Section 36 — Expenses or Payments Not Deductible | ITA 2025

Section 36 — EXPENSES OR PAYMENTS NOT DEDUCTIBLE

Section 36 is the substantive equivalent of 1961 s. 40A — covering excessive related-party payments, cash payments above prescribed thresholds, gratuity provisions (only contribution to approved fund qualifies), non-statutory welfare fund contributions. The most-litigated sub-clause: cash payment > ₹10,000 (₹35,000 for transport) in a single day — automatic disallowance under s. 36(3) (s. 40A(3) of 1961 Act).

Statutory text — Income-tax Act, 2025

Marginal note — Expenses or payments not deductible in certain circumstances

(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 compu- tation of income under the head “Profits and gains of business or profession”.

(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.

(3) For the purposes of sub-section (2) and this sub-section,—

(a) “specified person” shall mean the following,—

(i) in relation to an assessee mentioned in column B of the Table below, the person referred to in column C thereof:—

TABLE Sl. Assessee Specified person No.

A B C

1. Individual. Any relative of the assessee.

2. Company. Any director of the company or his relative.

3. Firm. Partner of the firm or his relative.

4. Association of Member of the association or his relative. persons.

5. Hindu undivided Member of the family or his relative; family.

(ii) 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, part- ner, member or any other company in which the first mentioned company has substantial interest;

(iii) 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) any person carrying on a business or profession, where 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 pro- fession” if—

(i) in a case where the business or profession is carried on by a com- pany, such person is, at any time during the tax year, the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits) carrying not less than 20% of the voting power; and

(ii) in any other case, such person is, at any time during the tax year, beneficially entitled to not less than 20% of the profits of such business or profession.

(4) Where in respect of any expenditure incurred by the assessee, any payment or aggregate of payments made in a day to a person exceeds ` 10000 and is not made through specified banking or online mode, then the expenditure by way of such payments shall not be allowed as a deduction.

(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 sub- sequent tax year and if such payment or aggregate of payments made in a day to a person exceeds ` 10000 and is not made 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.

(6) For the purposes of sub-sections (4) and (5), the figures “` 10000” shall be read as “` 35000” in case the payment is made for plying, hiring or leasing of goods carriages.

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

(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.

(9) No deduction or allowance shall be allowed in respect of marked to market loss or other expected loss, except as allowable under section 32(1)(h). Certain deductions allowed on actual payment basis only.

Corresponding provision — 1961 regime

INCOME-TAX ACT, 2025	INCOME-TAX ACT, 1961
INCOME-TAX ACT, 2025 — s. 36	INCOME-TAX ACT, 1961 — s. 40A
Excessive related-party payments	1961 s. 40A(2) — preserved
Cash payment > ₹10,000 / ₹35,000 (transport) — disallowed	1961 s. 40A(3) — preserved
Gratuity provisions — only approved fund contribution qualifies	1961 s. 40A(7) — preserved
Non-statutory welfare fund contributions	1961 s. 40A(9) — preserved

STATUTORY ARCHITECTURE

Section 36 has four operative limbs: (1) Related-party excessive payments (s. 36(1)/(2) — disallow excess over reasonable amount); (2) Cash payment > ₹10,000 (₹35,000 transport) — full disallowance (s. 36(3)); (3) Gratuity provisions — only contribution to approved fund qualifies (s. 36(4)); (4) Welfare-fund contributions to non-statutory funds — disallowed (s. 36(5)).

JUDICIAL EVOLUTION — Cash Payment Bar (Attar Singh Gurmukh Singh)

Attar Singh Gurmukh Singh v. ITO, (1991) 191 ITR 667 (SC) — upheld constitutional validity of s. 40A(3) [now s. 36(3) of 2025 Act]. The disallowance is not penal but a regulatory measure to channel transactions through banking system. Rule 6DD exceptions (banking holiday, agricultural producer, no banking facility) provide statutory safety-valves.

HELD: Section 40A(3) of the Act and Rule 6DD of the Rules are intended to regulate business transactions and to prevent the use of unaccounted money or reduce the chances to use black money for business transactions. The provisions are aimed at creating an offence with civil consequences only — not penal. (per Attar Singh Gurmukh Singh ¶ 12).

JUDICIAL EVOLUTION — Related-Party Reasonableness (s. 40A(2))

CIT v. Glaxo SmithKline Asia (P.) Ltd., (2010) 195 Taxman 35 (SC) — for related-party expenditure, the AO must demonstrate that the payment is excessive having regard to FAIR MARKET VALUE; mere relationship with payee is insufficient. Onus on Department to establish excessiveness.

DEPARTMENTAL PRACTICE

Income-tax Rules, 2026 r. 6DD — exceptions to s. 36(3) cash-payment disallowance (banking holiday, agricultural payment to producer, transport contractor with no banking facility at site, etc.). Form 3CD Item 21(d) — auditor's reporting on s. 36 disallowances. Form 3CD Item 23 — auditor's reporting on related-party transactions u/s 36(1) read with s. 36(2).

PLANNING NOTES & LITIGATION DEFENCE

(i) For business expenditure of ≥ ₹10,000, ALWAYS pay through banking channels — disallowance u/s 36(3) is automatic without Rule 6DD exception. (ii) For genuine cash-only scenarios (e.g., payment to truck driver at remote site), document Rule 6DD applicability — bounce-cheque / no-banking-facility evidence. (iii) For related-party payments, document arms-length-pricing (TP-equivalent analysis); cite Glaxo SmithKline to require AO to establish excessiveness. (iv) For gratuity, contribute to APPROVED fund; ad-hoc provisions or non-approved fund contributions disallowed under s. 36(4).

CROSS-REFERENCES

Section 32 — Other deductions (s. 36 overrides where applicable).
Section 35 — Amounts not deductible.
Section 37 — Actual-payment basis (s. 43B equivalent).
Section 92BA — Specified domestic transactions (TP for related-party, post FA 2017 ₹20 cr threshold).
Income-tax Rules, 2026 r. 6DD — cash-payment exceptions.

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