CBDT Issues FAQs on Settlement Expenses Disallowance u/s 37 of Income Tax Act [Read Notification]

The Central Board of Direct Taxes (CBDT) has issued detailed Frequently Asked Questions (FAQs) clarifying the scope and implications of Notification No. 38/2025 dated April 23, 2025, regarding the disallowance of settlement-related expenses under Section 37(1) of the Income Tax Act, 1961.

Why This Clarification?

The CBDT, via Notification No. 38/2025, notified certain laws where settlement-related expenses would fall under the ambit of disallowance under Section 37 of the Income Tax Act. The FAQs were issued to explain the implications of this notification and the amendments made to Section 37(1) of the Income Tax Act.

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Understanding Section 37(1) and Its Explanations

Section 37(1) of the Income Tax Act allows the deduction of business expenses incurred wholly and exclusively for the purpose of business or profession, except where such expenses fall under specific exclusions. However, Explanation 1 to Section 37(1) disallows any expenditure incurred for purposes which are:

• An offence, or
• Prohibited by law.

Further, Explanation 3, as amended by the Finance (No. 2) Act, 2024, clarifies that the phrase “expenditure incurred for any purpose which is an offence or which is prohibited by law” also includes any settlement expenditure incurred by an assessee in connection with proceedings initiated for such contraventions under any notified laws.

Which Laws Are Covered by This Disallowance?

As per Notification No. 38/2025, the following laws are covered:

1. Securities and Exchange Board of India Act, 1992
2. Securities Contracts (Regulation) Act, 1956
3. Depositories Act, 1996
4. Competition Act, 2002

Any settlement payments, penalties, or charges paid for contraventions under these laws are not allowable as business expenditure.

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Nature of Expenses Disallowed

Expenses disallowed include:

• Payments made to settle or compound regulatory proceedings.
• Settlement charges, penalties, or amounts paid as part of any negotiated or formalized settlement process initiated by the respective regulatory authorities under the above-mentioned laws.

Even if such payments are incurred in the course of regular business activities, they will not be treated as allowable business expenses.

From Which Year Will This Apply?

The disallowance applies from:

• April 1, 2025 (Effective Financial Year: 2024-25)
• Applicable from Assessment Year (AY) 2025-26 onwards.

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Additional Reporting Requirement in Tax Audit (Form 3CD)

The CBDT confirms that Form No. 3CD (Tax Audit Report) has been amended by CBDT Notification No. 23/2025 dated March 28, 2025, requiring detailed disclosure of such settlement-related expenses. This ensures better reporting and monitoring by the tax authorities.

Example

If a company pays ₹10 lakh as a settlement fee to SEBI for violating insider trading regulations, such a payment cannot be claimed as an expense under Section 37(1). Even though the settlement resolves the regulatory issue, the nature of the expense remains connected to a contravention of law and hence is disallowed.

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To Read the full text of the Order CLICK HERE

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