When running a business or practicing a profession, managing finances effectively is crucial, not just for day-to-day operations but also for optimizing your tax liabilities. One of the key sections of the Income Tax Act that can help reduce your taxable income is Section 36. This section provides a comprehensive list of deductions that can be claimed under the head “Profits and Gains of Business or Profession,” ensuring that businesses and professionals only pay taxes on their net income after accounting for various allowable expenses.
In this blog, we will explore the deductions available under Section 36 of the Income Tax Act, the conditions attached to these deductions, and how they can benefit your business.
Key Deductions Under Section 36
1. Insurance Premiums
a. Insurance Against Damage or Destruction of Stocks or Stores
Businesses can claim a deduction for premiums paid to insure against the risk of damage or destruction of their stock or stores. This deduction is essential for businesses dealing with inventory, helping to mitigate potential losses from unforeseen events like fires or natural disasters.
b. Life Insurance for Cattle Owned by Members of Milk Co-operatives
Federal milk co-operative societies can deduct the premiums paid for insuring the life of cattle owned by members of primary co-operative societies. This deduction supports the financial security of dairy farmers, ensuring their assets are protected.
c. Health Insurance for Employees
Employers who pay premiums (by any mode other than cash) for health insurance policies covering their employees can claim a deduction for these expenses. The insurance must be under a scheme approved by the General Insurance Corporation of India or any other insurer approved by the Insurance Regulatory and Development Authority (IRDAI).
2. Employee-Related Deductions
a. Bonus or Commission to Employees
Businesses can deduct amounts paid to employees as bonuses or commissions for services rendered. However, these payments should not be considered as profits or dividends, making them a straightforward expense related to employee compensation.
b. Contributions to Provident and Superannuation Funds
Employers are eligible for deductions on contributions made towards recognized provident funds or approved superannuation funds, provided they adhere to the prescribed limits and conditions. These contributions are crucial for securing the future of employees after retirement.
c. Pension Scheme Contributions
Contributions made by the employer towards a pension scheme, as outlined in Section 80CCD, are deductible up to 10% of the employee’s salary in the previous year. This provision encourages employers to contribute to their employees’ long-term financial planning.
d. Gratuity Fund Contributions
Employers can claim a deduction for contributions made to an approved gratuity fund, which is set up for the exclusive benefit of employees under an irrevocable trust.
e. Employee Contributions to Welfare Funds
Any sum received by an employer from their employees towards provident, superannuation, or other welfare funds must be deposited by the due date to qualify for a deduction. The “due date” is defined as the date by which the employer is required to credit the employee’s contribution to the respective fund under any law or contract.
3. Interest on Borrowed Capital
Interest paid on capital borrowed for business purposes is deductible under Section 36, provided the funds are used for the business. A specific proviso states that interest on borrowed capital for acquiring an asset is not deductible until the asset is first put to use. This ensures that the expense is only recognized when the asset starts generating income for the business.
4. Bad Debts
a. General Bad Debts
Businesses can claim a deduction for bad debts that have been written off as irrecoverable in the accounts. This provision helps businesses manage losses from customers who fail to pay their dues, ensuring that the income is not taxed if it is not realized.
b. Banks and Financial Institutions
For banks and other specified financial institutions, there is an additional provision allowing deductions for bad and doubtful debts. However, such institutions must adhere to specific limits and maintain proper provision accounts to qualify for these deductions.
5. Provision for Bad and Doubtful Debts
Certain banks, financial institutions, and non-banking financial companies (NBFCs) can claim deductions for provisions made towards bad and doubtful debts. The deduction is subject to limits based on the total income and the nature of the advances. This helps financial institutions cushion themselves against potential losses from non-performing assets (NPAs).
6. Special Reserves
Financial institutions, including housing finance companies and co-operative banks, can claim a deduction for amounts transferred to special reserves. These reserves must be created and maintained for specific purposes, such as infrastructure development or housing finance. The provision encourages long-term investments in crucial sectors.
7. Family Planning Expenditure
Companies can deduct bona fide expenses incurred for promoting family planning among their employees. If the expenditure is of a capital nature, it is deductible over five years. This deduction aligns with the broader goals of employee welfare and responsible corporate governance.
8. Expenditure on Y2K Compliance
During the transition to the year 2000, companies that incurred expenses to make their computer systems Y2K compliant could claim these expenses as deductions. Although this specific deduction is no longer relevant, it reflects the government’s responsiveness to unique challenges businesses may face.
9. Taxes
a. Securities Transaction Tax (STT)
Businesses can claim a deduction for the securities transaction tax paid on taxable securities transactions if the income from these transactions is included in their taxable income.
b. Commodities Transaction Tax (CTT)
Similar to STT, businesses can also deduct the commodities transaction tax paid on taxable commodities transactions, provided the income is reflected in the business’s taxable income.
10. Other Specific Deductions
a. Contributions to Credit Guarantee Funds
Public financial institutions can claim deductions for contributions made to the Credit Guarantee Fund Trust for Small Industries, as notified by the Central Government. This deduction supports the availability of credit to small industries, fostering economic growth.
b. Banking Cash Transaction Tax (BCTT)
Although BCTT is no longer in effect, businesses could previously claim deductions for the tax paid on taxable banking transactions, reflecting the broader principle that taxes related to business operations are often deductible.
FAQs on Deductions Under Section 36 of the Income Tax Act
1. What is Section 36 of the Income Tax Act?
Section 36 of the Income Tax Act outlines various deductions that are allowable when computing income under the head “Profits and Gains of Business or Profession.” These deductions cover a range of expenses, including insurance premiums, employee benefits, interest on borrowed capital, and more.
2. Can I claim a deduction for insurance premiums paid for my business assets?
Yes, you can claim a deduction for insurance premiums paid to cover the risk of damage or destruction of stocks or stores used in business. This deduction is crucial for protecting your business assets from unforeseen events.
3. Are contributions to provident and superannuation funds deductible?
Yes, contributions made by an employer to recognized provident funds or approved superannuation funds are deductible under Section 36, subject to the prescribed limits and conditions.
4. How are bad debts treated under Section 36?
Bad debts that have been written off as irrecoverable in the accounts are deductible under Section 36. This helps businesses manage losses arising from non-payment by customers or clients. However, specific rules apply to financial institutions and banks regarding provisions for bad and doubtful debts.
5. Is interest on borrowed capital fully deductible?
Interest paid on capital borrowed for business purposes is deductible under Section 36. However, if the borrowed capital is used to acquire an asset, the interest is not deductible until the asset is put to use.
6. Can I deduct the amount paid as bonus or commission to employees?
Yes, the amount paid as bonus or commission to employees for services rendered is deductible under Section 36. However, these payments should not be considered as profits or dividends.
7. What deductions are available for family planning expenses?
Companies can claim deductions for bona fide expenses incurred for promoting family planning among their employees. If these expenses are capital in nature, they are deductible over five years.
8. Are there any deductions for taxes like Securities Transaction Tax (STT) and Commodities Transaction Tax (CTT)?
Yes, deductions are available for Securities Transaction Tax (STT) and Commodities Transaction Tax (CTT) paid on taxable transactions, provided the income from these transactions is included in your taxable income.
9. How does Section 36 benefit financial institutions?
Financial institutions, including banks, NBFCs, and housing finance companies, can claim deductions for provisions made towards bad and doubtful debts, contributions to special reserves, and other specific expenses related to their business operations.
10. Where can I find more information on tax deductions and how they apply to my business?
For detailed information and guidance on tax deductions under Section 36 and other provisions of the Income Tax Act, visit SmartTaxSaver. Our platform provides comprehensive resources and insights to help you optimize your tax planning and compliance.
Conclusion
Understanding the various deductions under Section 36 of the Income Tax Act is essential for businesses and professionals aiming to optimize their tax liabilities. By taking full advantage of these deductions, businesses can ensure they only pay tax on their net profits after accounting for all allowable expenses. Whether it’s insurance premiums, contributions to employee welfare funds, or bad debts, each deduction plays a vital role in the overall financial management of a business.
For more insights and detailed explanations on tax deductions and how they can benefit your business, visit SmartTaxSaver, your go-to resource for all things related to the Income Tax Act and other tax laws.
