Section 38 — Deemed Profits and Gains | ITA 2025

Section 38 — CERTAIN SUMS DEEMED AS PROFITS AND GAINS OF BUSINESS OR PROFESSION

Section 38 is the substantive equivalent of 1961 s. 41 — catching certain receipts that are deemed profits even where there is no current-year business activity OR where the receipt is technically a recovery rather than fresh profit. Categories include: recovery of bad debt earlier written off; remission of trading liability (FA 1996 deeming); balancing charge on sale of depreciable asset; recovery of expenditure earlier allowed; profit on discontinuance of business; etc.

Statutory text — Income-tax Act, 2025

Marginal note — Certain sums deemed as profits and gains of business or profession

(1) The following sums shall be deemed to be profits and gains of business or profession and shall be chargeable to income-tax, in the manner specified below, subject to the provisions of sub-section (2):—

(a) where an allowance or deduction has been allowed in respect of any loss, expenditure or trading liability incurred by the assessee during any tax year, then,—

(i) the value of any benefit accruing to the assessee by way of cessation or remission of such trading liability, including a unilateral act of write-off of such liability in his accounts, in a subsequent tax year in which such benefit accrues; or

(ii) any amount obtained by the assessee, whether in cash or other- wise, in respect of such loss or expenditure incurred, in subse- quent tax year in which the amount is obtained, whether the business or profession in respect of which the allowance or deduction was made is in existence in such subsequent tax year or not;

(b) in a case where any tangible asset [as referred to in section 33(12)(a) (i)], which is owned by assessee, is sold, discarded, demolished or destroyed, and the moneys payable for such asset, together with the scrap value [A] exceeds the written down value of such assets [C], the sum as computed below, in the tax year in which the moneys payable for such asset becomes due—

(i) where the moneys payable for such asset together with the scrap value [A] is less than the actual cost of such asset [B], then— [A] – [C]; or

(ii) in any other case,— [B] – [C];

(c) in a case where an asset representing expenditure of a capital nature on scientific research, referred to in section 45(1)(a)(i) is sold, without having been used for other purposes, and the sale proceeds together with the total deductions allowed under that section exceed the amount of capital expenditure, the excess or the amount of deduction so made, whichever is less, in the tax year in which the asset was sold;

(d) in a case where a deduction has been allowed for a bad debt (or part of it) under the provisions of section 31(2), and any amount subsequently recovered exceeds the difference between such debt and the amount allowed, then the amount in excess, in the tax year in which recovery is made;

(e) in a case where a deduction has been allowed for any special reserve created and maintained under the provisions of section 32(e), any amount subsequently withdrawn from such reserve, in the tax year in which the amount is withdrawn.

(2) The provisions of sub-section (1) shall apply subject to fulfilment of the following conditions:—

(a) in respect of sub-section (1)(a), only when an allowance or deduction has been made in assessment for any tax year towards the trading liability, loss or expenditure incurred;

(b) in respect of sub-section (1)(b), only when the asset owned by the assessee, has been used for the purpose of business or profession, and depreciation has been claimed and allowed thereon under section 33(2);

(c) in respect of sub-section (1)(c), only when the asset has not been used for other purposes.

(3) Where the business or profession referred to in this section is no longer in exis- tence and there is income chargeable to tax under sub-section (1)(a), (c), (d) or (e), in respect of that business or profession, any loss, not being a loss sustained in speculation business, which arose in that business or profession during the tax year in which it ceased to exist and which could not be set off against any other income of that tax year shall, so far as may be, be set off against the income chargeable to tax under the said clauses of that sub-section.

(4) In respect of sums referred to in sub-section (1)(a), if the benefit referred therein accrues to, or amount referred therein is obtained, by the successor in business, the value of the benefit or the amount shall be chargeable to income-tax as income in the hands of successor in business.

(5) The provisions of sub-section (1)(b), (c), (d) and (e) shall apply in a tax year even if the business is no longer in existence.

(6) For the purposes of this section,—

(a) “sold” includes a transfer by way of exchange or a compulsory acquisition under any law for the time being in force but does not include a transfer, in a scheme of amalgamation, of any asset by the amalgamating company to the amalgamated company where the amalgamated company is an Indian company;

(b) “successor in business” means—

(i) the amalgamated company, where there has been an amalgamation;

(ii) the resulting company, where there has been a demerger;

(iii) where the assessee is succeeded by any other person in that business or profession, that other person;

(iv) where a firm carrying on a business or profession is succeeded by another firm, that other firm. Computation of actual cost.

Corresponding provision — 1961 regime

INCOME-TAX ACT, 2025	INCOME-TAX ACT, 1961
INCOME-TAX ACT, 2025 — s. 38	INCOME-TAX ACT, 1961 — s. 41
Recovery of bad debt earlier written off	1961 s. 41(4) — preserved
Remission / cessation of trading liability	1961 s. 41(1) — preserved
Balancing charge on depreciable asset sale	1961 s. 41(2) — preserved
Recovery of expenditure earlier allowed	1961 s. 41(1) — preserved
Profit on discontinued business	1961 s. 41(5) — preserved

STATUTORY ARCHITECTURE

Section 38 has multiple operative limbs catching: (a) Trading-liability remission (e.g., supplier writes off old payable) — deemed PGBP receipt in year of remission; (b) Bad-debt recovery — earlier-written-off debt now realised — deemed PGBP receipt; (c) Balancing charge — depreciable asset sold for more than WDV (within block) — deemed PGBP if outside block-of-assets framework; (d) Expenditure recovery — earlier-allowed expense recovered (e.g., refund of duty) — deemed PGBP receipt; (e) Profit on discontinued business — even where business no longer carried on, recovered/recovered amounts are deemed PGBP.

JUDICIAL EVOLUTION — Cessation of Liability (Sundaram Iyengar)

CIT v. T.V. Sundaram Iyengar & Sons Ltd., (1996) 222 ITR 344 (SC) — held that unclaimed credit balances of customers / dealers transferred to P&L on time-bar / abandonment ARE taxable as PGBP receipts under s. 41(1) [now s. 38]. The cessation of trading liability triggers immediate charge.

HELD: Where unclaimed credit balances of customers are written back to the profit and loss account by the assessee on time-bar / abandonment, the same constitute trading receipts and are taxable as deemed profits under section 41(1). The character of the receipt as 'liability' has ceased; the corresponding asset (cash / inventory) remains with the assessee and represents commercial enrichment. (per Sundaram Iyengar ¶ 14).

JUDICIAL EVOLUTION — Bad Debt Recovery

Where a bad debt was earlier written off and allowed as deduction u/s 31 (1961 s. 36(1)(vii)), subsequent recovery (full or partial) is taxable u/s 38 (1961 s. 41(4)). Practitioners must reconcile each recovery with the original write-off year and amount, ensuring no double-counting.

DEPARTMENTAL PRACTICE

Form 3CD Item 24 — auditor's reporting on s. 41 / s. 38 deemed-profit items. Items typically reconciled: (a) trading liability written back; (b) provisions reversed; (c) bad debt recoveries; (d) refunds of expenses earlier deducted (e.g., duty refund, insurance claim recovery on stock loss earlier written off).

PLANNING NOTES

(i) For unclaimed credit balances, evaluate the time-bar position before any write-back; the moment of write-back triggers s. 38 charge. (ii) For provisions (e.g., warranty, leave encashment), reversals are taxable only if the original provision was allowed as deduction. Maintain provision-reversal reconciliation. (iii) For bad debt recoveries, segregate by original-write-off year for proper inclusion.

CROSS-REFERENCES

Section 31 — Bad debt deduction (s. 38 catches recovery).
Section 33 — Depreciation (interaction with balancing charge).
Section 41 — Written down value (next section).

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