When anyone starts a business some expenditure is incurred in the form of preparation of Memorandum of Association, feasibility report, project report this is called preliminary expenditure. Section 35D of the Income Tax Act lays down the requirements, the amount of preliminary expenditure, and other conditions to be satisfied to claim the expenditure.
Who can Claim this Deduction?
- Indian company
- Person (other than company) who is resident in India
What Expenditure can be Claimed as a Deduction?
Expenditure incurred for the following items can be claimed as a deduction:
- Preparation of feasibility report
- Preparation of project report
- Conducting market survey necessary for business
- Engineering services relating to business
- Preparation of agreements between the assessee and any other person for setting up and or conduct of business
- Drafting and printing of Memorandum of Association (MoA) and Articles of Association (AoA)
- Incorporation of a company
- Public issue of shares or debentures of the company
When Should the Expenditure be Incurred?
- Before the commencement of business, OR
- After the commencement of business in relation to the extension or setting up of a new unit.
What Amount Qualifies as a Deduction?
The maximum amount allowable as a deduction is 5% of the cost of project or 5% of capital employed whichever is higher.
The number derived above is compared with the preliminary expenditure incurred. The lease of these 2 is the amount that qualifies as a deduction.
This amount has to be claimed as a deduction in 5 equal installments.
“M/S Servex Motors Limited incurs a preliminary expenditure of Rs 5 lakh. The cost of the project is Rs 50 lakh and the capital employed is Rs 40 lakh.”
Here is how preliminary expenditure allowed as a deduction will be calculated:
- 5% of Cost of Capital = 5% of Rs 50 lakh = Rs 2.5 lakh
- 5% of Capital Employed = 5% of Rs 40 lakh = Rs 2 lakh
- Though the company has incurred Rs 5 lakh as preliminary expenditure, the eligible amount is Rs 2.5 lakh. 1/5th of Rs 2.5 lakh, i.e Rs 50,000 can be claimed as deduction every year for 5 consecutive years.
Preliminary expenditure thus is required to be deferred to 5 years and claimed 1/5 th in each year.