A Comprehensive Legal & Practical Analysis

Tax Law Series | June 2025

Abstract

The Income-tax Act, 2025 (hereinafter “the Act”) consolidates and modernises India’s direct tax framework, replacing the Income-tax Act, 1961 after more than six decades of incremental amendments. Among the five heads of income enumerated under the Act, “Profits and Gains of Business or Profession” (PGBP) represents the most commercially significant and legally complex head, encompassing income derived from trade, commerce, manufacturing, vocation, and professional services.

This article provides a rigorous examination of the PGBP provisions under the 2025 Act — covering chargeability, computation methodology, allowable deductions, disallowances, special schemes, and the evolving judicial landscape. It is aimed at tax practitioners, chartered accountants, corporate counsel, and senior finance professionals.

1. Introduction and Legislative Background

The Income-tax Act, 2025 represents a significant step toward simplifying and modernising India’s income-tax legislation. The Act seeks to improve readability, reduce interpretational complexity, and reorganise various provisions without materially altering several long-established principles of taxation.

Among the various heads of income, Profits and Gains of Business or Profession (PGBP) remains one of the most commercially important and frequently litigated areas of tax law. The provisions governing this head determine the taxability of income earned through business activities, professional services, manufacturing operations, trading transactions, consultancy assignments, and other commercial ventures.

The taxation framework under the Act is built upon certain fundamental principles, including:

Taxation of real income;
Recognition of business expenditure incurred wholly and exclusively for business purposes;
Distinction between capital and revenue receipts;
Allowance of depreciation on business assets;
Regulation of related-party transactions;
Prevention of tax avoidance through specific anti-abuse provisions; and
Special taxation regimes for small businesses and professionals.

The Act also addresses modern business models involving digital transactions, cross-border commerce, virtual digital assets, and non-resident enterprises conducting business with Indian customers.

Consequently, a clear understanding of the PGBP provisions is essential for businesses, professionals, tax practitioners, auditors, and corporate decision-makers alike.

2. Chargeability: What Constitutes ‘Business or Profession’?

2.1 Statutory Definition

The 2025 Act defines ‘business’ to include any trade, commerce, manufacture, or adventure or concern in the nature of trade, commerce, or manufacture. ‘Profession’ is defined to include a vocation. Together, these terms sweep in a wide spectrum of economic activities — from organised manufacturing enterprises to individual freelance consultants.

2.2 Incomes Chargeable as PGBP

The following receipts and deemed receipts are taxable under this head:

Profits and gains arising from any business or profession carried on by the assessee at any time during the previous year
Any compensation or other payment due to or received by a person in connection with the termination or modification of any agency, management contract, or distribution agreement
Income derived by a trade, professional, or similar association from specific services rendered to its members
Value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession
Any interest, salary, bonus, commission, or remuneration paid to a partner by a firm, to the extent chargeable under the firm’s profits
Income from speculative transactions treated as a separate business
Any sum received under a Keyman Insurance Policy, including bonuses
Fair market value of inventory on the date of conversion to capital asset

IMPORTANT: The doctrine of mutuality may shield certain receipts of mutual associations from PGBP taxation, but this exception has been narrowed under the 2025 Act.

3. Basis of Charge and the Concept of ‘Previous Year’

Consistent with the scheme of the Act, PGBP income is assessed on the basis of the previous year — i.e., the financial year ending 31 March immediately preceding the assessment year. For newly commenced businesses, the previous year begins on the date of commencement and ends on 31 March of that financial year.

The 2025 Act retains the concept of ‘accrual basis’ for most business income, while also recognising the ‘cash basis’ for certain professions. The choice of accounting method is significant for timing of recognition of income and expenditure, and the Act lays down specific rules to prevent abuse through method-switching.

4. Computation of Business Income: The Framework

4.1 Net Profit as the Starting Point

The computation of PGBP income begins with the net profit as per the books of account, prepared in accordance with the applicable accounting standards (or ICDS — Income Computation and Disclosure Standards). Adjustments are thereafter made to:

Add back expenditures disallowed under the Act
Deduct incomes not taxable under this head (e.g., capital receipts, dividend income taxable under other heads)
Make ICDS-driven adjustments where the treatment under the accounting standard diverges from the Act

4.2 Income Computation and Disclosure Standards (ICDS)

The 2025 Act statutorily incorporates ICDS, which prescribe specific rules for recognition of revenue, treatment of construction contracts, valuation of inventories, borrowing costs, and government grants. The ICDS framework takes precedence over Indian GAAP (but not Ind AS in all cases) for computing taxable income, even while financial statements may follow a different standard.

PRACTICE NOTE: ICDS XI on Stock-in-Trade, and ICDS IV on Revenue Recognition, are among the most frequently litigated standards under the 2025 Act’s framework.

5. Allowable Deductions

5.1 General Principles

In computing PGBP income, an assessee is entitled to deduct expenditure that is:

Wholly and exclusively incurred for the purposes of the business or profession
Of a revenue (not capital) nature
Actually paid or payable during the previous year (subject to method of accounting)
Not covered by a specific disallowance provision under the Act

The foundational principle — that only revenue expenditure incurred wholly and exclusively for business is deductible — has been preserved from the 1961 Act and reinforced by the Supreme Court’s jurisprudence over decades.

5.2 Specific Allowable Deductions

5.2.1 Rent, Rates, Taxes, Repairs and Insurance

Amounts paid as rent for premises used for business, municipal and local taxes, insurance premiums for business assets, and expenditure on repairs of business premises (where the assessee is not the owner) are fully deductible. Owned premises attract depreciation rather than deductibility of purchase cost.

5.2.2 Depreciation

Depreciation is a cornerstone deduction under PGBP. The 2025 Act provides for Written Down Value (WDV) depreciation on block of assets. Key features include:

Block concept: assets of the same class are grouped and depreciation applied to the block as a whole
Half-year rule: assets put to use for less than 180 days attract 50% of the normal depreciation rate
Additional depreciation of 20% (35% for notified backward areas and new manufacturing units) available in the year of acquisition
Accelerated depreciation for eligible assets under specified schemes
Terminal depreciation/short-term capital loss on sale of entire block

5.2.3 Expenditure on Scientific Research

The 2025 Act incentivises investment in R&D by allowing weighted deduction of 150% (subject to conditions) for in-house R&D expenditure of eligible companies. Contributions to approved scientific research associations and universities attract 100% deduction. The framework is aligned with India’s technology and manufacturing policy objectives.

5.2.4 Amortisation of Preliminary Expenses

One-fifth of preliminary expenses (incurred for setting up or extension of the business) is deductible over five successive years. Eligible expenses include feasibility studies, legal charges for drafting memoranda and articles, and registration fees.

5.2.5 Bad Debts

A debt that has been taken into account in computing income in the current or any earlier year, and that has become bad and is written off as irrecoverable in the books, is deductible. Importantly, the 2025 Act clarifies that it is sufficient if the debt has been written off in the accounts; the assessee need not establish that the debt is, in fact, irrecoverable. Subsequent recovery of bad debts is taxable in the year of recovery.

5.2.6 Employer’s Contribution to Provident Fund and Gratuity

Contributions made by an employer to a recognised provident fund, approved superannuation fund, or approved gratuity fund, within the prescribed limits, are deductible. Contributions beyond the statutory threshold attract disallowance.

6. Disallowances: Expenditure Not Deductible

6.1 Personal and Capital Expenditure

Any expenditure of a personal nature or incurred for capital purposes is not deductible. The line between capital and revenue expenditure has generated extensive litigation, and the courts have evolved a multi-factor test — considering whether the expenditure creates or improves an enduring asset, whether it is recurring, and whether it goes to the profit-earning structure (capital) or the profit-earning process (revenue).

6.2 Payments to Relatives: Section 40A(2)

Expenditure incurred towards payments made to related parties (directors, their relatives, associated concerns) is disallowable to the extent the Assessing Officer considers the payment to be excessive or unreasonable having regard to the fair market value of the goods, services, or facilities provided. The 2025 Act provides an extended definition of ‘relative’ and ‘associated person’ to plug potential avoidance routes.

6.3 Cash Payments Exceeding Prescribed Limits

Expenditure in excess of ₹10,000 made to a single person in a day otherwise than by account payee cheque, draft, or electronic means is disallowed. This limit is reduced to ₹35,000 for payments made to transporters. The provision is designed to promote financial inclusion and a less-cash economy.

6.4 Unpaid Statutory Dues

Amounts payable by the assessee as employer’s contribution to PF/ESI that are not actually paid on or before the due date under the relevant welfare legislation — and in any event before the due date for filing the income-tax return — are disallowed. This rule has been significantly tightened under the 2025 Act compared to the 1961 regime.

6.5 Interest, Royalty, and Fee for Technical Services to Non-Residents

Where tax is deductible at source on payments to non-residents (by way of interest, royalty, or fee for technical services) and such tax has not been deducted or deposited, the expenditure is disallowed to the extent of 30% in the year of payment. The disallowance is reversed in the year of actual tax payment.

6.6 Payments Without PAN / Aadhaar

Payments made without obtaining the permanent account number (PAN) or Aadhaar of the payee, where required under the Act, attract disallowance at a flat 20% of the payment. This provision is a critical compliance pressure point for large organisations with high-volume vendor payments.

COMPLIANCE TIP: Maintaining structured vendor master data — including PAN/Aadhaar, bank details, and nature of payment — is essential to avoid inadvertent disallowances under Section 40A.

7. Special Provisions: Presumptive Taxation Schemes

The 2025 Act retains and refines several presumptive taxation schemes, which provide significant compliance relief to small and medium taxpayers by deeming a fixed percentage of gross receipts or turnover as income, thereby eliminating the need for detailed books of account in many cases.

7.1 Section 44AD: Eligible Businesses

Individual taxpayers, Hindu Undivided Families (HUFs), and partnership firms (excluding LLPs) engaged in eligible businesses — excluding professionals, commission agents, plying/hiring/leasing goods carriages, and persons with agency-type income — with turnover up to ₹3 crore may opt for presumptive taxation at 8% of gross receipts (6% for digitally received payments). An assessee who opts for this scheme for any year and thereafter declares lower income is prohibited from opting for the scheme for the following five years.

7.2 Section 44ADA: Eligible Professions

Resident professionals — including doctors, lawyers, engineers, architects, accountants, and technical consultants — with gross receipts not exceeding ₹75 lakhs may declare income at 50% of gross receipts. For receipts received by account payee cheque or electronic clearing, the threshold has been raised under the 2025 Act. The scheme eliminates the audit requirement for qualifying professionals.

7.3 Section 44AE: Goods Carriage Business

Persons owning not more than ten goods carriages may declare income at ₹1,000 per tonne of gross vehicle weight or unladen weight per month as income from each goods vehicle. This scheme is available even if turnover exceeds the general threshold.

8. Taxation of Digital Businesses and Emerging Models

One of the most significant additions in the 2025 Act is its explicit recognition of income arising from digital business models, platform economies, and data-driven enterprises. Key provisions include:

8.1 Significant Economic Presence (SEP)

The 2025 Act codifies the concept of Significant Economic Presence (SEP) as a nexus rule for non-resident entities. A non-resident having transactions with Indian residents exceeding a prescribed monetary threshold, or engaging with a prescribed number of Indian users, is deemed to have a business connection in India. PGBP income attributable to the SEP is taxable in India, even in the absence of a physical presence.

8.2 Equalisation Levy

While technically outside the income-tax regime (operating as a separate levy), the Equalisation Levy on e-commerce supply of goods or services by foreign e-commerce operators interacts with the PGBP computation and credit mechanism. Amounts subject to equalisation levy are excluded from the scope of income-tax to avoid double taxation.

8.3 Cryptocurrency and Virtual Digital Assets (VDAs)

The 2025 Act introduces a self-contained taxation regime for Virtual Digital Assets. Income from transfer of VDAs is taxed at a flat rate of 30% (plus surcharge and cess), with no deduction permitted except the cost of acquisition. Losses from VDA transactions cannot be set off against any other income. Mining income from VDAs is treated as PGBP and valued at fair market value on the date of mining.

9. Business Losses: Set-off and Carry Forward

The 2025 Act retains a structured framework for treatment of business losses:

Current year intra-head set-off: A loss from one business can be set off against profits of another business in the same assessment year, subject to the exception for speculative losses
Inter-head set-off: Business losses (other than speculative) can be set off against income from any other head in the same year, except income from salaries
Carry forward: Unabsorbed business losses can be carried forward for eight assessment years. Unabsorbed depreciation, however, can be carried forward indefinitely
Continuity of business: For a company to carry forward and set off losses, there is a requirement of at least 51% continuity of shareholding (the beneficial ownership test), except for companies under insolvency proceedings
Speculative losses: Losses from speculative business can only be set off against profits from speculative business and can be carried forward for four years

KEY POINT: Unabsorbed depreciation has no time limit for carry forward — a critical planning consideration for capital-intensive businesses with volatile profitability cycles.

10. Transfer Pricing and Related-Party Transactions

The 2025 Act continues India’s comprehensive transfer pricing regime, under which any international transaction or specified domestic transaction between associated enterprises must be conducted at arm’s length price. The PGBP income of the taxpayer is adjusted upward to the arm’s length price if the actual price paid or charged deviates therefrom.

The prescribed methods for determining arm’s length price include Comparable Uncontrolled Price, Resale Price, Cost Plus, Profit Split, Transactional Net Margin Method, and any other method as may be prescribed. The onus lies on the taxpayer to select and demonstrate the most appropriate method.

The 2025 Act strengthens the secondary adjustment mechanism, requiring taxpayers to either repatriate excess profits or treat the amount as a deemed advance or loan, with corresponding interest imputation. Advance Pricing Agreements (APAs) and Safe Harbour Rules remain available as mechanisms for certainty and litigation reduction.

11. Maintenance of Books of Account and Audit

11.1 Mandatory Books of Account

The 2025 Act prescribes that persons carrying on a business with turnover exceeding ₹25 lakhs, or a profession with gross receipts exceeding ₹10 lakhs, in any of the three years immediately preceding the current year must maintain books of account and other documents in the prescribed form. Failure to maintain books attracts penalty and may lead to best judgment assessment.

11.2 Tax Audit

Persons whose business turnover exceeds ₹1 crore (₹10 crore if the cash transaction ratio is within limits) or whose professional receipts exceed ₹50 lakhs in the previous year are required to obtain a tax audit from a Chartered Accountant. The auditor must report in Form 3CA/3CB and 3CD, covering details of income, deductions, disallowances, and compliance with ICDS. The tax audit report must be furnished on or before 30 September of the assessment year.

12. Special Categories of Business Income

12.1 Non-Resident Shipping Business

Income of non-resident shipping companies is deemed to accrue in India at 7.5% of the amount paid or payable on account of carriage of passengers, livestock, mail, or goods shipped at Indian ports. The 2025 Act extends this fiction to cover digital/electronic freight booking where shipment originates from India.

12.2 Non-Resident Aircraft Operators

Similar to shipping, income of non-resident airline operators is computed at 5% of the aggregate of amounts paid or payable for carriage of passengers or goods loaded at Indian airports.

12.3 Turnkey Projects and Construction Contracts

Income derived by foreign companies from construction, assembly, or installation projects in India is taxable under PGBP. The 2025 Act clarifies the attribution rules for multi-year projects that straddle the previous year boundary, largely adopting ICDS III (Construction Contracts) for recognition purposes.

13. Recent Judicial Trends and Key Decisions

The transition to the 2025 Act does not erase the judicial legacy of over six decades of Income-tax Act, 1961 jurisprudence. Courts have consistently held that decisions interpreting provisions of the 1961 Act that are substantially reproduced in the 2025 Act remain good law unless expressly overridden.

Notable areas of ongoing judicial development include:

Whether software subscription fees constitute royalty or business income under tax treaties — the Supreme Court’s ruling in Engineering Analysis Centre of Excellence has significant implications for PGBP computation of software companies
The character of non-compete payments — capital receipt (not taxable) versus revenue receipt — continues to generate litigation, with courts applying a multifactor contextual test
The treatment of cryptocurrencies held as stock-in-trade versus capital assets before the specific VDA provisions came into force
The deductibility of compounding fees and penalties paid to regulatory bodies — courts have distinguished between payments that are compensatory (deductible) versus those that are punitive (not deductible)
The scope of ‘business connection’ in the context of foreign digital companies operating in India through algorithmic engagement.

14. Interaction with GST and Other Regulatory Frameworks

The PGBP computation under the 2025 Act must be read in conjunction with the Goods and Services Tax (GST) framework. Specific considerations include:

Input Tax Credit (ITC) claimed under GST reduces the cost of inputs and is therefore not separately deductible as a business expense under income tax
Reversal of ITC under GST (e.g., in case of exempt supplies or non-payment to vendors within 180 days) may create a deductible expense in the relevant income-tax year
Penalties and interest paid under GST law are not deductible under income tax to the extent they are penal in nature
For turnover thresholds under presumptive taxation, GST is excluded from gross receipts, consistent with the position that turnover is computed net of taxes collected.

15. Conclusion and Outlook

The PGBP provisions of the Income-tax Act, 2025, represent a carefully calibrated balance between simplification and substantive change. The new Act preserves the foundational architecture — chargeability, the revenue-capital distinction, matching principles, and the deduction-disallowance framework — while modernising the statute for the digital economy, strengthening anti-avoidance measures, and incorporating ICDS-driven precision in computation.

For practitioners, the transition to the 2025 Act demands careful comparison of every operative provision against its 1961 Act counterpart, attention to newly introduced definitions and deemed provisions, and proactive review of existing positions that may be affected by the changed statutory language.

From a policy perspective, the PGBP head remains the fiscal backbone of India’s corporate and professional tax collections. As the economy expands — particularly in areas such as financial technology, digital platforms, artificial intelligence, and green energy — the PGBP framework will continue to evolve, guided by legislative action, CBDT circulars, and judicial interpretation.

Profits and Gains of Business or Profession under the Income-tax Act, 2025