Essential Guide to Non-Deductible Expenses for Businesses

A Guide to Non-Deductible Expenses Under Section 21 of the Income Tax Ordinance

While Section 20 of the Income Tax Ordinance offers businesses the opportunity to reduce their taxable income through deductible expenses, Section 21 serves as a crucial boundary, outlining expenses that cannot be deducted. Let’s explore these restrictions to ensure accurate tax calculations and compliance.

Key Expenses That Cannot Be Deducted:

1. Taxes on Profits or Gains: Any cess, rate, or tax levied on your business’s profits or gains, whether paid in Pakistan or abroad, cannot be deducted. This prevents double-counting of tax payments.
2. Tax Deducted at Source (TDS): If a tax has already been deducted from an amount you’ve earned, you cannot claim it as a deduction again.
3. Expenses Without Required Tax Deductions: If you haven’t paid or deducted and paid taxes as required under Part V of Chapter X or Chapter XII, the associated expenses cannot be deducted.
4. Excessive Commissions: Commissions exceeding 0.2% of gross supplies for products listed in the Third Schedule of the Sales Tax Act, 1990, paid to non-active taxpayers, are not deductible.
5. Excessive Entertainment Expenses: Entertainment expenses beyond prescribed limits or violating specific conditions are disallowed.
6. Contributions to Non-Approved Funds: Contributions to funds other than recognized provident funds, approved pension funds, superannuation funds, or gratuity funds are not deductible.
7. Contributions Without Tax Deduction Arrangements: Contributions to employee benefit funds without arrangements for tax deduction under Section 149 are not deductible.
8. Fines and Penalties: Fines or penalties for violating laws or regulations cannot be deducted.
9. Personal Expenses: Expenses of a personal nature cannot be claimed as business deductions.
10. Reserve Funds and Capitalization: Amounts carried to reserve funds or capitalized in any way are not deductible.
11. Certain Payments to Association Members: Profit on debt, brokerage, commission, salary, or other remuneration paid by an association of persons to its members is not deductible.
12. Large Cash Transactions: Expenditures exceeding 250,000 rupees made in cash (not through crossed cheque, bank draft, pay order, or digital means) are not deductible, with specific exceptions.
13. Large Cash Salary Payments: Salaries exceeding 32,000 rupees per month paid in cash (not through crossed cheque, direct bank transfer, or digital means) are not deductible.
14. Capital Expenditures: Expenditures of a capital nature, with exceptions under Division III of Part IV, are not deductible.
15. Excessive Sales Promotion for Pharmaceuticals: Expenditures on sales promotion, advertisement, and publicity exceeding 10% of turnover for pharmaceutical manufacturers are not deductible.
16. Excessive Utility Bills: Utility bill expenditures exceeding prescribed limits or violating specific conditions are disallowed.
17. Sales to Unregistered Entities: A portion of expenditures attributable to sales made to persons required to be registered but not registered under the Sales Tax Act, 1990, may be disallowed for industrial undertakings.
18. Sales Without FBR Integration: A portion of expenditures attributable to sales may be disallowed for businesses required to, but failing to, integrate with the FBR through approved fiscal electronic devices and software.

Understanding these restrictions is essential for accurate tax calculations and compliance. Consulting a tax advisor can provide clarity on specific expenses and ensure optimal tax strategies for your business.