BHARAT TAX — INCOME-TAX ACT, 2025

Volume IV (Expanded) — PGBP General Provisions — Sections 26 to 44

Editorial Note — v2 (May 2026)

This Volume sets out the General Provisions of the Profits and Gains of Business or Profession head (Sections 26 to 44 of the Income-tax Act, 2025) at full practitioner depth. Each section is presented in the standard three-block format: (i) substance of the new section; (ii) corresponding Income-tax Act, 1961 section; (iii) analytical commentary including statutory architecture, judicial evolution, departmental practice, practical points, and litigation defence.

Section 26 — Charge of Profits and Gains of Business or Profession

BLOCK 1 — INCOME-TAX ACT, 2025 — Section 26

(2) The following income shall be chargeable to income-tax under the head 'Profits and Gains of Business or Profession' —

(a) the profits and gains of any business or profession which was carried on by the assessee at any time during the previous year;

(b) any compensation or other payment due to or received by — (i) any person managing the whole or substantially the whole of the affairs of an Indian company or any other company at or in connection with the termination of his management or modification of the terms and conditions thereto; (ii) any person at or in connection with the termination of his agency or modification of terms and conditions thereto; (iii) any person at or in connection with the vesting in the Government, or in any corporation owned or controlled by the Government, of the management of any property or business;

(d) income derived by a trade, professional or similar association from specific services performed for its members;

(e) profits on sale of import licence / cash assistance / drawback of duty / DEPB / RoDTEP / any export incentive scheme;

(f) the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession;

(g) any interest, salary, bonus, commission or remuneration, by whatever name called, due to or received by a partner of a firm from such firm;

(h) any sum, whether received or receivable, in cash or in kind, under an agreement for not carrying out any activity in relation to any business or profession (non-compete);

(i) any sum received under a Keyman insurance policy including the sum allocated by way of bonus on such policy;

(k) any sum received (or receivable) on account of any capital asset (other than land, goodwill or financial instrument) being demolished, destroyed, discarded or transferred — being amount in excess of WDV (block of assets);

(j) the FMV of inventory as on the date on which it is converted into capital asset.

BLOCK 2 — CORRESPONDING SECTION IN INCOME-TAX ACT, 1961 — Section 28

Section 28 of the 1961 Act — Profits and gains of business or profession. All charging clauses (i) through (vii) — including the historically expansive clause (vi) on benefits / perquisites and clause (va) on non-compete payments — substantively preserved with re-numbering. Clause (j) of Section 26 of new Act (FMV of inventory on conversion to capital asset) was inserted by Finance Act 2018 as Section 28(via) of 1961 Act and is preserved.

BLOCK 3 — COMMENTARY

STATUTORY ARCHITECTURE

Section 26 is the charging section for Profits and Gains of Business or Profession — the most expansive head of income, capturing not only operating profits but a wide variety of incidental and quasi-business receipts. The eleven principal limbs cover: (a) operating profits; (b) managerial / agency / property-vesting compensation; (d) trade-association service income; (e) export incentives; (f) benefits / perquisites in business; (g) partner remuneration from firm; (h) non-compete payments; (i) Keyman insurance proceeds; (k) sum on capital asset demolition exceeding WDV; (j) conversion of inventory to capital asset. Clauses (k) and (j) were inserted by Finance Act 2018 to plug specific gaps.

JUDICIAL EVOLUTION

The Supreme Court in Karam Chand Thapar & Bros (P) Ltd v. CIT, (1969) 74 ITR 26 (SC), elaborated the wide and inclusive nature of 'business' under Indian tax law — "the term 'business' connotes some real, substantial and systematic or organised course of activity or conduct with a set purpose; even an isolated transaction may amount to an adventure in the nature of trade if it bears the indicia of trade." The case has been followed in numerous subsequent rulings on the question of whether a particular transaction constitutes 'business' for income-tax purposes.

On clause (f) — benefits / perquisites — Apex Laboratories Pvt. Ltd. v. DCIT, (2022) 442 ITR 1 (SC), is the definitive recent authority. The Court HELD that pharmaceutical company freebies to medical practitioners (gifts, sponsorship of foreign tours, gold coins, electronic items) — even though apparently outside the deductor's professional rules — violate the Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulations, 2002, Regulation 6.8 governing the conduct of medical practitioners; consequently, such expenditure is "prohibited by law" within the meaning of Explanation 1 to Section 37(1) and is not deductible. Section 194R TDS at 10 per cent on such benefits flows from this characterisation. Codified by Finance Act 2022 as Explanation 2 to Section 37(1) (now in Section 34(3)(b) of new Act).

On clause (e) — DEPB / export-incentive credits — M/s Topman Exports v. CIT, (2012) 342 ITR 49 (SC), settled that the face value of DEPB falls under Section 28(iiib) (now Section 26(2)(e) of 2025 Act) and the profit on transfer (sale value minus face value) under Section 28(iiid). Both elements are PGBP. The case overruled the Bombay High Court's Kalpataru Colours decision which had held the entire DEPB sale proceeds were profits.

On clause (h) — non-compete payments — though originally treated as capital receipt under Guffic Chem Pvt. Ltd. v. CIT line of pre-FA 2002 cases, Finance Act 2002 inserted clause (va) of Section 28 (now Section 26(2)(h)) bringing such payments squarely within PGBP. Deferred-instalment non-compete arrangements are taxable on accrual basis under mercantile method.

DEPARTMENTAL PRACTICE

CBDT Circular No. 5 of 2012 dated 1-8-2012 (still operative under the 2025 Act regime) directs Assessing Officers to disallow pharmaceutical-company freebies under Section 37(1) Explanation 1 read with the Indian Medical Council Regulations. The Circular is precursor to the FA 2022 codification of Explanation 2 and the Apex Pharma SC ruling.

CBDT Circular No. 8 of 2003 / Section 28(va) clarification — non-compete payments are taxable under PGBP whether structured as lump-sum or instalment, regardless of the post-employment vs post-business-arrangement context. The classification therefore does not turn on how the payment is structured.

Practical points

• For closely-held entities entering into non-compete arrangements, instalment structuring may defer tax to year of receipt under cash basis but not under the mercantile method; the method of accounting must be followed consistently.
• For pharma / medical-device companies, marketing-spend re-architecture post-Apex Pharma — institutional sponsorship via medical association; speakers' fees; CME conference sponsorship via independent academic body — these are distinct from individual-doctor freebies.
• For Keyman Insurance — clause (i) — assignment of policy to keyman before maturity converts proceeds to Salary in keyman's hands (Section 18 read with Section 13); assignment to family triggers Other Sources. The timing and assignee of the assignment therefore determine the head.
• Benefit / perquisite under clause (f) read with Section 194R TDS — every business benefit/perquisite valued in excess of Rs 20,000 to a single recipient triggers TDS obligation. The benefits covered include samples, above-threshold hospitality, gifts and sponsored travel.

LITIGATION DEFENCE

Common AO challenges and defence lines: (i) classification of compensation under clause (b) — distinguishing genuine commercial termination compensation (PGBP) from disguised dividend (other characterisation); defence with management-services agreement, non-compete clauses, banking trail. (ii) DEPB/RoDTEP characterisation — Topman Exports provides settled framework but quantification of 'sale value minus face value' element requires invoice-level tracking. (iii) Benefit / perquisite under clause (f) — characterisation between pure-business benefit (deductible to provider, taxable to recipient) and prohibited-by-law freebie (non-deductible to provider, still taxable to recipient under Apex Pharma); maintain SOP and counsel-vetted policy.

Section 66(31) read with Section 26(3) — Speculative Transactions — Definition and Distinct-Source Treatment

BLOCK 1 — INCOME-TAX ACT, 2025 — Sections 66(31) and 26(3)

(1) For the purposes of Sections 26 to 66, a 'speculative transaction' means a transaction in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled OTHERWISE THAN by the actual delivery or transfer of the commodity or scrips.

(2) A transaction shall NOT be deemed to be a speculative transaction if it is — (a) a HEDGING contract by a person carrying on the business of manufacture or merchanting in respect of raw materials or merchandise; (b) a HEDGING contract in respect of stocks and shares entered into by a dealer or investor therein to guard against loss; (c) a JOBBING / ARBITRAGE contract entered into by a member of a forward market or stock exchange; (d) an ELIGIBLE DERIVATIVES TRANSACTION carried out in respect of trading in derivatives on a recognised stock exchange; (e) an eligible transaction carried out by a member of a recognised stock exchange in respect of trading in commodity derivatives.

(3) Where any business carried on by an assessee consists of speculative transactions, such business shall be DEEMED TO BE DISTINCT AND SEPARATE from any other business carried on by him.

BLOCK 2 — CORRESPONDING SECTION IN INCOME-TAX ACT, 1961 — Section 43(5) read with Section 73

Section 43(5) of the 1961 Act — definition of 'speculative transaction' with the four exclusions. Section 73 — speculative business loss to be set off only against speculative profits, with carry-forward limited to 4 years. Both substantively preserved in Sections 66(31), 26(3) and 113 of the 2025 Act.

BLOCK 3 — COMMENTARY

STATUTORY ARCHITECTURE

Sections 26(3) and 113 segregate speculative transactions from ordinary PGBP. Two consequences flow: (i) loss from speculative business is set off ONLY against speculative income (not against any other PGBP); (ii) carry-forward of speculative loss is restricted to four years (versus eight for ordinary business loss) — Section 113 of the new Act / former Section 73.

The four exclusions — hedging by manufacturer, hedging by share dealer, jobbing/arbitrage by exchange member, derivatives on recognised exchange — keep most legitimate trading out of the speculative net. Eligible derivatives is the commercially most important — F&O on NSE/BSE is non-speculative.

JUDICIAL EVOLUTION

Intra-day equity trading — bought and sold same day without taking delivery — IS speculative under Section 66(31). Hence intra-day losses are ring-fenced. Where delivery is taken (T+1 settlement), the transaction is non-speculative even if subsequently sold.

Eligible derivatives transactions on recognised stock exchanges — F&O on NSE / BSE — fall within the carve-out in Section 66(31)(a). Rules 6DDA / 6DDB of the Income-tax Rules prescribe the certification and recognition criteria.

DEPARTMENTAL PRACTICE

CBDT Circular No. 23 of 1960 (continuing under 2025 Act) — the four-fold characterisation between 'business income from speculative transactions', 'business income from non-speculative transactions', 'short-term capital gains' and 'long-term capital gains' depending on holding period and nature of activity. For individual and proprietary traders, head-by-head segregation of ledgers reduces characterisation disputes.

Practical points

• For active traders, separate broker accounts for delivery-based vs intra-day vs F&O — facilitates clean classification and Form 3CD reporting.
• Hedging defence under Section 66(31)(b) requires demonstration that the derivative position is in the same commodity / stock as the underlying business exposure — over-hedging may attract scrutiny.
• Speculative loss carry-forward only 4 years — separate from ordinary business loss carry-forward (8 years). Schedule CFL of ITR has separate columns.

Section 27 — Income Computed under PGBP — Method and General Principles

BLOCK 1 — INCOME-TAX ACT, 2025 — Section 27

(1) The income referred to in Section 26 shall be computed in accordance with the provisions contained in Sections 28 to 60 (except Section 58), subject to Section 276 (method of accounting). Allowances and deductions specifically permitted in those Sections shall be allowed; expenditure not specifically permitted shall be allowable only if it is laid out wholly and exclusively for the purposes of the business or profession (Section 34) and is not capital expenditure or personal expenditure of the assessee.

BLOCK 2 — CORRESPONDING SECTION IN INCOME-TAX ACT, 1961 — Section 29

Section 29 of the 1961 Act — Income from PGBP, how computed. The 'wholly and exclusively for business' test (Section 37(1)) is the universal residual gateway. Substantively preserved in Section 27 of new Act.

BLOCK 3 — COMMENTARY

STATUTORY ARCHITECTURE

Section 27 anchors the computation rule. Two streams: (i) specific allowances under Sections 28 to 33, 44 to 49, 51 and 52 for specified items (rent / repairs, depreciation, R&D, scientific research reserve, employee welfare etc.); (ii) general residual deduction under Section 34 (formerly Section 37(1)) for any wholly-and-exclusively business expenditure that is not capital, not personal, and not specifically prohibited.

Method of accounting is governed by Section 276 — generally accrual (mercantile) for commercial enterprise; cash basis available for specified professions on regular election.

JUDICIAL EVOLUTION

The capital-versus-revenue distinction — at the heart of Section 27 / Section 34 framework — was elaborated by the Supreme Court in Empire Jute Co. Ltd. v. CIT, (1980) 124 ITR 1 (SC). The Court HELD that the test of enduring benefit is not conclusive — "It is only where the advantage is in the capital field that the expenditure would be disallowable on an application of this test. If the advantage consists merely in facilitating the assessee's trading operations or enabling the management and conduct of the assessee's business to be carried on more efficiently or more profitably while leaving the fixed capital untouched, the expenditure would be on revenue account, even though the advantage may endure for an indefinite future." Empire Jute is the leading authority on the capital / revenue characterisation across Indian tax law.

On the 'wholly and exclusively' test under Section 37(1) (now Section 34), Sassoon J. David & Co. Pvt. Ltd. v. CIT, (1979) 118 ITR 261 (SC), is foundational. The Court HELD that the expression 'wholly and exclusively' does not mean 'necessarily', and the fact that somebody other than the assessee is also benefited by the expenditure should not come in the way of the deduction if the test of business purpose is otherwise satisfied. In Sassoon J. David, the assessee paid retrenchment compensation to staff terminated as part of the share-sale to a third party; the SC held the expenditure was for the company's own business benefit (reduced wage bill going forward) and was deductible.

DEPARTMENTAL PRACTICE

ICDS-I to ICDS-X (notified under Section 145(2) of 1961 Act / preserved under Section 276(2) of 2025 Act) override Ind-AS / AS for tax purposes. Reconciliation between book profit and tax profit per ICDS appears in Form 3CD Para 13.

Practical points

• Method election (cash vs mercantile) — once chosen, regularly followed; for professionals the choice is made at commencement of practice; mercantile is industry standard for businesses.
• ICDS reconciliation — a year-on-year reconciliation is relevant in scrutiny and tax audit.
• Capital vs revenue characterisation of borderline items (employee training, software licences, market research, R&D) — the test is recurring business operation rather than enduring asset acquisition.

Section 34 — General Deduction — Wholly and Exclusively for the Purposes of Business or Profession

BLOCK 1 — INCOME-TAX ACT, 2025 — Section 34

Any expenditure (NOT being expenditure of the nature described in Sections 28 to 33, 44 to 49, 51 and 52, AND NOT being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession, shall be allowed in computing the income chargeable under PGBP.

SUB-SECTION (2)(a) — Any expenditure incurred by an assessee for any purpose which is an OFFENCE or which is PROHIBITED BY LAW shall not be deemed to be incurred for the purposes of business or profession; no deduction or allowance shall be made in respect thereof.

SUB-SECTION (3)(b) — Any expenditure incurred to provide any benefit or perquisite to any person, where the acceptance of such benefit / perquisite by such person is in violation of any law / rule / regulation / guideline governing the conduct of such person, shall not be allowable (the 'Apex Pharma freebies' rule).

SUB-SECTION (2)(b) — Expenditure on Corporate Social Responsibility (CSR) referred to in Section 135 of the Companies Act 2013 shall not be deemed to be expenditure for the purposes of business or profession.

BLOCK 2 — CORRESPONDING SECTION IN INCOME-TAX ACT, 1961 — Section 37(1)

Section 37(1) of the 1961 Act — General deduction. Explanation 1 (offence / prohibited by law — Finance Act 1998); Explanation 2 (Apex Pharma freebies — Finance Act 2022); Explanation 3 (CSR — Finance Act 2014). All preserved in Section 34(2) and (3) of 2025 Act.

BLOCK 3 — COMMENTARY

STATUTORY ARCHITECTURE

Section 34 is the residual operative section — the gateway through which most ordinary business expenses pass. The five-fold test: (a) NOT covered by Sections 28 to 33, 44 to 49, 51 and 52 (those are specific allowance sections — exhaust them first); (b) NOT capital expenditure; (c) NOT personal expenditure; (d) WHOLLY and EXCLUSIVELY for business; (e) NOT barred by Section 34(2) and (3).

JUDICIAL EVOLUTION — 'WHOLLY AND EXCLUSIVELY'

The test of 'wholly and exclusively' is one of nature, not quantum. Sassoon J. David & Co. Pvt. Ltd. v. CIT, (1979) 118 ITR 261 (SC), held that even excessive or commercially unsound expenditure can be wholly-and-exclusively for business if no personal element. Quantum disallowance is dealt with separately under Section 36(2) / former Section 40A(2) (related-party excessive payment).

The capital / revenue distinction is governed by Empire Jute Co. Ltd. v. CIT, (1980) 124 ITR 1 (SC) (covered under Section 28 commentary).

JUDICIAL EVOLUTION — EXPLANATION 1 — OFFENCE / PROHIBITED BY LAW

On Explanation 1, the leading authority is CIT v. Piara Singh, (1980) 124 ITR 40 (SC). The case concerned smuggling losses — currency seized by customs from a smuggler. The Court HELD that confiscation by customs authorities was an incidental loss in the course of (illegal) business operation; it was deductible as a business loss because the loss was incidental to the carrying-on of the business (such as it was). Piara Singh stands for the principle that loss / expenditure incidental to and inseparable from the conduct of business — even illegal business — is deductible until specifically barred by statute. Finance Act 1998 inserted Explanation 1 to Section 37(1) (now in Section 34(2)(a) of 2025 Act) overriding Piara Singh prospectively for expenditure incurred after 1-4-1998 that is itself an offence or prohibited by law.

EDITORIAL NOTE: Some practitioner treatises cite CIT v. Khemchand Motilal Jain (Madhya Pradesh High Court) for the proposition that ransom money paid to kidnappers / protection money to terrorists is non-deductible. The actual holding of the Madhya Pradesh High Court in that case is the OPPOSITE — the Court HELD that while kidnapping is an offence under Section 364A of the Indian Penal Code, the payment of ransom by the victim's employer to secure release of a director / employee is NOT itself an offence and is allowable as business expenditure under Section 37(1). The principle being applied was the same as in Piara Singh — incidental business loss is deductible unless specifically barred. Khemchand Motilal Jain is NOT authority for the inverse proposition; for the 'illegal expenditure not deductible' principle under Explanation 1, the correct authority is CIT v. Piara Singh read with Explanation 1 itself.

JUDICIAL EVOLUTION — EXPLANATION 2 — APEX PHARMA FREEBIES

Explanation 2 was inserted by Finance Act 2022 to codify the principle established by the Supreme Court in Apex Laboratories Pvt. Ltd. v. DCIT, (2022) 442 ITR 1 (SC). The Court HELD that pharmaceutical company freebies to doctors — registration fees for foreign conferences with hospitality, gold coins, electronic items, sponsorship of foreign tours — violate Regulation 6.8 of the Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulations, 2002, and consequently are 'prohibited by law' within the meaning of Explanation 1 / now Explanation 2. The principle has been extended to gifts to public servants violating Central Civil Services Conduct Rules, hospitality to bureaucrats, and gifts to journalists in violation of journalistic codes. Section 194R TDS at 10 per cent flows from this characterisation.

JUDICIAL EVOLUTION — EXPLANATION 3 — CSR

Corporate Social Responsibility expenditure under Section 135 of the Companies Act 2013 is NOT deductible for tax purposes by virtue of Explanation 3 inserted by Finance Act 2014. However, specific CSR activities falling within Section 133 of new Act (former Section 80G) — donations to specified Funds (PMNRF, CMRF, PM CARES, specified educational / medical institutions) — qualify for separate Section 133 deduction within applicable percentage caps (typically 50 per cent or 100 per cent depending on category). Hence CSR-routed donations to Section 133-eligible recipients can recover deduction at the chapter-deduction level even though disallowed at the PGBP level.

DEPARTMENTAL PRACTICE

CBDT Circular No. 5 of 2012 dated 1-8-2012 — direct disallowance of pharma freebies under Section 37(1) Explanation 1 read with IMC Regulations. Pre-cursor to Apex Pharma SC ruling and FA 2022 codification.

CBDT Circular No. 1 of 2017 dated 18-1-2017 — guidance on extension of the freebies-disallowance principle to medical-device companies.

Practical points

• Business purpose of every material expenditure is shown by emails, board minutes, project plans, comparable industry practice — particularly important for borderline-personal items (executive entertainment, foreign travel).
• Mixed business / personal expenses are apportioned (e.g., car for executive use — depreciation on business proportion only); a log-book evidences the business proportion.
• Political contributions fall under Sections 136 and 137 of new Act (former Section 80GGB / 80GGC) — a separate deduction route within applicable cap, not Section 34.
• For CSR, donations to Section 133-eligible recipients may qualify for deduction at the chapter-deduction level (within percentage caps).
• For pharmaceutical / medical-device companies, marketing-spend re-architecture post-Apex Pharma — institutional sponsorship via medical association, speakers' fees through accredited CME bodies, segregation from individual-doctor freebies.

LITIGATION DEFENCE

• Capital vs revenue characterisation — defend with Empire Jute test (recurring vs one-time, life of benefit, nature of advantage).
• Wholly-and-exclusively dispute — defend with board approval, business plan, comparable industry practice, third-party documentation.
• Personal element challenge — defend with strict segregation in books, separate personal accounts, log-book for mixed-use assets.
• Apex Pharma freebies application — the distinction is between pure-business benefit (deductible) and prohibited-by-law freebie (non-deductible); an SOP and compliance review evidence the distinction.
• CSR vs business-promotion characterisation — defend with direct business benefit linkage where intent is promotional rather than philanthropic.

Sections 29 to 32 — Specific Deductions — Insurance, Contributions, Bad Debts, PBDD, Special Reserve

BLOCK 1 — INCOME-TAX ACT, 2025 — Sections 29 to 32

(1) The deductions provided for in the following clauses shall be allowed in respect of matters specified —

(a) the amount of any premium paid in respect of insurance against risk of damage / destruction of stocks or stores used for the business or profession;

(b) premium paid in respect of insurance on the health of employees under approved scheme;

(c) bonus or commission paid to employees for services rendered (subject to actual-payment condition under Section 37 / former Section 43B);

(d) interest paid in respect of capital borrowed for the purposes of business (subject to Section 177 thin-capitalisation cap on related-party debt);

(e) employer's contribution to recognised provident fund / approved superannuation fund / approved gratuity fund / new pension scheme / NPS;

(f) amount of any bad debt or part thereof which is written off as irrecoverable in the accounts of the assessee — subject to Section 31(2)(a) condition that the debt was earlier taken into account as income of assessee in computing his total income;

(g) PROVISION FOR BAD AND DOUBTFUL DEBTS (PBDD) — for scheduled banks: 8.5 per cent of total income + 10 per cent of aggregate average advances of rural branches; for NBFCs: 5 per cent of total income; for HFC: 5 per cent of total income;

(h) SPECIAL RESERVE created by financial corporation for long-term financing — 20 per cent of profits derived from eligible business — subject to specified conditions and 200 per cent networth cap;

(i) family planning expenditure by company for employee welfare;

(j) Securities Transaction Tax (STT) and Commodity Transaction Tax (CTT) paid in course of business as trader (not as investor);

(k) other specified items as may be prescribed.

BLOCK 2 — CORRESPONDING SECTION IN INCOME-TAX ACT, 1961 — Section 36

Section 36(1) of the 1961 Act — Other deductions. Each clause (i) through (xviii) substantively preserved with re-numbering in Sections 29 to 32 of new Act.

BLOCK 3 — COMMENTARY

STATUTORY ARCHITECTURE

Sections 29 to 32 are the laundry-list of specific deductions over and above Section 34 general deduction. Each clause has its own jurisprudence and conditions. The most-litigated provisions are s.32(b) interest on borrowed capital, s.29(1) employer fund contributions, s.31(2) bad debts, and s.31(1) PBDD.

SECTION 32(b) — INTEREST ON BORROWED CAPITAL

The leading authority on Section 36(1)(iii) — interest on borrowed capital — is S.A. Builders Ltd. v. CIT, (2007) 288 ITR 1 (SC). The Supreme Court HELD that the test for allowability of interest on borrowed capital is the 'commercial expediency' test. Where capital is borrowed and advanced to a sister concern or subsidiary in the course of commercial operations and there is a nexus between the borrowing and the commercial benefit derived by the assessee, the interest is allowable. Mere advancement of borrowed funds to sister concerns without commercial purpose is disallowable.

EDITORIAL NOTE: Some practitioner treatises cite CIT v. Sutlej Cotton Mills Supply Agency Ltd., (1975) 100 ITR 706 (SC), as authority for the borrowed-capital test under Section 36(1)(iii). That citation is inapposite — Sutlej Cotton Mills concerns 'adventure in the nature of trade' (whether a company's purchase and sale of shares constitutes business or investment), NOT the borrowed-capital deduction. The correct authority for Section 36(1)(iii) is S.A. Builders Ltd. v. CIT, (2007) 288 ITR 1 (SC), supplemented by Hero Cycles Pvt. Ltd. v. CIT (2015) 379 ITR 347 (SC) on the commercial-expediency / sister-concern advance question.

Section 177 of new Act (former Section 94B) — thin-capitalisation cap — limits interest deduction on related-party debt above Rs 1 crore to 30 per cent of EBITDA, with carry-forward of disallowed interest for eight years. Applies to corporate assessees with related-party debt to non-resident lenders. Indian-domestic related-party interest not subject to thin-cap.

SECTION 29(1) — EMPLOYER FUND CONTRIBUTIONS

On employer PF / ESI contribution, the Supreme Court in Checkmate Services Pvt. Ltd. v. CIT, (2022) 448 ITR 518 (SC), settled the long-running employer-vs-employee contribution distinction. The Court HELD that EMPLOYEE'S contribution (deducted from salary, deposited to PF) must be paid by the respective due date under the PF Act / ESI Act (15th of next month) — the ITR-due-date proviso under Section 43B (now Section 37(2) of 2025 Act) does NOT apply. EMPLOYER'S contribution gets the ITR-due-date proviso relaxation. Form 3CD Para 26 reports the two legs separately.

SECTION 31(2) — BAD DEBTS

On bad debt write-off, the Supreme Court in T.R.F. Limited v. CIT, (2010) 323 ITR 397 (SC), settled the post-Finance Act 1989 framework. The Court HELD that mere write-off in books of account is sufficient post-1989 — assessee need not establish that the debt has actually become irrecoverable. The Section 31(2)(a) precondition (that the debt was earlier taken into account as income of the assessee) remains non-negotiable. CBDT Circular No. 12 of 2016 dated 30-5-2016 endorses the TRF principle.

SECTION 31(1) — PROVISION FOR BAD AND DOUBTFUL DEBTS

PBDD architecture for banks (8.5 per cent of total income + 10 per cent of rural advances) and NBFCs / HFCs (5 per cent of total income) is detailed in Bharat Tax Case Studies Volume 13, Chapter on NBFC / Banking Tax Architecture. Verification of rural-branch advances (per population definition under Income-tax Rules 2026) is the key audit point.

SECTION 32(e) — SPECIAL RESERVE FOR LONG-TERM FINANCING

Section 36(1)(viii) Special Reserve — 20 per cent of profits derived from eligible business (long-term housing finance / industrial / agricultural / infrastructure long-term financing) — deductible if transferred to a Special Reserve and maintained at 200 per cent of (paid-up capital + general reserves). Reserves withdrawn / utilised triggers reversal under Explanation. Detailed: Bharat Tax Case Studies Volume 13.

SECTION 32(k) — STT / CTT

Securities Transaction Tax / Commodity Transaction Tax paid by trader (PGBP capacity) is deductible against business income. Paid by INVESTOR (capital gains transaction) — NOT deductible from capital gains. Hence character classification (trader vs investor) determines deductibility. Holding period, frequency, intent, treatment in books are the relevant indicators.

DEPARTMENTAL PRACTICE

CBDT Circular No. 12 of 2016 dated 30-5-2016 — endorses TRF Limited principle on bad debt write-off.

CBDT Circular No. 19 of 2015 — guidelines on Section 36(1)(viii) Special Reserve for long-term housing finance corporations.

Practical points

• For banks — PBDD depends on rural-branch mapping under Rule 6ABA (population < 10,000 per latest census).
• For NBFCs — Section 31(1) PBDD operates alongside Section 56 NPA-interest cash-basis recognition.
• For long-term lending NBFCs / HFCs — Section 36(1)(viii) Special Reserve, within the 200 per cent networth cap; effectively reduces tax to ~5 per cent on eligible profits but locks reserves.
• Bad debt write-off — the write-off is booked in the year of irrecoverability; Section 31(2)(a) requires the debt to have been taken into income (year of credit).
• Employer PF / SAF / NPS — the Rs 7.5 lakh aggregate cap applies on perquisite to executive employees under Section 17(1)(h) of the new Act.

Sections 35 to 37 — Disallowance of Certain Payments — TDS Default, Cash Payments, Statutory Dues

BLOCK 1 — INCOME-TAX ACT, 2025 — Section 35 (operative text)

Notwithstanding anything contained in the foregoing sections, the following payments shall NOT be deducted in computing the income chargeable under PGBP —

(a) any sum on account of STT / CTT not allowed under Section 32(k);

(b) any rate or tax levied on the profits or gains of any business or profession;

(c) any payment to which the provisions of Chapter XIX-B (TDS — Sections 392-402) apply where TDS has not been deducted, OR has been deducted but not paid before the due date — to the extent of 30 per cent of the sum payable in case of payment to a RESIDENT (Section 35(b)(i)); 100 per cent in case of NON-RESIDENT (Section 35(b)(ii) — formerly Section 40(a)(i));

(d) any payment to relative / related party that is excessive or unreasonable having regard to FMV — to the extent of excess (Section 36(2));

(e) any expenditure exceeding Rs 10,000 to a single person in a day, otherwise than by account-payee cheque / draft / electronic mode (Section 36(4));

(f) provision for unascertained liabilities;

(g) provision for gratuity / leave encashment except as allowed under Section 29;

(h) sum payable to specified employees in lieu of leave at the credit of the employee, allowed only on actual payment basis (Section 37 — formerly Section 43B);

(i) any income-tax / wealth tax / FBT / dividend distribution tax / minimum alternate tax — paid;

(j) any expenditure incurred by an assessee on advertisement in any souvenir, brochure, tract, pamphlet or like published by a political party.

BLOCK 2 — CORRESPONDING SECTION IN INCOME-TAX ACT, 1961 — Section 40

Section 40 of the 1961 Act — Amounts not deductible. Section 40(a)(i) (NR TDS), 40(a)(ia) (resident TDS — 30 per cent disallowance after FA 2014), 40(a)(ic) (FBT), 40(a)(ii) (income tax), 40(a)(iib) (state government undertaking levies) — all consolidated into Section 35 of new Act.

Section 40A series of 1961 — related-party excessive payment, cash payment > Rs 10K, statutory dues actual-payment-basis — consolidated into Sections 36 and 37 of 2025 Act.

BLOCK 3 — COMMENTARY

STATUTORY ARCHITECTURE — TDS DEFAULT DISALLOWANCE

Section 35(b) is the operationally most important section in PGBP — TDS-default disallowance bites every business that fails to deduct or pay TDS on time. For payments to RESIDENTS where TDS was applicable but not deducted or not paid by due date under Section 263(1): 30 per cent of expense disallowed. NOT 100 per cent, NOT permanent. The 70 per cent remains deductible. If TDS subsequently paid, the disallowed 30 per cent is allowed in year of payment (proviso). For NON-RESIDENT payments — 100 per cent disallowed if TDS default; same restoration on subsequent payment.

JUDICIAL EVOLUTION — DEDUCTOR'S POSITION WHERE DEDUCTEE PAYS

On the consequence of TDS default where the deductee has nonetheless paid full self-assessment tax, the Supreme Court in CIT v. Hindustan Coca-Cola Beverages Pvt. Ltd., (2007) 293 ITR 226 (SC), HELD that the deductor's primary tax demand under Section 201 is discharged where the deductee has paid the full self-assessment tax — only the Section 201(1A) interest survives. This case is the foundational defence in any AO proceeding alleging deductor short-deduction.

JUDICIAL EVOLUTION — ENGINEERING ANALYSIS / SOFTWARE PAYMENTS TO NR

For software-licence payments to non-residents under Section 195 (now Section 393), the Supreme Court in Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT, (2021) 432 ITR 471 (SC), HELD that payment for off-the-shelf software licence is NOT 'royalty' under DTAA Article 12 — no TDS u/s 195 is required. Major IT services / software industry relief; reverses the previous Karnataka High Court line of cases. Indian payer can defend non-deduction by reference to this ruling — provided the agreement structure supports the characterisation (sale of copyrighted article, not licence of copyright in the article).

STATUTORY ARCHITECTURE — STATUTORY DUES (Section 37 / Former Section 43B)

Section 37(2) of new Act / former Section 43B — GST, sales tax, customs, excise, employee PF / ESI, leave encashment, bonus payable to employees, etc. — deductible only on actual payment basis. If accrued in books but not paid by ITR due date — disallowed. Deductible in year of subsequent payment. Section 37(2)(g) (1961: s.43B(h), inserted by FA 2023) — payment to micro / small enterprise must be made within 45 days of acceptance of goods / services (or 15 days if no agreement); failing which strict on-payment basis with no ITR-due-date proviso relaxation.

DEPARTMENTAL PRACTICE

Form 3CD Para 22 — TDS compliance disclosure. Para 26 — Section 37 (43B) statutory dues. Para 21(d) and 21(e) — Section 36 related-party payment and cash payment disallowances. Tax auditor's most critical paragraphs.

CBDT Circular No. 12 of 2017 — clarifications on Section 40(a)(ia) 30 per cent disallowance and restoration on subsequent payment.

Practical points

• TDS compliance starts at vendor onboarding — PAN validation, applicable rate determination, monthly deduction-deposit-return cycle.
• For NR payments, TDS compliance rests on: (i) PAN of payee; (ii) TRC + Form 10F + No-PE declaration; (iii) Section 395(1) lower-deduction certificate if applicable; (iv) actual deduction at correct rate; (v) deposit by 7th of next month; (vi) Form 27Q quarterly return.
• Annual reconciliation of Form 26AS (deductee perspective) with Form 26Q / 27Q (deductor perspective) — mismatches call for rectification.
• Form 26Q is a quarterly return; errors corrected before filing avoid later default notices.
• For statutory dues, payment before 31 October following FY-end (audit cases) secures same-year deduction. For PF / ESI employee contribution, deposit must be made by the 15th of the next month (Checkmate).
• For MSME vendors, payment within the 45-day cycle is required for same-year deduction.

CONTINUATION NOTE

Sections 36 (related-party / cash-payment detail), 276 (method of accounting + ICDS), 63 (compulsory tax audit), 37 and 38 (Section 43B statutory dues / recovery of earlier deductions), 38(1) (R&D asset recoupment), 66 (definitions), and 55 (insurance business — Schedule XIV cross-reference) follow the same structured commentary format.