Many times we fall into a confusion regarding the difference between business losses and business expenditure. A business loss can come from the normal operation of the business or an irregular activity arising out of the business whereas expenditure is something which is deliberately incurred for the moving of the business.
Let us figure out the distinction between the two so as to obtain CRYSTAL CLEAR understanding of both the terms principally as well as legally.
Deductions, which are not specifically provided needs to be taken in to consideration while computing the business income. For example, there is no specific provision to take into account opening stock as an item of expenditure on debit side of the profit and loss account, closing stock as an item on credit side of the profit and loss account and even the purchases of the business, still the same are to be considered for reducing profits or gains.
In a business the assessee may suffer loss of several types like ï¿½
Loss in trading or manufacturing or other business operations: Such loss occurs mainly due to high costs incurred and low price realized for the overall volume of business. When the business operations are below the break-even level there is loss because fixed costs are not covered due to lower margin or contribution realized at low volume of activity achieved. Sometimes the market force causing fluctuation in price of inputs and output also results into loss in the business.
Loss of trading assets: Sometimes loss may occur due to loss of trading assets like stock-in-trade, obsolescence of stock-in-trade, shortages in stock, loss due to theft, pilferage etc. The loss can also occur due to detoriation of market value. Unrecoverable debts, loans and advances are also in nature of business loss. Loss due to theft, of materials as well as cash balance is a business loss.
Trade Advances given to Parties: Loss due to advance provided becoming unrecoverable or the supplier / service provider failing to perform the contract and fails to return advances in relation to business activities are in the nature of business loss which are considered while computing profits and gains from the business.
- Loss incurred for standing as a surety ï¿½ Where a assessee stands surety for the debts of another and such guarantee is for the purpose of the trade, any payment made as a result of such guarantee can be deducted as a business loss.
- Loss due to forfeiture of deposit made by the assessee for properly carrying out of contract for supply of commodities.
- Loss due to fluctuation in foreign exchange in which money is receivable or payable.
- Losses due to force measures or other reasons causing breach of contract.
We find that there is no specific provision for allowing losses of above nature. However, the same are part of business activities only, therefore such losses are considered in ascertaining profits and gains from business of the assessee.
By expenditure we mean an outgo in form of cash or kind incurred in the course of business. Section 30 to 36 contain a list of certain expenses which are allowed in computing the income under this head, few of them are rent, repairs, contributions to funds, depreciation, etc.
Various deductions provided are contained in section 37 which is a residuary and general provision in which expense can be allowed after complying the following:
- It is not in the nature of capital expenditure
- It is not in the nature of personal expenses of the assessee
- It is laid out wholly and exclusively for the purposes of business or profession of the assessee.
Since section 28 of the Act governs the profits and gains of any business which interprets that profit to be computed shall be after all the deductions allowBusiness Loss vis-ï¿½-vis Business Expenditureable to the business, still there are provisions for specific deductions in sections 30-36 of the Act, also it is question that why only specific items are covered in the said provisions, and why not all the deductions are covered there?
It is because section 30-36 of the Act deals with only those items, for the allowance of which specific conditions are attached i.e., particular conditions to be complied with in order to claim the deduction in the business.
The major difference between an expenditure and loss is of ï¿½intentionï¿½
In case of expenditure, there is an intention and activity involved while spending money which is required for the purpose of carrying on the business activities whereas,
In case of loss there is no intention or desire to suffer loss it is not by actions of the businessman but it usually is due to certain external factors, which are beyond control of the businessman. Sometimes business loss may be suffered due to mistake of businessman or his representatives as well but if the loss is incidental to business, it will be business loss though there may be mistake of businessman or his representatives.
Letï's consider an example:
ABC Ltd. incurred the following expenditure and losses in relation to the business for the financial year 2017-18.
- Warehouse rent of Rs. 3 Lacs per annum for storage of stock-in-trade
- Obsolescence of stock-in-trade amounting to Rs.2 Lacs
Now, let's understand the allowability of the above items in computation of the profits of the business
Obsolescence of Stock
It is allowed as business expenditure
It is allowed as business loss
Allowed as per Section 30 of the Act.
Allowed as per Section 28 of the Act.
Incurred due to intention of the assessee
Not in control of the assessee i.e., no intention is involved
Now, it could be clearly seen from the above illustration that although there are differences in nature of both the items, still they are allowable for the purpose of computation of profits as per Income Tax Act.
Although, there is an apparent difference between business expenditure and business loss, circumstances may exist which depict that there is very thin line of distinction between the both.
In such cases the decision will depend on surrounding circumstances and activities thereon.
For example in case of loss of food items from canteen, the loss should be disclosed separately or as an expenditure by way of note that canteen expenses include loss due to pilferage, theft or spoilage etc.
Restrictions pertaining to Specific Deductions not applicable for Business Losses
Section 30-37 provides for the specific items to be allowed as business expenditure after complying with the provisions as contained in the above mentioned sections in computation of business profits. It is observed that there are certain restrictions like expenditure should not be prohibited by law or against public policy etc.
However, it is not necessary that restrictions pertaining in allowability of business expenditure shall also prevail while determining the loss in computation of profits and gains of the business as per Section 28 of the Act which implies that the restrictions which cover business expenditure are not applicable to business losses.
The above conclusion is apparent from the Supreme Court Judgment in the case of DR. T.A. Quereshi v. CIT  287 ITR 547 (SC) :
In this case the assessee is a doctor carrying on medical profession, for the purpose of preparation of medicines, he used to hold as a stock-in-trade heroin. The authorities under the provisions of Narcotic Drugs and Psychotropic Substances Act, 1985, seized certain quantity of heroin because holding of heroin was not permitted under law.
It was contended by the High Court that the deduction could not be claimed by the assessee keeping in view the explanation to section 37 of the Act which states that no deduction to be allowed in case where business expenditure incurred for any purpose not permitted under law.
The Supreme Court in this case held that as per the legal principles, the explanation tosection 37is not applicable in case of business loss, in the present case it is not in the nature of business expenditure, but of business loss.
It was further held that the business losses are allowable on ordinary commercial principles in computing profit and once it was found that heroin seized was stock-in-trade of the assessee, it follows that the seizure and confiscation of such stock-in-trade has to be allowed as a business loss and loss of stock-in-trade has to be considered as a trading loss.
Hence, the order was passed by the Supreme Court in favor of assessee.
Therefore, from above it is understood that expenditure and loss are different items in accounting and commercial parlance as well as in the context of legal provisions of the Income Tax Act. The rules and exceptions applicable while considering allowability of expenditure may not applicable in case of consideration of business loss. Business loss can be considered as per normal principles of accounting and commerce. The losses will be allowable as loss incidental to business or profession while computing income under section 28 and cannot be considered as an item of "Expenditure".
I hope this article proves to be a smog remover vis-ï¿½-vis all the ambiguities regarding the business loss and business expenditure and tax implications thereon.