General Rule Under Income Tax Law

• Fines and penalties are generally not deductible under corporate tax provisions.
  
• Section 37(1) of the Income-tax Act disallows any expenditure incurred for an offense or prohibited act.
  
• The law clearly distinguishes between business expenditure and punitive charges.
  
• Even if the fine is paid in the course of business, it remains non-deductible.
  
• The objective is to prevent companies from reducing tax liability through penal payments.
  

Types of Non-Deductible Penalties

• Penalties for violation of laws such as traffic fines, pollution norms, or labor regulations.
  
• Penal interest or late fees for delayed tax payments under the Income-tax Act.
  
• Fines imposed by courts, tribunals, or regulatory authorities.
  
• Penalties for non-compliance with company law, SEBI, GST, or FEMA provisions.
  
• Any expenditure with an element of punishment or deterrence.
  

Allowable Charges in Specific Cases

• Compensatory payments or charges that are not punitive in nature may be allowed.
  
• Interest on delayed payments to creditors or vendors is generally deductible.
  
• Liquidated damages for breach of business contracts may be deductible.
  
• Payments under settlement schemes without penalty may qualify for deduction.
  
• The nature and intent of payment determine its deductibility.
  

Judicial Interpretations and Clarifications

• Courts have consistently held that penalties for infraction of law are not allowable.
  
• Disguised penalties or charges labeled as fees may still be disallowed.
  
• The assessing officer examines the purpose and character of such payments.
  
• Clarifications by CBDT and appellate authorities guide the treatment of borderline cases.
  
• Misclassification may lead to disallowance during assessments or audits.
  

Documentation and Audit Compliance

• Companies must properly classify fines and penalties in their financial statements.
  
• Separate disclosure helps avoid incorrect deduction claims.
  
• Maintain details and explanations for any such expense in tax audit reports.
  
• Disallowed penalties must be added back while computing taxable income.
  

Transparent accounting and proper justification prevent future disputes.