Start with the assessed deduction
Under the Income-tax Act, 2025, section 38(1)(a)(i) treats a benefit from remission or cessation of a trading liability as business income in the subsequent tax year of accrual, including unilateral write-off in the assessee’s accounts. Section 38(2)(a) requires an allowance or deduction in assessment for the relevant liability, loss or expenditure. A ledger credit alone therefore does not establish the taxable amount. This guide uses the 2025 Act for tax years beginning on or after 1 April 2026. The earlier return for FY 2025–26, AY 2026–27, is governed by the applicable 1961 Act; check section 536 when an allowance under the 1961 Act is followed by a recovery or release under the 2025 Act. For a qualifying benefit or recovery in a year governed by the 1961 Act, the comparable provision is section 41(1).
Read the applicable text: Income-tax Act, 2025 as amended: sections 38 and 536 Income Tax Department: transition guidance.
Trace the benefit to the original tax line
Link the original creditor, invoice or expense to the assessment record, filed computation and any later operative order. Break out amounts never allowed, partly allowed or allowed in a later year. Where relief applies to particular items, match it to those items before allocating. A payable’s age, missing confirmation or movement to another ledger does not by itself prove a benefit; identify an effective waiver, cessation or actual write-off. Test trading liabilities separately from loan principal, capital balances, tax components and unrelated receipts. A failure to meet this provision does not decide whether another charging provision applies.
Distinguish a release from a cash recovery
Section 38(1)(a)(ii) separately addresses amounts obtained in cash or otherwise in respect of prior loss or expenditure. Keep evidence of receipt and trace it to the deduction. A full settlement of a liability at a discount can involve cash outflow and a separate release; the payment is not the amount of the release. Check the agreement’s effective conditions, including whether an instalment or consent is still pending, and identify which amount accrued in the year.
Control the computation and successor file
Reconcile the section 38 income item with the amount already credited in profit and loss before posting an adjustment. Section 38(1)(a) can apply even if that business has ceased, and section 38(4) charges the qualifying amount in the hands of the successor if that person obtains it. Section 38(6) defines the included categories of successor, including specified amalgamations, demergers and firm successions. For a discontinued business, section 38(3) has a specific set-off for qualifying non-speculation loss of the cessation tax year that could not be set off there; do not assume every old loss is eligible. Preserve the prior allowance and release records even after a company closes its operations.
Six worked illustrations
All facts and amounts are fictional. Calculations illustrate the stated assumptions, not a predetermined legal outcome.
Illustrative example 1: Part payment and release
A company settles a ₹24 lakh trade payable, previously allowed in assessment in full, by paying ₹17 lakh and securing an effective release of the balance. The benefit is ₹7 lakh, assuming no further condition.
Illustrative example 2: Release allocated by invoice
A signed waiver covers ₹4 lakh of an allowed trade invoice and ₹3 lakh of a different invoice never allowed in assessment. The book credit is ₹7 lakh. On the stated facts section 38(1)(a)(i) supports ₹4 lakh; review the remaining ₹3 lakh separately before any tax adjustment.
Illustrative example 3: Balance merely aged
A ₹9 lakh payable remains recognised and a company pays ₹2 lakh against it; the rest remains enforceable on the assumed facts. Closing balance is ₹7 lakh and there is no release from the payment alone.
Illustrative example 4: Current book credit already captures income
A supported taxable release is ₹8 lakh, and the entire ₹8 lakh was credited in current book profit. The section 38 bridge requires zero incremental addition for that item, assuming no other difference.
Illustrative example 5: Recovery of an earlier expense
A company obtains ₹5 lakh in respect of a ₹12 lakh expense previously allowed in assessment. Assuming it is an actual qualifying recovery, the current section 38(1)(a)(ii) item is ₹5 lakh; the unrecovered amount is ₹7 lakh.
Illustrative example 6: Business discontinued
A qualifying ₹10 lakh release arises after cessation. Assume a ₹4 lakh non-speculation loss from the same discontinued business arose in the cessation year, could not be set off against any other income of that year and meets section 38(3). The illustrative balance after that set-off is ₹6 lakh.
Ten-step verification table
| Step | Action | Evidence |
|---|---|---|
| 1 | Classify the ledger item | Invoice, agreement and nature of the underlying liability. |
| 2 | Confirm the tax period | Operative law and release or receipt date. |
| 3 | Trace the original allowance | Assessment evidence, computation and later orders. |
| 4 | Split disallowed components | Year-wise deductions and invoice-level reconciliation. |
| 5 | Identify the benefit event | Effective waiver, discharge or actual write-off. |
| 6 | Quantify payment and release separately | Settlement terms and cash record. |
| 7 | Review successor and closure facts | Transaction documents and identity of beneficiary. |
| 8 | Check any statutory cessation-year set-off | Proof of qualifying loss and earlier utilisation. |
| 9 | Bridge current book income | Posted credit, supported tax amount and single adjustment. |
| 10 | Archive an item-level register | Underlying evidence, dates, basis and review sign-off. |
Sixteen practitioner FAQs
1. Does age alone create a section 38 charge?
No. Establish the qualifying benefit event or recovery and the earlier allowance.
2. Can a unilateral write-off count?
Section 38(1)(a)(i) expressly includes a unilateral write-off of the trading liability in the assessee’s accounts.
3. Is a disputed balance transferred to a suspense account necessarily written off?
No. Review whether the liability was actually derecognised and the facts supporting any cessation.
4. Is a prior deduction in book accounts enough?
No. Section 38(2)(a) requires allowance or deduction in assessment.
5. Can a disallowed expense give rise to this charge automatically?
No. Trace what was allowed; analyse other provisions independently.
6. Does payment of a discounted settlement measure the remission?
Measure the value of the release rather than the cash paid.
7. Can a conditional release be assumed effective on signature?
Read the conditions and verify when the benefit accrues.
8. Does a loan-principal waiver automatically meet this trading-liability test?
No. Determine the nature, prior allowance and any separately applicable charge.
9. What if a cash recovery arises from prior expenditure?
Consider section 38(1)(a)(ii) and trace the amount obtained.
10. Does a book credit require a second addition?
Reconcile it to the current tax item; inclusion should occur once.
11. Can a business that stopped trading have this income?
Yes. Subsection (1)(a) expressly allows that situation.
12. Can a successor be charged?
Yes, where the successor provisions and the relevant facts apply.
13. Does the cessation-year loss rule include speculation loss?
Section 38(3) excludes it.
14. Can the settlement be allocated solely by the total ledger balance?
Prefer item-level settlement terms and evidence before using any supported allocation.
15. Should old and new enactments use the same section numbers?
No. Check the operative year and applicable transitional rules.
16. What should the close reviewer tie together?
Original deduction, current benefit or recovery, book treatment and the final tax adjustment.
Official sources
Income-tax Act, 2025 as amended: sections 38 and 536 Income Tax Department: transition guidance