5% of HIGHER of (Cost of Project OR Capital Employed)
Other Resident Assessee
5% of Cost of Project
### Key Definitions
Cost of Project = Amount invested in fixed assets of the new business / extension / new unit.
Capital Employed = Share Capital (excluding Application & Allotment money & Share Premium) + Debentures + Long-term Borrowings of the new business / extension / new unit.
## Deduction Amount
```
Actual Preliminary Expenses ┐
OR ├──► LOWER ──► Allowed in 5 EQUAL installments over 5 years
Limit (5%) ┘
```
So, Deduction per year = 1/5 × Lower of (Actual Preliminary Expenses OR 5% Limit)
Worked example
### Example 1
Example — Indian Company:
ABC Ltd. (Indian Co.) sets up a new unit with:
Cost of Project (fixed assets) = ₹ 80,00,000
Capital Employed = ₹ 1,00,00,000
Actual preliminary expenses = ₹ 6,00,000
Step 1: Limit = 5% × HIGHER of (80 lakhs OR 1 crore) = 5% × 1,00,00,000 = ₹ 5,00,000
Step 2: Eligible = Lower of (Actual ₹ 6,00,000 OR Limit ₹ 5,00,000) = ₹ 5,00,000
Step 3: Deduction per year = 5,00,000 / 5 = ₹ 1,00,000 for 5 years
### Example 2
Example — Resident Individual:
Mr. P (resident) commences a new business:
Cost of Project = ₹ 40,00,000
Actual preliminary expenses = ₹ 1,50,000
Limit = 5% × 40,00,000 = ₹ 2,00,000
Eligible = Lower of (1,50,000 OR 2,00,000) = ₹ 1,50,000
Deduction per year = 1,50,000 / 5 = ₹ 30,000 for 5 years
⚠️ Common exam mistakes
For an Indian company, applying the 5% only on Cost of Project — for companies, the limit is on the HIGHER of Cost of Project OR Capital Employed.
Including Share Application Money or Share Premium in Capital Employed — both are EXCLUDED.
Claiming the entire eligible amount in the first year — it MUST be spread over 5 equal annual installments.
Granting Section 35D deduction to non-resident assessees — only RESIDENTS qualify.
Including short-term borrowings in Capital Employed — only LONG-term borrowings count.
Bare-Act text Section 35D · Income Tax Act, 1961 · click to expand
Section 35D — Where an assessee, being an Indian company or a person (other than a company) who is resident in India, incurs, after the 31st day of March, 1970, any expenditure specified in sub-section (2),— (i) before the commencement of his business, or (ii) after the commencement of his business, in connection with the extension of his undertaking or in connection with his setting up a new unit, the assessee shall... be allowed a deduction of an amount equal to one-fifth of such expenditure for each of the five successive previous years beginning with the previous year in which the business commences or, as the case may be, the previous year in which the extension of the undertaking is completed or the new unit commences production or operation.