profits and gains of business or profession ( part 1)

PROFITS AND GAINS OF BUSINESSOR PROFESSION ( Part 1)

PROFITS AND GAINS OF BUSINESSOR PROFESSION ( Part 1)

INDTRODUCTION

»The income from business and profession is known as profit and gains.

» While calculating the profit and gains, we deduct various expenses from it.

» The expenses to be deducted for calculating the gain are defined in the income tax act.

» Sections 30 to 37 cover expenses, which are expressly allowed as deduction .

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Typical Profit and loss accountPROFIT AND LOSS ACCOUNT FOR THE YEAR ENDING Amount

A SALES

B Cost of sales

C Gross Profit (A-B)

Operating Expenses

(1) selling and marketing expenses

(2) administrative expenses

D Total operating expenses

E EBIDT ( A- B- D = EBIT)

F Depreciation and amortization

G EBIT

H Financial charges

H EBT

I Tax

J PAT

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»While computing business income, sections 40, 40A and 43B cover expenses which are not deductible.

»Expenses deductions under section 30 to 37 are of two types.

»The first is specific deductions which are covered under section 30 to 35 and second is general deductions which are covered under section 36 and 37

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»Specific deductions are allowed only to some of the businesses while general deductions are allowed to all the businesses.

»There are certain provisions which allow an assessee to calculate the profit on the presumptive basis, i.e., the profit is presumed on certain basis.

»These provisions are contained under section 44.

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OBJECTIVES

AFTER GOING THROUGH THIS LESSON YOU SHOULD BE ABLE TO UNDERSTAND:

»• Calculation of taxable profit and gains

»• Calculation of depreciation

»• Various specific deductions allowed

»• Various general deductions allowed

»• Presumptive taxation provisions

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BASIS OF CHARGE

Under section 28, the following income is chargeable to tax under the head “Profits and gains of business or profession”:

» a. profits and gains of any business or profession;

» b. any compensation or other payments due to or received by any person specified in section 28(ii);

» c. income derived by a trade, professional or similar association from specific services performed for its members;

» d. the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession;

» e. export incentive available to exporters;7

» f. any interest, salary, bonus, commission or remuneration received by a partner from firm;

» g. any sum received for not carrying out any activity in relation to any business or not to share any know-how, patent, copyright, trademark, etc.;

» h. any sum received under a Key man insurance policy including bonus;

» i. profits and gains of managing agency; and

» j. income from speculative transaction.

» Income from the aforesaid activities is computed in accordance with the provisions laid down in sections 29 to 44D.

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METHOD OF ACCOUNTING

»There are two main methods of accounting—mercantile system and cash system.

» In the case of mercantile system, net profit or loss is calculated after taking into consideration all income and expenditure of a particular accounting year irrespective of the fact whether income is not received or expenditure is not actually paid during the accounting period.

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»Therefore, if books of account are kept by an assessee on the basis of mercantile system, income of a business or profession, accrued during the previous year, is taxable whether it is received during the previous year or in a year preceding or following the previous year.

»Similarly, expenditure of business or profession, relating to the previous year, is deductible even if it is not paid during the previous year.

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» In the case of cash system of accounting, on the other hand, a record is kept of actual receipts and actual payments of a particular year.

»If books of account are kept by an assessee on the basis of cash system of accounting, income collected during the previous year is taxable whether it relates to the previous year or a year preceding or following the previous year.

» Similarly, expenditure actually paid during the previous year is deductible irrespective of the fact whether it relates to the previous year or some other year(s).

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SCHEME OF BUSINESS DEDUCTIONS

»Section 28 defines various income which are chargeable to tax under the head “Profits and gains of business or profession”. Section 29 permits deductions and allowances laid down by sections 30 to 43D while computing profits or gains of a business or profession.

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SPECIFIC DEDUCTIONS UNDER THE ACT

»Sections 30 to 37 cover expenses, which are expressly allowed as deduction while computing business income .

» Sections 40, 40A and 43B cover expenses which are not deductible.

»The following expenses are expressly allowed as deductions against profits and gains of business or profession

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RENT, RATES, TAXES, REPAIRS AND INSURANCE FOR BUILDING

»Under section 30 : The following deductions are allowed in respect of rent, rates, taxes, repairs and insurance for premises used for the purpose of B& P :

» The rent of premises.

»The amount of repairs (not being capital expenditure)

»Any sum on account of land revenue, local rates or municipal taxes; and

»Amount of any premium in respect of insurance against risk of damage or destruction of the premises.

14B& P= business and profession

REPAIRS AND INSURANCE OF MACHINERY,PLANT AND FURNITURE

»Under section 31 : The expenditure incurred on current repairs (not being capital expenditure) and insurance in respect of plant, machinery and furniture used for business purposes is allowable as deduction under section 31.

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DEPRECIATION

»Depreciation shall be determined according to the provisions of section 32.

»CONDITIONS FOR CLAIMING DEPRECIATION - In order to avail

»depreciation, one should satisfy the following conditions:

»Condition 1 Asset must be owned by the assessee.

»Condition 2 It must be used for the purpose of business or profession.

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»Condition 3 It should be used during the relevant previous year.

»Condition 4 Depreciation is available on tangible as well as intangible assets.

»ASSET SHOULD BE OWNED BY THE ASSESSEE - The asset should be owned by the assessee or the assessee should be the co-owner of the asset.

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»ASSET MUST BE USED FOR THE PURPOSE OF BUSINESS OR PROFESSION

»- The asset, in respect of which depreciation is claimed, must have been used for the purpose of business or profession

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» USER OF THE ASSET IN THE PREVIOUS YEAR - The asset, in respect of which depreciation is claimed, must have been used for the purpose of business.

» Normal depreciation (i.e., full year’s depreciation) is available if an asset is put to use at least for sometime during the previous year. However, depreciation allowance is limited to 50 per cent of normal depreciation, if the following two conditions are satisfied—

» a. where an asset is acquired during the previous year; and

» b. it is put to use for the purpose of business or profession for less than 180 days during that year.

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»DEPRECIATION IS AVAILABLE ON TANGIBLE AS WELL AS INTANGIBLE ASSETS - Under the Income-tax Act, one can claim depreciation in respect of the following assets—

»Tangible assets

»Intangible assets acquired after March 31, 1998

»Building, machinery, plant or furniture Know-how, patents, copyrights, trade marks, licenses, franchises or any other business or commercial rights of similar nature.

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»Building - “Building” means the superstructure only and does not include site.

»Plant - “Plant” includes ships, vehicle, books (including technical know-how report), scientific apparatus and surgical equipments used for the purpose of business or profession.

» It does not include tea bushes or livestock or buildings or furniture and fittings.

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»CONSEQUENCES WHEN ABOVE CONDITIONS ARE SATISFIED – If the above conditions are satisfied, depreciation is available. Depreciation is available whether or not the assessee has claimed the deduction for depreciation in computing his total income.

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»To understand method of computation of depreciation, one must know the meaning of the following terms:

»• BLOCK OF ASSETS

»• WRITTEN DOWN VALUE

»• ACTUAL COST

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BLOCK OF ASSETS [SEC. 2(11)]

The term “Block of Assets” means a group of assets falling within a class of assets comprising

a. Tangible assets , being buildings, machinery, plant or furniture;

b. Intangible assets, being know-how, patents, copyrights, trade marks, licenses, franchises or any other business or commercial rights of similar nature, in respect of which the same percentage of depreciation is prescribed.

In respect of which the SAME % OF DEPRECIATION is prescribed

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Taxpayer may have 13 blocks of Assets

Number Nature of assets Rate of depreciation

BLOCK 1 Building- Residential 5%

BLOCK 2 Building – office , factory, godowns etc 10%

BLOCK 3 Building – Temporary erections 100%

BLOCK 4 Furniture- including electrical fittings 10%

BLOCK 5 Plant and Machinery – including motor cars 15%

BLOCK 6 Ocean –going ships etc 20%

BLOCK 7 Plant and Machinery- Buses, lorries and taxies 30%

BLOCK 8 Plant and Machinery- Aero planes 40%

BLOCK 9 Plant and Machinery- Containers made of glass or plastic

50%

BLOCK 10 Plant and Machinery- Computers including software 60%

BLOCK 11 Plant and Machinery- energy saving devices 80%

BLOCK 12 Plant and Machinery- Air pollution control equipments 100%

BLOCK 13 Intangible Assets 25% 25

WRITTEN DOWN VALUE [SEC. 43(6)]

»Written down value for the assessment year 2011-12 will be determined as under:

»Step 1 Find out the depreciated value of the block on the April 1, 2010.

»Step 2 To this value, add “actual cost” of the asset (falling in the block) acquired during the previous year 2010-11.

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»Step 3 From the resultant figure, deduct money received/receivable (together with scrap value) in respect of that asset (falling within the block of assets) which is sold ,discarded, demolished or destroyed during the previous year 20010-11.

»The resulting amount is the written down value of the block of assets on March 31 2011 relevant for the assessment year 2011-12

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COMPUTATION OF NORMAL DEPRECIATION

»From the assessment year 1988-89 depreciation is admissible on the basis of block of assets. To ascertain the amount of depreciation , one should find out the following :

»Written down block of assets

»Rate of depreciation

»Rule of Computation- The product of aforesaid two is the amount of depreciation

»The aforesaid rule is not applicable in the cases mentioned in next slide

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EXCEPTIONS TO THE RULE

Exception 1 If the WDV of block of assets is reduced to zero , though the block is not empty

Slide 44

Exception 2 If the block of assets is empty or ceases to exist on the last day of the previous year ( though the WDV is not zero)

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Exception 3 In the case of imported Cars 51

Exception 4 In the case of succession or amalgamation or demerger

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Exception 5 If in the first year in which an asset is acquired , it is put to use for less than 180 days

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ACTUAL COST section 43(1)

» It means the actual cost to the assesse as reduced by the proportion of the cost thereof if any as has been met , directly or indirectly , by any other person or authority.

»What is includible in Actual cost : all the expenses directly relatable to acquisition of the asset , cost price of the asset, interest on money borrowed for the purchase of the asset , expenses necessary to bring the asset to site, install it and make it fit for use ( carriage inwards , loading and unloading charges , installation charges etc)

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»Expenses incurred to facilitate the use of the asset. The cost of repairs and modification prior to use of the asset to make it workable, training expenses of the staff , expenses on essential construction and expenses on insurance , power and fuel , incurred before commencement of business

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EXAMPLE

Blocks of asset Rate of depreciation (per cent )

Depreciated value onApril 1, 2010

Plant A, B and C 15 10,40,000

Plant D and E 40 2,60,000

Plant F 50 70,000

Building A, B, C and D 10 10,90,600

Building E, F and G 5 7,10,200

Building H, I, J and K 100 16,90,000

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Compute the written down value from the following information for theassessment year 20011-12

Assets Date of purchase Rate of depreciation

Actual Cost Rs

Plant G April 6, 2010 50 6,000

Plant H May 11, 2010 15 18,000

Furniture June 6, 2010 10 56,000

Car July 7, 2010 15 2,56,000

Building L September 26, 2010

5 7,28,700

Computer September 27, 2010

60 90,000

Copy right September 30, 2010

25 17,50,000

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After April 1, 2010, the company purchases the following assets —April 1, 2005, the company purchases the following assets

Assets Date of sale Sale consideration

Plant B December 20, 2010 25,10,900

Plant D January 31, 2011 12,000

Building L March 6, 2011 6,00,000

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The following assets are transferred —

SOLUTION Block 1

Block 1 - Plant and machinery (rate of depreciation 15%)

Depreciated value of the block consisting of Plants A, B and C

Rs 10,40,000

Add actual cost of plant H and Car Rs 2,74,000

Total Rs 13,14,000

Less : Sale proceeds of Plant B [although sale proceeds of Plant B is more than Rs. 13,14,000, amount to be deducted is restricted to Rs. 13,14,000]

Rs 13,14,000

Written down value of the block consisting of Plants A, C and H on March 31, 2011

NIL

Depreciation for the previous year 2010-11 ?

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SOLUTION Block 2


Depreciated value of the block consisting of Plants D and E

Rs 2,60,000

Less : Sale proceeds of Plant D sold during 2010-11 Rs 12,000

Written down value of the block consisting of Plants E on March 31, 2011

Rs 2,48,000


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SOLUTION Block 3


Depreciated value of the block consisting of Plants F on April 1 2010

Rs 70,000

Add : cost of plant G purchased during the year 2010-11 Rs 6,000

Written down value of the block consisting of Plants F and G on March 31, 2011

Rs 76,000


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SOLUTION Block 4 Buildings

Block 4 – Building (rate of depreciation 10%)

Depreciated value of the block consisting of Buildings A, B, C and D on April 1 2010

Rs 10,90,600

Written down value of the block consisting of Buildings A,B,C and D on March 31, 2011

Rs 10,90,600


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Depreciated value of the block consisting of Buildings E, F, and G on April 1 2010

Rs 7,10,200

Add actual cost of Building L purchased during 2010-11 Rs 7,28.700

TOTAL Rs 14,38,900

Sale proceeds of Building L sold during 2010-11 Rs 6,00,000

Written down value of the block consisting of Buildings E,F and G on March 31, 2011

Rs 8,38,900


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Depreciated value of the block consisting of Buildings H, I,J and K on April 1 2010

Rs 16,90,000

Written down value of the block consisting of Buildings H,I ,J and K on March 31, 2011

Rs 16,90,000


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SOLUTION Block 7 Furniture

Block 7 – Furniture (rate of depreciation 10%)

Depreciated value of the block consisting of Furniture on April 1 2010 Nil

Purchases made during 20010 -11 Rs 56,000

Written down value on March 31, 2011 Rs 56,000


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SOLUTION Block 8 Plant

Block 8 – Plant (rate of depreciation 60%)

Depreciated value of the block on April 1 2010 Nil

Cost of Computer Purchased during 2010-11 Rs 90,000

Written down value on March 31, 2011 Rs 90,000


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SOLUTION Block 9 Copyright

Block 9 – COPYRIGHT (rate of depreciation 25%)

Depreciated value on April 1 2010 Nil

Cost of Copyright Purchased during 2010-11 Rs 17,50,000

Written down value on March 31, 2011 Rs 17,50,000


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EXCEPTION 1

WHEN THE WDV OF A BLOCK IS REDUCED TO ZERO :

»No depreciation is admissible where written down value has been reduced to zero , though the block of assets does not cease to exist on the last day of the previous year.

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Provision illustrated :

»On April 1, 2010 depreciated value of block of asset ( rate of dep 15%) is Rs 80000/- .

» It consist of Plant A and B.

» The Assesse purchases plant C (rate 15%) on December 28th 2010 for Rs 30000 and sells Plant A on May 3 ,2010 for Rs 1,80,000.

»In this case as on March 31 2011, the assesse has Plant B and Plant C in the block of assets, though the written down value of the block is zero.

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Depreciated value of the block consisting of plant A and B Rs 80,000

Add Actual cost of plant C Rs 30,000

Total Rs 1,10,000

Less Sale of plant A , though the plant is sold for Rs 1,80,000, the amount of reduction cannot exceed Rs 1,10,000 ; the difference of Rs 70,000 is the short term capital gain u/s 50 (1)

Rs 1,10,000

WDV of the block consisting of Plant B and C Rs Nil

Less Depreciation fore the previous year 2010-11 Rs Nil

Depreciated value of Block consisting of Plants B and C on April 1 2011

Rs Nil

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No depreciation will be admissible for the previous year 2010-11 ( ie assessment year 2011-12

EXCEPTIONS 2

BLOCK OF ASSET CEASES TO EXIST

»if the block of asset ceases to exist or if all the assets of the block have been transferred and the block of asset is empty on the last day of the previous year , no depreciation is admissible in such case

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Provision illustrated :

»X limited own two plants Plant A and Plant B

» On April 1, 2010 ( rate of depreciation 15 %) , depreciated value on April 1, 2010 : Rs 2,37,000.

»The company purchases Plant C on May 31 2010 for Rs 20000/- and sells Plant A (on April 10 ,2010) , Plant B (on December 12, 2010) and Plant C ( on March 1, 2011) for Rs 10,000 , Rs 15,000 , and Rs 24,000 respectively

»Compute Depreciation for the previous year 2010-11.

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Depreciated value of the block consisting of plant A and B Rs 2,37,000

Add Actual cost of plant C Rs 20,000

Total Rs 2,57,000

Less Sale of plant A , B and C Rs 49,000

WDV of the block ( which is empty) Rs 2,08,000

In the aforesaid case, no depreciation is admissible , as the block of assets ceases to exist on the last day of the previous year . Rs 2,08,000 will be treated as short term capital loss Depreciated value the block on the first day of next previous year (i.e April 1 2011 ) will be taken as nil.

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In the case study given above , if the plant A, B and C are transferred for a consideration which is higher than Rs 2,57,000 ( say Rs 3,57,000) , then no depreciation will be available and Rs 1,00,000 shall be taken as short term capital gain on sale of Plant A , B and C

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EXCEPTION 3 IMPORTED CARSImported cars acquired after Feb 28, 1975 but before April 2001

Imported cars acquired after march 31, 2001

Imported car is used for :

The business of running it on hire for tourist

Depreciation available Depreciation available

The purpose of business or profession outside India

Depreciation available Depreciation available

The purpose of business or profession in India

Depreciation not available

Depreciation available

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Depreciation in case of succession, Amalgamation or Demerger – exception 4

»In the year in which change of owner ship takes place because of the aforesaid reasons , depreciation shall be calculated as Under :

»Find the amount of depreciation of the previous year in the year of which of assets changes on the assumption that succession , amalgamation or demerger has not taken place.

»The amount of depreciation so determined shall be apportioned between the predecessor and the successor as the case may be , in the ratio of number of days for which the assets were used by them during the previous year

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Exception -5

»When the asset is put to use less than 180 days in the year of acquisition.

» If any asset falling within a block of asset is acquired by the assesse during the previous year and it is put to use for the purpose of business or profession for a period of less than 180 days in that previous year , the deduction in respect of such asset shall be restricted to 50% of the amount calculated at the percentage prescribed in the case of block of asset comprising of such asset

THE AFORESAID PROVISION IS APPLICABLE IF THE FOLLOWING CONDITIONS ARE SATISFIED.

Condition one

If the asset is “acquired “ during the previous year

Condition two

It is put to use for a period of less than 180 days

When the two conditions are satisfied , depreciation shall be restricted to 50% of the amount calculated at the percentage prescribed

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POVISION ILLUSTRATED

»X ltd purchases a plant ( dep rate 15%) on May 10 ,2010 .

»It is put to use on January 10, 2011

»In this case , the plant is acquired during 2010-11 and in 2010-11 , it is put to use for less than 180 days .

»It is therefore , qualified for half of the usual depreciation ( i.e. , 7.5% )

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»X Ltd owns two buildings A and B on April 1 2010 ( rate of Dep 10 %, depreciated value Rs 14,15,700)

»It purchases on December 1 2010 building C for Rs 3,10,000 ( rate 10%)

» and sells building A during the previous year 2010-11 ( say January 10 2011 ) for Rs 870000, then deprecation for the previous year 2010-11 shall be determined as under

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Depreciated value of the block A & B on April 1 2010

14,15,700

Add : cost of building C purchased 3,10,000

Total 17,25,000

Less sale proceeds of building A 8,70,000

Written value of the block 8,55,700

DEPRECIATION ( as building C is purchased in in year 2010-11 and put to use for less than 180 days , deprecation on Rs 3,10,000 and on the remaining amount of depreciation will be 10% of Rs 8,55,000-3,10,000)

70,070

Depreciated value of the block of assets on April 1 2011

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Condition one The assesse must be engaged in manufacture/production of any article or thing

Condition two New plant and machinery should be acquired and installed

Condition three It should be eligible plant and machinery

ELIGIBLE PLANT and MACHINERY

Following assets are not eligible for additional depreciation Ships and Aircrafts

Any office appliance or road transport vehicle

Machinery or plant installed in any office or any residential accommodation

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COMPUTATION OF ADDITTIONAL DEPERICIATION :CONDITIONS: To claim additional depreciation following conditions should be satisfied

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»Rate of additional Depreciation : additional depreciation shall be available @ 20 %of the actual cost of new plant and machinery. If however the asset is put to use for less than 180 days in the year in which it is acquired , the rate of additional depreciation will be 10%.

»Additional depreciation is available only in the year in which the new plant and machinery is first put to use

Example

BLOCK 1 BLOCK 2 BLOCK 3

Rate of Depreciation 15 % 30% 60%

No of assets in the block 11 12 17

Depreciated Value of the block on April 1,2010

18,00,000 25,00,000 5,00,000

Additions of plants (new)

Plant A 57,00,000

Plant B 4,00,000

Plant C 17,00,000

Sale of old plants ( one plant in each block)

8,000 28,70,000 42,00,000

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X ltd is engaged in the business of manufacture of computers Hardware since 1995 , during the previous year 2010-11, the following assets are acquired and put to use

Pants A, B and C are acquired during May 2010 and put to use during September 2010. However Plant B is put to use in the last week of March 2011

»Find out the amount of depreciation ,additional depreciation and capital gains

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Additional depreciation

PLANT A PLANT B PLANT C

Whether additional depreciation available

yes yes yes

Rate of Depreciation 20 % 10% 20%

Actual cost 57,00,000 4,00,000 17,00,000

Additional depreciation 11,40,000 40,000 3,40,000

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Computation of normal depreciation

Block 1 Block 2 Block 3

Rate of Depreciation 15% 30% 60%

Depreciated Value of the block on April 1,2010

18,00,000 25,00,000 5,00,000

Additions of plants (new)

57,00,000 4,00,000 17,00,000

TOTAL 75,00,000 29,00,000 22,00,000

Sale proceeds 8,000 28,70,000 42,00,000

WDV March 31,2011 74,92,000 30,000 NIL

NORMAL DEP 11,23,800 4,500 NIL

ADDTIIONAL DEP 11,40,000 40,000 3,40,000

Depreciated value on April 1 2011

52,28,200 Nil Nil

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Computation of Capital Gains

Block 1 Block 2 Block 3

Sale proceeds of old plants

8000 2870000 42,000,000

Whether capital gain is taxable ( the block does not cease to exist , sale proceeds do not exceed the opening balance plus new additions

no no yes

Less cost of acquisition 22,00,000

Short term capital Gain 20,00,000

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UNABSORBED DEPECIATION

STEP ONE

Depreciation allowance of the previous year is first deductible from the income chargeable under the head “profit and gains of business and profession

STEP TWO

If the depreciation allowance is not fully deductible under the head “profit and gains of business or profession “ because of absence or inadequacy of profits , it is deductible from income chargeable under other heads of income ( except income under the head “salaries” ) for the same assessment year

STEP THREE

If the depreciation allowance is still unabsorbed it can be carried forward to the subsequent year (s) by the same assesse

No, time limit is fixed for the purpose of carrying forward of unabsorbed depreciation . It can be carried forward for indefinite period

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While dealing with unabsorbed depreciation one should keep in mind the following steps

»In the subsequent years unabsorbed depreciation can be set off against any income whether chargeable under the head profits and gains or any income ( except Salaries).

»In the matter of set off , following order of priority is followed :

»Current Depreciation

»Brought forward business loss

»Unabsorbed depreciation

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»28 chargeability

»29

»30 rent building

»31 repairs to plant

»32 dep

»33,34

»35 scientific research/telecom licence/preliminary/exp on merger

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»36 health insurance/bonus /interset/bad debts

»37 advertisement /general ded

»40 amount not deductible

»43 disallowance of unpaid liability

»41 deemed profit

»44 maintenance of books

»44 audit of accounts

» valuation of stock

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profits and gains of business or profession ( part 1)

Documents

expenses deductions

computing business income

indtroductionthe income

following income

net profit

typical profit

various expenses

various general deductions