Expenses that are revenue in nature are, by and large, allowed as a deduction to businesses and professionals if they are:
- incurred wholly and exclusively for the purpose of the business or profession
- not in the nature of a personal expense, and
- not in the nature of a capital expense.
Depreciable assets are grouped in blocks, and each block is eligible for depreciation at a prescribed rate. The Indian Revenue Department clarified that with effect from 1 April 2017 the block of assets that are entitled to more than 40% depreciation will now be restricted to 40%. However, a higher depreciation rate of 45% is allowed for certain assets under the 'plant and machinery' block on satisfaction of certain conditions. Hence, the depreciation rate available in case of different blocks of assets ranges from 0% to 45%, depending upon the classification.
Until FY 2019/20, goodwill and commercial brand equity that are acquired in the course of amalgamation are intangible assets entitled to depreciation. The amalgamated/demerged company and the resulting company will not be entitled to claim deduction for depreciation exceeding the amount calculated in any previous year. The deduction will be apportioned between the amalgamating/demerging company and the amalgamated/demerged company in the ratio of the number of days for which the assets were used by them during any tax year. However, the issue of whether goodwill is eligible for tax depreciation or not was a subject of litigation, and there are divergent views of courts on this.
Putting a rest to the controversy, the government of India, in the Finance Act, 2021, has excluded 'goodwill of a business or profession' from the definition of block of asset. By virtue of this amendment, goodwill of any nature shall henceforth not be considered as a depreciable asset for the purpose of tax amortisation under the India Income-tax Act. There are no exceptions proposed. This amendment is applicable with effect from the tax year 2021/22 (i.e. relevant to FY 2020/21). The Finance Act, 2022 has further clarified that reduction of goodwill from the block of assets will be considered as ‘transfer’, and capital gains shall be computed accordingly. This shall apply retrospectively from 1 April 2022.
Expenses incurred before the commencement of business
Certain specified expenses are incurred by taxpayers either before the start-up of a business or after the commencement of a business, in connection with extension of the industrial undertaking, or in connection with setting-up a new unit. One-fifth of such expenditure is allowed as a deduction each year, over a period of five years.
Any interest paid by a taxpayer on capital borrowed for the purposes of the taxpayer’s business or profession is tax-deductible without any limit. However, if such interest is paid to certain related persons (non-resident associated enterprise), then, the interest expense will be restricted to 30% of earnings before interest, taxes, depreciation, and amortisation (EBITDA). Excess interest expenditure disallowed in that year can be carried forward for eight years and would be available for set-off. If the capital is borrowed for acquiring a capital asset, then interest liability pertaining to the period until the time the asset is used cannot be allowed as a tax-deductible expense and will have to be added to the cost of such asset.
There are some specific guidelines for interest deduction being prescribed in ICDS.
Expenditure incurred on corporate social responsibility (CSR) activities
Expenditure incurred by a taxpayer on CSR activities mandated under the Companies Act, 2013 is not allowed as a deduction for tax purposes under the Income-tax Act. However, if contributions are made to any prescribed charitable institutions, then deduction may be examined.
Expenses allowable on actual payment basis
Certain expenses, such as, but not limited to, employees’ provident fund dues (i.e. retirement benefit funds), bonus to employees, interest payable to financial institutions and banks, and payments to be made to micro, small, and medium enterprises are allowed as tax-deductible expenses only on actual payment. Tax disallowances are attracted if certain payments are delayed beyond their due dates under the respective laws.
Bribes, kickbacks, illegal payments
Expenditure incurred by a taxpayer that is illegal is deemed not to have been incurred for the purposes of the business or profession, and no deduction of such expenditure will be allowed. The Finance Act, 2022 has restricted the deductibility of the expenditure that is in relation to an offence or is prohibited by the law. It has been provided that the expenses incurred in connection with an offence or violation of any law (in India or outside India), including expenditure incurred for compounding of any offence, will not be allowed as a business expenditure. It is further provided that any benefit or perquisite paid to a person in violation of any laws, rules, and regulations governing such person’s conduct will not be allowed as business expenditure.
Fines and penalties
The Income-tax Act provides for deductibility of fines, penalties, and interest as follows:
- Fine or penalty will not be tax deductible if charged under any statute.
- Contractual penalty is allowed as a deduction.
All taxes (tax, duty, cess, or fees by whatever name called) relating to business (other than income tax) incurred during the tax year are usually deductible only in the year of payment. The Finance Act, 2022 has clarified that the term ‘tax’ includes surcharge and education cess, with retrospective effect from 1 April 2005.
Net operating losses
Losses can be carried forward and set-off against income from subsequent year(s) for periods set out in the following table:
|Types of losses||Time limit|
|Business losses (other than speculation business losses)||8 years|
|Speculation business losses||4 years|
|Capital losses||8 years|
There are no provisions in India for carrying losses back to earlier years.
Payments to foreign affiliates
Indian companies can claim deduction for payments on account of royalties, and for interest and fees for technical or management service provided by foreign affiliates, so long as they are not capital in nature. Such payments are deductible in the year the requisite WHT is paid into the government treasury.