Which business expenses are not allowed as a deduction under section 21?

Section 21 of the Income Tax Ordinance, 2001 is the list of expenses that cannot be deducted from business income. It overrides the general rule in section 20: an expense can be genuinely for the business and still be refused because section 21 names it. The list below covers the clauses a small business is most likely to meet.

What does the law say?

Section 21 opens by saying that, except as otherwise provided in the Ordinance, no deduction is allowed in computing income under the head Income from Business for the items that follow. Here are the clauses that matter most to sole proprietors, in plain words.

Clause	What is disallowed	Plain meaning
(a)	Any cess, rate or tax levied on the profits or gains of the business, or assessed on the basis of those profits	Income tax on your profit is not a business expense
(b)	Tax deducted from an amount you receive under Division III of Part V of Chapter X	Tax withheld from your receipts is not deducted as a cost
(c)	Expenditure from which you had to deduct or collect tax, unless you deducted and paid it	Not withholding when the law required it costs you the deduction. For purchases of raw materials and finished goods, the disallowance is capped at twenty percent of those purchases
(d)	Entertainment above the prescribed limits or in breach of conditions	Rule 10 of the Income Tax Rules, 2002 sets out which entertainment is allowed
(g)	Any fine or penalty for breaking any law, rule or regulation	Traffic fines, late-filing penalties and similar are not deductible
(h)	Any personal expenditure	Household and family spending is not a business cost
(i)	Any amount carried to a reserve fund or capitalised	Setting money aside is not spending it
(l)	Expenditure under a single account head above Rs. 250,000 not paid through the banking channel from the business bank account	Large cash payments lose the deduction, with exceptions
(m)	Salary above Rs. 32,000 a month to an individual not paid by crossed cheque, direct bank transfer or digital means	Cash wages above that level are not deductible
(n)	Expenditure of a capital nature, except as provided for depreciation and similar allowances	Equipment and vehicles are recovered through depreciation, not deducted outright
(p)	Utility bills above prescribed limits or in breach of prescribed conditions	Depends on limits set by rules
(q)	Ten percent of claimed expenditure attributable to purchases from persons who are not National Tax Number holders	A tenth of non-NTN purchases is added back
(r)	Three percent of the expenditure claimed by a person who fails to install the required electronic resource or act as an integrated enterprise as required by law	Applies to those the law requires to integrate
(s)	Fifty percent of the expenditure claimed in respect of a sale where more than Rs. 200,000 was received against a single invoice otherwise than through a banking channel or digital means	Large cash sales cost half the related expense

Clauses (e), (ea), (f) and (j) deal with employee funds and payments by an association of persons to its members. Clause (ca) applies to commission on Third Schedule goods under the Sales Tax Act, and clause (o) to pharmaceutical manufacturers.

How does it work in practice?

You first list the expenses that meet section 20, then check each against section 21. Anything caught is added back to profit. Capital spending caught by clause (n) is not lost entirely: section 22(1) allows depreciation on depreciable assets used in the business, spread over the asset’s life.

Clause (q) is a fixed percentage. It does not ask whether the supplier’s price was fair. The first proviso limits it, for agricultural produce, to purchases from a middleman. The second proviso lets the Board exempt persons or classes of persons by notification in the official Gazette. Any such notification is outside this corpus.

Worked example (illustrative figures)

Tariq runs a hardware store in Peshawar. His made-up figures for tax year 2027 include:

Item	Amount
Purchases from suppliers without an NTN	Rs. 2,000,000
Traffic and municipal fines paid from the till	Rs. 15,000
Family groceries paid from the business account	Rs. 300,000
New display shelving	Rs. 400,000

Step by step:

1. Clause (q): Rs. 2,000,000 x 10% = Rs. 200,000 added back.
2. Clause (g): fines of Rs. 15,000 added back.
3. Clause (h): groceries of Rs. 300,000 added back.
4. Clause (n): shelving of Rs. 400,000 added back as a deduction, then recovered through depreciation under section 22.
5. Total added back before depreciation: Rs. 200,000 + Rs. 15,000 + Rs. 300,000 + Rs. 400,000 = Rs. 915,000.

What if …?

What if I paid a big supplier bill in cash? Clause (l) may apply. The limits and exceptions are explained on the page on cash payments.

What if I did not deduct withholding tax on rent I paid? Clause (c) may disallow the rent. Its second proviso says that if the tax is later recovered under the recovery provisions it names, that recovery is considered tax paid.

What if the utility bill limit applies to me? Clause (p) depends on limits “as may be prescribed”. The Income Tax Rules held here, amended to 24 November 2023, do not set that limit. Any later rule is outside this corpus.

Common mistakes

• Deducting income tax paid. Clause (a) blocks it.
• Deducting the full cost of a non-NTN purchase and forgetting clause (q). Ten percent comes back.
• Treating fines as a cost of doing business. Clause (g) blocks all fines and penalties for breaking the law.
• Assuming capital spending is lost. Clause (n) blocks the direct deduction; depreciation under section 22 still applies.

What to check in the official text

Read section 21 clause by clause, including the provisos to clauses (c), (l) and (q). For entertainment, read rule 10 of the Income Tax Rules, 2002. Check for any Board notification exempting your class of person from clause (q), and for any rule prescribing utility bill limits under clause (p).