Income from Business or Profession

Income from Business or Profession

Income from profits and gains of business or profession is a critical aspect of taxation in India, governed by Section 28 of the Income Tax Act. This section serves as the cornerstone for assessing taxable income generated from trade, commerce, or professional activities. Whether you’re an entrepreneur running a startup, a seasoned professional offering specialized services, or a small business owner, understanding the nuances of Section 28 is essential for effective tax planning and compliance.

This blog explores the essentials of income from business or profession, including the purpose of Section 28, the types of incomes it covers, and the deductible expenses that can optimize your tax liability. You’ll also learn about the step-by-step process to calculate taxable income and the importance of maintaining accurate records to ensure smooth compliance.

Stay tuned to uncover actionable insights and tips to navigate the complexities of Section 28 and align your financial practices with the tax regulations. Whether you’re aiming to save taxes legally or gain a deeper understanding of this pivotal section, this guide is your roadmap.

Heads of Income in Indian Taxation

The Income Tax Act classifies income into five broad categories:

  1. Income from Salary: Earnings from employment, including wages, pensions, and allowances.
  2. Income from House Property: Income derived from letting out a property.
  3. Income from Profits and Gains of Business or Profession: Revenue earned from business operations or professional services.
  4. Income from Capital Gains: Profits from the sale of capital assets like property or stocks.
  5. Income from Other Sources: A residual category that captures all other income.

What is Section 28 of the Income Tax Act?

Section 28 of the Income Tax Act, 1961, lays out the framework for taxing income earned from business or professional activities. It defines the scope of “profits and gains from business or profession” as a specific category of income, distinct from other heads like salary or capital gains.

Under this section, business refers to any trade, commerce, manufacturing, or adventure with a profit motive, while profession includes specialized services that require technical knowledge or skill, such as those provided by doctors, lawyers, or consultants.

Section 28 also lists specific types of income that must be included under this head, such as:

  • Profits from any trade, commerce, or manufacture.
  • Compensation received for discontinuing a business or modifying terms.
  • Income derived from speculative transactions.
  • Any profit or gain from the export of goods or services.
  • Interest earned on capital
  • Remuneration such as salaries, commissions, or bonuses received by partners of a partnership firm.

It ensures that all earnings derived from business or professional pursuits are taxed fairly, contributing to India’s tax base while allowing for deductions and exemptions where applicable.

Purpose of Section 28

The primary purpose of Section 28 is to define and standardize how income from business or profession is assessed for taxation. It ensures consistency in the treatment of such income, offering clarity to taxpayers and preventing ambiguity in tax calculations.

Key objectives include:

  1. Ensuring Comprehensive Taxation
    Section 28 ensures that all forms of income derived from business or professional activities, including direct profits, compensations, and speculative gains, are brought under the tax net.

  2. Facilitating Accurate Tax Assessment
    By clearly specifying what constitutes income from business or profession, Section 28 provides a solid foundation for calculating taxable income, avoiding misclassification under other income heads.

  3. Encouraging Compliance
    By detailing the types of income and allowable deductions, it encourages taxpayers to maintain accurate records and comply with the tax laws, reducing disputes with tax authorities.

In essence, Section 28 not only defines taxable income but also supports fair taxation and promotes financial discipline among business owners and professionals.

Types of Incomes Covered under Section 28

Section 28 of the Income Tax Act, 1961, defines the types of income that are taxable under the head “Profits and Gains from Business or Profession.” Below are the key categories covered under this section:

  1. Profits from Business or Profession
    Any income generated during the financial year through the conduct of a business or profession is taxable under Section 28. This includes:

    • Profits from the sale of goods or services.
    • Professional fees earned by individuals such as consultants, doctors, or lawyers.
    • Earnings from freelance work or contractual assignments.
  2. Salary, Commission, Bonus, etc.
    Section 28 also includes income derived as rewards for services connected to trade or profession. This may include:

    • Salaries, commissions, or bonuses received in connection with a trade or profession.
    • Income earned by partners of a firm in the form of salary, commission, or any other reward for their contribution.
  3. Compensation Payments
    Compensation payments received under specific circumstances are taxable under this section. Examples include:

    • Payments received upon the termination of employment or a professional engagement.
    • Compensation for modifications to employment terms or agency agreements.
    • Payments arising from the termination or alteration of contracts related to managing or supervising Indian companies.
  4. Income from Specific Activities
    Income derived from specific business or professional activities is also taxable under Section 28. Examples include:

    • Profits from import/export activities.
    • Remuneration received by a partner from a partnership firm, such as salary, interest on capital, commission, or bonus.
  5. Receipts under Agreements
    Amounts received as part of agreements that involve:

    • Compensation for refraining from conducting certain business activities.
    • Payments for not disclosing or sharing intellectual property, such as know-how, patents, copyrights, trademarks, licenses, or franchises.
    • Compensation for transferring commercial rights that could be used in the manufacturing or processing of goods or services.
  6. Keyman Insurance Policy Proceeds
    Any sum received by an employer or other persons as a beneficiary under a Keyman Insurance Policy is considered taxable income under Section 28. This policy is typically taken to insure the life of a key employee or partner whose absence would significantly impact the business.

  7. Fair Market Value of Converted Inventory
    When inventory is converted or treated as a capital asset, the fair market value (FMV) of the inventory on the date of conversion is treated as business income and taxed accordingly.

Section 28 ensures that a wide array of incomes linked to business or professional activities is brought under the tax ambit, thereby maintaining a comprehensive tax structure.

Example for Understanding Section 28

Mr. A, a software developer, runs a tech consulting business. His income and transactions for the year are as follows:

  1. Consulting Fees Earned: ₹10,00,000
  2. Compensation for Discontinuing a Contract: ₹2,00,000
  3. Export Incentives for Overseas Projects: ₹1,00,000
  4. Value of Perquisites Received: A free training course worth ₹25,000 offered by a client.

Analysis under Section 28:

  • The ₹10,00,000 consulting fees form the core business income.
  • The ₹2,00,000 received as compensation is taxable under Section 28.
  • The ₹1,00,000 export incentives are part of taxable income.
  • The ₹25,000 value of the free training course is treated as a taxable benefit under Section 28.

Total Income under Section 28:

₹10,00,000 + ₹2,00,000 + ₹1,00,000 + ₹25,000 = ₹13,25,000

This example illustrates how various types of income linked to business or professional activities are aggregated under Section 28 for tax purposes.

Expenses Deductible under Income from Business or Profession

Section 28 of the Income Tax Act allows taxpayers to deduct certain expenses incurred during the course of running a business or profession. These deductions help reduce the taxable income, ensuring that only the net profit is taxed. The list provided below is only a illustrative list.

Key Deductible Expenses:

  1. Employee Costs

    • Salaries, wages, and bonuses paid to employees.
    • Contributions to employee welfare funds like Provident Fund (PF) or Employee State Insurance (ESI).
  2. Operational Expenses

    • Rent, electricity, and other utilities for business premises.
    • Repairs and maintenance costs related to business assets.
    • Telephone, internet, and other communication expenses.
  3. Depreciation

    • Deduction for the wear and tear of tangible and intangible business assets, as per the rates prescribed under the Income Tax Act.
  4. Loan and Interest Expenses

    • Interest paid on loans taken for business purposes.
    • Processing fees or charges related to business loans.
  5. Professional and Legal Fees

    • Fees paid to chartered accountants, lawyers, consultants, or other professionals.
  6. Marketing and Advertising

    • Expenses for advertising, promotions, and other marketing efforts.
  7. Travel and Conveyance

    • Expenses incurred for business-related travel, both domestic and international.
  8. Bad Debts

    • Irrecoverable debts written off as bad debts, provided they were previously included in income.
  9. Miscellaneous Business Expenses

    • Office supplies, software subscriptions, and consumables.
    • Insurance premiums for business assets.

Non-Deductible Expenses:

  • Personal expenses unrelated to business or profession.
  • Income tax payments or penalties for non-compliance.

How to Calculate Income from Business or Profession

Calculating income from business or profession involves a systematic approach to determine the net taxable income after accounting for allowable deductions and expenses. Here’s a step-by-step guide:

Step 1: Determine Gross Income

Add up all the earnings from business or professional activities, including:

  • Revenue from sales or services.
  • Compensation or subsidies related to business.
  • Export incentives, benefits, or perquisites.

Step 2: Subtract Allowable Expenses

Deduct all expenses incurred exclusively for business purposes. Ensure these are supported by proper documentation like invoices, receipts, and contracts.

Example of Expense Categories:

  • Employee salaries and benefits.
  • Rent for business premises.
  • Depreciation on business assets.
  • Travel and marketing expenses.

Step 3: Adjust for Disallowed Expenses

Exclude expenses that are not allowed under the Income Tax Act, such as personal expenses, penalties, or fines.

Step 4: Include Specific Additions

Add back any amounts specified under Section 28 that are not already part of gross income, such as compensation for discontinued contracts or speculative gains.

Step 5: Account for Depreciation and Amortization

Calculate depreciation on tangible and intangible assets as per the rates prescribed by the Income Tax Act and deduct it from the income.

Step 6: Calculate Net Income

The result after subtracting expenses and adjusting for additions is the net income from business or profession.

Formula:

Net Income = Sales – Allowable Expenses + Disallowed expenses

Importance of Record-Keeping for Income from Business or Profession

Effective record-keeping is the backbone of compliance under Section 28 of the Income Tax Act. Accurate records not only help in calculating taxable income but also ensure transparency and minimize disputes with tax authorities.

Why is Record-Keeping Important?

  1. Tax Compliance
    Maintaining proper records ensures that income and expenses are correctly reported, meeting the requirements of the Income Tax Act.

  2. Claiming Deductions
    To claim deductions, you must have supporting evidence, such as invoices, receipts, and agreements.

  3. Audit Requirements
    If your gross receipts or turnover exceed ₹1 crore for businesses (or ₹50 lakh for professionals), your accounts may require an audit under Section 44AB. Proper records simplify this process.

  4. Avoiding Penalties
    Inadequate or inaccurate records can lead to penalties for non-compliance during assessments.

  5. Business Analysis
    Record-keeping not only helps with tax but also provides insights into business performance and financial health.

Types of Records to Maintain

  1. Income Records

    • Sales invoices or bills.
    • Receipts from services rendered.
  2. Expense Records

    • Bills for purchases of goods and services.
    • Rent agreements and utility bills.
    • Receipts for employee salaries, bonuses, and other payments.
    • Documentation of travel, advertising, and marketing expenses.
  3. Asset Records

    • Purchase invoices for machinery, furniture, and equipment.
    • Records of depreciation calculations.
  4. Loan and Liability Records

    • Loan agreements and repayment schedules.
    • Interest payment receipts.
  5. Tax Records

    • Copies of GST returns.
    • TDS records and challans.
    • Previous years’ income tax returns and assessment orders.
  6. Other Relevant Documents

    • Partnership deeds, if applicable.
    • Contracts and agreements related to business.
    • Insurance policies for business assets.

Guidelines for Maintaining Records

  1. Digital Records
    Use accounting software or tools to maintain digital records, which are easier to manage and retrieve during audits.

  2. Retention Period
    As per the Income Tax Act, records should be preserved for at least six years from the end of the relevant assessment year.

  3. Categorization
    Organize records into categories (e.g., income, expenses, assets) for better clarity and quick access.

  4. Audit Trail
    Ensure that all entries in your books of accounts have an audit trail linking them to the supporting documents.

  5. Backup and Security
    Regularly back up your digital records and store physical documents securely to prevent loss or damage.

All Services across Bharat

  1. Income tax
  2. GST
  3. Business registration
  4. Accounting
  5. Audit
  6. ROC filings
  7. Certificates
  8. Project report or CMA data
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