[Bhaskar Vishwajeet is a lawyer at a law firm in New Delhi]
On April 23, 2025, the Central Board of Direct Taxes issued a Notification that any expenditure incurred in settlement proceedings concerning contraventions under certain laws will not be deemed deductible from the taxable income of a settlement-seeking entity. The Notification exclusively covers only the following legislations: the Securities and Exchange Board of India Act 1992, the Securities Contracts (Regulation) Act 1956, the Depositories Act 1996, and the Competition Act 2002.
In this regard, a blanket limitation on availing a deduction/allowance raises some critical concerns, operating largely in the context of the regulatory intent to encourage settlement proceedings as an alternative to prolonged litigation. This note critically examines some practical challenges posed by the Notification.
Unravelling the Limitation
The Statutory Basis and the Insertion
Section 37 of the Income-tax Act, 1961 (the “Act”) lays down the general framework for permissible deductions and allowances that are expended through payments for the purposes of an assessee’s business or profession. Explanation 3 to Section 37 states that the expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law will include the expenditure incurred by the assessee on the compounding of offences under any law. This expenditure cannot be deducted while calculating the taxable income.
The Finance Act of 2024 inserted another instance into Explanation 3 – item (iv) (the “Insertion”), elaborating that the expenditures incurred to settle proceedings initiated in relation to contraventions under specific laws designated by the Central Government will also be excluded from the scope of the permissible deductions and allowances under Section 37. The Notification has explicitly operationalised the Insertion, reiterating that the expenditure incurred by an assessee for the settlement of proceedings initiated with regard to contravention or defaults under the above-mentioned laws cannot be claimed as a deduction or allowance under the Income-tax Act from the 2025-26 assessment year.
The Scope of “Any” Expenditure: An Overreach
It must be noted, however, that the Notification has applied the restriction on any expenditure incurred in such settlement proceedings. In the absence of any further clarifications, the term “any” expenditure in this context could be interpreted as all expenditure. This ambiguity is problematic on two doctrinal grounds, which are discussed below.
Guilt v. Settlement
First, extending the restriction on all expenditures concerning regulatory settlements turns a blind eye to the value of the findings that require such payments. Typically, in assessments of regulatory breaches, preliminary findings or observations comprise a regulator’s notice to an entity. Preliminary findings, by nature, are inchoate, i.e., they lack significance in crystallising the commission of an offence as their value depends on further scrutiny and appreciation of evidence. In Deputy CIT v. Anil Dhirajlal Ambani (“Anil Ambani”), the Income Tax Appellate Tribunal (the “tribunal”), dealing with an action initiated by SEBI on the basis of prima facie findings, held that the SEBI had not “held or found that an offence had actually occurred.”
The difference between a prima facie finding of an offence and a definitive order for punishment for an offence was noted in Reliance Share and Stock Brokers (P.) Ltd. (2013) (“Reliance”). Herein, the tribunal observed that the pendency of an appeal against a SEBI order that levied punishment on an assessee, diluted the value of the definitive findings in the SEBI order, eventually becoming the basis for holding that there was no offence and that the settlement charges paid by the assessee were not towards a penalty, i.e., an admission of guilt.
As a consequence, it can be argued that payments made without admitting or denying the guilt of an alleged regulatory violation exist in a separate silo, one that cannot necessarily be elevated to the status of a (punitive) payment towards direct admission of guilt. This claim can be rationalised by the following observation by the tribunal in Anil Ambani: “In the absence of any finding of an offence having been committed, the allegation of the payment itself being for an offence and/or by way of penalty cannot apply and there can be no disallowance” (underlined for emphasis).
Settlement without Admission: A Commercial Choice
Second, in clarifying the scope of payments made without admitting or denying guilt, the Anil Ambani tribunal also recognised that it would be “logical to hold that the assessee was apprehensive of the toll that a long winded litigation – both, in terms of time, cost and hassle as also in terms of reputation – would take.” This touches upon the well-recognised practice of assessees often settling with regulators for the sake of ‘commercial expediency’, i.e., in the best interest of their businesses and clients. Additionally, in cases such as CIT v. Sales Magnesite (P.) Ltd., tribunals have largely deferred to the businessman’s point of view to identify what comprises commercial expediency. This lends credence to the idea that expenditure on settlement proceedings can also lie in a second domain of commercially expedient payments (as opposed to punitive payments).
Read together, these two doctrinal frameworks make up the schema to assess the applicability of Explanation 3 to Section 37 of the Act; per the schema, business expenditures, particularly with regard to regulatory proceedings, must be assessed from the following perspectives: the confirmation (or lack thereof) of guilt and by identifying a commercially expedient decision to settle and avoid regulatory litigation. Summarily, the limitation imposed by the Notification does not appreciate this fine nuance in distinguishing between payments pursuant to confirmed guilt and settlement payments made in a bid to avoid damage to commercial operations and reputation.
Practical Concerns with the Limitation
Financial Burden on Entities
Allowances and deductions under India’s taxation regime permit assessees to legitimately reduce their taxable income, thereby encouraging prudent tax planning. Excluding expenditure for settlement-proceedings before specified regulators from the scope of deductions and allowances increases the financial liability of entities that have incurred regulatory defaults/settlements during an accounting period.
For instance, in October 2024, the National Securities Depository Ltd. (“NSDL”) settled a case with the SEBI by paying for alleged violations of the SEBI (Depository and Participants) Regulations 2018. It must be reiterated that the confirmation of guilt was not a concern in this case since most settlement-proceedings after Reliance have proceeded without an admission of guilt on the assessee’s part – including this one. However, in the wake of the Notification, an entity like NSDL would not only be liable for the settlement amount but also for a higher post-tax provisioning cost that may ultimately get passed on to its clients or discourage proactive compliance in the future.
Discouraging Settlements?
Disallowing settlement-related payments as deductions may discourage entities from opting in for settlement proceedings with regulators, potentially leading to prolonged litigation and an increased regulatory burden. For example, the Anil Ambani tribunal observed the utility of the consent-order mechanism introduced by the SEBI after borrowing from the US Securities and Exchange Commission’s practice to achieve the “twin goals of appropriate sanction and deterrence without resorting to a long drawn litigation.” SEBI consent orders form a part of the conciliatory proceeding that precedes the imposition of full legal proceedings under the SEBl Act 1992. Hence, there is clear evidence of an intention to institute channels to settle with regulators.
The Notification, through its blanket disallowance, negates the incentive to pursue such channels, leaving all stakeholders in a lurch, with only the traditional courts/tribunals as a fallback. One would then have to think about pendency, an altogether different creature.
Conclusion
In failing to differentiate between settlements based on confirmed findings of guilt and those made as part of prudent and risk-averse business decision-making, the Notification undermines both the jurisprudential clarity developed under Section 37 and the regulatory culture of voluntary compliance that sectoral regulators have sought to foster.
The absence of a methodical approach risks disincentivising assessees from pursuing settlement arrangements, possibly increasing the burden on regulatory efficiency. A clarificatory circular from the Central Board of Direct Taxes could resolve this tension by: (1) recognising the financial burden of not providing assessees an opportunity to identify and put forth the nature of their settlement payments; and (2) acknowledging the distinction between punitive settlement payments and commercially expedient ones.
– Bhaskar Vishwajeet
