Deemed Business Profits under the Income Tax Act 2025: Sums Taxed as Business Income (Section 38)

Section 38 of the Income-tax Act, 2025 lists five groups of sums (clauses (a) to (e)) that are deemed to be profits and gains of business or profession, even though they may not look like business receipts. They are: a trading liability that is written off or waived after you deducted it, or a loss or expense you recover after deducting it (clause (a)), the excess when a depreciated asset sells above its written down value (clause (b)), the excess when a scientific research asset is sold (clause (c)), a bad debt recovery above the debt less the amount allowed (clause (d)), and a withdrawal from a special reserve (clause (e)). Each is taxed in the tax year the event happens, in the manner set out in section 38(1).

The common thread is a deduction already given earlier. When the money comes back, or the liability disappears, the earlier deduction is reversed through income. This guide explains each clause, the conditions in section 38(2), what happens after the business closes, and the successor rule. Last reviewed against the Act (as amended by the Finance Act, 2026) on 10 November 2026.

What does section 38 of the Income-tax Act, 2025 cover?

Section 38(1) deems the following sums to be business income, chargeable "in the manner specified below, subject to the provisions of sub-section (2)".

Clause	Trigger	Amount taxed	Tax year
38(1)(a)(i)	Benefit from cessation, remission or unilateral write-off of a trading liability for which a deduction was allowed	Value of the benefit	Later year in which the benefit accrues
38(1)(a)(ii)	Amount obtained, in cash or otherwise, in respect of a loss or expenditure for which a deduction was allowed	Amount obtained	Later year in which it is obtained
38(1)(b)	Tangible asset (building, machinery, plant, furniture) sold, discarded, demolished or destroyed; price plus scrap value exceeds written down value	[A] − [C] or [B] − [C] (see below)	Year in which the moneys payable become due
38(1)(c)	Scientific research capital asset sold without being used for other purposes; sale proceeds plus deductions allowed exceed the capital expenditure	The excess or the deduction made, whichever is less	Year of sale
38(1)(d)	Bad debt deduction allowed under section 31(2); recovery later exceeds the debt less the amount allowed	The excess	Year of recovery
38(1)(e)	Deduction allowed for a special reserve under section 32(e); amount later withdrawn	Amount withdrawn	Year of withdrawal

Is writing back an old creditor in the books taxable?

It depends on the gate in section 38(2)(a). If the creditor balance was earlier claimed as a deduction, for example as an expense or purchase cost, writing it back is a unilateral write-off and the benefit is business income of that year. If no allowance or deduction was ever made for that liability, clause (a) does not apply. Check what was deducted in the earlier assessment before treating a stale creditor as income.

When is a written-off or waived liability taxable? (section 38(1)(a))

A "trading liability" is an amount you owe because of your business, for example a supplier's invoice for goods you bought. If you claimed that expense in an earlier year and a supplier later waives the amount, or you remove it from your books yourself, the benefit is taxable in the year it accrues. The Act expressly includes a unilateral write-off of the liability in your accounts.

Clause (a)(ii) is the receipt side. If you were allowed a deduction for a loss or expenditure and you later obtain an amount in respect of it, in cash or otherwise, that amount is income in the year you obtain it. Both limbs apply whether or not the business is still in existence in that later year.

Section 38(2)(a) sets the condition: clause (a) applies only when the allowance or deduction was actually made in an assessment for a tax year, for the trading liability, loss or expenditure.

What if a depreciated asset is sold for more than its written down value? (section 38(1)(b))

This clause applies to tangible assets in section 33(12)(a)(i): buildings, machinery, plant and furniture. The asset must be owned by you, and be sold, discarded, demolished or destroyed. Three amounts matter:

• [A]: the moneys payable for the asset, together with its scrap value;
• [B]: the actual cost of the asset;
• [C]: the written down value (WDV).

The clause bites only when [A] exceeds [C]. Then the taxable sum is [A] − [C] if [A] is less than the actual cost [B], and [B] − [C] in any other case. It is taxed in the year the moneys payable become due. Section 38(2)(b) adds that the asset must have been used for the business or profession, and depreciation must have been claimed and allowed under section 33(2).

"Sold" includes exchange and compulsory acquisition under any law. It does not include a transfer by an amalgamating company to an amalgamated company in a scheme of amalgamation, where the amalgamated company is an Indian company (section 38(6)(a)).

How is the excess on a research asset taxed? (section 38(1)(c))

Section 45(1)(a)(i) allows a deduction for capital expenditure on scientific research related to the business. If that asset is sold without having been used for other purposes, and the sale proceeds plus the total deductions allowed exceed the capital expenditure, the taxable sum is the excess or the deduction made, whichever is less, in the year of sale. Section 38(2)(c) repeats the condition that the asset has not been used for other purposes.

What happens when a bad debt is recovered? (section 38(1)(d))

Section 31(2) allows a bad debt as a deduction in the year it is written off as irrecoverable. If you recover money later, section 38(1)(d) taxes only the part of the recovery that exceeds the difference between the debt and the amount allowed. Recovery up to that difference is not taxed here, since that part never got a deduction. The excess is taxed in the year of recovery.

Section 31(2)(b) works in the opposite direction. If the final recovery is less than the difference between the debt and the amount deducted, the shortfall is deductible in the year the ultimate recovery is made.

What if money is withdrawn from a special reserve? (section 38(1)(e))

Section 32(e) allows a deduction for an amount carried to a special reserve created and maintained by a specified entity (long-term finance businesses, subject to the limits in that clause). When any amount is later withdrawn from that reserve, the amount withdrawn is business income in the year of withdrawal.

Worked example 1: sale of a machine above its WDV (tax year 2026-27)

Assumptions: a manufacturing firm has used a machine for the business and has claimed depreciation on it under section 33(2). Its actual cost [B] is Rs 10,00,000 and its written down value [C] is Rs 2,00,000. The scrap value is nil. The moneys become due in 2026-27.

Step	Case 1: sold for Rs 6,00,000	Case 2: sold for Rs 12,00,000
[A] = price + scrap value	Rs 6,00,000	Rs 12,00,000
Does [A] exceed [C] (Rs 2,00,000)?	Yes	Yes
Is [A] less than [B] (Rs 10,00,000)?	Yes, so use [A] − [C]	No, so use [B] − [C]
Deemed business income	6,00,000 − 2,00,000 = Rs 4,00,000	10,00,000 − 2,00,000 = Rs 8,00,000

In case 2 the sum taxed under this clause is capped by the actual cost. The section does not say how the part of the price above the cost is treated; look at the capital gains provisions for that.

Worked example 2: a bad debt recovered later (tax years 2026-27 and 2027-28)

Assumptions: Meena's trading firm is owed Rs 1,00,000 by a customer. The debt was taken into account in her income. In 2026-27 she writes off Rs 60,000 as irrecoverable and is allowed that deduction under section 31(2).

Step	Scenario A: recovers Rs 40,000	Scenario B: recovers Rs 55,000
Debt less amount allowed	1,00,000 − 60,000 = Rs 40,000	Rs 40,000
Recovery made in 2027-28	Rs 40,000	Rs 55,000
Recovery exceeds Rs 40,000?	No	Yes, by Rs 15,000
Deemed business income under 38(1)(d)	Nil	Rs 15,000

Real-life example 1: a supplier waives an old invoice

Ravi runs a hardware shop. In 2026-27 he bought goods worth Rs 5,00,000 on credit and, in a regular assessment, his cost of goods was deducted. In 2028-29 the supplier closes down and tells Ravi he need not pay. The liability has ceased, so under section 38(1)(a)(i) Rs 5,00,000 becomes business income of 2028-29. If Ravi had instead struck the liability off his own books without the supplier's consent, the unilateral write-off limb would apply in the same way.

Real-life example 2: the firm that changed hands

A partnership firm deducted Rs 3,00,000 of expenses. After the firm is succeeded by another firm in that business, the benefit of a waiver of that liability reaches the new firm. Section 38(4) says the value of the benefit, or the amount obtained, by the successor in business is chargeable as income in the successor's hands. Under section 38(6)(b), a successor includes an amalgamated company, a resulting company in a demerger, another person who succeeds the assessee in the business, or another firm that succeeds a firm.

Does section 38 apply after the business has closed?

Yes. Section 38(1)(a) applies whether or not the business is in existence in the later year, and section 38(5) says clauses (b), (c), (d) and (e) apply in a tax year even if the business is no longer in existence.

Section 38(3) gives some relief. If the business no longer exists and there is income under clause (a), (c), (d) or (e), any loss that arose in that business in the tax year it ceased, and could not be set off against other income of that year, is set off against that income. A loss sustained in a speculation business is excluded. Clause (b) is not listed in section 38(3).

Quick reference: conditions and special rules

Provision	What it says
38(2)(a)	Clause (a) applies only if an allowance or deduction was made in an assessment for a tax year
38(2)(b)	Clause (b) applies only if the asset was used for business and depreciation was claimed and allowed under section 33(2)
38(2)(c)	Clause (c) applies only if the asset was not used for other purposes
38(3)	Closed business: unabsorbed loss of the closing year set off against income under clauses (a), (c), (d), (e)
38(4)	Successor in business is taxed on benefits under clause (a)
38(5)	Clauses (b) to (e) apply even if the business has ceased

Common mistakes

• Treating a waiver as a non-cash item. A supplier's waiver or your own write-off of a liability you already deducted is income, even though no money moves.
• Taxing the whole recovery of a bad debt. Only the part above the debt less the amount allowed falls under clause (d).
• Missing the timing for asset sales. Clause (b) is taxed in the year the moneys payable become due, which can differ from the year cash is received.
• Assuming a closed business is out of reach. Section 38(5) and the words of clause (a) keep these sums chargeable.
• Forgetting the successor. After a merger, demerger or succession, the benefit can be taxed in the successor's hands.
• Ignoring the opposite deduction. A recovery lower than expected can give a deduction under section 31(2)(b).

How can a CA firm track these items across clients?

These sums surface at year end, when ledgers show written-off creditors, recovered debts and sold assets. A running list per client makes them easier to catch before the return is prepared. Finexo's practice management software can hold such year-end checklists and deadlines for each client. It does not decide the tax treatment for you.

Where this is in the Act

• Section 38(1)(a) to (e): the deemed sums
• Section 38(2): conditions; section 38(3): closed business set-off; section 38(4): successor; section 38(5): business no longer in existence; section 38(6): meaning of "sold" and "successor in business"
• Section 31(2): bad debt deduction (and see bad debt and provision for doubtful debts)
• Section 32(e): special reserve deduction
• Section 33(2) and 33(12)(a)(i): depreciation and tangible assets
• Section 45(1)(a)(i): scientific research capital expenditure

This article explains the Income-tax Act, 2025 (as amended by the Finance Act, 2026). It is general information, not tax advice. Confirm the position for a specific case with a qualified chartered accountant.