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Procedure for Computing Business Income – Step-by-Step

₹50 lakh accounting profit = ₹50L taxable income? Not at all! Personal expenses, depreciation differences, disallowed expenses - all need adjustments. Let's master the systematic procedure to compute taxable business income.

Overview - From Books to Tax

Accounting profit (as per books) ≠ Taxable profit (as per Income Tax Act)

Why different?

  • Books follow Companies Act/Accounting Standards
  • Tax follows Income Tax Act
  • Many differences in treatment!

Step-by-Step Procedure

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Step 1: Net Profit as per Profit & Loss Account

Starting point: Net Profit from books

Format:

Revenue/Turnover
(-) Cost of Goods Sold (COGS)
= Gross Profit
(-) Operating Expenses
= EBITDA
(-) Depreciation as per books
(-) Interest
= Net Profit (before tax)

This is book profit, NOT taxable profit!

Step 2: Add Back - Expenses Debited but Not Allowed

Add back to profit:

1. Personal Expenses (Section 37(1) - not for business):

  • Personal car fuel
  • Family medical bills
  • Personal travel

2. Disallowed Expenses:

  • Section 40: Interest/salary to partners beyond limits
  • Section 40A:Payments > ₹10k in cash (disallowed)
  • Section 43B: Unpaid statutory dues (not allowed on provision basis)

3. Capital Expenditure (if wrongly debited):

  • Building purchase (should be capitalized)
  • Machinery purchase

Example additions:

  • Personal car expenses: ₹50,000
  • Cash payment >₹10k: ₹30,000
  • Unpaid ESI/PF: ₹20,000
  • Total add back: ₹1,00,000

Step 3: Add Back - Provisions Not Allowed

Provisions (estimated expenses) often not allowed:

Not allowed:

  • Provision for bad debts
  • Provision for warranty
  • Provision for loss on contracts

Allowed:

  • Actual bad debts written off (Section 36)
  • Actual warranty expenses paid

Why?: Tax on cash/mercantile basis, not estimated provisions

Step 4: Deduct - Incomes Credited but Exempt/Taxable Elsewhere

Deduct from profit (taxed separately or exempt):

1. Exempt Incomes (Section 10):

  • Agricultural income
  • Dividend (taxable under Other Sources)
  • Capital gains (separate head)

2. Incomes Taxable Under Other Heads:

  • Interest on FD (Other Sources)
  • Rental from building (House Property)

Why deduct?: Already taxed elsewhere or exempt, shouldn't be taxed again as business income

Step 5: Depreciation Adjustment

Books depreciation ≠ Tax depreciation

Add back: Depreciation as per books (charged in P&L)

Deduct: Depreciation as per Income Tax Act rates

Usually: Tax depreciation > Book depreciation (benefit!)

Example:

  • Book depreciation (Companies Act): ₹8,00,000
  • Tax depreciation (IT Act): ₹12,00,000

Adjustment:

  • Add back: ₹8,00,000
  • Deduct: ₹12,00,000
  • Net effect: -₹4,00,000 (profit reduced by ₹4L)

Step 6: Add - Deemed Profits (Section 41, 43, 43CA)

Deemed profits (not in books):

1. Section 41: Remission of liability

  • Creditor waives ₹5L debt → ₹5L deemed profit

2. Section 43CA: Sale of land/building below stamp duty value

  • Sold land for ₹80L, stamp duty value ₹1 cr → ₹20L deemed profit

3. Unrecorded cash sales (if found in search)

Complete Computation Format

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Practical Example

ABC Pvt Ltd - FY 2024-25:

P&L Account:

  • Turnover: ₹2 crore
  • Operating profit: ₹60,00,000
  • Less: Depreciation (books): ₹8,00,000
  • Less: Interest: ₹5,00,000
  • Net Profit: ₹47,00,000

Adjustments needed:

  • Personal car expenses debited: ₹80,000
  • Cash payment to supplier (₹15k): ₹15,000 (disallowed)
  • Provision for bad debts: ₹1,20,000
  • Dividend income credited: ₹50,000 (taxable as Other Sources)
  • Agricultural income: ₹30,000 (exempt)
  • Tax depreciation as per IT Act: ₹12,00,000

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Book profit: ₹47,00,000 Taxable income: ₹44,35,000 (₹2.65L less due to higher tax depreciation!)

Common Adjustments - Quick Reference

ADD BACK:

  • Personal expenses
  • Provisions (bad debts, warranty)
  • Book depreciation
  • Cash payments >₹10k
  • Unpaid statutory dues (ESI, PF if not paid before due date)
  • Penalties/fines
  • Wealth tax
  • Income tax paid

DEDUCT:

  • Exempt incomes (agricultural)
  • Other head incomes (dividend, interest, rent)
  • Tax depreciation
  • Actual bad debts written off (if provision was added back)

Special Cases

Case 1: Presumptive Taxation (Section 44AD)

Small businesses (turnover < ₹2 crore):

Can declare 8% of turnover as income (no detailed computation needed!)

Example:

  • Turnover: ₹1.5 crore
  • Deemed income: ₹1.5 cr × 8% = ₹12 lakh (final, no adjustments!)

Benefit: Avoid detailed books, audit

Case 2: Professional Income (Section 44ADA)

Professionals (doctors, CAs, lawyers):

50% of gross receipts if < ₹50 lakh

Summary

  • Procedure: Start with book profit → Add disallowed expenses → Deduct exempt incomes → Adjust depreciation → Add deemed profits = Taxable business income
  • Add back: Personal expenses, provisions, book depreciation, cash payments >₹10k, unpaid statutory dues
  • Deduct: Exempt incomes (agricultural), other head incomes (dividend, rent), tax depreciation
  • Depreciation: Add book depreciation, deduct tax depreciation (usually tax > book, reducing profit)
  • Deemed profits: Section 41 (liability remission), 43CA (below circle rate), unrecorded income
  • Format: Systematic P&L adjustments to arrive at PGBP income
  • Presumptive: 44AD (8% of turnover for small business), 44ADA (50% for professionals)

Quiz Time! 🎯

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Next Chapter: Revenue vs Capital Expenses! 💼

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