Computation of Income from Business – Problems
The Profit & Loss Account prepared by an accountant follows Accounting Standards. For Tax, we need to adjust it to follow the Income Tax Act. The "Add Back" and "Deduct" method is the key!
The Formula for Computation
Instead of preparing a new P&L, we start with the Net Profit as per P&L A/c and make adjustments.
Start"Net Profit as per P&L Account"
↓
ADD"Disallowed Expenses debited to P&L"
↓
ADD"Business Incomes NOT credited to P&L"
↓
LESS"Non-Business Incomes credited to P&L (Rent, Interest)"
↓
LESS"Allowed Expenses NOT debited to P&L"
↓
Result"Taxable Income from Business"
Problem 1: General Business
Mr. X gives the following P&L for FY 2024-25:
| Debit Side | Amount | Credit Side | Amount |
|---|---|---|---|
| Salaries | 3,00,000 | Gross Profit | 8,00,000 |
| Rent | 50,000 | Rent from House | 1,20,000 |
| Income Tax | 20,000 | Bad Debts Recovered (Allowed earlier) | 30,000 |
| Charity | 5,000 | ||
| Life Insurance (Self) | 10,000 | ||
| Depreciation (Books) | 40,000 | ||
| Net Profit | 5,25,000 | Total | 9,50,000 |
Additional Information:
- Depreciation allowable as per IT Act is ₹35,000.
- Salary includes ₹20,000 paid to domestic servant.
- Bad Debts recovered were allowed in 2021.
Solution:
Computation of Business Income
| Net Profit as per P&L A/c | ₹5,25,000 |
| Add: Add: Disallowed Expenses (Inadmissible) | |
| Add: - Income Tax (Personal/Direct Tax) | ₹20,000 |
| Add: - Charity (Not business exp) | ₹5,000 |
| Add: - Life Insurance Premium (Personal) | ₹10,000 |
| Add: - Depreciation (Book figure) | ₹40,000 |
| Add: - Salary to domestic servant (Personal) | ₹20,000 |
| Subtotal | ₹6,20,000 |
| Add: Less: Incomes to be treated separately | |
| Less: - Rent from House (Taxable under House Property) | (₹1,20,000) |
| Add: Less: Expenses Allowed but not debited | |
| Less: - Depreciation allowed as per IT Rules | (₹35,000) |
| Taxable Income from Business | ₹4,65,000 |
Notes:
- Bad Debts Recovered (Allowed earlier) is Business Income (Section 41(1)), so it remains part of profit (no adjustment needed).
- Book Depreciation is added back fully; Tax Depreciation is deducted.
Problem 2: Partnership Firm (Salary/Interest to Partners)
M/s ABC & Co. (Partnership Firm) P&L:
- Net Profit: ₹2,00,000
- Debited:
- Interest to Partners @ 20%: ₹40,000
- Salary to Partners: ₹3,00,000
- Donation to Political Party: ₹10,000
Solution:
Firm's Business Income
| Net Profit as per P&L | ₹2,00,000 |
| Add: Add: Disallowed Expenses | |
| Add: - Donation to Political Party (80GGC deduction, not exp) | ₹10,000 |
| Add: - Interest to Partners (Excess over 12%) (40k * 8/20) | ₹16,000 |
| Add: - Salary to Partners (Add full, allow later) | ₹3,00,000 |
| Book Profit | ₹5,26,000 |
| Add: Less: Allowable Remuneration (Sec 40(b)) | |
| Add: - On first 3L: 2,70,000 (90%) | |
| Add: - On balance 2.26L: 1,35,600 (60%) | |
| Less: - Total Limit: 4,05,600 vs Actual 3,00,000 (Lower) | (₹3,00,000) |
| Taxable Business Income | ₹2,26,000 |
Problem 3: Cash Payments and 43B Dues
Mr. Raj P&L Net Profit: ₹8,00,000 Adjustments required:
- Purchase of goods ₹25,000 paid in Cash.
- GST Liability ₹40,000 unpaid till due date of filing return.
- Audit Fees ₹10,000 unpaid (but allowed on accrual generally).
- Opening Stock Overvalued by 10% (Amount ₹1,10,000).
Solution:
Adjusted Business Profit
| Net Profit | ₹8,00,000 |
| Add: Add: Disallowed Items | |
| Add: - Cash Purchase (>10k) u/s 40A(3) | ₹25,000 |
| Add: - Unpaid GST u/s 43B | ₹40,000 |
| Add: Adjustment for Opening Stock Valuation | |
| Add: - Overvaluation reduces profit, so Add back (1.1L - 1L) | ₹10,000 |
| Add: Less: Audit Fees (Allowed on accrual basis) | Nil |
| Taxable Business Income | ₹8,75,000 |
Summary of Common Adjustments
| Item in P&L | Treatment | Reason |
|---|---|---|
| Rent to House Property | Deduct | Taxed under HP head |
| Dividend Income | Deduct | Taxed under Other Sources |
| Income Tax / Wealth Tax | Add Back | Personal nature disallowed |
| GST / Customs Duty | Add Back if Unpaid | Section 43B (Payment basis) |
| Provision for Bad Debts | Add Back | Disallowed (only actual write-off allowed) |
| Donations / Charity | Add Back | Application of income, not expense |
| Capital Expenditure | Add Back | Claim Depreciation instead |
Quiz Time! 🎯
Test Your Knowledge
Question 1 of 5
1. Rent from House Property credited to P&L A/c should be:
Next Chapter: Business/Profession Practicals! 📝
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