PROFITS AND GAINS OF BUSINESS OR 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. 2

Typical Profit and loss account PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDINGAmount ASALES BCost of sales CGross Profit (A-B) Operating Expenses (1) selling and marketing expenses (2) administrative expenses DTotal operating expenses EEBIDT ( A- B- D = EBIT) FDepreciation and amortization GEBIT HFinancial charges HEBT ITax JPAT 3

»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 4

»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. 5

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 6

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. 8

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. 9

»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. 10

» 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). 11

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. 12

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 13

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. 14 B& 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

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. 16

»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. 17

»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 18

»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. 19

»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. 20

»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. 21

»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. 22

»To understand method of computation of depreciation, one must know the meaning of the following terms: »• BLOCK OF ASSETS »• WRITTEN DOWN VALUE »• ACTUAL COST 23

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 24

Taxpayer may have 13 blocks of Assets NumberNature of assetsRate of depreciation BLOCK 1Building- Residential5% BLOCK 2Building – office, factory, godowns etc10% BLOCK 3Building – Temporary erections100% BLOCK 4Furniture- including electrical fittings10% BLOCK 5Plant and Machinery – including motor cars15% BLOCK 6Ocean –going ships etc20% BLOCK 7Plant and Machinery- Buses, lorries and taxies30% BLOCK 8Plant and Machinery- Aero planes40% BLOCK 9Plant and Machinery- Containers made of glass or plastic 50% BLOCK 10Plant and Machinery- Computers including software60% BLOCK 11Plant and Machinery- energy saving devices80% BLOCK 12Plant and Machinery- Air pollution control equipments100% BLOCK 13Intangible Assets25% 25

WRITTEN DOWN VALUE [SEC. 43(6)] »Written down value for the assessment year will be determined as under: »Step 1 Find out the depreciated value of the block on the April 1, »Step 2 To this value, add “actual cost” of the asset (falling in the block) acquired during the previous year

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

COMPUTATION OF NORMAL DEPRECIATION »From the assessment year 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 28

EXCEPTIONS TO THE RULE Exception 1If the WDV of block of assets is reduced to zero, though the block is not empty Slide 44 Exception 2If the block of assets is empty or ceases to exist on the last day of the previous year ( though the WDV is not zero) 47 Exception 3In the case of imported Cars 51 Exception 4In the case of succession or amalgamation or demerger 52 Exception 5If in the first year in which an asset is acquired, it is put to use for less than 180 days 53 29

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) 30

»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 31

EXAMPLE Blocks of assetRate of depreciation (per cent ) Depreciated value on April 1, 2010 Plant A, B and C1510,40,000 Plant D and E40 2,60,000 Plant F50 70,000 Building A, B, C and D1010,90,600 Building E, F and G57,10,200 Building H, I, J and K10016,90, Compute the written down value from the following information for the assessment year

AssetsDate of purchase Rate of depreciation Actual Cost Rs Plant GApril 6, ,000 Plant HMay 11, ,000 FurnitureJune 6, ,000 CarJuly 7, ,56,000 Building LSeptember 26, ,28,700 ComputerSeptember 27, ,000 Copy rightSeptember 30, ,50, After April 1, 2010, the company purchases the following assets — April 1, 2005, the company purchases the following assets

AssetsDate of saleSale consideration Plant BDecember 20, ,10,900 Plant DJanuary 31, ,000 Building LMarch 6, 20116,00, 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 CarRs 2,74,000 TotalRs 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 ? 35

SOLUTION Block 2 Block 2 - Plant and machinery (rate of depreciation 40%) Depreciated value of the block consisting of Plants D and E Rs 2,60,000 Less : Sale proceeds of Plant D sold during Rs 12,000 Written down value of the block consisting of Plants E on March 31, 2011 Rs 2,48,000 Depreciation for the previous year ? 36

SOLUTION Block 3 Block 3 - Plant and machinery (rate of depreciation 50%) Depreciated value of the block consisting of Plants F on April Rs 70,000 Add : cost of plant G purchased during the year Rs 6,000 Written down value of the block consisting of Plants F and G on March 31, 2011 Rs 76,000 Depreciation for the previous year ? 37

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 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 Depreciation for the previous year ? 38

SOLUTION Block 5 Buildings Block 5 – Building (rate of depreciation 5%) Depreciated value of the block consisting of Buildings E, F, and G on April Rs 7,10,200 Add actual cost of Building L purchased during Rs 7, TOTALRs 14,38,900 Sale proceeds of Building L sold during 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 Depreciation for the previous year ? 39

SOLUTION Block 6 Buildings Block 6 – Building (rate of depreciation 100%) Depreciated value of the block consisting of Buildings H, I,J and K on April 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 Depreciation for the previous year ? 40

SOLUTION Block 7 Furniture Block 7 – Furniture (rate of depreciation 10%) Depreciated value of the block consisting of Furniture on April Nil Purchases made during Rs 56,000 Written down value on March 31, 2011Rs 56,000 Depreciation for the previous year ? 41

SOLUTION Block 8 Plant Block 8 – Plant (rate of depreciation 60%) Depreciated value of the block on April Nil Cost of Computer Purchased during Rs 90,000 Written down value on March 31, 2011Rs 90,000 Depreciation for the previous year ? 42

SOLUTION Block 9 Copyright Block 9 – COPYRIGHT (rate of depreciation 25%) Depreciated value on April Nil Cost of Copyright Purchased during Rs 17,50,000 Written down value on March 31, 2011Rs 17,50,000 Depreciation for the previous year ? 43

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. 44

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 28 th 2010 for Rs and sells Plant A on May 3,2010 for Rs 1,80,000. »In this case as on March , the assesse has Plant B and Plant C in the block of assets, though the written down value of the block is zero. 45

Depreciated value of the block consisting of plant A and BRs 80,000 Add Actual cost of plant C Rs 30,000 TotalRs 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 CRs Nil Less Depreciation fore the previous year Rs Nil Depreciated value of Block consisting of Plants B and C on April Rs Nil 46 No depreciation will be admissible for the previous year ( ie assessment year

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 47

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 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

Depreciated value of the block consisting of plant A and BRs 2,37,000 Add Actual cost of plant C Rs 20,000 TotalRs 2,57,000 Less Sale of plant A, B and CRs 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 ) will be taken as nil. 49

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 50

EXCEPTION 3 IMPORTED CARS Imported 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 The purpose of business or profession outside India Depreciation available The purpose of business or profession in India Depreciation not available Depreciation available 51

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 52

53 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 54

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 and in , it is put to use for less than 180 days. »It is therefore, qualified for half of the usual depreciation ( i.e., 7.5% ) 55

»X Ltd owns two buildings A and B on April ( rate of Dep 10 %, depreciated value Rs 14,15,700) »It purchases on December building C for Rs 3,10,000 ( rate 10%) » and sells building A during the previous year ( say January ) for Rs , then deprecation for the previous year shall be determined as under 56

Depreciated value of the block A & B on April ,15,700 Add : cost of building C purchased3,10,000 Total17,25,000 Less sale proceeds of building A8,70,000 Written value of the block8,55,700 DEPRECIATION ( as building C is purchased in in year 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

Condition oneThe assesse must be engaged in manufacture/production of any article or thing Condition twoNew plant and machinery should be acquired and installed Condition threeIt 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 58 COMPUTATION OF ADDITTIONAL DEPERICIATION : CONDITIONS: To claim additional depreciation following conditions should be satisfied

59 »Rate of additional Depreciation : additional depreciation shall be 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 1BLOCK 2BLOCK 3 Rate of Depreciation 15 %30% 60% No of assets in the block Depreciated Value of the block on April 1, ,00,00025,00,0005,00,000 Additions of plants (new) Plant A57,00,000 Plant B4,00,000 Plant C17,00,000 Sale of old plants ( one plant in each block) 8,00028,70,00042,00, X ltd is engaged in the business of manufacture of computers Hardware since 1995, during the previous year , 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 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 61

Additional depreciation PLANT APLANT BPLANT C Whether additional depreciation available yes Rate of Depreciation 20 %10% 20% Actual cost57,00,0004,00,00017,00,000 Additional depreciation11,40,00040,0003,40,000 62

Computation of normal depreciation Block 1Block 2Block 3 Rate of Depreciation15%30%60% Depreciated Value of the block on April 1, ,00,00025,00,0005,00,000 Additions of plants (new) 57,00,0004,00,00017,00,000 TOTAL75,00,00029,00,00022,00,000 Sale proceeds 8,000 28,70,00042,00,000 WDV March 31,201174,92,000 30,000 NIL NORMAL DEP11,23,8004,500 NIL ADDTIIONAL DEP11,40,00040,0003,40,000 Depreciated value on April ,28,200Nil 63

Computation of Capital Gains Block 1Block 2Block 3 Sale proceeds of old plants ,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 yes Less cost of acquisition22,00,000 Short term capital Gain20,00,000 64

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 65 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 66

»28 chargeability »29 »30 rent building »31 repairs to plant »32 dep »33,34 »35 scientific research/telecom licence/preliminary/exp on merger 67

»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 68