One Business with Two Profits—The Puzzle

Imagine you are going to appear for an interview for the post of ‘Tax Associate’ without knowing properly the ‘Heads of Income” under the Income Tax Act, 1961 chaos! So, when you sit for interviews for such a job role, interviewers often test your basic knowledge of such subject.  Let study one story of Miss Pooja to make this topic clearer.

We know that Income Tax in India is governed by the Income Tax Act, 1961. As direct tax it is taken care of by the Central Board of Direct Taxes (CBDT). Under the Income Tax Act, 1961, there are five heads of income-

1. Income from Salaries
2. Income from House Property
3. Profits and Gains of Business or Profession (PGBP)
4. Income from Capital Gains
5. Income from other Sources.

Section 28 of the Income Tax Act, 1961 outlines the provisions relating to PGBP. It covers income generated through regular business or professional services whether in a small way even a shop, factory, company or you practice as a Professional.

For the Finance and Accounting students, this topic is important because it connects two different worlds – Principles of Accounting and Tax Laws and introduces two different profits Book Profit and Tax Profit. These two terms often confuse students and business owners, but it’s a real fact.

The question confuses students- Is the Book Profit shown in the books of accounts same as the Tax Profit calculated under the head PGBP?   

The answer is – No

Let’s understand these two terms through a journey of young entrepreneur who is running a showroom of electrical gadgets.

Pooja’s confusion – Book profit and Tax Profit!

Miss Pooja, a woman entrepreneur who runs a showroom called “Pooja Collection” and has prepared her books of accounts with the help of her accountant for the FY 2024-25 and finds that the Net Pofit (Book Profit) is Rs. 11,00,000.

However, when she meets with her Chartered Accountant, she is surprised to know that the Taxable Income (Tax Profit) of the business is. Rs 13,50,000.

She asks with utter confusion, “How is this possible”. My accounts are prepared following all principles of accounts. Her consultant replies smilingly, listen Pooja, Accounting and Taxation are different and follow different rule books. Book profit is the language of business while Tax profit speaks the language of Law.

Let’s understand about two languages of business

Characteristic	Book Proft (Net Profit)	Tax Profit (Taxable Income)
Governing rule	Accounting Standards and Companies Act	Income Tax Act,1961
Objective	To show true and fair view to the stakeholders	To calculate profit for calculation of tax payable
Principles	Accrual, Matching, Conservatism and Consistency	Specific rules, allowable exemption and deductions as per law.
Focus	Financial performance and growth of business	Tax liability

In crux, while Book profit shows how the business performed, Tax profit determines how much tax it must may.

Pooja Collection – Calculation of Book Profit (Net Profit)

Details	Amount (Rs.)
Revenue from Business	20,30,000
Salaries paid	3,00,000
Rent and Utilities	2,20,000
Electricity charges	50,000
Depreciation (as per Books)	2,00,000
Provision for Doubtful Debts	1,10,000
Penalty for late GST filing	10,000
Income Tax paid	10,000
Interest on working capital loan	30,000
Net Profit for the year  as per Books	11,00,000

Now let’s understand how Tax Profit is calculated

Step 1–First start with Net Profit of Rs. 11,00,000

Step 2 – Add back all disallowed expenses as per Income Tax Rules

Disallowed Items	Amount (Rs)	Reason
Provision for Doubtful Debts	1,10,000	Not actual expenses, only an estimate
Penalty for late GST filing	10,000	Penalty for violation of Law
Income Tax paid	10,000	Personal expenses as per Income Tax Rule
Total Disallowed	1,30,000

Step 3 -Two Depreciation rules are different

Details	Amount (Rs.)
Depreciation as per Books	2,00,000
Depreciation as per Income Tax Act	80,000
Difference less allowed)	1,20,000

Step 4 – Computation of Tax Proft (Taxable Income)

Details	Amount (Rs.)
Net Profit as per Books	11,00,000
Add: Disallowed expenses	1,30,000
Add: Depreciation overcharged	1,20,000
Tax Profit	13,50,000

Learning Outcome

Basis	Purpose	Result
Book Profit (Accounting)	Shows performance to owners/shareholders	11,00,000
Tax Profit (Taxable Income)	Determines tax liability under Law	13,50,000

Observation: The difference of Rs. 2,50,0000 shows how disallowed items and different depreciation rules can make tax profit higher than book profit — even when both start from the same figure/data.

Pay Attention

1. Book profit and Tax profit are not same as laws and objectives differ.
2. Disallowed expenses always increase tax profit.
3. Depreciation rules are different and affects income.
4. The concept of DTA and DTL are introduced.

 Closing Memo

Understanding this concept equips students and business owners to bridge the gap between books of accounts and taxation a skill highly appreciated in academia and corporate world.