreciation on the cash-paid portion (permanent loss). Thirteen specific circumstances in S.39(4) Table modify the cost — amalgamation, demerger, gift, inheritance, reconversion from scientific research use, reacquired assets, and others. S.39(5)-(6) anti-avoidance: if the AO (with Joint Commissioner approval) finds the main purpose of transfer was to inflate cost for depreciation, the AO can determine actual cost at a fair figure.

4C.8.2 Section 41 — Written Down Value

Sections 42-43 — Foreign exchange fluctuations: S.42 addresses variations in liability for foreign-acquired assets due to exchange rate changes. The variation is added to or reduced from actual cost (or capital expenditure or cost of acquisition for capital gains). S.43 provides that all forex gains/losses on monetary items, non-monetary items, forward contracts, and translation reserves are computed per ICDS notified under S.276(2). This codifies the treatment that was previously governed only by ICDS and accounting standards.

4C.9.1 Section 44 — Preliminary Expenses

Expenditure incurred before business commencement or for extension/new unit — on feasibility reports, project reports, market surveys, engineering services, legal charges, company registration, prospectus costs — is amortised over five years at 1/5th per year, starting from the year of commencement/completion. Total deductible preliminary expenses are capped at 5% of the cost of the project OR 5% of capital employed (at the assessee’s option, for Indian companies). Non-company assessees must get accounts audited for the year(s) of expenditure.

4C.9.2 Section 45 — Scientific Research

Three channels of deduction: (a) S.45(1): in-house R&D — both revenue and capital expenditure (excluding land) on scientific research related to the business are fully deductible. Pre-commencement R&D salary and materials (within 3 years before business starts) are deemed incurred in the year of commencement. (b) S.45(2): enhanced deduction for in-house R&D facility of companies in biotechnology or manufacturing (not in Schedule XIII), subject to approval by prescribed authority. (c) S.45(3): contributions to approved research associations, universities, companies with R&D objects, national laboratories, or IITs under approved programmes. S.45(6) prevents double benefit: if capital expenditure is deducted under S.45, depreciation under S.33 is not available on the same asset.

4C.9.3 Section 46 — Investment-Linked Deduction for Specified Businesses

This is the successor to old S.35AD. It allows deduction of the ENTIRE capital expenditure incurred for specified businesses in the year of expenditure (100% write-off instead of depreciation over years). Fourteen specified businesses qualify, including: cold chain facilities, agricultural warehousing, natural gas pipelines, 2-star+ hotels, 100-bed+ hospitals, slum rehabilitation housing, affordable housing, fertilizer plants, container depots, bee-keeping, sugar warehousing, slurry pipelines, semiconductor fabrication, and infrastructure development.

Key conditions: (a) Not set up by splitting/reconstruction of existing business. (b) No transfer of previously used P&M. (c) Eight-year lock-in: if asset is diverted to non-specified use within 8 years, the entire deduction (minus notional depreciation) is reversed as deemed income. (d) No Chapter VIII-C deduction for the same business. (e) Cash payments >Rs.10,000 and expenditure on land/goodwill/financial instruments are excluded from eligible capital expenditure. (f) In amalgamation/demerger, the benefit transfers to the successor entity.

4C.9.4 Sections 47-52 — Other Specialised Provisions

Section 47 — Agricultural extension and skill development: Expenditure (excluding land/building) on notified agricultural extension projects (any assessee) or skill development projects (companies only) is fully deductible.

Section 48 — Tea/coffee/rubber development: Deposit-based deduction computed per Schedule IX for growers-cum-manufacturers.

Section 49 — Site restoration fund: Petroleum/natural gas businesses with Central Government agreements can claim deductions for deposits into site restoration accounts (Schedule X).

Section 50 — Trade/professional associations: If member subscriptions fall short of expenditure incurred for common interest, the shortfall is deductible (capped at 50% of total income computed before this deduction).

Section 51 — Mineral prospecting amortisation: Expenditure on prospecting/extracting minerals (listed in Schedule XII) is amortised over 10 years (1/10th per year from year of commercial production). Expenditure on land/building acquisition and depreciable assets is excluded. Audit required for non-corporate assessees.

Section 52 — Telecom spectrum and licence fees: Capital expenditure on spectrum fees and telecom licences is amortised over the licence/spectrum validity period. VRS payments are amortised over 5 years. Amalgamation/demerger costs are amortised over 5 years.

4C.9.5 Sections 53-57 — Special Computation Rules

Section 53 — Stamp duty value for non-capital asset transfers: When land/building (held as stock-in-trade) is transferred and consideration is less than stamp duty value, the stamp duty value is deemed to be the full value of consideration. A 10% tolerance band applies: if stamp duty value does not exceed 110% of consideration, actual consideration prevails. This mirrors the capital gains provision in S.78 and prevents under-reporting by builders selling flats below stamp duty value.

Section 54 — Oil exploration business: Special deduction regime for businesses with Central Government participation agreements for prospecting/extracting mineral oils.

Section 55 — Insurance business: Profits of insurance business (including mutual insurance and co-operative insurance) are computed per Schedule XIV, overriding normal computation provisions.

Section 56 — Financial institution interest on bad debts: Interest on bad/doubtful debts of specified financial institutions is taxable on earlier of credit to P&L or actual receipt — a special provision overriding the general accrual rule.

Section 57 — Construction and service contracts: Profits from construction contracts and service contracts must be determined on percentage-of-completion method per ICDS. Exceptions: (a) service contracts with duration ≤90 days — project completion method; (b) indeterminate-acts contracts — straight line method. Contract revenue includes retention money; contract costs exclude incidental income (interest, dividends, capital gains).

Section 58 provides a simplified regime where income is deemed at specified percentages of turnover/receipts, eliminating the need for detailed books and audit. Three categories:

Five-year lock-in (S.58(7)): Once profit is declared under Sl.No.1, the assessee must continue for the next five years. Exit before completion triggers a 5-year bar from re-entering the regime. This does not apply to Sl.Nos.2 and 3.

No separate deductions (S.58(4)): The deemed rate is treated as including ALL expenses. No depreciation, rent, salary, or interest is separately deductible.

Deemed depreciation (S.58(6)): WDV is reduced as if full depreciation was claimed each year. This prevents WDV accumulation during presumptive years.

Firm’s carve-out (S.58(5)): For firms under Sl.No.2, salary and interest to partners are deductible from deemed income, subject to S.35(e) limits.

Non-resident presumptive (S.61): Parallel regime for non-residents in specified businesses (shipping, aircraft, civil construction, supply of P&M on hire, turnkey projects, royalty/FTS from government PE).

Section 62 — Maintenance of accounts: Mandatory when turnover/gross receipts exceed Rs.25 lakh (profession) or Rs.40 lakh (business) in any of the three preceding years. Prescribed books: cash book, journal, ledger, bills issued (>Rs.25), original expense bills (>Rs.50), receipt book. Specified professions (law, medicine, accountancy, engineering, architecture, technical consultancy, interior decoration, authorised representative, film artist, company secretary, IT) have the lower Rs.25 lakh threshold.

Section 63 — Tax audit: Mandatory when: (a) business turnover > Rs.1 crore (or >Rs.10 crore if cash receipts and payments are each ≤5% of total); (b) profession gross receipts > Rs.50 lakh; (c) presumptive assessee under S.58(Sl.1 or 3) declares profit below deemed rate. Audit by a chartered accountant before 30 September (or 31 October if transfer pricing applies). Penalty for non-compliance: 0.5% of turnover or Rs.1.5 lakh, whichever is less.

[End of Chapter IV-C (Profits and Gains of Business or Profession). Chapter IV-D: Capital Gains follows.]