No Tax Deduction on Expenses for Settling Legal Violations Under Financial Laws

🚫 No Tax Deduction on Expenses for Settling Legal Violations Under Financial Laws

The Income Tax Department has reiterated a clear stance—expenses incurred to settle violations under financial laws are not allowable as tax deductions. This includes fines, penalties, and other outflows made to resolve non-compliance or regulatory breaches.

This update is a part of ongoing efforts to discourage non-compliance with financial regulations and maintain the integrity of tax assessments.

🧾 What Does the Law Say?

As per Section 37(1) of the Income-tax Act, 1961, any expenditure incurred “for any purpose which is an offence or which is prohibited by law” shall not be allowed as a deduction while computing taxable income.

This includes:

1. Compounding fees paid to regulatory authorities
2. Penalties imposed by SEBI, RBI, FEMA, or any financial law
3. Legal settlement amounts arising out of violation of statutes

🔍 Common Disallowed Expenses

1. Penalties imposed by SEBI, RBI, GST, or Income Tax Authorities
2. Legal fees paid as part of settlement for regulatory breaches
3. Payments made under consent orders or compounding of offences
4. Expenses related to insider trading, price rigging, or non-compliance with financial regulations

⚖️ Judicial Backing

Courts have consistently upheld that:

“Allowing deductions for illegal or unethical expenses would amount to subsidizing unlawful behavior.”

Even if the payment is made voluntarily or under a settlement, it cannot be claimed as a business expense if it arises from a violation of law.

✅ What Can Be Claimed?

1. Routine legal fees for advisory or defending lawful operations
2. Compliance-related consultancy fees
3. Expenses incurred to rectify non-penal deficiencies, if not prohibited by law

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