Section 38 of the Income-tax Act, 2025 deems certain receipts to be business profits: remission or cessation of a trading liability including a unilateral write-off, the balancing charge on sale of a depreciated asset, scientific research asset sales, bad debt recoveries and special reserve withdrawals.
What section 38 does
Section 38 is the claw-back provision — the successor to section 41 of the Income-tax Act, 1961. Where you have already taken a deduction and the underlying liability or loss later reverses, the benefit comes back as business income.
Its most striking feature is preserved from the old law: sub-section (1)(a)(i) taxes the cessation or remission of a trading liability including a unilateral act of write-off of such liability in the assessee's accounts. Writing a stale creditor back to your own profit and loss account is itself the taxable event.
Equally important is sub-section (5): clauses (b) to (e) apply even if the business is no longer in existence. Closing the business does not switch off the claw-back.
The Income-tax Act, 2025 takes effect from 1 April 2026 and applies from tax year 2026-27. The Income-tax Act, 1961 continues to govern every year up to 31 March 2026, including assessments, appeals and penalties for those years, because of the repeal and savings provision in section 536. Figures quoted here are the amounts written into the Act as enacted (with the Gazette corrigenda of 3 September 2025); the annual Finance Act can change rates and thresholds.
Old Act and new Act, side by side
The table below shows what the Income-tax Act, 1961 did and where the same ground is covered in the Income-tax Act, 2025.
| Income-tax Act, 1961 | What it did | Income-tax Act, 2025 |
|---|---|---|
| 41(1) | Remission or cessation of trading liability | 38(1)(a) |
| 41(2) | Balancing charge on sale of a depreciated asset | 38(1)(b) |
| 41(3) | Sale of a scientific research asset | 38(1)(c) |
| 41(4) | Recovery of a bad debt written off | 38(1)(d) |
| 41(4A) | Withdrawal from a special reserve | 38(1)(e) |
| 41(5) | Set off of a loss of the discontinued business | 38(3) |
| 41(1), Explanation 2 | Charge in the hands of a successor | 38(4) with 38(6)(b) |
Section 38 sub-section by sub-section
Read this alongside the bare text — each heading below is a sub-section of the section as enacted.
Sub-section (1)(a) — remission or cessation of a trading liability
Where an allowance or deduction was allowed for a loss, expenditure or trading liability, then (i) the value of any benefit from cessation or remission of that trading liability, including a unilateral write-off in the accounts, is taxed in the year the benefit accrues; and (ii) any amount obtained, in cash or otherwise, in respect of that loss or expenditure is taxed in the year it is obtained — whether or not the business is still in existence.
Sub-section (1)(b) — the balancing charge
Where a tangible asset as defined in section 33(12)(a)(i), owned by the assessee, is sold, discarded, demolished or destroyed, and the moneys payable together with scrap value exceed the written down value , the excess is taxed in the year the moneys become due. The amount is − where is less than actual cost , and − in any other case. In other words, the charge is capped at the depreciation actually allowed; anything beyond original cost is a capital gain, not a balancing charge.
Sub-section (1)(c) — scientific research assets
Where an asset representing capital expenditure on scientific research under section 45(1)(a)(i) is sold without having been used for other purposes, and the sale proceeds plus the deductions already allowed exceed the capital expenditure, then the excess or the deduction allowed, whichever is less, is taxed in the year of sale.
Sub-section (1)(d) and (e) — bad debt recoveries and reserve withdrawals
Where a bad debt deduction was allowed under section 31(2) and the amount subsequently recovered exceeds the difference between the debt and the amount allowed, the excess is taxed in the year of recovery. And where a deduction was allowed for a special reserve created under section 32(e), any amount later withdrawn from that reserve is taxed in the year of withdrawal.
Sub-section (2) — the conditions
Each limb has a gate. Clause (1)(a) applies only where an allowance or deduction was actually made in an assessment. Clause (1)(b) applies only where the asset was used for business and depreciation was claimed and allowed under section 33(2). Clause (1)(c) applies only where the asset was not used for other purposes.
Sub-section (3) — set off of the discontinued business loss
Where the business no longer exists and income arises under clause (1)(a), (c), (d) or (e), any loss — other than a speculation loss — that arose in that business in the year it ceased and could not be set off against other income of that year may be set off against this deemed income.
Sub-sections (4) to (6) — successors, closed businesses and definitions
Sub-section (4) charges the benefit in the hands of the successor in business where it accrues to them. Sub-section (5) makes clauses (b) to (e) apply even if the business is no longer in existence. Sub-section (6) defines sold (including exchange and compulsory acquisition, but excluding a transfer in an amalgamation to an Indian amalgamated company) and successor in business — the amalgamated company, the resulting company on demerger, any person succeeding to the business, or a firm succeeding another firm.
Worked example
A business closed its manufacturing division in 2025-26. In tax year 2026-27 the following happen.
| Event | Working | Taxable under section 38 |
|---|---|---|
| A creditor of ₹18,00,000, for which a deduction was allowed, is written back unilaterally | Sub-section (1)(a)(i) — unilateral write-off is itself the trigger | ₹18,00,000 |
| Plant sold for ₹30,00,000; actual cost ₹50,00,000; written down value ₹12,00,000 | ₹30,00,000 < ₹50,00,000, so − = ₹30,00,000 − ₹12,00,000 | ₹18,00,000 |
| Plant sold for ₹62,00,000; actual cost ₹50,00,000; written down value ₹12,00,000 | exceeds , so − = ₹50,00,000 − ₹12,00,000; the ₹12,00,000 above cost is a capital gain | ₹38,00,000 |
| Bad debt of ₹9,00,000 written off earlier; ₹7,00,000 recovered | Section 38(1)(d), to the extent of the excess over the allowed amount | As computed |
| Withdrawal from a special reserve created under section 32(e) | Section 38(1)(e) | Amount withdrawn |
The business no longer exists, but sub-section (5) keeps clauses (b) to (e) alive and sub-section (1)(a)(ii) expressly applies whether or not the business is in existence. Against this deemed income, sub-section (3) permits set off of the unabsorbed non-speculation loss of the year the business ceased.
Compliance checklist and due dates
- Before writing back a stale creditor, check whether a deduction was originally allowed — sub-section (2)(a) is the gate.
- On disposal of a depreciated asset, compute the balancing charge with all three figures: moneys payable plus scrap , actual cost and written down value .
- Split proceeds above original cost out of the balancing charge; that portion is a capital gain, not business income.
- Track special reserves created under section 32(e); any withdrawal is taxable under clause (1)(e).
- Where a business has ceased, preserve the unabsorbed non-speculation loss of the closing year so it can be set off under sub-section (3).
- On amalgamation, demerger or succession, identify the successor in business under sub-section (6)(b) — the charge follows them.
Common mistakes
- Believing a unilateral write-back is not taxable because the creditor never released the debt. Sub-section (1)(a)(i) covers it expressly.
- Assuming closure of the business ends the exposure. Sub-section (5) and clause (1)(a)(ii) say otherwise.
- Taxing the entire excess over written down value as business income where the sale price exceeds original cost.
- Applying the balancing charge to an asset on which depreciation was never claimed and allowed — sub-section (2)(b) requires it.
- Forgetting the set off available under sub-section (3) for the discontinued business's own loss.
This is an explanatory guide, not tax advice, and it does not reproduce the section in full. Read the bare text of the section before you rely on it, and check for later amendments, the Income-tax Rules made under the new Act, and CBDT circulars and notifications.