Income Tax Department Tightens Tax Deductions on Legal Settlement Costs
In a significant shift, the Income Tax Department has announced a change that will impact how businesses report certain legal expenses in their tax filings. A notification issued by the Central Board of Direct Taxes (CBDT) on April 24 has clarified that costs related to legal settlements under four specific laws will no longer be eligible for tax deductions as business expenses.
The new directive targets legal expenses arising from settlements under the following regulations:
- SEBI Act, 1992 (relating to stock market violations)
- Securities Contracts (Regulation) Act, 1956
- Depositories Act, 1996 (governing shareholding systems)
- Competition Act, 2002 (addressing anti-trust and monopoly issues)
Under the updated rule, companies will no longer be able to claim deductions for payments made in relation to legal settlements, including fines or voluntary consent settlements, even if they were agreed upon outside of court.
Impact on Businesses
Previously, businesses could report such expenses in their profit and loss accounts, which helped lower their taxable income. However, with this latest change, any payments related to legal disputes under the aforementioned laws will no longer be considered legitimate business expenses, leading to an increase in tax liabilities for companies involved in regulatory settlements.
Reason Behind the Change
The Income Tax Department’s move is aimed at ensuring that businesses do not benefit from tax deductions on payments made in relation to legal violations. The new policy treats legal settlements, even voluntary ones, as separate from legitimate business activities.
With the new rule in place, companies are advised to revise their tax strategies and make necessary adjustments to avoid compliance issues when filing taxes in the upcoming period.
