In a move that signals a tightening of the tax laws around regulatory violations, the Central Board of Direct Taxes (CBDT) has now issued a notification that blocks taxpayers from claiming deductions on any expenditure made to settle or compound proceedings under four key financial and competition laws.
The CBDT issued an official notification on April 23 in a direct implementation of amendments introduced in the Finance Act 2024. Clause (iv) to Explanation 3 of Section 37(1) of the Income-tax Act, 1961 was inserted in the Finance Act, which clearly specifies that any expense incurred to resolve violations under the following three acts will not be considered as a legitimate business expenditure for tax purposes:
Sebi Act, 1922
Securities Contracts (Regulation) Act, 1956
Depositories Act, 1996 or the Competition Act, 2002
This clarification by the tax authority comes in the wake of several past disputes where taxpayers have claimed such expenses as business outgoings, citing commercial expediency. In some cases, in fact, consent fees paid to Sebi were earlier allowed as deductible.
The latest notification, however, puts an end to these interpretations for these four laws. The tax department, with this rule, has drawn a clear boundary: If a payment arises from a violation or contravention of regulatory laws, even if settled, such costs cannot be deducted to reduce taxable income.
What will be the implications of this new order?
Says Amit Baid, Head of Tax, BTG Advaya, “Government has sent a clear message: non-compliance will now carry both regulatory and tax costs.”
The order could have serious implications for companies in the securities and capital markets, as well as those subject to regulatory scrutiny by the Competition Commission of India.
“This move aligns with the broader principle that businesses should not derive tax benefits from actions that violate the law or public policy. It also underscores the growing emphasis on ethical and lawful business conduct,” Baid states.
He further explains that from a compliance and governance standpoint, it creates a strong deterrent against regulatory breaches, particularly in the financial markets and competition law domains. “Until now, companies had, in some cases, sought to claim settlements, penalties, or related legal expenses as deductible business expenditure under the guise of commercial expediency. The new notification effectively shuts that door.”
Baid advises that corporates must now reassess their risk management frameworks, as the financial fallout of violations will be more significant, impacting both their bottom line and tax position.
What About Past Settlements?
Another important area that needs clarification is whether this notification applies retrospectively to past settlements, or will it only apply to agreements entered into after April 23, 2025.
Explains Baid: The notification draws its authority from Explanation 3 to Section 37(1) of the Income-tax Act, introduced by the Finance Act, 2022. Notably, this Explanation is expressly retrospective, it deems that expenses incurred to settle violations of law have always been non-deductible.
What Should Taxpayers Do?
So in this context, the notification may be viewed as clarificatory, reinforcing the retrospective nature of the law. “This could have implications for tax positions taken with respect to past settlements, including ongoing or completed assessments for earlier years,” Baid notes.
Moreover, he further advises that taxpayers should be prepared for potential scrutiny by tax authorities and reassess the risk of retrospective disallowance where such expenses were earlier claimed as deductions.
The move, while closing loopholes and bringing alignment between tax policy and regulatory enforcement, also leaves some grey areas. It’s unclear whether similar treatment will apply to other statutes such as Foreign Exchange Management Act (FEMA) or regulatory actions by the Reserve Bank of India (RBI).
