This document provides frequently asked questions (FAQs) regarding Notification No. 38/2025 issued by the Central Board of Direct Taxes (CBDT). This notification, stemming from an amendment to Explanation 3 of Section 37(1) of the Income-tax Act, 1961, clarifies the non-deductibility of certain expenditures. Section 37 generally allows deductions for business or professional expenses. However, Explanation 1 to this section already disallowed expenses related to offenses or activities prohibited by law. The Finance (No. 2) Act, 2024, further amended Explanation 3 to explicitly include within this disallowance any expenditure incurred by an assessee to settle proceedings initiated due to contraventions under specific laws.

Notification No. 38/2025 specifically names four acts under which settlement expenditures will not be considered deductible business expenses. These include the Securities and Exchange Board of India Act, 1992; the Securities Contracts (Regulation) Act, 1956; the Depositories Act, 1996; and the Competition Act, 2002. Consequently, any costs incurred by taxpayers to settle legal proceedings arising from violations of these acts cannot be claimed as deductions when calculating their taxable income from Assessment Year 2025-26 onwards. To ensure compliance and reporting of such disallowed expenses, Form No. 3CD of the Income-tax Rules, 1962, has also been amended by a separate notification (No. 23/2025) to capture the necessary details. This amendment to Section 37 and the subsequent notification aim to prevent taxpayers from claiming tax benefits on expenses incurred to resolve breaches of these specified regulatory frameworks.

FAQs on Notification No. 38/2025-Income Tax [F. No 370142/11/2025-TPL] / SO 1838(E)

Q1. What is section 37 of the Income-tax Act, 1961 (‘the Act’)?

Ans. Section 37 of the Act provides for allowability of expenditure laid out or expended wholly and exclusively for the purpose of business or profession.

Q2. What is Explanation 1 of sub-section (1) of section 37 of the Act and its relation with Explanation 3 thereof ?

Ans. Explanation 1 of sub-section (1) of section 37 provides that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and consequently, no deduction or allowance can be claimed for such expenditure.

Further, Explanation 3 of section 37 clarifies the term “expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law”

Q3. What is the amendment made in Explanation 3 vide Finance (no. 2) Act, 2024?

Ans. Explanation 3 to sub-section (1) of section 37 of the Act was amended vide Finance no. 2 Act, 2024 to clarify that the term “expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law” will also include any expenditure incurred by an assessee to settle proceedings initiated in relation to a contravention under any law for the time being in force, as may be notified by the Central Government in the Official Gazette in this behalf.

Q4. Which laws been notified under the amended Explanation 3?

Ans. Vide CBDT Notification no. 38/2025 dated 23.4.2025 it has been provided that any expenditure incurred to settle proceedings initiated in relation to contravention or defaults under the following laws shall not be deemed to have been incurred for the purpose of business or profession –

(i) the Securities and Exchange Board of India Act, 1992 (15 of 1992)

(ii) the Securities Contracts (Regulation) Act, 1956 [42 of 1956]

(iii) the Depositories Act, 1996 [22 of 1996]

(iv) the Competition Act, 2002 [12 of 2003].

Q5. What are the implications of this notification?

Ans. Any expenditure incurred by an assessee for settlement of proceedings initiated in relation to contravention or defaults under the abovementioned laws cannot be claimed as a deduction or allowance under the Income tax Act from AY 2025-26 onwards.

Form no. 3CD of the Income-tax Rules, 1962 has also been amended by CBDT Notification no. 23/2025 dated 28.3.2025 to capture details pertaining to such expenses.

Q6. From when has the amendment been made effective?

Ans. This amendment is effective from 1^st day of April, 2025 and shall accordingly apply from Assessment Year 2025-26 onwards.