Section 35D Deduction – For Preliminary Expenses

Seep Gupta

27 Jan, 2023

A massive amount of money and capital is required during the incorporation or starting of any business. Various expenses are incurred by businessmen for the successful incorporation of the business. Section 35D deduction of the Income Tax Act of 1961 was introduced by the government of India for the deduction of preliminary expenses for budding entrepreneurs who have invested a massive chunk of money and capital in incorporating their businesses. The present article involves a detailed discussion regarding various provisions related to Section 35D deduction of the Income Tax Act.

What are Preliminary Expenses?

As the name suggests, preliminary expenses are those expenses which a business or an entity incurred before the formal incorporation and establishment of that business. It generally includes all the costs related to the starting capital, stocks, and money required for establishing new units for already established businesses also come under preliminary expenses.

Generally, preliminary expenses are either dismissed or not taken into account because they are of a capital nature and costs which were incurred during the formal establishment of the business.

They are generally shown in the financial statements of a company. In the case of a legal corporate entity, they are shown in the MoA of the company. Only a professional auditor can appropriately assess and determine the preliminary expenses.

General Provisions Related to Section 35D of the Income Tax Act.

General provisions laid down under section 35D deduction of the Income Tax Act of 1961 are given below-

Who can Claim a Deduction under Section 35D of the Income Tax Act?

Following, people can claim a deduction under Section 35D deduction of the Income Tax Act. They are mentioned below:-

• For claiming a deduction under Section 35D deduction, the company has to be an Indian company or registered in India.
• Deduction under Section 35D deduction of the Income Tax Act can also be claimed by a person who is an Indian proprietor or an Indian by birth.

Expenditure on Which Section 35D Deduction of the Income Tax is Eligible

Following are the expenditures on which the deduction u/s 35D of the Income Tax Act, 1961, is applicable. These are mentioned below:-

• Expenses or costs are incurred before the establishment or commencement of the said business.
• Expenditure or costs are incurred after the establishment or incorporation of a business related to the establishment of new units at various places.

Types of Preliminary Expenses that are Eligible for Deduction under Section 35D of the Income Tax Act 1961

The following types of preliminary expenses are eligible for deduction under Section 35D of the Income Tax Act. These are given below:-

• Expenses which are required to prepare feasibility reports and project reports for conducting a market survey and for other surveys which are necessary for the purpose of the business. Preliminary expenses also include the engineering services related to the business.
• Charges incurred from drafting any type of legal agreement required for the establishment and conduct of the business.
• In the case of a legal corporate entity or a company, preliminary charges also include the legal charges incurred from drafting the memorandum of association of a company, article of association, printing fees and total incorporation fee.
• Charges incurred in writing, preparing and printing of prospectus of a company. It will also include media and advertisement charges as well as both digital and print media charges.
• Apart from all the above-mentioned expenses, preliminary charges also include other expenses as notified by the government in its statute from time to time.

The Extent of Deduction Allowed under Section 35D of the Income Tax Act

The maximum amount that can be deducted or allowed under Section 35D deduction of the Income Tax Act, 1961^[1] cannot exceed the limit of 5 per cent of the total cost or revenue of the business. In the case of a corporate entity or company, the maximum amount cannot exceed the limit of 5 per cent of the total capital or cost incurred in the incorporation or establishment of the company.

The amount which is eligible for deduction under the Section 35D of the Income Tax Act is equivalent to the five years of annual instalments of a company beginning from the previous year of commencement of business or from the previous year when the establishment of new units of an already established business was completed.

Mandatory Audit of Accounts under Section 35D of the Income Tax Act 1961

According to the provisions and rules laid out in the Section 35 D deduction of the IT Act 1961, in the case of a single assessee’s business, no amount shall be permissible for deduction before the proper assessment and audit of the assessee’s account for a year on which the expenditure is incurred by a professional Chartered Accountant.

The due report of such audit shall be filled in the prescribed format in Form 3B and should be signed by the Chartered Accountant.

However, it is really crucial to note that this rule only applies to the individual assessees running businesses. This doesn’t apply to legal corporate entities and companies.

Form 3B under Section 35D Deduction of Income Tax Act

Form 3B is used and required by chartered accountants and auditors. They dictate and report costs and expenditures incurred by the business accounts in Form 3B. This Form 3B summarises the monthly returns and can be changed as per the QRMP taxpayers.

Conclusion

In a nutshell, it can be concluded that Section 35D deduction of the Income Tax Act 1961 is highly beneficial for budding entrepreneurs and businessmen who really find it hard with a shoestring budget to incorporate or establish a new company. There are certain provisions and rules, and regulations u/s 35D of the Income Tax Act which need to be followed by the assessee in order to claim the deduction under this section 35D deduction of the IT Act, 1961.

Read Our Article: Tax Implication of ‘Income and Expenditure’ before the Commencement of Business