Direct Tax Laws & International Taxation · Profits and Gains of Business or Profession

Basis of Charge and Computation of Business Income

Updated 5 October 2026 · Fact-checked

Business income is the profit of any business or profession you carry on during the tax year, plus specified deemed receipts. You compute it from the books under the regular method of accounting. Start with net profit, add back inadmissible items, deduct admissible items not in the books, and move non-business income to its own head.

Understand Basis of Charge and Computation of Business Income

The head Profits and Gains of Business or Profession taxes the profit from a trade, commerce, manufacture or profession that the assessee carries on during the tax year. The test is carrying on the activity, not owning the premises or receiving cash. Profit means income minus the expenses the law allows.

The Act also names some receipts that are taxed as business income even if they do not look like normal profit. Examples are compensation on termination of a business contract or agency, cash assistance or duty drawback linked to exports, the value of a benefit or perquisite arising from business, and a bad debt or trading liability recovered after it was earlier allowed. Always check the exact provision for the receipt in the question.

You compute income by the method of accounting regularly employed by the assessee, cash or mercantile. Where a notified income computation and disclosure standard applies, it governs how items are recognised. You do not change the method just to suit a year. Accounts profit is only the starting point. Tax law then adds back what it disallows and gives what it allows.

The core rule for expenses is simple. An expense is deductible only if it is revenue in nature, incurred wholly and exclusively for the business, and not specifically disallowed. Capital expenses are generally not deductible, but the Act gives depreciation and some specific capital deductions. Personal expenses, and the assessee's own income-tax, are not deductible.

The last idea is head discipline. Items that belong to another head, such as rent from house property, capital gains, bank interest or dividend, must come out of business profit and be taxed under their own head, even if the books show them in the profit and loss account.

Key rules to remember

Business income from books: Business income = Net profit as per books + Inadmissible expenses debited − Admissible deductions not debited − Income credited but taxable under other heads or exempt; Use this as the standard reconciliation layout. Show every adjustment with a reason.
General test for a deductible expense: Revenue in nature + Wholly and exclusively for business + Not disallowed by any provision = Deductible; All three conditions must be met. Failing any one means no deduction under the general rule.
Capital vs revenue (broad guide): Enduring benefit or asset or structure of the business = Capital; Day-to-day running or profit-earning process = Revenue; This is a guide, not a rule of law. Courts decide on the facts, so state the facts you rely on.
Method of accounting: Income computed per cash or mercantile system regularly followed by the assessee; A method that is not regularly followed, or leads to distorted profit, can be rejected by the Assessing Officer under the Act.
Deemed business receipts: Recovery of earlier allowed loss, bad debt or expense, or remission of a trading liability = Business income in the year of recovery or remission; Applies only if the earlier amount was allowed as a deduction. Check this condition first.

How to solve Basis of Charge and Computation of Business Income questions

Use this order for any theory or numerical question on business income. It keeps your answer in provision, facts, conclusion form and prevents missed adjustments.

1Confirm that a business or profession is carried on in the tax year and identify the assessee's method of accounting.
2List every receipt and classify it: business income, deemed business income, another head, or exempt.
3List every expense and test it: revenue or capital, wholly and exclusively for business, and personal or not.
4Check whether a specific disallowance or a specific deduction overrides the general rule for that item.
5Start from net profit and add back inadmissible debits such as capital items, personal items, own income-tax, and book depreciation.
6Deduct items credited that are taxable under other heads or exempt, and deduct admissible items not debited, such as tax depreciation.
7Add deemed receipts that are not in the books, such as recovery of an earlier allowed item.
8Write the final figure clearly with a one-line reason against each adjustment.

Quickest way: Three-column adjustment table

When to use it: Use it for profit and loss based numerical questions where time is short and several items are given.

Draw three columns on your sheet: Add back, Deduct, No change.
Go through the debit side of the profit and loss account once and place each item in a column.
Go through the credit side. Items taxable elsewhere go to Deduct. Items that are normal business income go to No change.
Add the Add back column to net profit, subtract the Deduct column, and add any deemed receipts.
Write one reason beside each figure. Marks are given for the reasoning.

Common mistakes in Basis of Charge and Computation of Business Income

Treating book depreciation as an allowed deduction.
Students see depreciation in the profit and loss account and leave it alone.
Fix: Always add back book depreciation and deduct depreciation as computed under the Act.
Leaving bank interest, dividend or rent in business income.
Students follow the books and ignore the head of income.
Fix: Remove the item from business profit and tax it under its proper head. Mention this in your working.
Calling every large expense capital.
Size is confused with nature. Students rely on amount, not on benefit.
Fix: Ask whether the spending creates an enduring asset or advantage. Repairs that only maintain an existing asset are revenue.
Allowing the assessee's own income-tax as a business expense.
It appears in the profit and loss account like other taxes.
Fix: Add back income-tax paid on the assessee's own income. It is not an expense of earning profit.
Taxing a recovery of a bad debt without checking an earlier deduction.
Students memorise that recovery is taxable.
Fix: Tax it only to the extent it was allowed earlier. State this condition in your answer.
Applying the cash method when the assessee follows the mercantile method.
Students compute from payments and receipts made in the year.
Fix: Read the method stated in the question and recognise income and expense on that basis.

Worked examples

Example 1

Sharma Traders, a proprietary concern, shows a net profit of ₹12,00,000 for the tax year. The profit and loss account includes these debits: depreciation per books ₹1,50,000; legal fees on a dispute over title of land bought for the business ₹80,000; income-tax paid on the proprietor's own income ₹2,00,000; repairs to existing machinery ₹60,000. Credits include bank fixed deposit interest ₹40,000 and dividend from a company ₹20,000. Depreciation as computed under the Act is ₹1,90,000. Compute business income.

Show the solution

Start with net profit: ₹12,00,000.
Book depreciation ₹1,50,000 is added back. Tax depreciation is allowed separately.
Legal fees on title to land are capital in nature because they protect an enduring asset. Add back ₹80,000.
Income-tax on the proprietor's own income is personal and not a business expense. Add back ₹2,00,000.
Repairs to existing machinery are revenue expenditure. No change.
Bank interest ₹40,000 and dividend ₹20,000 are not business income. Deduct ₹60,000 and tax them under their own heads.
Deduct depreciation as computed under the Act: ₹1,90,000.
Add-backs: 1,50,000 + 80,000 + 2,00,000 = ₹4,30,000. Deductions: 40,000 + 20,000 + 1,90,000 = ₹2,50,000.
Business income = 12,00,000 + 4,30,000 − 2,50,000 = ₹13,80,000.

Answer: Business income is ₹13,80,000.

Example 2

Mehta Engineering buys a new machine for ₹5,00,000. It also pays ₹30,000 for transport and installation of that machine, and ₹40,000 to replace a worn part of an existing machine without increasing its capacity. Classify each item and state the amount that is capital and the amount that is revenue.

Show the solution

The purchase price of ₹5,00,000 buys an asset with enduring benefit. It is capital.
Transport and installation of ₹30,000 are costs of bringing the asset into working condition. They form part of its cost and are capital.
Capital total = 5,00,000 + 30,000 = ₹5,30,000. This is not deductible as an expense, but it is the base for depreciation as allowed by the Act.
Replacing a worn part of an existing machine, with no new asset and no extra capacity, only maintains the existing asset. It is revenue expenditure.
The ₹40,000 is deductible if it is not specifically disallowed and was incurred wholly and exclusively for the business.

Answer: Capital: ₹5,30,000, eligible for depreciation only. Revenue: ₹40,000, deductible in computing business income.

Exam tips

In theory answers, quote the three-part test for deductibility and then apply it to the facts given. Do not just state the rule.
For capital vs revenue questions, name the facts that point either way, such as enduring benefit, asset created, or running expense. Courts decide on facts, so a one-word answer loses marks.
In numerical questions, show a reconciliation from net profit. Even if one item is wrong, step marks protect the rest.
Read the question for the method of accounting and for any earlier-year deduction. These two facts decide many deemed-income items.
Case-scenario MCQs reward quick classification. Practise placing items as business income, another head, or capital, within seconds.

Practice questions from Profits and Gains of Business or Profession

Basis of Charge and Computation of Business Income in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Basis of Charge and Computation of Business Income: frequently asked questions

How do I compute business income under the Income-tax Act, 2025?

Start with net profit as per the books. Add back items the Act disallows, deduct items it allows that the books do not show, remove income taxable under other heads, and add deemed business receipts. Apply the method of accounting the assessee regularly follows.

What is the difference between capital and revenue expenditure for CA Final?

Capital expenditure creates an asset or an enduring advantage in the business structure. Revenue expenditure meets the day-to-day cost of running the business and earning profit. The line is decided on the facts of each case, so always give your reasons.

Is book depreciation allowed in computing business income?

No. Book depreciation is added back to net profit. You then deduct depreciation as computed under the Act on the eligible assets.

Can the method of accounting be changed every year?

No. The method must be regularly followed. A change should be a real and consistent change, and a method that does not give a proper income can be rejected by the Assessing Officer.