Income Tax 2025

Appearance

Expenses or payments not deductible in certain circmstances. ​

36(1) ​

The provisions of this section shall have effect irrespective of anything to the contrary contained in any other provision of this Act relating to computation of income under the head “Profits and gains of business or profession”.

36(2) ​

If the assessee incurs any expenditure for which payment has been or is to be made to any “specified person”, which in the opinion of the Assessing Officer is excessive or unreasonable having regard to the––

  • (a) fair market value of the goods, services or facilities; or
  • (b) legitimate needs of the business or profession of the assessee; or
  • (c) benefit derived by or accruing to the assessee therefrom, so much of the expenditure as considered excessive or unreasonable by him shall not be allowed as a deduction.

36(3) ​

For the purposes of sub-section (2),––

  • (a) “specified person”,–– (i) in relation to an assessee mentioned in column B of the Table below, shall be the person referred to in column C thereof:—

Table

(ii) shall mean any person being an individual or company or firm or association of persons or Hindu undivided family having substantial interest in the business or profession of the assessee, or any director, partner, member thereof or any relatives of such individual, director, partner, member or any other company in which the first mentioned company has substantial interest; (iii) shall mean a company, firm, association of persons, or Hindu undivided family whose director, partner or member has substantial interest in the business or profession of the assessee, or any director, partner or member thereof and their relatives, as the case may be; (iv) shall mean any person carrying on a business or profession, in which assessee, being–– (A) an individual or his relative; or (B) a company, its directors or their relatives; or (C) a firm, its partners or their relatives; or (D) an association of persons, its members or their relatives; or (E) a Hindu undivided family, its members or their relatives, has substantial interest in the business or profession of such person;

  • (b) a person is deemed to have “substantial interest in the business or profession” if, at any time during the tax year, such person is— (i) the beneficial owner of shares (not being shares entitled to fixed rate of dividend with or without a right to participate in profits) carrying at least 20% of the voting power, in case of assessee being a company; and fession in any other case, at any time during the tax year.

36(4) ​

Where any expenditure is incurred by the assessee and payment or aggregate of payments made in a day to a person is exceeding ten thousand rupees and is not through specified banking or online mode, then the expenditure by way of such payments shall not be allowed as deduction.

36(5) ​

Where any deduction was made in any preceding tax year for a liability incurred for any expenditure and payment in respect of such liability is made during a subsequent tax year and if such payment or aggregate of payments made in a day to a person exceeds ten thousand rupees and is not through specified banking or online mode, such payment shall be deemed to be the income under the head “Profits and gains of business or profession” in such subsequent tax year.

36(6) ​

For the purposes of sub-sections (4) and (5), the figure “ten thousand rupees” shall be read as “thirty-five thousand rupees” in case the payment is made for plying, hiring or leasing of goods carriages.

36(7) ​

The provisions of sub-sections (4) and (5) shall not be applicable in cases and circumstances, as prescribed, having regard to the nature and extent of banking facilities available, considerations of business expediency and other relevant factors.

36(8) ​

Nothing (with reference to mode of payment) contained in any other law in force or in any contract, shall apply in respect of any payment which has been made through specified banking or online mode, in compliance of sub-sections (4) to (7), and no plea shall be allowed to be raised, in any suit or other proceeding on the ground that the payment was not made or tendered in cash or in mode other than through specified banking or online mode.

Explanation

Section Summary: ​

This section outlines the circumstances under which certain expenses or payments made by taxpayers (individuals or businesses) are not deductible when computing taxable income under the head "Profits and gains of business or profession." It specifically targets payments that are deemed excessive, unreasonable, or made in non-compliant modes (e.g., cash payments exceeding specified limits). The section overrides any conflicting provisions in the Income Tax Act, ensuring uniformity in its application.

Key Changes: ​

  1. Expenses to "Specified Persons": Introduces restrictions on deductibility of payments made to "specified persons" (e.g., related parties) if the Assessing Officer deems them excessive or unreasonable based on fair market value, business needs, or benefits derived.
  2. Cash Payment Limits: Imposes a limit of ₹10,000 per day per person for cash payments (₹35,000 for goods carriage-related payments). Payments exceeding this limit must be made through specified banking or online modes to qualify as deductible expenses.
  3. Deemed Income for Non-Compliant Payments: If a payment exceeding the cash limit is made in a subsequent year for a liability deducted earlier, it will be treated as income in the year of payment.
  4. Overriding Provision: Ensures that compliance with this section takes precedence over other laws or contractual agreements regarding payment modes.

Practical Implications: ​

  1. For Businesses:

    • Payments to related parties (e.g., directors, relatives, or entities with substantial interest) must be justified based on fair market value and business needs.
    • Cash payments exceeding ₹10,000 per day per person (₹35,000 for goods carriage) will not be deductible unless made through banking or online modes.
    • Non-compliant payments could lead to disallowance of deductions or reclassification as income in subsequent years.

  2. For Taxpayers:

    • Increased scrutiny on transactions with related parties, requiring proper documentation to justify expenses.
    • Need to adopt digital payment methods to avoid disallowance of deductions.

  3. For Compliance:

    • Taxpayers must maintain detailed records of payments, including mode of payment and justification for expenses.
    • Assessing Officers have broader discretion to disallow unreasonable or excessive payments.

Critical Concepts: ​

  1. Specified Person:

    • Includes individuals or entities with a substantial interest in the taxpayer’s business (e.g., relatives, directors, partners, or companies with at least 20% voting power).
    • Also covers entities where the taxpayer has a substantial interest.

  2. Substantial Interest:

    • Defined as owning at least 20% of voting power in a company or having significant control in other entities.

  3. Specified Banking or Online Mode:

    • Refers to payments made through digital methods like NEFT, RTGS, UPI, or other prescribed electronic modes.

  4. Deemed Income:

    • If a payment exceeding the cash limit is made in a subsequent year for a liability deducted earlier, it is treated as income in the year of payment.

Compliance Steps: ​

  1. Documentation:

    • Maintain records of payments to specified persons, including invoices, contracts, and justification for the amount paid.
    • Ensure payments exceeding ₹10,000 per day per person (₹35,000 for goods carriage) are made through banking or online modes.

  2. Justification of Expenses:

    • Be prepared to demonstrate that payments to related parties are reasonable and aligned with fair market value and business needs.

  3. Adopt Digital Payments:

    • Transition to digital payment methods for all business transactions to avoid disallowance of deductions.

  4. Review Past Deductions:

    • Ensure that any liabilities deducted in previous years are paid in compliance with the cash payment limits to avoid reclassification as income.

Examples: ​

  1. Excessive Payment to Related Party:

    • A business pays ₹5 lakh to a director’s relative for consulting services. The Assessing Officer determines that the fair market value for such services is ₹3 lakh. The excess ₹2 lakh will be disallowed as a deduction.

  2. Cash Payment Exceeding Limit:

    • A business pays ₹15,000 in cash to a supplier in a single day. Since the payment exceeds ₹10,000 and is not made through a banking or online mode, the entire ₹15,000 will be disallowed as a deduction.

  3. Goods Carriage Payment:

    • A transport company pays ₹40,000 in cash to a truck owner for leasing services. Since the limit for goods carriage payments is ₹35,000, the excess ₹5,000 will be disallowed unless paid through a banking or online mode.

  4. Deemed Income Scenario:

    • In FY 2022-23, a business deducts ₹50,000 as a liability for unpaid vendor fees. In FY 2023-24, it pays ₹60,000 in cash to the vendor in a single day. Since the payment exceeds ₹10,000 and is not made through a banking or online mode, the ₹60,000 will be treated as income in FY 2023-24.

This section emphasizes the importance of transparency, reasonableness, and digital compliance in business transactions, ensuring that deductions are only allowed for legitimate and properly documented expenses.