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Anlaysis of Expenses (Residuary ) under Admissible Deductions [Section 37] – Income Tax

Residuary Expenses under Admissible Deductions [Section 37] :

(1) Revenue expenditure incurred for purposes of carrying on the business, profession or vocation – This is a residuary section under which only business expenditure is allowable but not the business losses, e.g., those arising out of embezzlement, theft, destruction of assets, misappropriation by employees etc. (These are allowable under section 29 as losses incidental to the business). The deduction is limited only to the amount actually expended and does not extend to a reserve created against a contingent liability.

(2) Conditions for allowance: The following conditions should be fulfilled in order that a particular item of expenditure may be deductible under this section:

(a) The expenditure should not be of the nature described in sections 30 to 36. 

(b) It should have been incurred by the assessee in the accounting year.

(c) It should be in respect of a business carried on by the assessee the profits of which are being computed and assessed.

(d) It must have been incurred after the business was set up.

(e) It should not be in the nature of any personal expenses of the assessee.

(f) It should have been laid out or expended wholly and exclusively for the purposes of such business.

(g) It should not be in the nature of capital expenditure. (The principles to be followed for distinguishing capital expenditure from revenue are discussed below.)

(h) The expenditure should not have been incurred by the assessee for any purpose which is an offence or is prohibited by law.

This section is, thus, limited in scope. It does not permit an assessee to make all deductions which a prudent trader would make in ascertaining his own profit. It might be observed that the section requires that the expenditure should be wholly and exclusively laid out for purpose of the business but not that it should have been necessarily laid out for such purpose. Therefore, expenses wholly and exclusively laid out for the purpose of trade are, subject to the fulfilment of other conditions, allowed under this section even though the outlay is unnecessary.

  • Explanation 1 to section 37(1) – This Explanation provides that any expenditure incurred by the assessee for any purpose which is an offence or is prohibited by law shall not be allowed as a deduction or allowance. Inadmissibility of expenses incurred in providing freebees to medical practitioner by pharmaceutical and allied health sector industry [Circular No. 5/2012 dated 1-8-2012] Section 37(1) provides for deduction of any revenue expenditure (other than those falling under sections 30 to 36) from the business income if such expense is laid out or expended wholly or exclusively for the purpose of business or profession. However, the Explanation below section 37(1) denies claim of any such expenses, if the same has been incurred for a purpose which is either an offence or prohibited by law.

The CBDT, considering the fact that the claim of any expense incurred in providing freebees to medical practitioner is in violation of the provisions of Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulations, 2002, has clarified that the expenditure so incurred shall be inadmissible under section 37(1) of the Income-tax Act, 1961, being an expense prohibited by the law. The disallowance shall be made in the hands of such pharmaceutical or allied health sector industry or other assessee which has provided aforesaid freebees and claimed it as a deductible expense in its accounts against income.

This circular has also clarified that a sum equivalent to value of freebees enjoyed by the aforesaid medical practitioner or professional associations is also taxable as business income or income from other sources, as the case may be, depending on the facts of each case.

  • Disallowance of CSR expenditure [Explanation 2 to Section 37(1)]

(i) Section 135 of the Companies Act, 2013 read with Schedule VII thereto and Companies (Corporate Social Responsibility) Rules, 2014 are the special provisions under the new company law regime imposing mandatory CSR obligations.

Mandatory CSR obligations under section 135:

Ø Every company, listed or unlisted, private or public, having a –

– net worth of Rs 500 crores or more [Net worth criterion]; or

– turnover of Rs 1,000 crores or more [Turnover criterion]; or

– a net profit of Rs 5 crores or more [Net Profit criterion] during any financial year to constitute a CSR Committee of the Board;

Ø CSR Committee has to formulate CSR policy and the same has to be approved by the Board;

Ø Such company to undertake CSR activities as per the CSR Policy;

Ø Such company to spend in every financial year, at least 2% of its average net profits made in the immediately three preceding financial years, on the CSR activities specified in Schedule VII to the Companies Act, 2013.

(ii) As per Rule 4 of the Companies (CSR) Rules, 2014, the following expenditure are not considered as CSR activity for the purpose of section 135:
 Expenditure on activities undertaken in pursuance of normal course of business;
 Expenditure on CSR activities undertaken outside India;
 Expenditure which is exclusively for the benefit of the employees of the company or their families; and
 Contributions to political parties.

(iii) Under section 37(1) of the Income-tax Act, 1961, only expenditure, not covered under sections 30 to 36, and incurred wholly and exclusively for the purposes of the business is allowed as a deduction while computing taxable business income. The issue under consideration is whether CSR expenditure is allowable as deduction under section 37.

(iv) It has now been clarified that for the purposes of section 37(1), any expenditure incurred by an assessee on the activities relating to corporate social responsibility referred to in section 135 of the Companies Act, 2013 shall not be deemed to have been incurred for the purpose of business and hence, shall not be allowed as deduction under section 37.

(v) The rationale behind the disallowance is that CSR expenditure, being an application of income, is not incurred wholly and exclusively for the purposes of carrying on business.

(vi) However, the Explanatory Memorandum to the Finance (No.2) Bill, 2014 clarifies that CSR expenditure, which is of the nature described in sections 30 to 36, shall be allowed as deduction under those sections subject to fulfillment of conditions, if any, specified therein.

  • Advertisements in souvenirs of political parties: Section 37(2B) disallows any deduction on account of advertisement expenses representing contributions made by any person carrying on business or profession in computing the profits and gains of the business or profession. It has specifically been provided that this provision for disallowance wou ld apply notwithstanding anything to the contrary contained in section 37(1). In other words, the expenditure representing contribution for political purposes would become disallowable even in those cases where the expenditure is otherwise incurred by the assessee in his character as a trader and the amount is wholly and exclusively incurred for the purpose of the business. Accordingly, a taxpayer would not be entitled to any deduction in respect of expenses incurred by him on advertisement in any souvenir, brochure, tract or the like published by any political party, whether it is registered with the Election Commission of India or not.

Isac limited is a company engaged in the business of biotechnology. The net profit of the company for the financial year ended 31.03.2016 is ` 15,25,890 after debiting the following items:

1.Purchase price of raw material used for the purpose of in-house research and development1,80,000
2.Purchase price of asset used for in-house research and development wrongly debited to profit and loss account: 
 (1) Land5,00,000
 (2) Building3,00,000
3.Expenditure incurred on notified agricultural extension project1,50,000
4.Expenditure on notified skill development project: 
 (1) Purchase of land2,00,000
 (2) Expenditure on training for skill development2,50,000
5.Expenditure incurred on advertisement in the souvenir published by a political party75,000

 Compute the income under the head “Profits and gains of business or profession” for the A.Y.2016-17 of Isac Ltd.

Computation of income under the head “Profits and gains of business or profession” for the A.Y.2016-17

 Net profit as per profit and loss account 15,25,890
Add:Items debited to profit and loss account, but to be disallowed  
 Purchase price of Land used in in-house research and development – being capital expenditure not allowable as deduction under section 355,00,000 
 Purchase price of building used in in-house research and development – being capital expenditure, 100% of which is allowable as deduction u/s 35(1)(iv) read with section 35(2) 
 Expenditure incurred on notified agricultural extension project (to be treated separately)1,50,000 
 Expenditure incurred on notified skill development project – Purchase of land – being capital expenditure not qualifying for deduction under section 35CCD2,00,000 
 Expenditure incurred on notified skill development project – Expenditure on training for skill development (to be treated separately)2,50,000 
 Expenditure incurred on advertisement in the souvenir published by a political party not allowed as deduction as per section 37(2B)75,00011,75,000
Less:Purchase price of raw material used for in-house research and development qualifies for 200% deduction under section 35(2AB). Since, it is already debited to profit and loss account balance 100% is allowed.1,80,000 
Less:Expenditure incurred on notified agricultural extension

project qualifies for 150% deduction under section 35CCC.

Less:Expenditure incurred on training for skill development in a notified skill development project qualifies for 150% deduction under section 35CCD.3,75,0007,80,000
 Profit and gains from business19,20,890

Note : The expenditure incurred on advertisement in the souvenir published by a political party is disallowed as per section 37(2B) while computing income under the head “Profit and Gains of Business or Profession” but the same would be allowed as deduction under section 80GGB from the gross total income of the company.

Lavish Dey

Lavish Dey

"I would like to electrocute everyone who uses the word 'fair' in connection with income tax policies."
- William F. Buckley, Jr.
Lavish Dey

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