Check the proceeding before testing the ledger label
For FY 2025–26 and AY 2026–27, section 37(1) Explanation 3(iv) of the Income-tax Act, 1961 and Notification 38/2025 address expenditure incurred to settle proceedings initiated in relation to contraventions or defaults under the notified laws. A payment characterised as a settlement under this test is not deductible merely because it was described as a business expense or made without an admission. The notification was published on 23 April 2025 and states that it takes effect on publication. CBDT’s accompanying FAQs state that the disallowance applies from AY 2025–26 onward. This guide covers the later AY 2026–27; it does not address disputes about earlier-period expenditure.
Read the applicable text: Income Tax Department: section 37 CBDT Notification 38/2025 CBDT Notification 23/2025: Form 3CD clause 21(a) CBDT FAQs on Notification 38/2025.
Identify the enabling law and each payment
The four laws notified by Notification 38/2025 are the Securities and Exchange Board of India Act, 1992, the Securities Contracts (Regulation) Act, 1956, the Depositories Act, 1996 and the Competition Act, 2002. Match the notice and final order to the exact law and proceeding. Separately identify amounts incurred to settle that proceeding, refundable deposits, independently billed services and unrelated commercial payments. Separating a line in the ledger does not itself establish that it is outside the rule or deductible. Test what it actually paid for, including whether it was part of settling the proceeding.
Keep other statutory restrictions visible
An expenditure outside the four-law list is not automatically allowable. Review the other limbs of Explanation 3 and the ordinary section 37 conditions where applicable, including separate treatment of compounding. A commercial settlement between private parties also needs a facts-and-law review; it does not become a notified regulatory settlement just because both use the same ledger account.
Reconcile the expense to taxable business income once
Map the settlement order to the account debited and each period’s accounting profit and loss. The illustrations reconcile accounting profit to taxable business income; they do not calculate the separate minimum alternate tax book profit under section 115JB. If a provision was already disallowed and the later payment merely debits that provision, do not add the cash payment to profit again. For applicable tax audits, match the expense to the dedicated Form 3CD clause 21(a) row inserted by Notification 23/2025 and reconcile it to the tax computation. Review reversals, capitalised amounts and disputed timing separately. Use an order-to-ledger bridge instead of relying on a single year’s bank total.
Six worked illustrations
All facts and amounts are fictional. Calculations illustrate the stated assumptions, not a predetermined legal outcome.
Illustrative example 1: Single settlement debit
₹18 lakh incurred to settle a proceeding under a notified law was fully expensed. On the stated facts, the upward book-to-tax adjustment is ₹18 lakh.
Illustrative example 2: Mixed payment file
A ₹23 lakh cash packet contains ₹20 lakh paid to settle the notified proceeding and a ₹3 lakh refundable deposit carried as an asset. The upward adjustment to accounting profit for the business income computation is ₹20 lakh, assuming that alone was expensed.
Illustrative example 3: Two regulators
Two amounts of ₹7 lakh and ₹11 lakh paid to settle separate proceedings under notified laws are expensed. The combined adjustment is ₹18 lakh, supported by two separate proceeding references.
Illustrative example 4: Provision already disallowed
A ₹12 lakh provision was previously disallowed in full. The company pays ₹10 lakh against it without a current expense. Additional add-back for that payment is zero; ₹2 lakh remains in the provision before further accounting review.
Illustrative example 5: One ledger, different transactions
A ₹16 lakh expense ledger includes a ₹9 lakh notified settlement and a ₹7 lakh independently documented commercial payment. This rule identifies ₹9 lakh for add-back. The ₹7 lakh needs its own deduction review.
Illustrative example 6: Incremental settlement charge
A ₹15 lakh settlement uses a prior ₹13 lakh provision already disallowed and results in a fresh ₹2 lakh expense. On these facts the current upward adjustment is ₹2 lakh.
Ten-step verification table
| Step | Action | Evidence |
|---|---|---|
| 1 | Obtain the initiation document | Notice, authority, grounds and governing statute. |
| 2 | Identify the final settlement | Order, agreement and conditions. |
| 3 | Check the notified list | Match the legal basis against Notification 38/2025. |
| 4 | Separate components | Settlement, deposits, service fees and unrelated amounts. |
| 5 | Review independent restrictions | Check other limbs and ordinary deductibility. |
| 6 | Match period and ledger | Journal and account where book profit was affected. |
| 7 | Trace prior provisions | Opening balance and prior tax computation. |
| 8 | Reconcile cash and charges | Payment advice, remaining balance and release evidence. |
| 9 | Review reporting | Applicable tax-audit and return forms, without duplicate add-back. |
| 10 | Approve the bridge | Signed order-to-ledger reconciliation and open questions. |
Sixteen practitioner FAQs
1. Does a no-admission clause allow deduction?
It does not displace the statutory test for the notified expenditure.
2. Is a notified law enough on its own?
Link the expenditure to settlement of the relevant initiated proceeding.
3. Does the rule cover every regulator?
Notification 38/2025 names four laws; check other rules separately.
4. Is a securities-market invoice necessarily within the rule?
No. Identify what the amount was incurred for.
5. Does payment timing always determine the adjustment?
Reconcile recognition and prior deductions before deciding the correct period.
6. Is a refundable deposit necessarily a settlement expense?
No. Check its terms and whether it affected book profit.
7. Can legal fees always be excluded from the restriction?
No. Review their precise connection to settling the proceeding.
8. Can independently incurred advice be separately considered?
Yes, if the facts support separation; assess ordinary deductibility.
9. What if the law in the order differs from the ledger description?
The proceeding and statutory basis carry more weight than the ledger label.
10. Does a private dispute automatically qualify?
No. Review the actual legal basis and other applicable restrictions.
11. Is compounding the same statutory limb?
No. Review the separate limb in Explanation 3.
12. What if the settlement is paid from an old provision?
Check prior tax treatment and the current debit before adding anything back.
13. Can a prior add-back be inferred from the trial balance?
No. Verify the prior tax computation and supporting schedules.
14. Can two orders be combined for reporting?
Reconcile them individually before aggregating supported adjustments.
15. Does a capitalised payment escape review?
No. Analyse its tax basis separately instead of assuming a current deduction.
16. Which year does this working address?
FY 2025–26 and AY 2026–27 under the 1961 Act.
Official sources
Income Tax Department: section 37 CBDT Notification 38/2025 CBDT Notification 23/2025: Form 3CD clause 21(a) CBDT FAQs on Notification 38/2025