Deemed Profits Chargeable to Tax as Business Income

Recovery against any Allowance or Deduction Allowed earlier [Section 41(1)]

(A) Recovery by the same assessee [Section 41(1)(a)]:

Where an allowance or deduction has been made in the assessment for any year in respect of

1. loss,
2. expenditure or
3. trading liability

incurred by the assessee and subsequently, during any previous year, he (the same assessee) has obtained, whether in cash or in any other manner, whatsoever—

1. any amount in respect of such loss or expenditure; or

2. some benefit in respect of such trading liability by way of remission or cessation thereof,

then, the amount obtained by the assessee or the value of benefit accruing to him shall be deemed to be profit and gains of business or profession and accordingly chargeable to income-tax as the income of that previous year.

It may be mentioned that the business or profession, in respect of which the allowance or deduction has earlier been made, may or may not be in existence in the previous year in which such amount is obtained or the benefit accrued to him.

(B) Recovery by the Successor in Business or Profession [Section 41(1)(b)]:

If in the above case, instead of the assessee, the successor in business has obtained, whether in cash or in any other manner whatsoever,—

1. any amount in respect of which loss or expenditure was incurred by the predecessor; or

2. some benefit in respect of trading liability referred to in clause (A) above by way of remission or cessation thereof,

the amount obtained by successor in business or the value of benefit accruing to the successor in business shall be deemed to be income under the head profits and gains from business or profession of the successor of that previous year.

Sale of Assets used for Scientific Research [Sec. 41(3)] –

Where any capital asset used in scientific research is sold without having been used for other purposes and the sale proceeds, together with the amount of deduction allowed under section 35, exceeds the amount of the capital expenditure, such surplus or the amount of deduction allowed, whichever is less, is chargeable to tax as business income in the year in which the sale took place.

For Example :

the assessee purchases a machinery for Rs.90,000 during the previous year 2013-14 for scientific research and is allowed a deduction of Rs. 90,000 u/s 35. This machinery is sold during the previous year 2017-18 for Rs. 30,000. In this case Rs. 30,000 shall be treated as a business income for the previous year 2017-18.

It may be noted that where the asset, after it ceases to be used for scientific research included is used for the purpose of business or profession, then such asset will form part of the block of asset and its 'cost of acquisition' to be included in the block of assets shall be nil. Subsequently if this asset is sold, section 41(3) will not be applicable as the asset has been included in the block.

Recovery of Bad Debts [Sec. 41(4)] –

Where any bad debt has been allowed as deduction under section 36(1)(vii) and the amount subsequently recovered on such debt is greater than the difference between the debt and the deduction so allowed, the excess realisation is chargeable to tax as business income of the year in which the debt is recovered.

For example,

The assessee who was allowed a deduction of Rs. 60,000 on account of bad debts in the previous year 2015-16, recovers the entire amount of Rs. 60,000 during the previous year 2017-18. The amount so recovered, shall be taxable as income even if that business in respect of which deduction was allowed was not in existence in that year. If he recovers Rs. 15,000 only, then Rs. 15,000 shall be taxable.

Amount withdrawn from Special Reserve created and maintained by certain Financial Institutions [Sec. 41(4A)] –

Where a deduction has been allowed in respect of any special reserve created and maintained under section 36(1)(viii), by certain financial institution, etc. if any amount is subsequently withdrawn from the special reserve, it shall be deemed to be the profits and gains of business or profession and accordingly be chargeable to income-tax as the income of the previous year in which such amount is withdrawn, whether the business is in existence in that previous year or not.

Recovery of any sum in case of Discontinued Business [Section 176(3A)]:

Where any business is discontinued in any year, any sum received after the discontinuance shall be deemed to be the income of the recipient and charged to tax accordingly in the year of receipt, if such sum would have been included in the total income of the person who carried on the business had such sum been received before such discontinuance.

Recovery of any sum in case of Discontinued Profession [Section 176(4)]:

Where any profession is discontinued in any year on account of the cessation of the profession by, or the retirement or death of, the person carrying on the profession, any sum received after the discontinuance shall be deemed to be the income of the recipient and charged to tax accordingly in the year of receipt, if such sum would have been included in the total income of the aforesaid person had it been received before such discontinuance.