Under the Income Tax Act, 1961, income earned during the year must be classified under appropriate heads for the purposes of computation of taxable income.
Today, we see many people in the field of IT, accounting, law, designing and other similar professions doing part-time activities to earn extra income. An important question is whether their income is Business/Professional Income (BPI) or Income from Other Sources (IOS) particularly when such income usually forms a small chunk of their overall income.
Under the Income Tax Act, 1961, income earned during the year must be classified under appropriate heads for the purposes of computation of taxable income. Each of these heads has a different scheme for deductibility of expenses and computation of taxable income. Expenses incurred to earn BPI can be claimed as a deduction along with certain other allowances like depreciation, etc. Under the IOS, even though expenses incurred to earn that income can be allowed but typically, such expenses are difficult to substantiate considering that one off incomes would hardly have expenses associated with them. The pertinent question to ask is, what is ‘profession’.
The Income Tax law is not of much help as it defines it as “profession includes vocation”. Oxford dictionary defines it as “a paid occupation, especially one that involves prolonged training and a formal qualification”. Looking at these definitions, many such people can be classified as professionals. It could be altogether different from business which may not fulfil the aforesaid requisites but, profession has been included on the same head along with business for computation of income.
There are some legal precedents available in this regard, [like G.Venkataswami Naidu & Co. vs CIT  35 ITR 594 (SC); Bhogilal H. Patel vs CIT  74 ITR 692 (Bom.) and P. M. Mohammed Meerakhan vs CIT  73 ITR 735 (SC)] wherein, courts have given some guidance as to facts which should be observed to adjudge business income like magnitude and volume of the income, time and effort spent, whether the involvement is regular or not, and motive of the activities performed, etc.
Time and effort
A freelancer works in a field trained in along with the job, spending regular time and effort to earn this income on a part-time basis; such a person may be considered exercising a profession and accordingly his income could be taxed as BPI. However, a salaried individual who has provided certain consultancy occasionally (for instance, once or twice during the year) may have to classify his income as IOS. Hence, the key factor is the consistent time and efforts, and not necessarily the outcome as it is anyway uncertain in a business or profession.
If the income is adjudged as IOS, it can be reported in Form ITR-1 or ITR-2 as applicable to the person. However, if there is income under the head BPI, ITR-3 or 4 must be filed. Reporting requirements in ITR-3 and ITR-4 are greater and more complex than ITR-1 or ITR-2. ITR-3 which deals with regular business/professional income is more onerous than filing ITR-4 and typically requires professional help.
In case of person engaged in profession1 (for the purposes of this section includes legal, medical, engineering, architectural profession or profession of accountancy, technical consultancy, interior decoration, authorised representative or film artist) having gross receipts not more than Rs 50 lakh, they can choose to consider at least 50% of their gross receipts as income as per the provisions of 44ADA of the Act.
No further expense is allowed as a deduction. If one is not eligible to avail this scheme, the person shall file his return of income in ITR-3 which calls for more details information than those asked in ITR-4. Unlike IOS, for BPI, one is also required to maintain books of accounts u/s 44AA failing which penalty u/s 271A for `25,000 could also be levied irrespective of whether 44ADA is opted or not.
As for the due date for filing of return of income approaches, one must take due care to characterise income under the appropriate heads of income to fulfil one’s obligation of reporting income earned during the year and avoid any penal consequences. Even though filing of ITR-1/2, as the case maybe, seems a simpler option, it is advisable to file correct forms and maintain regular books of account for business/professional income.
The writer is partner, Ashok Maheshwary & Associates LLP (With inputs from Sandeep Sehgal, director, Tax and Regulatory, Ashok Maheshwary & Associates LLP)