Introduction
We are pleased to present the latest edition of Tax Street – our newsletter that covers all the key developments and updates in the realm of taxation in India and across the globe for the month of April 2025.
- The 'Focus Point' elaborates upon the recent CBDT notification that outlines how expenses on settlement under certain notified laws not allowed as deduction.
- Under the 'From the Judiciary' section, we provide in brief, the key rulings on important cases, and our take on the same.
- Our 'Tax Talk' provides key updates on the important tax-related news from India and across the globe.
- Under 'Compliance Calendar', we list down the important due dates with regard to direct tax, transfer pricing and indirect tax in the month.
We hope you find our newsletter useful and we look forward to your feedback.
Focus Point
Section 37(1) – Expenses on settlement under certain notified laws not allowed as deduction – CBDT Notification – Settling or unsettling the law?
Recently the Central Board of Direct Taxes(CBDT) has released a notification1 wherein it has been mentioned that if an assessee incurs any expenditure for settlement of proceedings initiated in relation to contravention or defaults under notified laws, the same will not be considered as incurred for the purposes of business and profession and will be disallowed while computing the income under the head Profits and Gains from Business and Profession (PGBP). Whether this notification has settled an unclear position or brought in new questions? Let us understand this issue in a bit detail.
Section 37 of the Income-tax Act, 1961 (ITA) mentions that any expenses not covered under Section 30-36 of the ITA, incurred wholly and exclusively for the purposes of business, revenue in nature and are not personal can be claimed as a deduction. Explanation 1 to the said section mentions that any expenditure incurred for any purpose which is an offence, or which is prohibited by law shall not be allowed as a deductible expenditure.
Further, the Explanation 3, inserted by Finance Act, 2022 and further amended by Finance Act (No.2), 2024 seeks to clarify the expression "expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law" and states that any expenditure incurred to settle proceedings initiated in relation to contravention under such law as may be notified by the Central Government in the Official Gazette in this behalf shall also be disallowed.
Recently the CBDT notified2 the relevant statutes covered in Explanation 3 above. The notification states that expenses incurred to settle proceedings initiated in relation to contravention or defaults, for the below-mentioned acts shall not be allowed as deduction:
- The Securities and Exchange Board of India Act, 1992 (15 of 1992);
- The Securities Contracts (Regulation) Act, 1956 (42 of 1956);
- The Depositories Act, 1996 (22 of 1996);
- The Competition Act, 2002 (12 of 2003).
It is pertinent to note that the notification mentions proceedings initiated in relation to contravention or defaults in respect of the said laws. However, the Explanation 3 uses the term contravention only. The terms contravention and default are not synonymous and have different meanings. The notification appears to expand the scope of the explanation to include defaults as well under the notified laws. This may lead to challenging the notification as well as question which amounts will not be allowed as a deduction.
Also, as of now only 4 laws are notified. Interestingly the notification does not cover Goods and Service Tax, Companies Act 2013, Foreign exchange Management Act 1999 etc.
In the past prior to the above amendments, deductibility of compounding charges or settlement charges paid under various laws has been a matter of litigation. While it is a settled position that illegal payments or penalties are not allowed as a deduction3, compounding or settlement charges take a different flavor.
The Honorable Mumbai Tribunal in the case of Deputy Commissioner of Income tax, Circle 3(3)(1), Mumbai v. Anil Dhirajlal Ambani4, had held that the settlement charges paid to SEBI under SEBI's Guidelines regarding consent terms without admitting guilt could not be said to be 'an offence' or 'prohibited by law'. These were not in the nature of hafta, bribe, protection money, etc. It was further mentioned that such payments were made with an intention to save the time and cost of the assessee and hence were allowed as a business expenditure.
Similar contention was held in the case of Income-tax Officer-4(2)(1), Mumbai v Reliance Share & Stock Brokers (P.) Ltd,5 wherein it was held that as the consent fee was paid by assessee-stock broker to SEBI for some technical violations and without admitting guilt, it was an allowable business expenditure.
Thus, it can be observed that such expenditures have been allowed as business expenditure in the past based on facts and circumstances of the case and also the nature of the settlement charges paid by the assessee. The Finance Act (No.2), 2024, by inserting the clause iv has made the intent of the revenue clear that such expenditures would not be allowed as deductible expenditure and the same is a straightforward disallowance with no conditions attached to it per se.
In light of the previous judicial precedents, it may be interpreted that post this amendment and notification, any 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.
In line with the said notification, CBDT has issued FAQs wherein it has been mentioned that the said notification would be effective with effect from 1 April 2025 and shall apply from AY 2025-26 and onwards. To bring the reporting requirements also in alignment with the same, the 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 28 March 2025 to capture details of such expenses separately. This will enhance the transparency of reporting and assist in stricter scrutiny during tax assessments.
Thus, in a way the above-mentioned notification has given clarity about the settlement charges paid for the notified laws, however, has also created some new questions.
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Footnotes
1. Notification No. 38/2025 dated 23 April 2025
2. Notification No. 38/2025 dated 23 April 2025
3. AIR 1998 SUPREME COURT 563
4. [2018] 93 taxmann.com 492 (Mumbai)
5. [2014] 51 taxmann.com 215 (Mumbai)
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