Section 38 · Computation of total income
Section 38 of the Income-tax Act, 2025 — Certain Sums Deemed as Profits and Gains of Business or Profession
By CA Rajat Agrawal
Updated 04 Jul 2026
Chapter IV
📜 What the law says — Section 38, Income-tax Act 2025
38. (1) The following sums shall be deemed to be profits and gains of business or
profession and shall be chargeable to income-tax, in the manner specified
below, subject to the provisions of sub-section (2):—
(a) where an allowance or deduction has been allowed in respect of any loss,
expenditure or trading liability incurred by the assessee during any tax
year, then,—
(i) the value of any benefit accruing to the assessee by way of cessation
or remission of such trading liability, including a unilateral act of
write-off of such liability in his accounts, in a subsequent tax year
in which such benefit accrues; or
(ii) any amount obtained by the assessee, whether in cash or other-
wise, in respect of such loss or expenditure incurred, in subse-
quent tax year in which the amount is obtained,
whether the business or profession in respect of which the allowance or
deduction was made is in existence in such subsequent tax year or not;
(b) in a case where any tangible asset [as referred to in section 33(12)(a)
(i)], which is owned by assessee, is sold, discarded, demolished or
destroyed, and the moneys payable for such asset, together with the
scrap value [A] exceeds the written down value of such assets [C], the
sum as computed below, in the tax year in which the moneys payable
for such asset becomes due—
(i) where the moneys payable for such asset together with the scrap
value [A] is less than the actual cost of such asset [B], then—
[A] – [C]; or
(ii) in any other case,—
[B] – [C];
(c) in a case where an asset representing expenditure of a capital nature
on scientific research, referred to in section 45(1)(a)(i) is sold, without
having been used for other purposes, and the sale proceeds together
with the total deductions allowed under that section exceed the amount
of capital expenditure, the excess or the amount of deduction so made,
whichever is less, in the tax year in which the asset was sold;
(d) in a case where a deduction has been allowed for a bad debt (or part of
it) under the provisions of section 31(2), and any amount subsequently
recovered exceeds the difference between such debt and the amount
allow
In plain language
What Section 38 is all about
Section 38 of the Income-tax Act, 2025 is the "claw-back" provision of business taxation. It says that if you got a deduction or allowance in an earlier year for a loss, expenditure, trading liability, bad debt, scientific-research asset or a special reserve, and in a later year that benefit comes back to you (the liability is waived, the debt is recovered, the asset is sold, or the reserve is withdrawn), then that recovered amount is treated as your business income and taxed again. In plain words: what the tax system once let you deduct, it takes back when you actually get the money or benefit.
This section is the direct successor to the well-known Section 41 of the Income-tax Act, 1961. The concept is unchanged — only the numbering and drafting have been modernised under the new 2025 Act (effective 1 April 2026).
The five situations it covers — Section 38(1)(a) to (e)
- (a) Remission or cessation of a trading liability: You claimed a deduction for an expense or trading liability (say, a supplier's bill). Later the creditor waives it, or you simply write it back in your books. The benefit is taxed. This explicitly includes a unilateral write-off of the liability in your own accounts.
- (b) Balancing charge on assets: Where sale proceeds of a depreciable/tangible asset exceed its written-down value, the excess (to the extent of depreciation earlier allowed) is deemed income.
- (c) Sale of a scientific-research asset: If an asset on which 100% capital expenditure was allowed for scientific research is later sold, the recovery is taxed as business income.
- (d) Recovery of a bad debt: A bad debt was written off and allowed as a deduction (linked to Section 31(2) of the 2025 Act, the old 36(1)(vii)). If you later recover more than the net amount, the excess is taxable.
- (e) Withdrawal from a special reserve: Amounts withdrawn from a special reserve for which a deduction was earlier claimed (e.g., reserve by financial corporations) are brought to tax.
Who does it apply to
It applies to every person carrying on (or who has carried on) a business or profession — proprietors, firms, LLPs, companies and professionals — who has previously enjoyed a deduction that is now being reversed by a real-world event.
Key conditions and important carve-outs
- Prior allowance is a must: The amount is taxable only if the loss, expense, debt or liability was actually allowed as a deduction earlier. If it was never deducted, its recovery is not caught here.
- Even if the business has closed: A crucial feature — clauses (b), (c), (d) and (e) apply even if the business no longer exists in the year of recovery. So you cannot escape tax merely by shutting shop.
- Successor in business: For remission/cessation of trading liability under (1)(a), if the benefit or amount is obtained by a successor in business, it is taxed in the successor's hands.
- Set-off relief: The section allows unabsorbed losses and depreciation of the discontinued business to be set off against this deemed income, softening the blow.
How it interacts with other sections
Section 38 works with Section 31 (deductions, including bad debts under 31(2)), the depreciation and block-of-asset rules (balancing charge), and the scientific-research deduction provisions. It is the mirror image of those deduction sections — they give the relief, Section 38 reverses it on recovery.
Practical implications
- Do not casually write back old creditor balances to "clean up" the balance sheet — an unpaid trade creditor written off can trigger tax under 38(1)(a).
- Maintain a clear trail of which debts/expenses were claimed as deductions, because only those recoveries are taxable.
- The classic "loss of profits" (business-interruption) insurance recovery is treated as trading income; recoveries of already-allowed items feed into this section.
💡 Example
Example 1 — Remission of a trading liability [Section 38(1)(a)]: In FY 2024-25, Sharma Traders bought goods worth ₹5,00,000 on credit and claimed the purchase as an expense. In FY 2026-27 the supplier, settling a dispute, waives ₹2,00,000 of the outstanding bill. Since a deduction was earlier allowed, the ₹2,00,000 remitted benefit is deemed profit under Section 38 and added to Sharma Traders' business income for FY 2026-27 — taxable at its applicable slab/rate.
Example 2 — Recovery of bad debt [Section 38(1)(d)]: A firm wrote off a ₹3,00,000 debt as bad in FY 2023-24 and the full amount was allowed as a deduction. In FY 2026-27 the debtor unexpectedly pays ₹1,80,000. Because the debt was already allowed, the recovered ₹1,80,000 is treated as business income in FY 2026-27 under Section 38 — even if the firm has since wound up that line of business.
A relatable story: Meena ran a boutique that shut down in 2025. She thought her tax worries were over. In 2026 an old customer cleared a ₹90,000 dues that Meena had written off as bad debt years ago (and claimed as a deduction then). Her CA explained that under Section 38 this recovery is taxable as business income even though the boutique no longer exists — but the good news was that Meena's unabsorbed business loss from the closure year could be set off against it, leaving little or no tax to pay.
| Clause | What is recovered / the trigger | Amount deemed as business income | Applies even if business closed? |
|---|
| 38(1)(a) | Remission/cessation of a trading liability or unilateral write-off; refund of tax/duty/cess earlier allowed | Value of the benefit obtained | Yes (via set-off relief; successor taxed if benefit accrues to successor) |
| 38(1)(b) | Sale of a tangible/depreciable asset above written-down value | Excess of proceeds over WDV, limited to depreciation earlier allowed (balancing charge) | Yes |
| 38(1)(c) | Sale of an asset used for scientific research (100% capital expenditure earlier allowed) | Recovery up to the deduction earlier allowed | Yes |
| 38(1)(d) | Recovery of a bad debt earlier written off and allowed under Section 31(2) | Amount recovered in excess of (debt minus deduction allowed) | Yes |
| 38(1)(e) | Withdrawal from a special reserve for which a deduction was earlier claimed | Amount withdrawn | Yes |
Related sections
Section 41 of the Income-tax Act 1961 — the earlier equivalent of Section 38 Section 31 — Deductions (including bad debts) for business or profession Section 26 — Profits and gains of business or profession chargeable to tax Section 33 — General deduction for business expenditure Section 28 — Amounts not deductible / disallowances in computing business income Section 37 — Special provision for computing profits (e.g. deemed profits)
Frequently asked questions
Is Section 38 of the 2025 Act the same as Section 41 of the old Act?
Yes. Section 38 of the Income-tax Act, 2025 replaces Section 41 of the Income-tax Act, 1961. The core concept — taxing recovery of items earlier allowed as deductions — is unchanged; only the drafting and numbering are modernised.
I wrote off an old creditor balance in my books. Is it taxable?
Yes, if the original expense or trading liability was earlier allowed as a deduction. Section 38(1)(a) specifically covers a unilateral write-off of a trading liability in your own accounts and treats the benefit as business income.
My business has closed. Can Section 38 still tax me?
Yes. For clauses (b), (c), (d) and (e), the provision applies even if the business no longer exists in the year of recovery. However, you can set off unabsorbed losses and depreciation of that business against the deemed income.
If I recover a bad debt I had written off, how much is taxable?
Only the excess of the amount recovered over the portion that was NOT allowed as a deduction is taxable. In effect, recovery up to the deduction earlier allowed is brought to tax under Section 38(1)(d).
Who pays the tax if the benefit goes to a successor of the business?
For remission or cessation of a trading liability, if the benefit or amount is obtained by the successor in business, it is chargeable to tax in the successor's hands, not the original owner's.
Does recovery of an amount that was never deducted get taxed under Section 38?
No. Section 38 applies only where a deduction or allowance was actually allowed earlier. If the loss, expense or liability was never claimed as a deduction, its later recovery is not deemed income under this section.
Under which head is this deemed income taxed?
It is taxed under the head 'Profits and gains of business or profession' and added to your business income for the year in which the benefit accrues or the amount is recovered.
C
CA Rajat Agrawal
Chartered Accountant, EaseValue · Reviewed 04 Jul 2026
This explainer is prepared and reviewed by EaseValue's tax team, based on the text of the Income-tax Act, 2025 (as amended by the Finance Act, 2026).
Disclaimer: This page explains the law in general terms for education and is not professional advice. The Income-tax Act, 2025 takes effect from 1 April 2026; provisions, thresholds and interpretations may change. Please confirm your specific position with our team before acting.
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