Income Tax : If you are a taxpayer in India, a significant development has recently taken place that directly affects you. The Income Tax Department has issued a major decision that will come as a jolt to millions of people who regularly file their returns. According to the new rules, taxpayers will no longer be able to claim deductions on certain expenses, especially those incurred for settlements or penalties under specific laws such as the SEBI Act and the Competition Act. This move has been made to bring more clarity to the long-debated issue of whether such expenses should be treated as legitimate business or professional deductions. Let’s take a detailed look at what has changed, how it affects taxpayers, and what experts have to say about this policy shift.
Income Tax : The Big Decision by the Income Tax Department
On Friday, the Income Tax Department announced that deductions will no longer be allowed for expenses arising out of proceedings initiated under certain regulatory laws. Until now, there had been confusion about whether payments made in settlement of regulatory actions—such as consent fees, penalties, or charges—could be claimed as deductible business expenses.
With this new decision, taxpayers will not be able to claim any such expenses as deductions while filing their income tax returns. This applies particularly to proceedings under laws like the SEBI Act, the Competition Act, and a few other regulatory frameworks. The department has made it clear that the costs incurred to resolve violations or defaults under these laws cannot be treated as business expenditures.
This decision is likely to impact a large number of businesses and individuals, particularly those operating in sectors heavily regulated by financial, securities, or corporate laws.
Income Tax : Notification Issued by the Central Board of Direct Taxes (CBDT)
To formalize this change, the Central Board of Direct Taxes (CBDT) has issued a notification clarifying the matter. In the notification dated 23rd July, the CBDT stated that any expenses incurred for settling proceedings arising from violations of specified laws will no longer qualify as deductible business expenses.
According to the CBDT, such payments are essentially costs for resolving defaults or non-compliance, and therefore cannot be treated in the same way as legitimate operational expenses of a business or profession. This means that companies or individuals who make such payments will now have to bear the full financial burden without expecting any tax relief.
Income Tax : The Legal Background: Section 37(1) of the Income Tax Act, 1961
The issue of deductibility of settlement payments has been under debate for a long time in various courts and tribunals. Section 37(1) of the Income Tax Act, 1961 provides for deduction of expenses incurred “wholly and exclusively” for the purpose of business or profession, provided such expenses are not personal in nature or capital in nature.
Taxpayers often argued that settlement fees or charges paid to regulators should qualify under this section, as they were part of the cost of conducting business. However, authorities frequently disputed this interpretation, claiming that such payments arose from violations or defaults and therefore could not be considered legitimate business expenses.
The new CBDT clarification finally resolves this long-standing debate by explicitly excluding such expenses from the scope of Section 37(1).
Income Tax : Example: Reliance Share and Stock Brokers Case
In one notable case, Income Tax Officer vs. Reliance Share and Stock Brokers Ltd., the issue of deductibility of consent fees paid to SEBI was examined. At the time, the tribunal had accepted that such consent fees could be considered as business expenditure since they were directly connected with the company’s operations.
However, the Finance Act, 2024 has now overruled such tribunal-level decisions. Under the revised provisions, any settlement or compounding expenses paid under Indian or foreign laws will not be eligible for tax deduction, regardless of earlier interpretations.
Expert Opinion on the New Rule
According to Amit Maheshwari, Tax Partner at AKM Global, this clarification was long overdue. He explained that the issue of settlement payments had created significant ambiguity for taxpayers as well as for the tax department. While some tribunals had accepted these as business expenses, others had rejected them.
Maheshwari noted that the new rules override earlier tribunal decisions and bring much-needed clarity to the tax framework. However, he also pointed out that there is still some uncertainty when it comes to expenses incurred under other regulatory frameworks like FEMA (Foreign Exchange Management Act) and RBI guidelines. These areas remain somewhat unclear, leaving room for further interpretation in the future.
Finance Act, 2024 and Its Impact
The Finance Act, 2024 has played a crucial role in cementing this change. It clearly states that expenses incurred in settlement or compounding proceedings under any Indian or foreign law cannot be claimed as deductions.
This is a significant shift in tax policy because earlier, companies could at least argue their case in tribunals or courts, and sometimes even succeed in getting such deductions allowed. Now, the law explicitly denies this possibility, leaving no room for interpretation.
The impact will be substantial for businesses operating in regulated sectors like finance, securities, banking, and corporate law, where settlement payments are not uncommon.
The Four Key Laws Covered
The new notification specifically mentions four laws under which expenses related to settlement or compounding will not be deductible. These include:
- The Securities and Exchange Board of India (SEBI) Act, 1992 – Governs securities markets and regulates stock exchanges.
- The Securities Contracts (Regulation) Act, 1956 – Deals with the regulation of securities contracts and trading in stock markets.
- The Depositories Act, 1996 – Pertains to the regulation of depositories that hold securities in electronic form.
- The Competition Act, 2002 – Focuses on promoting fair competition and preventing anti-competitive practices.
Any settlement fees, penalties, or compounding charges paid under these laws will no longer qualify for tax deduction.
Why This Matters for Taxpayers
For businesses and professionals, this change means that they must be extra careful about compliance. Any violation that leads to penalties or settlements will now directly increase their costs, since no tax relief will be available.
This also reinforces the principle that taxpayers cannot treat the cost of wrongdoing as a legitimate business expense. The government’s intention is to discourage violations and promote better compliance with regulatory laws.
Conclusion
The Income Tax Department’s decision to deny deductions for settlement-related expenses under specific laws is a landmark move that brings clarity to a long-disputed area of taxation. With the CBDT notification and changes introduced by the Finance Act, 2024, taxpayers can no longer claim such expenses as business deductions under Section 37(1) of the Income Tax Act.
While this decision will undoubtedly increase the financial burden on businesses and individuals involved in regulatory proceedings, it also promotes greater accountability and compliance. Tax experts believe that the move was necessary to resolve ambiguity, though some areas like FEMA and RBI regulations still need further clarification.
For taxpayers, the key takeaway is clear: compliance is not only good practice but also financially wise, since the cost of violations will now be fully borne by them without any tax benefit.
