Basic understanding of the five heads of Income & Tax Computation for a Company, Income under the head” Profits and gains of business or profession” and its Computation Basis of charge, Methods of Accounting, Specific Deductions, Specific Disallowances

Income under the head” Profits and Gains of Business or Profession” and its computation Basis of charge

Under the Indian Income Tax Act, the income earned by a company from its business or profession is taxed under the head “Profits and Gains of Business or Profession.” The computation of income under this head is based on certain principles and rules outlined in the Income Tax Act. Here are the key aspects of the computation basis of charge for this head:

  • Revenue Recognition: The income under this head is generally recognized on an accrual basis, meaning it is recognized when it becomes due, irrespective of whether it has been received or not.
  • Deductible Expenses: The income earned from the business or profession is arrived at by deducting allowable expenses from the gross receipts. Allowable expenses are those that are incurred wholly and exclusively for the purpose of the business or profession.
  • Depreciation: Depreciation is the systematic allocation of the cost of assets used in the business over their useful life. It is an allowable deduction and is computed based on the rates and methods prescribed by the Income Tax Act.
  • Provisions and Reserves: Specific provisions and reserves created by the company for meeting liabilities or losses are allowed as deductions in computing the taxable income.
  • Valuation of Stock: The closing stock of goods held by the company is valued at cost or net realizable value, whichever is lower, for the purpose of computing the taxable income.
  • Income from Speculative Transactions: Income derived from speculative transactions, such as intra-day trading in stocks or commodities, is treated separately and subject to specific rules and tax treatment.
  • Business Losses and Carry Forward: Business losses incurred during the financial year can be set off against other income under the same head or other heads of income. Unused losses can be carried forward for a certain period, subject to certain conditions.
  • Presumptive Taxation: The Income Tax Act provides for a presumptive taxation scheme for certain eligible small businesses or professions, where income is deemed to be a certain percentage of the gross receipts. This allows for a simplified method of computation.

Methods of Accounting Tax for a Company

In India, companies have the option to follow different methods of accounting for tax purposes. The Income Tax Act, 1961 provides certain methods of accounting that can be adopted by companies. The two main methods of accounting for tax purposes in India are:

  • Cash Basis Accounting: Under the cash basis of accounting, income and expenses are recognized when they are received or paid, respectively. This method is based on actual cash flow, and transactions are recorded when cash is physically received or disbursed. However, certain specific incomes and expenses may have different recognition rules even under the cash basis accounting.
  • Accrual Basis Accounting: The accrual basis of accounting follows the matching principle, where income and expenses are recognized when they are earned or incurred, irrespective of actual cash flow. Under this method, revenue is recognized when it becomes due, regardless of whether it has been received or not. Similarly, expenses are recognized when they are incurred, irrespective of actual payment.

Companies in India are generally required to follow the accrual basis of accounting for tax purposes, unless they fall under the specified turnover threshold and opt for the presumptive taxation scheme.

Additionally, there are certain other methods and rules that may be applicable for specific circumstances or types of businesses. These include:

  • Project Completion Method: For certain construction and infrastructure projects, the project completion method may be followed, where revenue is recognized based on the stage of completion of the project.
  • Percentage of Completion Method: The percentage of completion method is applied to long-term construction contracts, where revenue and expenses are recognized based on the proportionate completion of the contract.
  • Specialized Accounting Methods: Certain industries or businesses may have specific accounting methods prescribed by the Income Tax Act. For example, the Indian accounting standards (Ind AS) may be applicable to companies that fall within their purview.

It’s important to note that the method of accounting chosen by a company for tax purposes should be consistently followed from year to year, and any change in the method requires approval from the tax authorities.

It is advisable to consult with a qualified tax professional to determine the appropriate method of accounting for your specific circumstances and to ensure compliance with the applicable tax laws and regulations.

Specific Deductions for a Company

Companies in India are eligible for various deductions under the Income Tax Act, 1961. These deductions are available for specific expenses or investments incurred by the company. Here are some of the common deductions available to companies:

  • Depreciation: Companies can claim depreciation on assets used in their business, including buildings, machinery, vehicles, and furniture. The depreciation deduction is allowed based on the prescribed rates and methods specified in the Income Tax Act.
  • Deduction for Rent: Companies can claim a deduction for rent paid for the premises used for business purposes. The deduction is subject to certain conditions and limitations.
  • Employee Expenses: Companies can claim deductions for salaries, wages, bonuses, and other employee-related expenses incurred in the course of business. However, certain employee benefits like contributions to the employee provident fund (EPF) and employee state insurance (ESI) are not allowed as deductions.
  • Research and Development (R&D) Expenses: Companies engaged in scientific research and development activities can claim deductions for R&D expenses. The deduction is available for revenue and capital expenses related to R&D activities.
  • Export Promotion Expenses: Companies can claim deductions for expenses incurred in promoting export activities. This includes expenses for participation in trade fairs, exhibitions, and overseas business development.
  • Charitable Contributions: Companies can claim deductions for donations made to eligible charitable institutions or funds. The deduction is limited to a specified percentage of the company’s profits.
  • Start-up Deductions: Start-up companies can avail themselves of certain deductions and incentives under the Start-up India initiative. These include a deduction of 100% of profits for three out of the first ten years of operation, subject to certain conditions.
  • Incentives for Special Economic Zones (SEZs): Companies operating in SEZs can avail themselves of various tax incentives, including deductions on profits derived from eligible business activities within the SEZ.
  • Deduction for Export Profit: Companies engaged in the export of goods or services can claim a deduction for profits derived from such exports. The deduction is available under certain conditions.
  • Deduction for Losses: Companies can carry forward and set off losses incurred in previous years against future profits, subject to certain conditions and limitations.

Specific Disallowances for a Company

Under the Indian Income Tax Act, 1961, there are certain expenses and items that are disallowed for deduction while computing the taxable income of a company. These disallowances are intended to ensure that only genuine business expenses are claimed as deductions. Here are some common disallowances for a company:

  • Personal Expenses: Any expenses that are of a personal nature or not incurred wholly and exclusively for business purposes are generally disallowed. This includes expenses such as personal travel, personal entertainment, and personal fines or penalties.
  • Dividend Distribution Tax: Dividend distribution tax paid by the company on the distribution of dividends to shareholders is not allowed as a deduction.
  • Interest Expenses on Unauthorized Loans: Interest expenses incurred on loans or advances taken from certain specified entities or persons, where the interest payment is not subject to tax, may be disallowed.
  • Contributions to Political Parties: Contributions made by the company to political parties or electoral trusts are disallowed as deductions.
  • Certain Taxes and Levies: Certain taxes and levies, such as wealth tax, gift tax, and securities transaction tax, are not allowed as deductions.
  • Capital Expenditures: Expenses incurred for the acquisition or improvement of capital assets, such as land, buildings, plant, and machinery, are generally not allowed as revenue deductions. However, depreciation on such assets is allowed as a deduction.
  • Fines and Penalties: Any fines or penalties imposed by regulatory authorities or courts are typically disallowed as deductions.
  • Provisions for Contingent Liabilities: Provisions made for contingent liabilities that are not based on actual liabilities or estimates supported by evidence may be disallowed.
  • Excess Managerial Remuneration: Excessive payments made as managerial remuneration that exceed the prescribed limits under the Companies Act, 2013, may be disallowed as deductions.
  • Specified Speculative Business Losses: Losses incurred from speculative transactions, such as intra-day trading in stocks or commodities, are disallowed and cannot be set off against other income.

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