Background
Globalisation has integrated the entire world into a single market. As more organisations engage in cross-border transactions, the level of complexity of business agreements and transactions keeps increasing. New avenues emerge which require new skillsets, talent, goods, agreements and the like, such of which, the world may not have witnessed in the past 200 years.
As new avenues of trade and commerce emerge, organisations engage in structuring new business transactions and agreements and restructure the existing ones to best fit them in line with their requirements, which would have a bearing on their legal and regulatory aspects.
Service sector is one of the biggest sectors in our country. It is one of the major engines of growth for the Indian economy. It is safe to say that the service sector is crucial for India to achieve its vision of the ‘$5 trillion economy.’
Service sector has also been one of the frequently debated topics by professionals, industry experts and has also been a subject matter of disputes in the Tribunals and courts concerning the direct taxes. Income tax broadly categories services into those services which constitute business income and those services which constitute professional income.
Having an understanding of the categorisation of the services is essential in order to mitigate legal disputes. Let us know look into the definition of business and profession.
Definitions
Section 2(13) of the Income Tax Act defines the word business as under:
“business” includes any trade, commerce or manufacture or any adventure or concern in the nature of trade, commerce or manufacture.
The definition is wide enough to cover:
- manufacture, production, supply, repairs, trading of goods, products, articles or things and
- provision, trading of and/or engaging, rendering all kinds of services.
Section 2(36) of the Income Tax Act defines the word profession as under:
“profession” includes vocation.
It is the cardinal rule of construction that ‘a statute must be construed literally and grammatically, giving the words their natural meaning.’ Further the Rule of Reasonable Construction states that ‘words of a statute must be construed so as to lead to a sensible meaning.’ Taking the above rules into consideration, where an Act does not have a clear cut or an exhaustive definition for a word, it is best to understand the meaning of the word from the dictionary.
Oxford dictionary defines a profession (noun) as ‘a type of job that needs special training or skill, especially one that needs a high level of education’.
After the reading and interpretation of the above definitions, we can infer the following:
1. Activities concerning goods come under the definition of business whereas activities concerning services can come either under business or under profession.
2. It is important to note that under the Income Tax regime, the definitions of ‘business’ and ‘profession’ are inclusive. This means that the Income Tax Act does not have clear-cut guidelines which categorises the services under business or profession.
3. The Act does not empower any Officer to sit in judgement as to which service constitutes a business or a professional service. It is left to the assessee’s discretion and expertise, according to the general trade and commerce practices in the country, to offer his/her income to tax either under the business category or under the profession category, unless the Income Tax Act mentions otherwise.
4. A service which is provided by a person who has undergone a special training or skill, especially one that needs a high level of education can be categorised as a professional service. Further such person should be engaged in rendering such professional services on a full-time basis. In other words, his principal activities is rendering such professional services to his clients and customers.
5. A person is considered to be a professional if such person has the requisite academic qualifications, skill sets and has been recognised as a professional in his area of expertise. Such recognition can be provided by a Statutory or Governmental Authority. Further, the professional is required to use his professional knowledge and skills in his domain.
It has to be noted that there are certain services which can be provided by professionals and non-professionals. In this scenario, income from such services provided by a professional constitute ‘income from profession’ and such services provided by a non-professional constitute ‘income from business.’ This concept has been explained in the examples mentioned at the end of this section.
It is of utmost importance that an assessee offers to tax, his/her income, under the appropriate category. This basic distinction between business and profession has ramification on the aspects pertaining to taxation and Deduction of Tax at Source (TDS) on the assessee.
Further, it is in the best interest of the assessee to enter into a written contract which explicitly mentions the ‘scope of services’ to be rendered between the assessee and his customers/clients. Where the scope of services has been clearly defined in the agreement, the nature of the service can be better ascertained and this would be beneficial to the assessee during the assessment of his income by the Department.
Let us understand instances of services which can be categorized under Business or Profession through the following examples:
1. A civil engineer provides a structural design service (for which special training or skill is not mandatorily required) to a company at the Company’s request. This constitutes a service which is covered under ‘business’ for the civil engineer.
2. A civil engineer provides valuation and certification services (for which the engineer has a statutory licence) that are required under The Real Estate Regulation and Development (RERA) Act. This constitutes a service which is covered under ‘profession.’
Though both the above services are provided by a civil engineer, the structural design service constitutes a business income, whereas in the second example, the valuation service constitutes income from profession. This is due to the fact that such valuation services can be provided by individuals having specified skillsets, expertise and the authority (in this case, a statutory licence).
3. Similarly, a Chartered Accountant (not holding a Certificate of Practice) engaged in providing accounting services can offer such income under ‘Business Income’ whereas a Chartered Accountant (holding a Certificate of Practice) engaged in audit, assurance and attestation services will offer income from such services under ‘Income from Profession.’
This is because the Institute of Chartered Accountants of India (ICAI) prohibits members not holding a Certificate of Practice from providing statutory audit services (signing on the financial statements of entities). Statutory audit services can be provided by individuals having specified skillsets, expertise and the authority (in this case, a Certificate of Practice).
4. Sita, a MBA graduate, is providing ‘accounting services’ to different enterprises. Similarly, Ms. Padma, a Chartered Accountant (holding a Certificate of Practice), is providing ‘accounting services’ to some of her clients. In this scenario, accounting services would constitute ‘business income’ for Ms. Sita whereas it constitutes ‘income from profession’ for Ms. Padma. This is due to the fact that Ms. Padma is rendering such services in her professional capacity. Such services come under the ambit of ‘profession of accountancy’.
Having understood the categorisation of services under business and profession, let us now look into the taxability of income from Business and Profession.
Taxability of Business Income
Disclaimer:
1. This article covers aspects pertaining to the presumptive basis of taxation of business and profession only.
2. Only the relevant clauses sufficient enough to understand the categorisation of services have been covered in this article.
Section 44AD
Special provision for computing profits and gains of business on presumptive basis
(1) Notwithstanding anything to the contrary contained in sections 28 to 43C, in the case of an eligible assessee engaged in an eligible business, a sum equal to 8% of the total turnover or gross receipts of the assessee in the previous year on account of such business or, as the case may be, a sum higher than the aforesaid sum claimed to have been earned by the eligible assessee, shall be deemed to be the profits and gains of such business chargeable to tax under the head “Profits and gains of business or profession”
Provided that this sub-section shall have effect as if for the words “8%“, the words “6%” had been substituted, in respect of the amount of total turnover or gross receipts which is received by an account payee cheque or an account payee bank draft or use of electronic clearing system through a bank account or through such other electronic mode as may be prescribed during the previous year or before the due date specified in sub-section (1) of section 139 in respect of that previous year.
It is important to understand the words ‘eligible assessee’ and ‘eligible business.’ These words have been defined in the Explanation to Section 44AD.
- Eligible assessee” means
1. an individual, Hindu undivided family or a partnership firm, who is a resident, but not a limited liability partnership firm as defined under clause (n) of sub-section (1) of section 2 of the Limited Liability Partnership Act, 2008, and
2. who has not claimed deduction under any of the sections 10A, 10AA, 10B, 10BA or deduction under any provisions of Chapter VIA under the heading “C. – Deductions in respect of certain incomes” in the relevant assessment year.
- “Eligible business” means
1. any business except the business of plying, hiring or leasing goods carriages referred to in section 44AE; and
2. whose total turnover or gross receipts in the previous year does not exceed an amount of two crore rupees.
Important Observations:
From the analysis of the definition of ‘eligible business’, the following can be inferred:
1. Every business except the business of plying, hiring or leasing goods carriages referred to in section 44AE is an eligible business.
2. As per Section 2(13), “business” includes any trade, commerce or manufacture or any adventure or concern in the nature of trade, commerce or manufacture.
3. Services which are not provided by a professional or such services which are categorised as professional services by the Income Tax Act are outside the ambit of ‘eligible business.’
4. Similarly, vocational services do not constitute ‘eligible business.’
5. Such of those services which are not in the nature of professional services or vocational services can be considered under the category of ‘eligible business.’
Having understood the word ‘eligible business’, let us now understand the concept of Professional services within the purview of the Income Tax Act.
Professional Services
The word ‘professional services’ has been defined under the Explanation (a) to Section 194J of the Income Tax Act.
Explanation (a) to Section 194J of the Act
“Professional services” means services rendered by a person in the course of carrying on legal, medical, engineering or architectural profession or the profession of accountancy or technical consultancy or interior decoration or advertising or such other profession as is notified by the Board for the purposes of section 44AA or of this section.
The Income Tax Act has categorised certain services as ‘Professional Services’ under Section 44AA read with Rule 6F of the Income Tax Rules. The following are the professions notified:
1. legal,
2. medical,
3. engineering or
4. architectural profession or
5. the profession of accountancy or
6. technical consultancy or
7. interior decoration or
8. authorised representative or
9. film artist.
Analysis:
1. Under the Income Tax Act, only those services which have been notified by the Central Board of Direct Taxes (CBDT) under Section 44AA of the Act, constitute professional services for the purpose of Income Tax Act.
2. Services which are not explicitly mentioned as ‘professional services’ come under ‘business services’ under the Act.
3. The word ‘profession’ has to be interpreted and construed to mean those services that needs special training or skill, especially one that needs a high level of education.
4. The definition of ‘professional services’ is exhaustive. Since the word used in the definition is ‘means’ and not ‘includes’, only those services mentioned in Section 44AA read with Rule 6F are considered as professional services.
Technical Services
Explanation (b) to Section 194J of the Act defines “fees for technical services.”
Explanation (b) to Section 194J
“Fees for technical services” means any consideration (including any lump sum consideration) for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel) but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head “Salaries.
Analysis:
1. The Income Tax Act has made a clear distinction of professional services and technical services. In other words, a service cannot be considered as a business service or a professional service by different categories of assessees.
2. ‘Technical services’ as defined in this Explanation is different from ‘Technical Consultancy’ services mentioned in Section 44AA of the Act. Technical services are those services provided by assessees in the normal course of their business whereas Technical Consultancy service is to be construed to mean a service which can only be provided by persons having special skills, high level of education and recognition.
Section 44ADA
Special provision for computing profits and gains of profession on presumptive basis
(1) Notwithstanding anything contained in sections 28 to 43C, in case of an assessee, being an individual or a partnership firm other than a limited liability partnership as defined under clause (n) of sub-section (1) of section 2 of the Limited Liability Partnership Act, 2008 (6 of 2009), who is a resident in India, and is engaged in a profession referred to in sub-section (1) of section 44AA and whose total gross receipts do not exceed fifty lakh rupees in a previous year, a sum equal to 50% of the total gross receipts of the assessee in the previous year on account of such profession or, as the case may be, a sum higher than the aforesaid sum claimed to have been earned by the assessee, shall be deemed to be the profits and gains of such profession chargeable to tax under the head “Profits and gains of business or profession.”
Only those assessees operating through legal structures and rendering such of the services ‘as explicitly mentioned’ in Section 44AA, in their professional capacity, can claim the beneficial provisions of Section 44ADA, if their gross receipts during a previous year does not exceed rupees 50 lakhs.
Let us know look into the following questions which may arise to the viewers:
Q1 What are ‘technical services’ which are defined under the Act?
A. Explanation (b) to Section 194J defines “fees for technical services” means any consideration (including any lump sum consideration) for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel) but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head “Salaries.”
Q2 Do technical services constitute ‘business income’ or ‘income from profession’?
A. The word ‘Professional Services’ as defined under Section 44AA read with Rule 6F is an ‘exhaustive’ definition. Such of those services not explicitly mentioned in Section 44AA are not professional services under the purview of Income Tax Act. As a result, an assessee rendering ‘Technical Services’ would offer his income from technical services under ‘business income.’
Q3 Can an assessee engaging in rendering ‘technical services’ offer his income to tax under Section 44AD?
A. ‘Technical services’ come under the meaning of ‘eligible business’ as contained in Explanation (b) to Section 44AD. The assessee can offer such income under Section 44AD provided his turnover or gross receipts, as the case may be, during a financial year does not exceed rupees 2 crores.
Q4 Mr. Ram is a Chartered Accountant not holding a COP. He is engaged in providing management consultancy services. Can Mr. Ram offer such income under Section 44AD?
A. Though Mr. Ram is a Chartered Accountant, he is not engaged in the ‘profession of accountancy’. The Management Consultancy services provided by him constitute ‘technical services’ as defined under the Act. As a result, Mr. Ram can claim the benefits of Section 44AD.
Q5 Mr. Krishna, an MBA graduate, is engaged in providing recruiting services. In the course of his business, the debtors of Mr. Krishna have Deducted Tax at Source at 10% under Section 194J (considering the income to be a professional income). Should Mr. Krishna offer his income to tax under Professional Income?
A. Krishna would offer his income under ‘Business income’ and not ‘Professional Income.’ In the case of Pramod Lele Vs ITO (ITAT Mumbai), the Hon. ITAT held that ‘at what rate of tax the clients deduct while making payments to the assessee is of absolutely no relevance to determine the character of receipt in the hands of the assessee recipient and for determining the status of the assessee as to whether he is engaged in business or profession.’
Q6. BioMat Private Limited, is a company engaged in providing research services in ‘bioinformatics’ domain. Can the company offer its income to tax under Section 44AD of the Act?
A. In order to claim the presumptive provisions of Section 44AD, an assessee should fall under the categories of ‘eligible assessee’ and ‘eligible business.’ Even if one of the conditions is not fulfilled by the assessee, the assessee cannot offer the income to tax u/s 44AD. While ‘bioinformatics research services’ come under eligible business, the assessee, in this scenario, is a private limited company. Private limited companies are excluded from the definition of ‘eligible assessee.’ As a result, the company cannot offer its income to tax u/s 44AD.
Q7. Ms. Radha is engaged in a profession which is not covered u/s 44AA. Can she claim benefit of the provisions of Section 44ADA?
A. Though Ms. Radha is engaged in providing professional services, she cannot claim the beneficial provisions of Section 44ADA. This is due to the fact that assessees rendering only such of the services explicitly mentioned in Section 44ADA, can offer their income to tax under the provisions of that Section.
Disclaimer
The author’s write-up is based upon the author’s reading, understanding and interpretation of the legal and regulatory provisions. This article is not intended to constitute a legal or a professional advice.
Author Bio
Hello, thank you for this great article!
It is not clear to me whether a freelance software engineer offering software development services to clients are classified as a Profession or Business.
I do have a GST registration to operate as a freelancer, but I’m a sole-owner Proprietorship, not a Company. Does this make any difference on whether I should classify myself as a Business or Professional?
Thank you!