The Central Board of Direct Taxes (CBDT) has issued Notification No. 38/2025 dated 23rd April 2025, introducing important clarifications regarding the allowability of business expenditures under the Income-tax Act, 1961. This notification focuses on amendments made to Section 37, particularly relating to expenses incurred for purposes that are offenses or prohibited by law. Understanding these updates is essential for businesses and professionals to ensure proper compliance and accurate tax reporting.
Below, we address some frequently asked questions (FAQs) to help you clearly understand the implications of Notification No. 38/2025:
What is Section 37 of the Income-tax Act, 1961?
Section 37 of the Income-tax Act provides for the allowability of expenditure that is laid out or expended wholly and exclusively for the purpose of business or profession. It acts as a general provision for claiming deductions for business expenses not specifically covered under other sections.
What is Explanation 1 of sub-section (1) of Section 37, and how is it related to Explanation 3?
Explanation 1 to sub-section (1) of Section 37 states that any expenditure incurred by an assessee for any purpose which is an offense or which is prohibited by law shall not be deemed to have been incurred for business or professional purposes. As a result, no deduction or allowance can be claimed for such expenses.
Explanation 3 further clarifies the meaning of “expenditure incurred for any purpose which is an offense or which is prohibited by law,” strengthening the original intent of Explanation 1 and ensuring consistent interpretation.
What amendment was made to Explanation 3 by the Finance (No. 2) Act, 2024?
The Finance (No. 2) Act, 2024 amended Explanation 3 to clarify that the term also includes any expenditure incurred by an assessee to settle proceedings initiated in relation to a contravention under any law currently in force, as may be notified by the Central Government.
This means that expenses related to settlement of legal proceedings, even if resolved without an admission of guilt, will be treated as non-deductible if they relate to an offense or prohibited activity.
Which laws have been notified under the amended Explanation 3?
According to Notification No. 38/2025, expenditures incurred for settling proceedings related to contraventions under the following laws will not be considered allowable business expenditures:
- The Securities and Exchange Board of India Act, 1992
- The Securities Contracts (Regulation) Act, 1956
- The Depositories Act, 1996
- The Competition Act, 2002
This update highlights the government’s intention to discourage businesses from treating penalties, fines, or settlement amounts related to regulatory breaches as tax-deductible expenses.
What are the implications of this notification?
From Assessment Year 2025-26 onwards, any expenditure incurred by an assessee for the settlement of proceedings under the laws mentioned above cannot be claimed as a deduction or allowance under the Income-tax Act.
Additionally, Form No. 3CD of the Income-tax Rules, 1962, which is required to be filed during a tax audit, has been amended via CBDT Notification No. 23/2025 dated 28th March 2025 to capture details of such expenses separately. This will enhance the transparency of reporting and assist in stricter scrutiny during tax assessments.
From when has the amendment been made effective?
The amendment takes effect from 1st April 2025, and will apply from Assessment Year 2025-26 onwards. Businesses should adjust their accounting practices accordingly for transactions and expenses incurred during and after the financial year 2024-25.
Final Words
The recent clarification under Notification No. 38/2025 emphasizes that expenditures related to offenses or prohibited activities, including settlements under specified regulatory laws, are not allowable as deductions. Proper understanding and careful reporting of such expenses are now more critical than ever to maintain compliance and avoid tax complications.
Staying updated with such legal changes ensures that businesses operate within the framework of the law and adopt best practices in financial reporting.
