Section 35 Amounts not deductible in certain circumstances.

Income-tax Act, 2025 [As Passed]

At a Glance

Clause 35 of the Income Tax Bill, 2025 (Old Version) sets out amounts that shall be disallowed as deductions while computing income under the head "Profits and gains of business or profession" irrespective of Chapter IV-D. It matters to taxpayers (businesses, firms, AOPs), withholding agents, and employers; it also affects cross-border payments subject to TDS or equalisation levy. Effective date or enactment date: Not stated in the document.

Background & Scope

Statutory hooks: Clause 35 operates "Irrespective of any other provision of Chapter IV-D" and repeatedly references Chapter XIX-B (TDS provisions), section 263(1) (due date for payment of TDS), section 159/160 (relief for tax paid in another country), Chapter VIII of the Finance Act, 2016 (equalisation levy), and the Societies Registration Act, 1860. Coverage: the clause enumerates categories of payments/disbursements that are not deductible for computing business/professional income. Definitions or explanations supplied in the text include meanings of "book profit" and "working partner" and detailed treatment of "representative partner" and "representative member".

Statutory Provision Mode

Text & Scope

Clause 35 disallows deductions in several discrete areas:

• Payments of tax: any amount on account of tax paid on income, tax paid by certain employers (Schedule III, Table Sl. No.10), or foreign tax eligible for relief u/ss 159 or 160; surcharge or cess on such tax are included.
• Failure to deduct/pay TDS (30% rule): 30% of any sum payable to a resident on which tax is deductible under Chapter XIX-B is disallowed where TDS has not been deducted or, after deduction, not paid up to the due date in section 263(1). Where tax is deducted/paid in a subsequent year, deduction of such sum is allowed in that subsequent year in which tax has been paid. If the payer is required to deduct but fails to do so and is not deemed a defaulting assessee u/s 398(2), the payer is deemed to have deducted and paid tax on the date the payee files the return u/s 398(2).
• Overseas or non-resident payments: similar rule for interest, royalty, fees for technical services or other sums payable outside India or in India to non-residents (not companies) or to foreign companies; same 30% non-allowance and subsequent-year allowance mechanics apply, with a parallel deemed-deduction rule tied to section 398(2).
• Provident and other employee funds: payments to such funds are not deductible unless the assessee ensures effective arrangements for TDS under Chapter XIX-B from payments made from the fund that are taxable as "Salaries".
• Payments chargeable under "Salaries": payments chargeable under "Salaries" and payable outside India or to a non-resident where TDS under Chapter XIX-B is not deducted/paid are disallowed.
• Equalisation levy on specified services: any consideration paid or payable to a non-resident for a specified service on which equalisation levy is deductible under Chapter VIII of the Finance Act, 2016, and which has not been deducted/paid up to the due date in section 263(1), is disallowed; deduction of such consideration is allowed in any subsequent tax year in which such levy has been paid.
• State Government appropriations: amounts levied exclusively on, or appropriated from, a State Government undertaking by the State Government are not deductible.
• Partnerships: disallowance rules for firms where payments to partners (remuneration, salary, bonus, commission or interest) are not authorised by the partnership deed, relate to periods before the deed, or aggregate remuneration to working partners exceeds a specified formula (first Rs.600,000 or, in loss Rs.300,000 or 90% of book profit, whichever higher; balance at 60%). Interest above 12% p.a. is disallowed. Detailed rules deal with representative partners and exclude certain interest from computation in representative capacities.
• Associations of persons / bodies of individuals: disallowance for interest/salary/bonus/commission paid to members, with rules for netting cross-payments and special treatment for representative members; exclusions for companies, co-operative societies and societies registered under the Societies Registration Act are specified.

Interpretation

The text demonstrates a legislative intent to tighten deductibility where withholding obligations (TDS or equalisation levy) are not complied with by the payer, to align tax deduction obligations with allowance of expense deductions. The provisions adopt a mechanical approach: non-deductibility in the year of non-compliance with a pathway to allow deduction in the year when the withholding/levy obligation is actually fulfilled (i.e., payment/deduction). The partnership provisions reflect a policy of controlling tax avoidance by attributing unreasonable partner payments and interest to deny business deductions.

Exceptions/Provisos

The clause contains operational provisos:

• For TDS/equalisation levy shortfalls, the disallowance is limited to 30% of the sum (for resident payments) and similar treatment for non-resident/foreign company payments; where the tax/levy is paid in a later year, deduction is allowed in that later year.
• Where the payer fails to deduct but is not deemed an assessee in default u/s 398(2), the payer is deemed to have deducted and paid tax on the date the payee files the return as referred to in section 398(2) - an explicit deeming mechanism to avoid permanent disallowance in certain circumstances.
• Partnership remuneration and interest are allowed only to the extent authorised by partnership deed and subject to the formula and cap contained in the clause.

Illustrations

• Example 1: A resident service provider paid Rs.1,000,000 during FY where payer failed to deduct TDS by the due date. Under Clause 35(b)(i), 30% of that sum (Rs.300,000) is not allowed as deduction in the payer's computation for that FY. If the payer deducts and pays the tax in the next FY, deduction for the 30% would be allowed in that subsequent FY (subject to actual tax payment timing).
• Example 2: A firm pays interest at 15% p.a. to a partner as authorised by a post-dated partnership deed. Interest in excess of 12% p.a. would be disallowed under Clause 35(f)(iv), and the disallowed portion would be denied in computing firm profits.
• Example 3: An AOP pays interest to a member and receives interest back from that member; only the net excess interest (if any) paid by the AOP would be disallowed under Clause 35(g)(ii).

Interplay

Clause 35 expressly interacts with Chapter IV-D, Chapter XIX-B, section 263(1), section 398(2), sections 159/160 (double tax relief), Chapter VIII of the Finance Act, 2016 (equalisation levy), Schedule III (Table Sl. No.10) and the Societies Registration Act, 1860. The provision is designed to work in tandem with withholding provisions (Chapter XIX-B) and the equalisation levy regime; it uses existing deeming and due-date concepts from the TDS framework to time the allowance or denial of deductions. Not stated in the document: any cross-references to Rules, Forms or procedure to report delayed payment of TDS/equalisation levy beyond the general references.

Differences between Section 35 of the Income-tax Act, 2025 - (As Passed) and Clause 35 of the Income Tax Bill, 2025 - (Old Version)

• Placement and numbering of sub-clauses: The As Passed version reorders and renumbers certain sub-clauses (for example, provisions dealing with payments chargeable under "Salaries", State Government undertakings and partnership/AoP rules appear under different clause letters).
  • Practical impact: purely structural but may affect ease of cross-referencing; substantively most core rules remain with modest drafting changes.
• Equalisation levy / specified service consideration: The Old Version (Clause 35) contains an express sub-clause (d)(i) disallowing deduction for consideration paid to a non-resident for a specified service where equalisation levy under Chapter VIII of the Finance Act, 2016 had to be deducted but was not deducted/paid; it also provided that deduction is allowed in a subsequent year when levy is paid. The As Passed text (Section 35) does not contain this equalisation-levy sub-clause; instead it includes a clause (d) concerning amounts paid by or appropriated from a State Government undertaking.
  • Practical impact: removal of the equalisation-levy-specific disallowance in the As Passed draft narrows the scope of non-deductibility and leaves treatment of equalisation levy either to another provision or to administrative guidance; taxpayers paying cross-border specified services are less explicitly penalised here for non-deduction of equalisation levy under the Act as passed.
• 30% Rule and timing mechanics: Both texts contain a provision disallowing 30% of payments to residents (where TDS under Chapter XIX-B has not been deducted/paid by the due date). The As Passed drafting frames the conditional allowance when tax is deducted later slightly differently (refers to deduction in any subsequent year or during the tax year but paid after due date - 30% allowed in the year tax is paid). The Old Version similarly allows deduction in a subsequent tax year when tax is deducted and paid.
  • Practical impact: substantive effect appears similar (disallow 30% until tax is actually paid/deducted), but the As Passed drafting emphasises timing of payment versus deduction; possible interpretive emphasis on date of payment of tax as the trigger for allowance of the 30% element.
• Provident/other fund rule: Both versions disallow payments to employee funds unless effective arrangements exist to secure TDS under Chapter XIX-B from payments made from the fund that are taxable as "Salaries". Drafting varies slightly but content is aligned.
  • Practical impact: continuity of requirement; employers must ensure withholding mechanisms in place for fund disbursements or face disallowance.
• Partnership remuneration and interest rules: Both contain detailed rules limiting partner remuneration and interest (authorisation by partnership deed; computation of aggregate remuneration with sliding rates; 12% cap on interest). Differences are drafting and phrasing (Old Version uses words like "six lakh rupees" and explicit treatment of "representative partner"). As Passed uses numerals and reorganises representative capacity provisions.
  • Practical impact: substantive limits remain; drafting refinements may affect interpretation of "periods" and the interplay of partnership deeds dated after payment periods.
• Associations of persons / bodies of individuals: Old Version contains an extended clause (g) with more detailed subclauses addressing mutual interest payments, representative members and exceptions. As Passed consolidates and slightly narrows wording (f) and explicitly excludes companies, co-operative societies and societies registered under the Societies Registration Act, 1860.
  • Practical impact: largely consistent treatment but minor drafting differences could create interpretive questions (e.g., scope of exclusions and application to bodies formed under other laws).

Practical Implications

• Compliance and risk areas: Payers must ensure timely deduction and deposit of TDS and equalisation levy where applicable, failing which a portion (30% for specified resident payments; full or as specified for others) of the payment will be disallowed in the year of non-compliance. Employers must ensure arrangements for TDS on payments out of employee funds to secure deductibility.
• Record-keeping/evidence: Documentation demonstrating deduction and deposit dates, partnership deeds (and their effective periods), records of representative capacity arrangements, and evidence of payments/levy compliance will be critical to substantiate deductions in later years.

Key Takeaways

• Clause 35 denies deductions tied to failure to comply with withholding and equalisation levy obligations, but allows restoration of deduction in the year the obligation is satisfied.
• A 30% disallowance rule applies to certain resident payments subject to TDS until tax is actually paid/deducted.
• Distinct treatment is applied to payments outside India or to non-residents/foreign companies for interest, royalty and technical fees.
• Employers must ensure TDS arrangements for employee funds to retain deductibility.
• Partnership payments and interest are tightly regulated by reference to partnership deeds and prescribed caps (including a 12% interest ceiling and a formula for allowable working partner remuneration).
• Associations of persons / BOIs face disallowance for member payments, with netting for mutual interest payments and special rules for representative members.
• The clause operates through linkage with existing TDS and equalisation levy mechanisms and includes deeming provisions tied to section 398(2).

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Full Text:

Section 35 Amounts not deductible in certain circumstances.

Non-deductibility for unpaid withholding taxes: deductions denied until the required tax or equalisation levy is paid. Section 35 conditions deduction of business or professional expenses on compliance with withholding and levy obligations: where tax or equalisation levy required to be deducted or paid is not timely deducted/paid, a specified portion of the payment is disallowed in the year of non-compliance and is allowed only in the year when the tax or levy is actually deducted and paid; parallel deeming rules and provisos address later deduction/payment and certain default scenarios, while partnership and association rules restrict deduction for unauthorised or excessive partner/member remuneration and interest.