Section 37 of the Income Tax Act

What is the Section 37 of the Income Tax Act?

Conditions to Claim Deductions under Section 37 of the Income Tax Act

• Exclusion of Personal or Capital Expenditure: The expense must not be personal in nature or a capital investment. Only operational costs qualify under this section.
• Not Covered Under Sections 30 to 36: The expenditure should not fall under other sections of the Income Tax Act, such as those specifically addressing rent, repairs, insurance, or depreciation.
• Legal and Ethical Compliance: Expenses incurred for activities that constitute an offence or are prohibited by law are not eligible for deduction under Section 37.
• Business or Professional Purpose: The expenditure must be wholly and exclusively incurred for the purpose of running a business or practising a profession.
• Relates to the Relevant Financial Year: Only expenses paid or accrued during the previous financial year can be claimed for deduction under this section.

Expenses Allowed for Tax Deduction under Section 37 of the Income Tax Act

• Interest on Business Loans: Interest paid on loans taken for business purposes is deductible under Section 37(1). However, this deduction excludes loans used for capital expenditures.
• Legal Fees: Expenses related to legal services, such as fees paid to lawyers, advocates, and solicitors for business purposes, are eligible for deduction.
• Advertisement Expenses: Expenditures on advertisements across media platforms are deductible, provided they are business-related. Advertisements supporting political parties or agendas are excluded.
• Salaries to Employees: Salaries paid to employees are deductible, including compensation on termination. Salaries paid to partners of a firm may also qualify, subject to specific conditions, while payments to proprietors are not eligible.
• Loan Raising Expenses: Costs incurred in raising business loans, such as registration fees, stamp duty, and brokerage charges, are eligible for deduction under Section 37.
• Penalty Payments: Penalty payments may or may not qualify for the deduction. For example:
  • Penalties for legal violations are not deductible.
  • Compensatory payments arising from contractual obligations may qualify.
• Other Allowable Expenses: Additional deductions under Section 37 include:
  • Fees paid to the registrar of companies for legal compliance.
  • Employee welfare expenses.
  • Costs incurred for festivals (e.g., Diwali, Christmas).
  • Bonuses and gifts to employees (excluding perquisites).
  • Telephone connection expenses.
  • Professional fees.

Expenses Not Allowed for Tax Deduction under Section 37 of the Income Tax Act

• Fees to Registrar of Companies for Altering Articles of Association or Memorandum: These are considered capital expenditures as they alter the company's constitution and rights.
• Costs for Gaining Vacant Possession of Land: Such expenses are treated as revenue expenditures unrelated to regular business operations.
• Fees to Registrar of Companies for Increasing Authorised Capital: This is a capital expenditure as it enhances the company’s borrowing capacity and financial standing.
• Payments for Gaining Property Tenancy Rights: These are capital expenditures, providing the right to occupy and use the property for a specific duration.
• Bank Guarantee Commission for Securing Loans to Acquire Fixed Assets: This is considered a capital expense as it facilitates the acquisition of fixed assets.
• Penalties for Violating Laws or Regulations: Such payments are not allowable as they conflict with public policy and morality.
• Demolition Costs for Building a New Structure: Expenses for demolishing a building to construct another are capital in nature, leading to asset creation.
• Expenses for Relocating a Company’s Registered Office: These are administrative costs and do not directly relate to the company’s business operations.
• Sales Tax Payments for Goods Transactions: Sales tax payments are unrelated to a business’s profits and are therefore not deductible.

How to Claim Tax Deductions under Section 37 of the Income Tax Act?

• Ensure Eligibility: Ensure that the expenses you wish to claim are eligible under Section 37 as mentioned in this article.
• Maintain Proper Documentation: Keep all invoices, receipts, and proof of payment for the business expenses you intend to claim. Proper records are essential for validating the deductions in case of an assessment.
• Fill Out the Appropriate ITR Form:
  • If you are a businessman or professional, use ITR-3 to report your income and deductions.
  • If you are filing for a firm or LLP, use ITR-5.
  • If you're filing for a company, use ITR-6.
• Report the Expenses: In the ITR form, enter the eligible business expenses under the ‘Profit and Gains of Business or Profession’ section. Specify the deductions you are claiming under Section 37.
• Ensure Accurate Accounting: Account for the expenses in your profit and loss statement and ensure that the claimed deductions align with your business’s actual expenses.
• Submit the ITR: After completing the form with the correct details, file the ITR before the due date. If you claim deductions under Section 37, your return should be filed accurately to avoid issues during tax assessments.

Conclusion

DINESH P Expert

Updated on: January 3rd, 2025