Section 37 of Income Tax Act: List of Expenses Allowed & Disallowed as Deduction from Business Income

In India, the government offers certain tax deductions to businesses to promote growth. These deductions apply only to specific expenses outlined under Section 37 of Income Tax Act.

To file returns correctly and make the most of these benefits, businesses must clearly understand which expenses are allowed.

What is Section 37 of Income Tax Act?

Section 37 of Income Tax Act specifies that any expenditure related to business operations—excluding capital expenses and personal costs—can be claimed as a deduction if it is incurred wholly and exclusively for business purposes. Such deductions are considered when calculating taxable income under the head “profits and gains of business or profession”.

Section 37(1) of Income Tax Act

As per Section 37(1) of Income Tax Act, expenses related to unlawful activities or acts prohibited by law cannot be claimed as deductions. Examples include:

Bribes
Protection money
Illegal or policy-violating donations
Freebies given in violation of rules

Additionally, expenses on Corporate Social Responsibility (CSR) activities as defined under Section 135 of the Companies Act, 2013, are not eligible for deduction.

Conditions for Claiming Deduction under Section 37

To qualify for deductions under Section 37 of Income Tax Act, the following conditions must be met:

Must not be personal or capital expenditure
Should not fall under Sections 30 to 36 of the Act
Must not be for activities prohibited by law
Should be incurred exclusively for business or profession
Must be paid or accrued during the previous financial year
Should not be personal in nature to the assessee

List of Expenses Allowed as Deduction Under Section 37(1) from Business Income

Below is the list of expenses eligible for deduction under Section 37(1) of the Income Tax Act:

1. Interest on Business Loans
Interest paid on loans taken specifically for business purposes qualifies for deduction under Section 37(1), provided the funds are not used for capital expenditure.

2. Legal Fees
Payments made to lawyers, advocates, solicitors, or other legal professionals for business-related legal services or advice are deductible.

3. Advertisement Expenses
Expenditure on advertising products or services through any media platform is allowed as a deduction. However, advertisements promoting political parties or agendas are excluded.

4. Salaries to Employees
Salaries paid to tax-paying employees qualify for deduction. Compensation paid upon termination of employment is also covered. Salaries to partners may be deductible under certain conditions specified in Section 37, but salaries to proprietors are not eligible.

5. Loan Raising Expenses
Costs incurred to raise business loans—such as registration, stamp duty, and brokerage—are deductible under Section 37.

6. Penalty Payments
Penalty or damage payments may or may not qualify for deduction. Penalties for breaking the law are not deductible, but compensatory payments arising from contractual obligations may be allowed.

Other Deductible Expenses Under Section 37

Fees to the Registrar of Companies in compliance with legal requirements
Employee welfare expenses
Festival expenses (Diwali, Christmas, etc.)
Bonuses and gifts to employees (not treated as perquisites)
Telephone connection charges
Professional fees

Example of Deduction Under Section 37

If M.S. Infotech Pvt. Ltd. takes a loan for business purposes and pays ₹1,00,000 as interest plus ₹55,000 in brokerage, stamp duty, and related charges during the year, the company can claim a deduction of ₹1,55,000 under Section 37.

List of Expenses Disallowed as Deduction Under Section 37(1) from Business Income

The following expenses are not deductible under Section 37 of the Income Tax Act:

Fees to Registrar of Companies for altering Articles of Association or Memorandum – Capital expenditure that changes a company’s structure and rights.
Expenses to take possession of vacant land owned by the assessee – Not revenue expenditure; unrelated to regular business operations.
Fees to Registrar of Companies for increasing authorised capital – Capital expenditure that improves borrowing power and financial standing.
Payments to acquire tenancy rights for a property – Capital expenditure giving rights to occupy or use a property.
Bank guarantee commission for loans used to acquire fixed assets – Capital expenditure connected with acquiring assets.
Penalties for breaking any law or regulation – Disallowed as they go against public policy.
Demolition costs to rebuild a hotel on the same site – Capital expenditure leading to asset creation.
Costs for shifting the registered office – Administrative in nature, not directly tied to business operations.
Sales tax payments on purchase or sale of goods – Not considered part of business profits.

Summary of Deductions Allowed and Not Allowed from Business Income

Deductions Allowed
Under Section 37 of Income Tax Act, expenses eligible for deduction from business income include:

Interest on business loans
Legal fees
Advertisement expenses
Salaries paid to employees
Bonus or commission to employees
Loan raising expenses
Certain penalty payments (if compensatory in nature)
Rent paid
Depreciation
Bad debts written off
Insurance premium paid
Interest on late filing of returns
Late fees and other similar allowable costs

Deductions Not Allowed
The following expenses are disallowed under Section 37(1) of Income Tax Act:

Provision for bad debts (except for scheduled banks)
Personal expenses
Registrar fees for changing Articles of Association or Memorandum of Association
Illegal expenses
GST paid
Capital expenditure for acquiring new assets
Penalties for violating laws
Payments made for compounding an offence
Other non-allowable capital or personal costs

Example of Expenses Not Allowed Under Section 37

If DS Marble Exporters Ltd. relocates its Registered Office from Chennai to Gurgaon and spends ₹1 crore on the move, along with ₹55,00,000 for tenancy rights, these expenses cannot be claimed as deductions under Section 37 while filing income tax returns.

How to Claim Deductions Under Section 37 of the Income Tax Act, 1961

Step 1: Verify Eligibility
Ensure the expenses meet the criteria under Section 37.

Step 2: Maintain Proper Records
Keep all invoices, bills, and receipts for the expenses claimed.

Step 3: Select the Correct ITR Form

ITR 3 – for business owners or professionals
ITR 5 – for firms or LLPs
ITR 6 – for companies

Step 4: Report the Expenses
In the “Profits and Gains of Business or Profession” section of the chosen ITR form, list all eligible expenses under Section 37.

Step 5: Ensure Accurate Accounting
Match the expenses in the business’s income statement with those claimed in the ITR.

Step 6: File the ITR
Submit the ITR with all correct details before the due date.

FAQs on Section 37 of the Income Tax Act

1. What types of expenses are deductible under Section 37?
Expenses such as interest on business loans (excluding capital expenditure), advertisement costs, legal fees for business matters, salaries to employees, and other business-related operational expenses are deductible under Section 37.

2. Are salary and wage payments deductible under Section 37?
Yes. Salaries and wages paid to employees are considered operating expenses of the business and are allowed as deductions under Section 37 of the Act.

3. Are professional fees deductible under Section 37?
Yes. Payments made for professional services, such as consultancy, legal, or technical expertise related to business operations, are deductible under Section 37.

4. What is Section 37 of the Income Tax Act?
Section 37 of the Income Tax Act allows deductions for business expenditure that is not capital in nature or personal to the assessee. It specifies which expenses can be claimed and which are disallowed when calculating taxable business income.

5. Are advertising and promotional expenses deductible under Section 37?
Yes. Advertising and promotional costs incurred solely for business purposes are deductible under Section 37. However, political or policy-related advertisements are excluded.

6. Are CSR (Corporate Social Responsibility) expenses deductible under Section 37?
No. CSR expenses mandated under Section 135 of the Companies Act, 2013, are not eligible for deduction under Section 37.

7. Can penalties or fines be claimed under Section 37?
Penalties or fines for breaking laws are not deductible. However, compensatory payments arising from contractual obligations may be allowed.

8. Are expenses for raising business loans deductible under Section 37?
Yes. Loan raising costs such as stamp duty, registration charges, and brokerage fees are eligible for deduction.

9. Is GST paid on purchases deductible under Section 37?
No. GST paid on purchases is generally not deductible under Section 37, as it can be claimed as input tax credit under GST provisions.

10. Are partner’s salaries deductible under Section 37?
Salaries paid to partners may be deductible, but only under specific conditions provided in the Act. Salaries to proprietors are not eligible.