Tax Deduction for In-House R&D Expenses under Section 35 (2AB)

Section 35(2AB) of the Income Tax Act is one of the most powerful tax incentives for in-house R&D in India, especially for companies in manufacturing and technology-driven sectors. Used correctly, it can significantly reduce your effective cost of innovation and improve cash flows.

What is Section 35 (2AB)?

Section 35(2AB) allows a weighted deduction on expenditure incurred by a company on approved in-house research and development (R&D) facilities related to its business.

• It applies only to companies engaged in eligible businesses (typically manufacturing and specified sectors) that have an approved in-house R&D facility.
• The R&D facility must be approved by the Department of Scientific and Industrial Research (DSIR), Ministry of Science & Technology.
• The deduction covers both revenue and capital expenditure (excluding land and building) on scientific research carried out in-house.

Over the years, the rate of weighted deduction has been reduced by successive Finance Acts, and currently, the weighted part has either been phased down or phased out for many years, with normal 100% deduction continuing under other parts of Section 35. Always verify the applicable rate for the relevant assessment year with the latest Finance Act or a tax advisor.

Why Section 35 (2AB) Matters for Businesses

For Indian entrepreneurs and established companies, Section 35(2AB) is not just a tax clause; it is a strategic tool.

• It reduces your tax outgo on genuine R&D spends, improving post-tax return on innovation projects.
• DSIR recognition and 35(2AB) approval add credibility when dealing with investors, partners and global customers.
• Many grant schemes, government tenders and collaborations prefer or require DSIR-recognised R&D units.

​A simple example: if your company spends ₹5 crore on approved in-house R&D in a year and the applicable law allows weighted deduction above 100%, your taxable income can be reduced by more than ₹5 crore, depending on the applicable rate for that year.

Basic Conditions to Claim 35 (2AB) Deduction

To use Section 35(2AB), a business must meet several conditions.

• The taxpayer must be a company registered in India (partnership firms, LLPs, proprietorships are not eligible here).
• The company should be engaged in an eligible business, generally involving manufacturing, production or specific notified activities.
• ​The company must have an in-house R&D facility engaged in scientific research related to its business, not just general product support or quality control.
• The R&D facility must be approved by DSIR in the prescribed manner for the relevant period.
• The company must maintain separate books for R&D expenditure and comply with audit and reporting requirements.

If any of these conditions are not met or are only partially met, the claim can be questioned or disallowed during assessment.

Role of DSIR and Approvals

DSIR (Department of Scientific and Industrial Research) is the “prescribed authority” under Section 35(2AB).

• DSIR first recognises the in-house R&D unit of the company under its own guidelines.
• Only DSIR-recognised R&D units are eligible to apply for specific approval under Section 35(2AB).
• ​Approval is granted through Form 3CM and expenditure reporting and certification is done through Form 3CL under the Income-tax Rules.

Courts and tribunals have repeatedly held that DSIR approval is central to the benefit; mere internal classification of expenses as “R&D” without proper approval is not enough.

Step-by-Step: How to Obtain 35 (2AB) Approval

1. Build or formalise your in-house R&D unit

• Set up a dedicated R&D facility with clear physical boundaries (labs, pilot plants, testing facilities, etc.).
• Define organisational structure, staff, equipment, and documented R&D projects with clear objectives.
• ​Ensure the R&D is directly related to your existing business or proposed business areas.

2. Get DSIR recognition of the R&D unit

• Apply to DSIR using the prescribed application form for recognition of in-house R&D units (available on DSIR’s website).
• Provide details of infrastructure, manpower, R&D projects, expenditure, IP created, collaborations, etc.
• ​DSIR may seek clarifications or may inspect the facility before granting recognition.

3. Apply for Section 35(2AB) approval via Form 3CK

• Once recognised, apply for approval under Section 35(2AB) in Form 3CK as per Income-tax Rules, along with DSIR’s additional information requirements.
• ​DSIR processes the application and, if satisfied, issues approval in Form 3CM specifying the period for which the R&D facility is approved.

4. Annual reporting of R&D expenditure (Form 3CL)

• Every year, you must submit details of eligible R&D expenditure to DSIR.
• DSIR issues Form 3CL certifying the amount of expenditure eligible for weighted deduction for that year.
• ​Tax authorities increasingly rely on Form 3CL to verify and restrict the quantum of deduction.

Missing or delayed Form 3CL has been a frequent reason for disputes, though some tribunals have held that benefits cannot be denied for procedural lapses if other conditions are met, depending on the assessment year and rule position.

What Expenditure Qualifies Under 35 (2AB)?

Generally, the following types of expenditure incurred on approved in-house R&D facilities can qualify, subject to DSIR and Income-tax Rules.

• Salaries and wages of R&D staff directly engaged in research.
• Consumables, chemicals, materials and components used in R&D.
• Power, fuel and utilities directly attributable to R&D labs or pilot plants.
• Capital expenditure on plant, machinery, equipment, computers, and instruments used in R&D (excluding land and building).
• Fees for filing and maintaining patents arising from in-house R&D, where allowed.
• ​Testing, trials and validation costs within the R&D facility.

​Items usually excluded or treated cautiously include expenditure on land and buildings, general corporate overheads, sales promotion, routine quality control, and R&D work carried outside India or by associated enterprises abroad.

Common Compliance Requirements

To sustain a 35(2AB) claim, expect scrutiny around documentation and process.

• Maintain separate cost centres or ledgers for R&D revenue and capital expenses.
• Keep project-wise documentation: objectives, methodologies, experiment notes, test results, reports.
• ​Ensure all invoices, purchase orders and payrolls clearly link to the R&D facility where possible.
• File Form 3CK, 3CM and 3CL accurately and on time.
• Obtain a tax audit report and ensure your tax return correctly reflects the claim under Section 35(2AB) along with any other deductions under Section 35.

Frequent Issues and Litigation Trends

Several recurring issues show up in case law and assessments under Section 35(2AB).

• Disallowance due to absence or delay in Form 3CL or disagreement over the quantum certified.
• Claiming deduction on expenditure incurred before DSIR approval date or outside approved period.
• Including R&D expenses of facilities or locations not approved by DSIR.
• Claiming weighted deduction for R&D activities carried outside India or with overseas associated enterprises; tribunals have held such expenditure generally not eligible for weighted deduction.
• ​Treating normal quality control, troubleshooting or application engineering as “research”, which is often rejected.

​Tribunals have also emphasised that once DSIR approves the R&D facility, and if the expenditure is on that facility, weighted deduction should ordinarily be allowed subject to the prescribed rules and forms.

Strategic Benefits for Indian Entrepreneurs

For founders and CFOs, the real value of Section 35(2AB) emerges when it is integrated into business planning.

• You can design product roadmaps so that major innovation projects pass through DSIR-approved labs, making costs more tax-efficient.
• Combining 35(2AB) with other incentives (such as grants or state-level subsidies) can significantly reduce net R&D cost.
• ​Strong R&D documentation created for DSIR and tax purposes also supports IP creation, valuation and due diligence during funding rounds.

​Even if the weighted portion is reduced for some years, the discipline of having an approved, well-run R&D facility itself becomes a competitive advantage.

Practical Tips to Maximise 35 (2AB) Benefits

• Start early: Begin DSIR recognition and 35(2AB) approval process before ramping up large R&D spends; approvals are not always granted retroactively for long past periods.
• Align finance and technical teams: Finance should understand what counts as eligible R&D, while technical teams must understand documentation and cost coding needs.
• Avoid mixing routine operations and R&D: Clearly segregate commercial production/quality activities from experimental work in terms of locations, equipment use and records.
• ​Review contracts with group entities: If R&D is performed for foreign group companies, structuring and place of work can influence eligibility.
• Periodically review DSIR guidelines: DSIR updates its guidelines from time to time, including minimum investment thresholds or reporting requirements.

Factor	What it Means for Your Business	What You Must Do	Typical Pitfalls	Practical Tip
Eligible taxpayer	Only Indian companies can claim 35(2AB), not firms, LLPs or individuals.	Incorporate as a company if you want to use this incentive.	Trying to claim in non‑company structures.	Plan restructuring early if you foresee heavy R&D spends.
Eligible business	Typically manufacturing and specified sectors with in‑house R&D linked to products or processes.	Map your product lines and R&D projects to core business activities.	Claiming for unrelated or service-only activities.	Document how each R&D project supports your main business.
R&D facility recognition	DSIR must recognise your in‑house R&D unit before 35(2AB) approval.	Apply to DSIR with detailed infrastructure, manpower and project information.	Running informal R&D without formal recognition.	Treat R&D like a separate “business unit” with clear boundaries.
35(2AB) approval	Separate approval for tax deduction is given via Form 3CM.	File Form 3CK and follow DSIR’s process until you receive 3CM.	Assuming DSIR recognition alone is enough.	Track approval period carefully when planning large R&D capex.
Types of expenditure	Salaries, consumables, utilities and eligible capital assets used in in‑house R&D.	Tag every eligible cost to R&D cost centres and projects.	Including land, buildings, marketing and routine QC costs.	Prepare an annual mapping sheet of all R&D ledger heads.
Capital vs revenue	Both revenue and eligible capital spends (excluding land/building) can qualify.	Maintain separate registers for R&D fixed assets and expenses.	Missing asset-wise records or using assets mainly for production.	Capture usage patterns (hours used for R&D vs production) where shared.
Form 3CL	DSIR certifies eligible expenditure each year through Form 3CL.	Submit accurate annual data to DSIR on time.	No or delayed 3CL, or mismatch with books, leading to disallowance.	Reconcile 3CL numbers with your financial statements before filing tax returns.
Place of R&D	Weighted benefits focus on in‑house R&D done in India in approved facilities.	Ensure core work is carried in your DSIR‑approved facility.	Counting overseas or group‑company R&D costs as eligible.	Use clear internal policies for booking cross‑border R&D charges.
Documentation	Strong technical and financial records are critical for both DSIR and tax officers.	Maintain project files, lab records, test reports, IP documentation and audit trails.	Vague descriptions like “R&D expenses” without project details.	Standardise templates for experiment logs and project closure reports.
Litigation risk	Disputes often arise on quantum of deduction, eligibility window and procedural lapses.	Align claims strictly with DSIR certifications and current rules.	Aggressive claims without strong DSIR backing.	Get periodic reviews from a tax professional familiar with R&D incentives.
Strategic use	When used well, 35(2AB) can materially lower effective R&D cost and boost innovation capacity.	Integrate R&D tax planning into budgeting and product strategy cycles.	Seeing it as a mere compliance tick‑box.	Treat DSIR‑approved labs as the default home for all major innovation projects.

How Startups and SMEs Can Practically Use 35 (2AB)

Even if you are a small or mid-sized company, Section 35(2AB) can be powerful when aligned with your growth plan.

• Product startups in sectors like pharma, chemicals, engineering, automotive components, electronics or deep-tech can set up modest but focused R&D labs that qualify for DSIR recognition.
• Over time, the same facility can be expanded to handle scale-up trials, prototype development and testing while still keeping the core R&D identity.
• ​Using the same documentation for DSIR, investors, regulators and customers reduces friction and builds trust.

​Founders should view the initial effort to obtain DSIR recognition and 35(2AB) approval as a one-time capacity-building exercise that keeps paying back as the company grows.

Key Takeaways for Business Leaders

• If you are serious about product innovation, invest in a formal in-house R&D unit and aim for DSIR recognition early.
• Keep your finance, tax and technical teams on the same page; eligibility is as much about process and documentation as it is about spending money.
• Review the latest Finance Act and DSIR guidelines every year to understand the current deduction rate and any additional conditions.

Given the complexity and frequent changes, it is sensible to complement your internal efforts with professional advice from tax and R&D incentive specialists before making large claims.

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