Setting up a new business or expanding an existing one involves significant preliminary expenses. The Income Tax Act, under Section 35D, provides relief to businesses by allowing amortization of certain preliminary expenses over a specified period. This article explains the provisions of Section 35D, its applicability, eligible expenses, and the benefits available to businesses.
Applicability of Section 35D
Section 35D applies to:
Indian companies
Resident individuals (other than companies)
The provision covers expenses incurred after March 31, 1970, in two scenarios:
Before commencing a business
After business commencement, for:
Extension of an existing undertaking
Setting up of a new unit
Deduction Allowed Under Section 35D
The deduction under this section is available as follows:
For expenses incurred before April 1, 1998, one-tenth (1/10) of the eligible expenditure is deductible each year over 10 years.
For expenses incurred on or after April 1, 1998, one-fifth (1/5) of the eligible expenditure is deductible each year over 5 years.
Eligible Expenses Under Section 35D
The preliminary expenses eligible for amortization include:
(a) Feasibility and Project Reports
Preparation of feasibility reports
Preparation of project reports
Conducting market surveys and necessary business surveys
Engineering services related to the business
(b) Legal and Professional Charges
Legal charges for drafting business agreements
(c) Expenses for Company Formation
(Only for Indian companies)
Legal charges for drafting the Memorandum & Articles of Association
Printing costs of the Memorandum & Articles of Association
Fees for company registration under the Companies Act, 1956
Expenses related to the public issue of shares/debentures, including:
Underwriting commission
Brokerage fees
Costs for drafting, typing, printing, and advertising of the prospectus
(d) Other Prescribed Expenses
Expenses not eligible for deductions under other sections of the Income Tax Act but notified by the government.
Maximum Limit on Deduction
The total amount eligible for deduction is limited to 2.5% of the cost of the project or, in the case of a company, 2.5% of the capital employed.
For expenses incurred after March 31, 1998, the limit increases to 5%.
Definitions:
Cost of the Project: The actual cost of fixed assets such as land, buildings, leaseholds, plant, machinery, furniture, etc.
Capital Employed: The total of share capital, debentures, and long-term borrowings.
Long-Term Borrowings: Loans with a repayment tenure of 7 years or more.
Audit Requirement
For non-company assessees, audit of accounts is mandatory under Section 44AB for claiming deductions under Section 35D. The audit report must be filed in the prescribed form.
Impact of Business Restructuring
(a) Amalgamation
The amalgamating company cannot claim the deduction in the year of amalgamation.
The amalgamated company can continue claiming the deduction.
(b) Demerger
The demerged company cannot claim the deduction in the year of demerger.
The resulting company will be eligible for the deduction.
Restrictions on Claiming Deduction
Once a deduction under Section 35D is claimed, the same expenditure cannot be claimed under any other section of the Income Tax Act.
Conclusion
Section 35D provides a structured approach for businesses to amortize preliminary expenses, easing the financial burden in the initial years. By spreading the deduction over multiple years, businesses can optimize their tax liabilities and improve cash flow management. Understanding and utilizing this provision effectively can lead to significant tax savings for startups and expanding enterprises.
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