Section 37 of the Income Tax Act

Government provides several tax deductions to companies in order to boost business growth. However, they are applicable for a specific list of expenses which are stated under Section 37 of Income Tax Act. 

Thus, in order to accurately file returns and benefit from the available deductions, companies must have a clear idea of the allowed list of expenses. Read on to learn more! 

What Is Section 37 of Income Tax Act?

Section 37 of Income Tax Act states that any business expenditure, excluding capital expenditure and the individual’s personal expenses, that is spent or set out solely and entirely for the business’s operations shall be applicable for deduction. Additionally, it will be applicable while calculating a business’s taxable income which is payable under the head “profits and gains of business or profession”.    

Section 37(1) Of Income Tax Act

Businesses should also consider the guidelines present under Section 37(1) of Income Tax Act. It states that expenditure incurred by businesses for activities which are prohibited by law or are deemed as offences, will not be applicable for deduction under Section 37. They include:

• Bribes 
• Protection money
• Donations which are against public policy or illegal
• Freebies etc.

Furthermore, as per Section 37(1), expenditures on Corporate Social Responsibility activities under Section 135 of the 2013 Company Act will not be eligible for deduction.      

Conditions For Allowance Under Section 37

Now, to claim deductions under Section 37 of Income Tax Act, there are certain conditions which businesses need to abide by. They are as follows:

• Must not be personal or capital expenditure.
• Should not be present under Sections 30 to 36 of the Income Tax Act.
• Must not be paid for activities which are offenses or prohibited by law.
• Should be incurred purposefully for profession or business.
• Must be paid or accrued in the previous financial year. 
• Should not be of the nature of personal expense of the assessee

List Of Expenses Allowed As Deduction Under Section 37(1) From Business Income

Here is a list of expenses allowed under Section 37:

• Interest on Business Loans
  Interest payments on loans taken for business purposes are liable for deduction under Section 37(1). However, it must not be used for the company’s capital expenditure.   
• Legal Fees
  Any expenditure on legal fees to lawyers, advocates, solicitors, etc. to obtain legal services or advice relating to a company’s business is liable for deduction.  
• Advertisement Expenses
  Business expenditure on advertisement products and services in any type of media is liable for deduction. Advertisements relating to political parties or agendas are however not applicable.  
• Salaries to Employees
  The salaries which a company pays to its tax-paying employees are liable for deductions under Section 37(1). Compensation to employees upon termination of employment is also applicable. 
  Moreover, salaries paid to the firm’s partners can be eligible for deduction. However, it is limited to certain conditions present under Section 37 of the Act. Salary paid to the business’s proprietor will not be applicable for deduction.   
• Loan Raising Expenses
  Expenses incurred by businesses for raising loans are eligible for deduction under Section 37. They include registration, stamp and brokerage charges. 
• Penalty Payments   
  In case of penalty/damage payments relating to a business, it may or may not be eligible for deduction under Section 37(1). For instance, penalty payments for violating the law are not liable for deduction.
  However, if the expense is compensatory and arises as a result of contractual liabilities, the deduction may be permissible. 
  
  Additionally, the following expenses are liable for deduction under Section 37:
• Fees to the registrar of companies in case of legal obligations. 
• Employee’s welfare expenses. 
• Costs incurred during festivals like Diwali, Christmas, etc. 
• Bonuses and gifts to employees (however, they must not be a part of perquisites).
• Telephone connection expenses.
• Professional fees. 

Examples Of Expenses Allowed Under Section 37

To clearly understand the deductions available under Section 37 of Income Tax Act, let’s take a look at an example. 

Suppose, M.S. Infotech Pvt. Ltd. had taken a loan in the previous financial year for business purposes. Throughout the year, the company had paid a total interest amount of Rs.1,00,000 and an additional Rs.55,000 for brokerage fees, stamp duty, etc. relating to the loan. Thus, while filing its IT returns, the firm can claim a total deduction of Rs.1,55,000 under Section 37.   

List Of Expenses Disallowed As Deduction Under Section 37(1) From Business Income

The list of expenditure disallowed under Section 37 of Income Tax Act are as follows:

• Fees to Registrar of Companies for changing an organisation’s Articles of Association and Memorandum. 
  Reason – It is a capital expenditure that alters a company’s constitution and rights. 
• Costs incurred by an assessee to gain possession of a vacant land he/she owns. 
  Reason – It is not a revenue expenditure and is not related to a business’s normal operations. 
• Fees to Registrar of Companies to increase an organisation’s authorised capital. 
  Reason – Falls under capital expenditure as it increases the borrowing capacity as well as the financial status of a company.
• Payments for gaining a property’s tenancy rights. 
  Reason – It is a capital expenditure as it provides the right to occupy and use the property for a specific time period. 
• Bank guarantee commission payments for securing a loan in order to acquire a fixed asset. 
  Reason – Falls under capital expenditure as it is required for acquiring assets. 
• Penalties for infringing or violating any law or regulation. 
  Reason – Does not fall under allowable expenditure as it is against morality and public policy. 
• Costs incurred for demolishing a building in order to build a hotel on the same site. 
  Reason – Falls under capital expenditure as it leads to asset creation. 
• Costs incurred for shifting a company’s Registered Office from its present location to another. 
  Reason – Does not fall under allowable expenditure as it contributes to administrative convenience and is not directly related to business operations. 
• Sales tax payments for purchase and sale of goods. 
  Reason – They are not related to a business’s profits.        

Examples Of Expenses Not Allowed Under Section 37

Let’s take an example to understand which types of income do not fall under Section 37. 

Suppose, DS Marble Exporters Ltd. shifted its Registered Office from Chennai to Gurgaon. For this, the company incurred expenses of around Rs.1 crore. It also paid Rs.55,00,000 for the property’s tenancy rights. Thus, when filing its IT returns, the business will not be able to claim a deduction on these expenses under Section 37. 

In a nutshell, Section 37 of Income Tax Act provides deductions on expenses which are directly related to a business’s operations. Now, given the vast array of expenses which companies have to include in their returns, it might get confusing for them to understand which ones are applicable for deduction. Hence, consulting a tax professional in such cases is always advisable.

How Can You Claim Deductions Under Section 37 Of The Income Tax Act, 1961?

To claim deductions under section 37 of the Income Tax Act, 1961, the following steps should be followed.

Step 1: Check for eligibility

The expenses you want to claim as deductions should meet the eligibility criteria as specified under section 37.

Step 2: Maintenance of proper documentation

 A record of all business expenses, such as invoices and receipts, should be maintained to claim deductions under section 37.

Step 3: Fill the appropriate ITR form

One should know which ITR form to use for filing income tax returns. Different ITR forms are suitable for different individuals/ businesses.

Use ITR 3 if you are a businessman or a professional

Use ITR 5 if you are a firm or LLP.

Use ITR 6 if you are a company.

Step 4:

Report the expenses: After choosing the ITR form, under the section, Profit and gain of business or profession, the business expenses eligible under section 37 are entered. 

Step 5:

Check for accurate accounting: In the income statement of a business, the recorded expenses have to be matched with the expenses claimed under section 37 for filing income tax returns.

Step 6: Submit the ITR

On completing the ITR form with the correct details, file the ITR before the due date.