Which expenses does the law not allow as a deduction for a business?

What does the law say?

Section 20 of the Income Tax Ordinance, 2001 allows a deduction for expenditure incurred wholly and exclusively for the purposes of business. Section 21 then overrides it. It opens with “no deduction shall be allowed” and lists specific items. An expense can be a genuine business cost and still be refused because section 21 names it.

The clauses a shop owner, trader or small service business is most likely to meet are these:

Clause	What cannot be deducted
21(a)	Any cess, rate or tax levied on the profits or gains of the business, in Pakistan or abroad
21(b)	Tax deducted from amounts the business receives under Division III of Part V of Chapter X
21(c)	Payments on which you had to deduct or collect tax but did not deduct and pay it (capped at 20% of purchases of raw materials and finished goods)
21(d)	Entertainment expenditure beyond the limits and conditions prescribed
21(g)	Any fine or penalty for breaking a law, rule or regulation
21(h)	Personal expenditure
21(i)	Amounts carried to a reserve fund or capitalised
21(l)	Expenditure over Rs. 250,000 under a single account head not paid through the banking channel from the business bank account
21(m)	Salary over Rs. 32,000 a month paid other than by crossed cheque, bank transfer or digital means
21(n)	Expenditure of a capital nature, except as allowed in Division III (depreciation and similar)
21(p)	Utility bills beyond the limits and conditions prescribed
21(q)	Ten percent of expenditure on purchases from persons who are not National Tax Number holders
21(s)	Fifty percent of expenditure claimed for a sale where more than Rs. 200,000 against one invoice was received outside banking channels or digital means

How does it work in practice?

The disallowed amount is added back when business income is worked out. Your accounts may show the expense, but it does not reduce taxable income.

Personal spending. Household groceries, children’s school fees or a family holiday paid from the shop’s till are personal expenditure under section 21(h), even if the business account paid them.

Capital spending. Buying a freezer, a delivery van or shop fittings is capital expenditure. Section 21(n) blocks the full cost in one year. Section 20(2) routes it through depreciation under sections 22 and 23, so the cost is recovered over several years.

Entertainment. Rule 10 of the Income Tax Rules, 2002 sets the limits for clause 21(d). It allows entertainment of customers and clients at the business premises, entertainment of foreign customers and suppliers in Pakistan, entertainment at a meeting of shareholders, agents, directors or employees, entertainment at the opening of branches, and some spending outside Pakistan in connection with business. The people entertained must be related directly to the business. “Entertainment” means meals, refreshments and reasonable leisure facilities.

Utility bills. Clause 21(p) refers to limits and conditions “as may be prescribed”. The Income Tax Rules edition held in this corpus (amended to 24 November 2023) does not contain those limits, so they are not covered here.

Purchases from people without an NTN. Clause 21(q) does not refuse the whole purchase. It disallows ten percent of the expenditure attributable to those purchases. For agricultural produce it applies only to purchases from a middleman, and the Board can exempt classes of persons by notification.

No receipt. Separately from section 21, section 174(2) lets the Commissioner disallow or reduce any deduction if the taxpayer cannot, without reasonable cause, produce a receipt or other record of the transaction. Section 174(4) defines “deduction” for this purpose as any amount debited to the trading, manufacturing, receipts and expenses, or profit and loss account.

Worked example (illustrative figures)

Bilal runs a mobile accessories shop in Faisalabad. For tax year 2027 his expense ledger shows Rs. 3,400,000. Some of it is caught by section 21:

Item in the ledger	Amount (Rs.)	Treatment
Advance income tax paid	150,000	Disallowed, 21(a)
Fine for a municipal encroachment	20,000	Disallowed, 21(g)
Family wedding costs paid from the shop account	300,000	Disallowed, 21(h)
New glass display counters	400,000	Disallowed as capital, 21(n); claimed as depreciation instead
Purchases of Rs. 500,000 from suppliers without an NTN	50,000	Ten percent disallowed, 21(q)
Total added back	920,000

Step 1: Rs. 150,000 + 20,000 + 300,000 + 400,000 + 50,000 = Rs. 920,000.

Step 2: Expenses allowed = Rs. 3,400,000 - 920,000 = Rs. 2,480,000, plus any depreciation on the counters worked out under section 22.

The advance tax of Rs. 150,000 is a payment of income tax itself, which is why section 21(a) keeps it out of the expense side. How advance tax is adjusted against the final liability is a separate question, covered on the quarterly advance tax page.

What if my expense is partly business and partly personal?

Section 20(1) allows only expenditure incurred wholly and exclusively for business. Section 21(h) blocks personal expenditure. The Ordinance does not give a general formula for splitting a mixed expense such as a mobile phone bill. For depreciable assets used partly for private purposes, section 22(3) does give a proportional rule.

Common mistakes

• Treating withheld tax as an expense. Tax deducted from your receipts is disallowed by section 21(b). It counts against your tax bill, not your income.
• Expensing equipment in one year. Section 21(n) disallows capital expenditure. Depreciation is the route.
• Thinking “paid from the business account” makes it a business expense. The test is the purpose of the spending, not which account paid it.
• Ignoring the payment method. Clauses 21(l), 21(m) and 21(s) disallow amounts because of how money was paid or received, not what it was for.

What to check in the official text

Read section 21 in full: several clauses, including (ca) on commissions, (e) and (ea) on fund contributions, (o) on pharmaceutical promotion and (r) on electronic integration, apply only to particular businesses. Check rule 10 for entertainment. For utility limits under clause 21(p), look for the rule or notification in force, which this corpus does not hold. Check whether the Board has issued any exemption notification under the proviso to clause 21(q).