Section 35 of the Income Tax Act allows taxpayers to claim tax deductions on eligible expenses incurred for scientific research. The provision covers research carried out across different fields, including engineering, technology, natural sciences, and social sciences. Its primary objective is to encourage innovation and promote research and development (R&D) by reducing the tax burden on eligible businesses and organisations. These tax benefits help make investments in scientific research more affordable, allowing entities to focus on developing new products, improving processes, and advancing technology. The deduction is available only for qualifying research-related expenses as specified under the Income Tax Act.
In this article, we will explain the key features of Section 35 of the Income Tax Act, the tax benefits it offers, the eligibility criteria, and the types of scientific research and development (R&D) expenses that qualify for deductions under the applicable income tax provisions.
What is Section 35 of the Income Tax Act?
Section 35 of the Income Tax Act is a provision that allows taxpayers to claim deductions for expenses incurred in scientific research and development. This section aims to promote and support scientific research by providing financial incentives through tax deductions. It encompasses a wide range of scientific fields, including engineering, natural sciences, technology, and social sciences. By enabling deductions for both revenue and capital expenditures related to scientific research, Section 35 helps reduce the overall cost of R&D activities, thus encouraging more investment in innovation and technological advancement.
Applicability of section 35 of the income tax act
Section 35 applies to all entities involved in scientific research activities, irrespective of their field of study, such as engineering, natural sciences, technology, and social sciences. It is relevant for businesses and individuals who incur expenses related to experimental development, pure research, and applied research. The section extends to both revenue and capital expenditures, facilitating a broad range of scientific activities. The deductions can be claimed for expenses incurred in the year of spending or during the three years preceding the commencement of business activities related to scientific research.
Benefits of section 35
- Provides tax deductions: Reduces taxable income by allowing deductions for R&D expenditures, effectively decreasing overall research costs.
- Encourages innovation: Motivates companies to invest in developing new products, technologies, and services.
- Facilitates economic growth: Boosts productivity and creates job opportunities, contributing positively to economic development.
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Eligibility for deductions under section 35 of the income tax act
- Scientific research in India: Research activities must be conducted within India.
- Approval by DSIR: The research should be approved by the Department of Scientific and Industrial Research (DSIR).
- Purpose of research: Expenditures must be exclusively for scientific research purposes.
Types of Scientific Research Covered under Section 35
1. In-house scientific research & development
Section 35 allows deductions for both revenue and capital expenditures related to in-house scientific research and development. This includes expenses for conducting research activities and purchasing research materials.
2. Revenue expenditure [Section 35(1)(i)]
Revenue expenditure includes all routine expenses involved in operating a business, such as wages, salaries, rent, and maintenance. Under Section 35, these expenses are fully deductible in the year they are incurred. Additionally, expenses incurred within the three years prior to starting the business—such as salaries paid to research staff or material costs linked to scientific research—can also be claimed as deductions in the year the business begins operations.
3. Capital expenses
- Tax benefits are available for capital expenditure incurred on scientific research activities carried out during the same financial year.
- Under Section 35, deductions can be claimed on most capital expenses related to scientific research.
- The deduction does not apply to the purchase of land.
- Capital expenditure incurred up to three years before the commencement of business operations is treated as expenditure in the year the business starts operations.
- If scientific research assets are sold without being used for non-scientific purposes, the lower of the net sale value or the earlier deduction claimed under Section 35 will be treated as business income in the year of sale.
- Any sale amount above the original asset cost will be subject to capital gains tax.
- If the assets are sold after being used for other business activities, their actual cost will be considered nil because full deduction has already been claimed under Section 35.
- In such cases, the sale proceeds will reduce the value of the relevant asset block.
- Scientific research assets are not eligible for depreciation in the year of purchase or in subsequent years.
4. Payment for scientific research work to outside agencies
Section 35 allows taxpayers to claim deductions for payments made to outside agencies engaged in scientific research. This includes payments to institutions such as national laboratories, IITs, and other approved organizations. By facilitating these deductions, Section 35 encourages collaboration between businesses and research institutions, fostering advancements in science and technology.
1. Section 35(1)(ii) & (iia)
Section 35(1)(ii) allows for 100% deductions on payments made to national laboratories, universities, and other recognized research institutions for scientific research. Section 35(1)(iia) extends this benefit to payments made to companies engaged in scientific research, provided they meet specific criteria. These sections ensure that financial contributions towards research are fully deductible, supporting both internal and collaborative research efforts.
2. Section 35(1)(iii)
Section 35(1)(iii) provides for deductions on expenditures related to scientific research, not only within the taxpayer's own organization but also when paid to external research agencies. This section covers a broad spectrum of research activities, including those undertaken in collaboration with approved institutions, thus broadening the scope of deductible expenses.
3. Section 35(1)(iia)
Section 35(1)(iia) offers a 100% deduction for payments made to companies engaged in scientific research, provided these companies are registered and approved by the prescribed authority. This section incentivizes businesses to fund research activities by making such payments fully deductible, thereby supporting innovation and technological advancement.
4. Section 35(2AA)
Section 35(2AA) focuses on deductions for payments made to specified institutions and organizations engaged in scientific research and development. These deductions are available only if the institutions meet the criteria set by the government, ensuring that the funds are used effectively for advancing scientific research.
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Sale of an asset used for scientific research (Section 41(3))
Section 41(3) deals with the tax implications of selling an asset that was used for scientific research. If the asset is sold, the lower of the sale price and the asset’s original cost, which was previously deducted, is treated as business income. Any amount received over the original cost is subject to capital gains tax. This ensures that the tax benefits previously claimed are adjusted in line with the sale of the asset.
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1. Sold after being used for business
When a scientific research asset is sold after being used for business purposes, any previously claimed deductions must be adjusted. The sale proceeds, if exceeding the asset’s original cost, are considered business income. The differential amount, reflecting the actual depreciation or use, will be subject to tax, ensuring accurate tax reporting and compliance.
2. Uninvolved capital expenditure
Businesses can deduct their capital investment in scientific research from their earnings, but this deduction is capped at the company’s profit, unlike depreciation. If the profit falls short of the capital expenditure, the excess is termed as unabsorbed capital expenditure on scientific research. According to Section 72(2) (business losses) and Section 73(3) (speculation losses), this unabsorbed amount can be carried forward to subsequent years and deducted from future profits. This process can continue annually until the entire unabsorbed capital expenditure on scientific research is fully adjusted.
3. Procedure for approval
To qualify for deductions under Section 35, a research project must be approved by the designated authority by submitting Form 3CK, which includes details of the project's specifications, estimated costs, and expected benefits. The deduction amount depends on the type of expenditure: revenue expenses can be fully written off in the year they are incurred, while capital expenses are deductible over time through depreciation. Accurate records, such as invoices, bills, vouchers, and other supporting documents, must be maintained to claim the deduction.
4. Denial of deductions
Section 35 of the Income Tax Act provides tax deductions for expenses related to scientific research in India. It applies to businesses, individuals and organisations involved in research activities across fields such as engineering, technology, natural sciences and social sciences. Deductions are available for both revenue and capital expenditure, except land purchases. Businesses can also claim deductions for payments made to approved research institutions, universities and laboratories. To qualify, the research must be approved by the Department of Scientific and Industrial Research (DSIR) and the expenses must be wholly for research purposes. Proper documents, including bills and invoices, must be submitted while filing tax returns.
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Tax deductions available under Section 35
100% deduction for revenue expenditure
Businesses can claim a 100% deduction on eligible revenue expenses incurred for scientific research under Section 35. This includes regular operating costs such as employee salaries, raw materials, consumables, electricity, and other day-to-day research expenses. The deduction can be claimed in the same financial year in which the expenditure is incurred, helping reduce taxable income while supporting research and development activities.
100% deduction for capital expenditure (excluding land and building)
Eligible capital expenditure on scientific research, such as machinery, equipment, and other research assets, also qualifies for a 100% deduction. The full deduction can be claimed in the year the expense is incurred, improving cash flow for businesses investing in research infrastructure. However, expenditure on land and buildings does not qualify for this tax benefit under Section 35.
Weighted deductions (previously available)
Earlier, Section 35 allowed weighted deductions of 150% or 200% of eligible scientific research expenditure, enabling businesses to claim deductions exceeding the actual amount spent. These enhanced tax benefits have now been withdrawn, and only the standard deduction provisions are available under the current tax rules.
Treatment of unabsorbed R&D expenditure
If eligible research and development expenditure exceeds a business's taxable profits in a financial year, the unabsorbed amount can generally be carried forward, subject to the applicable provisions of the Income Tax Act. This allows businesses to claim the available tax benefit in future years when they earn sufficient taxable profits.
Conclusion
Section 35 of the Income Tax Act offers significant tax benefits for scientific research expenditures, supporting both in-house and collaborative research activities. By understanding the applicability, benefits, and procedures for claiming deductions, businesses and individuals can effectively reduce their tax liabilities and promote innovation. Ensure compliance with all requirements and maintain accurate documentation to maximize the advantages of Section 35.
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