Jun 217 min read

Section 37 of the Income Tax Act: An Overview of Deductions for Business and Profession

Updated: Jun 28

To encourage company expansion, the Indian government offers corporations several tax breaks. Nevertheless, Section 37 of the Income Tax Act specifies a precise list of expenses for which they are relevant. If an expense is allowed for determining a company's profit and gains, it implies that the tax authorities would not recognise the benefits of that spending and that the assessee would have to pay taxes on it by remitting it back to net earnings. Therefore, corporations need to be well-informed about the list of allowable expenses to file returns effectively and take advantage of the available deductions.

Understanding Section 37 of the Income Tax Act

Conditions for Applicability of Allowance under Section 37

Expenses Allowed as Deduction under Section 37

Expenses Not Permissible as Deduction under Section 37

Understanding Section 37(1) of the Income Tax Act

Conclusion

Most Asked Questions

Understanding Section 37 of the Income Tax Act

According to Section 37 of the Income Tax Act, every business expense that is used or allocated exclusively and totally for the operations of the firm is deductible, except capital expenditures and the individual's expenses. It will also be relevant when determining the taxable income of a business, which is paid under the heading "profits and gains of business or profession." This section covers all kinds of businesses and professions, including limited liability partnerships, partnership firms, single proprietorships, and professions including law, medicine, and chartered accounting.

Conditions for Applicability of Allowance under Section 37

Now, firms must meet specific requirements to claim deductions under Section 37 of the Income Tax Act. They are listed as follows:

It cannot be a capital or personal expense.
It should not come under the Income Tax Act's Sections 30 to 36.
Payment cannot be made for actions that violate the law or are forbidden.
It should be deliberately incurred for a business or profession.
It has to be accrued or paid for within the preceding fiscal year.

Expenses Allowed as Deduction under Section 37

Any expense paid solely and exclusively for running a company or profession is deductible under Section 37. These costs, which fall under the wide category of revenue expenses, may be related to:

Wages and salaries: You may deduct the amount you pay employees for services they provide to your company or profession.
Rent, rates, taxes, and insurance: You can deduct any amount paid for rent for space utilised for your business or profession, as well as property taxes, municipal taxes, fire insurance premiums, and other related costs.
Interest paid on loans and overdrafts: You may deduct interest paid on loans and overdrafts obtained for business or professional purposes.
Repairs and maintenance: You may deduct the costs you pay for fixing and maintaining the equipment, real estate, and other assets you use for your business or occupation.
Travel-related expenses: You may deduct costs for transportation, lodging, and other related expenses you incur when conducting business.
Advertising and sales promotion costs: You can deduct advertising and sales promotion costs like hoardings, newspaper ads, and other promotional activities.
Professional fees: You may deduct expenses for paying experts like attorneys, certified public accountants, and consultants for services they provide to your company or line of work.

Apart from the previously specified charges, Section 37 permits the deduction of costs associated with research and development endeavours carried out by professionals or businesses. These expenditures may include those associated with market research, experimentation, and the development of new goods or technology. Furthermore, the following elements also qualify for deductions:

Employee’s welfare expenses
Bonuses and gifts to employees
Fees paid to registrar of companies to fulfil legal obligations
Costs incurred during festivals
Telephone connection expenses

Illustration: For commercial purposes, X Pvt. Ltd. had taken out a loan in the preceding fiscal year. The company paid a total of Rs. 2,00,000 in interest over the course of the year, plus an extra Rs. 50,000 for loan-related brokerage costs, stamp duty, etc. As a result, the company is eligible to deduct a total of Rs. 2,50, 000 from their IT returns under Section 37.

Expenses Not Permissible as Deduction under Section 37

While many expenses are allowed as deductions under Section 37, some expenses are expressly prohibited under the clause. Among these costs are:

Personal expenses: You are not permitted to deduct any costs that you incur for your own use, including clothing, travel, or other personal expenses.
Capital expenditure: Under Section 37, no deduction is permitted for any capital expenditure made in connection with the purchase of a capital asset, such as real estate, machinery, buildings, or plants.
Losses resulting from illegal activity: You are not permitted to deduct any costs associated with engaging in actions that are prohibited by law, including paying bribes or other similar expenses.
Expenses incurred for non-business activities: You are not permitted to deduct any costs incurred for non-business purposes, including contributions to political parties and charities.

Some examples of these expenses include:

Fees for amending a company's articles of association and memorandum that are paid to the Registrar of Companies. Given that it modifies the company's rights and constitution, this is a capital expenditure.
A charge made to the Registrar of Companies to raise a company's permitted capital. Since it improves the company's financial standing and ability to borrow money, this is also a capital expenditure.
The costs borne by an assessee in order to obtain vacant possession of their land. Since it has nothing to do with the regular company or professional operations, this is not a revenue expense.
Commission paid to the bank that guarantees the loan for buying a fixed asset. Being a side expense of purchasing an asset, this is considered a capital expenditure.
The amount paid to avail of the right to occupy a specific property as a tenant. Given that it grants the right to use and occupy the property for an extended amount of time, this is a capital expenditure.
A fine incurred for breaking any law or regulation. Since it is against morality and public policy, this is not an expense that can be approved.
Expenditures incurred by a business while moving its registered office. Since this expense is for administrative convenience rather than the business or profession, it is not permitted.
The cost incurred to demolish a structure and establish a hotel on the same property. Given that it creates a new asset, this is a capital expenditure. Interest is paid when advance tax is not paid, is paid in full, is paid later than expected, or is postponed. Since it is not an income tax or a business expense, it is not an eligible expense.
Sales tax paid when items are bought or sold. Since this is a turnover tax rather than a profit tax, it is an expense that is permitted. However, since they are paid after earnings are earned and are not for the business or profession, taxes like income tax, surcharges, etc., are not considered permitted expenses.

Illustration: Assume that Noida has become the Registered Office of Y Ltd., moving it from Bangalore. The company had to pay about Rs. 1 crore for this. In addition, it paid Rs. 40,00,000 for the tenancy rights on the land. The company will therefore be unable to deduct these costs from its income when filing its IT returns under Section 37.

Understanding Section 37(1) of the Income Tax Act

Companies should also take into account the rules outlined in Income Tax Act Section 37(1). It says that expenses incurred by companies for legal crimes or activities that are restricted by law cannot be deducted under Section 37. Among them are:

Bribes
Cash for protection
Donations that violate public policy
Unlawful freebies

Additionally, under Section 37(1) of the Income Tax Act, deductions for expenses linked with Corporate Social Responsibility (CSR) under Section 135 of the 2013 Company Act are not permitted.

Conclusion

Section 37 of the Income Tax Act, 1961 is a key clause that permits professionals and enterprises to deduct costs incurred for the operation of their company or occupation. To support their claims, taxpayers must keep accurate records and paperwork and be aware of the requirements and restrictions related to claiming these deductions.

FAQ

Q1. What is Section 37 of the Income Tax Act?

The Income Tax Act, Section 37, allows deductions for business expenses, except capital costs, as well as personal expenses incurred by the assessee. It includes a list of expenses that can be written off as well as those that cannot.

Q2. What expenses are permissible as a deduction under Section 37?

Under Section 37, any expense that is incurred solely and exclusively for the sake of a business or profession is deductible. Rent, rates, taxes, insurance, salaries, wages, maintenance, travel costs, advertising and sales promotion, interest on loans and overdrafts, and professional fees are a few examples of these costs.

Q3. What expenses are not permissible as a deduction under Section 37?

Section 37 prohibits the deduction of expenses that are personal in nature or unrelated to the company or profession. These costs may consist of capital expenditures, personal expenses, losses from illicit activity, and costs for non-business uses.

Q4. Can research and development expenses be claimed as a deduction under Section 37?

As per Section 37, enterprises and professionals may deduct expenses incurred for research and development operations. These expenditures may include those associated with market research, experimentation, and the development of new goods or technology.

Q5. What are the conditions and limitations applicable to claiming deductions under Section 37?

To be eligible for a deduction under Section 37, a cost must be made during the fiscal year in question and be substantiated by sufficient documentation. Additionally, the costs that are claimed as deductions have to be incurred to generate taxable revenue and they have to be fair, not disproportionate.

Q6. Is there any limit on deductions claimed under Section 37?

No, there is no limit on the total amount of deductions allowed by Section 37. Nonetheless, the costs deducted must be incurred with the intention of generating taxable income and must be fair, not disproportionate.

Q7. What is the deduction under Sections 30 to 36 of the Income Tax Act?

The Act's Sections 30 through 36 address deductions for calculating company or professional profits and gains. They also provide requirements for utilising certain deductions. Among them is the interest rate charged on funds borrowed for ventures into business or profession.