CBDT Notification No. 38/2025: Disallowance of Settlement Expenses
On April 23, 2025, the Central Board of Direct Taxes (CBDT) issued Notification No. 38/2025, introducing significant changes to the deductibility of certain business expenditures under the Income-tax Act, 1961. This notification, effective from April 1, 2025, applies to Assessment Year 2025–26 onwards and aims to prevent taxpayers from claiming deductions on expenses incurred to settle proceedings related to contraventions under specified laws.
Understanding Section 37 of the Income-tax Act
Section 37(1) of the Income-tax Act allows taxpayers to deduct any business
expenditure not covered under specific sections, provided it is not personal or
capital in nature and is incurred wholly and exclusively for business purposes.
However, Explanation 1 to this section disallows deductions for any expenditure
incurred for purposes that are offenses or prohibited by law.
The Finance (No. 2) Act, 2024 introduced Explanation 3 to Section 37(1),
expanding the scope of disallowance to include any expenditure incurred to
settle proceedings initiated in relation to a contravention under any law, as
notified by the Central Government.
Key Highlights of Notification No. 38/2025
CBDT Notification No. 38/2025 specifies that expenses incurred to settle
proceedings related to contraventions under the following laws are not
deductible:
1. Securities and Exchange Board of India (SEBI) Act, 1992
2. Securities Contracts (Regulation) Act, 1956
3. Depositories Act, 1996
4. Competition Act, 2002
This means that any fines, penalties, compounding fees, or settlement amounts
paid under these laws cannot be claimed as business expenditures for tax
deduction purposes.
Effective Date: The notification came into force on April 1, 2025, and is applicable from
Assessment Year 2025–26 onwards.
Implications for Taxpayers
- Non-Deductibility: Expenses incurred to settle proceedings under the specified laws are disallowed as deductions.- Increased Tax Liability: Businesses may face higher tax liabilities due to the disallowance of these expenses.
- Enhanced Compliance: Taxpayers must ensure accurate reporting of such expenses in their tax filings.
Amendment in Tax Audit Report (Form 3CD)
To ensure proper disclosure, the CBDT has amended Form 3CD of the Income-tax Rules, 1962, via Notification No. 23/2025 dated March 28, 2025. Tax auditors are now required to report expenses incurred to settle proceedings under the specified laws separately.Illustrative Example
Scenario: A company pays ₹10 lakh to settle a proceeding initiated by SEBI for a regulatory contravention.- Before Notification No. 38/2025: The company could claim this ₹10 lakh as a deductible business expense under Section 37(1).
- After Notification No. 38/2025: The ₹10 lakh is disallowed as a deduction, increasing the company's taxable income by the same amount.
Comparative Table: Deductibility of Settlement Expenses
|
Law |
Deductibility Before Notification |
Deductibility Before Notification |
|
SEBI Act, 1992 |
Deductible |
Deductible |
|
Securities Contracts (Regulation) Act, 1956 |
Deductible |
Not Deductible |
|
Depositories Act, 1996 |
Deductible |
Deductible |
|
Competition Act, 2002 |
Deductible |
Not Deductible |
Conclusion
CBDT Notification No. 38/2025 underscores the government's intent to discourage non-compliance with financial and competition laws by disallowing tax deductions on settlement expenses. Businesses must reassess their compliance strategies and ensureaccurate reporting to avoid adverse tax consequences.
References:
- CBDT Notification No. 38/2025
- Finance (No. 2) Act, 2024
- Income-tax Act, 1961
Frequently Asked Questions (FAQs)
Q1. What is Section 37 of the Income-tax Act, 1961?A1. Section 37 allows for the deduction of any business expenditure not covered under specific sections, provided it is
not personal or capital in nature and is incurred wholly and exclusively for business purposes.
Q2. What does Explanation 1 to Section 37(1) state?
A2. Explanation 1 disallows deductions for any expenditure incurred for purposes that are offenses or prohibited by law.
Q3. What is the significance of Explanation 3 introduced by the Finance (No. 2) Act, 2024?
A3. Explanation 3 expands the scope of disallowance to include any expenditure incurred to settle proceedings initiated in
relation to a contravention under any law, as notified by the Central Government.
Q4. Which laws have been notified under the amended Explanation 3?
A4. The following laws have been specified:
- Securities and Exchange Board of India (SEBI) Act, 1992
- Securities Contracts (Regulation) Act, 1956
- Depositories Act, 1996
- Competition Act, 2002
Q5. From when is this amendment effective?
A5. The amendment is effective from April 1, 2025, and applies from Assessment Year 2025–26 onwards.
Q6. What are the implications of this notification for taxpayers?
A6. Taxpayers cannot claim deductions for expenses incurred to settle proceedings under the specified laws, leading to increased taxable income and tax liability.
Q7. Has there been any change in the tax audit reporting requirements?
A7. Yes, Form 3CD has been amended to require separate disclosure of such expenses during tax audits.
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Income Tax