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Income Tax

Comparison of Section 36 "Expenses or payments not deductible in certain circumstances" between the Income-Tax Act, 2025 (as passed) and the Income-Tax Bill, 2025 (as originally introduced)

21 August, 2025

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Section 36 Expenses or payments not deductible in certain circumstances.

Income-tax Act, 2025 [As Passed]

At a Glance

Document: Clause 36 of the Income Tax Bill, 2025 (Old Version). It prescribes items not deductible while computing income under "Profits and gains of business or profession," notably allowing Assessing Officer to disallow excessive payments to specified persons and imposing limits on cash payments. It affects taxpayers engaged in business or profession and entities transacting with related/specified persons. Effective date or decision date: Not stated in the document.

Background & Scope

Statutory hooks: The provision is titled "Expenses or payments not deductible in certain circmstances" and is framed as Clause 36 of the Income Tax Bill, 2025, operating in relation to computation of income under the head "Profits and gains of business or profession". The clause contains a non-obstante provision in sub-section (1) making it effective irrespective of contrary provisions elsewhere in the Act. Definitions and coverage are contained in clause (3).

The text sets out: Assessing Officer's power to disallow excessive/unreasonable payments to "specified person"; a regime for disallowing cash payments exceeding the stated thresholds; exceptions to cash restrictions as to be prescribed; and a non-application of modes of payment in other law or contract when payment is through specified banking/online mode. The Bill text provides definitions of "specified person" and tests for "substantial interest".

Statutory Provision Mode

Text & Scope

The clause applies to computation of business/professional income. Key elements: (1) non-obstante clause; (2) AO power to disallow amounts paid to "specified person" if, in AO's opinion, payments are excessive/unreasonable with reference to fair market value, legitimate business needs, or benefit to the assessee; (3) detailed definition of "specified person" covering relatives, directors, partners, members, entities with substantial interest and associated persons; (4) deeming tests for "substantial interest" - at least 20% beneficial shareholding (company) or 20% beneficial entitlement to profits (other cases); (5) prohibition on allowing expenditure where aggregate of payments in a day to a person exceeds Rs.10,000 and not made through specified banking/online mode; (6) corresponding deeming of such payments as business income where deduction was previously allowed and payment occurs subsequently; (7) higher limit of Rs.35,000 for plying/hiring/leasing of goods carriages; (8) exceptions to cash restriction "as prescribed"; and (9) overriding of other laws/contracts where specified banking/online payment is made.

Interpretation

The Bill gives the Assessing Officer discretionary power to characterise payments to specified persons as excessive or unreasonable, using three yardsticks: fair market value, legitimate needs, and benefit to the assessee. The presence of a non-obstante clause indicates legislative intent to prioritise this provision over any conflicting computation rules. The text uses "in the opinion of the Assessing Officer", signalling an evaluative fact-intensive enquiry; however, the Bill does not specify procedural safeguards or standards for such opinion. "Specified person" is defined broadly to capture related parties and persons with "substantial interest" (20% threshold), indicating an intent to curb transfer of business income to relatives/associates by supra-market transactions.

Exceptions/Provisos

Exceptions are limited: sub-section (7) contemplates prescribed cases/circumstances where sub-sections (4) and (5) (cash payment rules) will not apply, with reference to banking facilities and business expediency; specifics are "as prescribed" and thus contingent on delegated legislation. The clause provides an absolute override of other laws/contracts in respect of mode of payment when the taxpayer complies with specified banking/online mode (sub-section (8)). No other provisos (for example, thresholds for different industries or de minimis exceptions) are specified in the Bill text.

Illustrations

  • Example 1: An assessee pays Rs.12,000 in cash in a single day to a service provider who is a relative. Under the clause, because aggregate cash payment exceeds Rs.10,000 and is not through specified banking/online mode, the expenditure shall not be allowed as a deduction. (This example follows directly from sub-sections (3) and (4).)
  • Example 2: A company pays a director's relative an amount for supply of goods which, in the Assessing Officer's opinion, is substantially above fair market value. The AO may disallow the excess portion as not allowable. (Direct application of sub-section (2) and definition in sub-section (3)(a)(ii)).
  • Example 3: An assessee had earlier claimed deduction for a liability; subsequent payment in the following tax year to the creditor in cash exceeding Rs.10,000 will be treated as income under "Profits and gains of business or profession". (Directly from sub-section (5)).

Interplay

The clause states it applies "irrespective of anything to the contrary" in the Act, indicating primacy over other computation provisions. It contemplates delegated rules ("as prescribed") to carve out exceptions for cash/online rules but does not reference specific existing Rules, Notifications or sections (other than the head of income). Interaction with other statutory provisions (e.g., transfer pricing, section dealing with related-party transactions, or specific provisions on mode of payment elsewhere) is not spelled out in the text. Any interplay with those regimes must be inferred; the Bill does not provide cross-references. Not stated in the document: specifics of interaction with transfer pricing or procedural safeguards for AO opinion.

Differences between Section 36 of the (Income-tax Act, 2025 [As Passed]) and Clause 36 of the Income Tax Bill, 2025 (Old Version)

  • Structure and wording: The two texts are substantially similar in structure and core substance; both make subsection (1) a non-obstante clause and contain provisions on Assessing Officer's power to disallow excessive payments to "specified person", definitions of "specified person" and "substantial interest", restrictions on cash payments exceeding a threshold, a higher threshold for goods carriages, savings/exemptions and non-availability of pleas based on other laws or contracts.
  • Terminology in sub-section (3): The As Passed version (Section 36) uses the phrase "For the purposes of sub-section (2) and this sub-section" whereas the Old Version (Clause 36) states "For the purposes of sub-section (2),".
    • Practical impact: The As Passed version signals that the definitional provision expressly applies both to subsection (2) and to the subsection containing the definition itself (i.e., broader textual application), while the Old Version indicates application only to subsection (2). This is largely drafting nuance with minimal practical difference in ordinary interpretation because definitions typically apply to the section's operative parts; however, the As Passed wording reduces any potential argument that portions of the section other than sub-section (2) were outside the definitional scope.
  • Minor drafting differences in list items: The Old Version frames the entries under clause (3)(a) with repeated "shall mean" language for each clause (ii)-(iv). The As Passed version uses a consolidated parent provision and different punctuation.
    • Practical impact: Drafting clarity improved in As Passed text; no substantive policy change.
  • Scope of sub-section (3)(b) definition of "substantial interest": The Old Version sets the tests as "(i) the beneficial owner of shares ... carrying at least 20% of the voting power" and "(ii) entitled to at least 20% of the profits ... at any time during the tax year." The As Passed version phrases these as "not less than 20%".
    • Practical impact: No substantive change - "at least" and "not less than" are equivalent numerically, but the As Passed phrasing is marginally more conventional in Indian statutory drafting.
  • Sub-section numbering and cross-references: The As Passed Act adds an explicit sub-section (9) stating "No deduction or allowance shall be allowed in respect of marked to market loss or other expected loss, except as allowable u/s 32(1)(h)." This clause is absent from the Old Version.
    • Practical impact: This is a substantive addition in the As Passed Act restricting deductions for marked-to-market or other expected losses except to the extent allowable u/s 32(1)(h). The Old Version does not contain this limitation, so the legislative process inserted a new restriction before enactment. Practically, taxpayers claiming deductions for such expected/MTM losses would face disallowance unless they fall within section 32(1)(h) under the enacted law; under the Old Version there would have been no express prohibition in this section.
  • Application of the exclusion from other laws/contracts (sub-section (8)): Both versions contain this provision. Wording differences are minor and do not create substantive divergence.

Practical impact summary of each change

  • Clarification of definitional reach (As Passed): Marginally strengthens the textual scope of the definitions - lowers risk of semantic challenges to applicability across subsection(s).
  • Presentation of monetary thresholds: No practical change; thresholds remain Rs.10,000 and Rs.35,000 (for goods carriages).
  • Addition of prohibition on deductions for marked-to-market/expected losses in As Passed: Significant substantive change - narrows allowable deductions and creates a specific exclusion that could affect entities (e.g., traders, financial firms) that recognise MTM or anticipated losses; such losses will be allowable only if covered u/s 32(1)(h) as enacted.
  • Overall drafting refinement: As Passed drafting appears more precise and inclusive; reduces interpretive ambiguity but does not alter most taxpayers' obligations beyond the new MTM/expected loss restriction.

Practical Implications

  • Compliance and risk areas: Payments to relatives, directors, partners, members, or other related entities will attract scrutiny. Entities should ensure transactions with specified persons reflect fair market value and legitimate business needs because the AO may disallow excess portions.
  • Mode of payment and documentation: Cash payments exceeding Rs.10,000 (Rs.35,000 for goods carriages) in a day will lead to disallowance if not through specified banking/online mode; where deduction was earlier claimed but payment later made in cash exceeding threshold, the payment will be treated as business income in the year of payment. This creates a risk of reassessment/recapture and underscores the need to document payment modes and maintain bank/online transaction evidence.
  • Record-keeping/evidence points suggested by the text: Evidence of arm's-length pricing, contemporaneous documentation showing legitimate business need, details of beneficial ownership/entitlement to profits to establish absence of "substantial interest", and bank/online payment records. Not stated in the document: required form/format or specific documentary standards; those are left to general tax practice and possible rules.

Key Takeaways

  • Clause 36 empowers the Assessing Officer to disallow payments to specified persons that are excessive or unreasonable against fair market value, business needs, or derived benefit.
  • "Specified person" is broadly defined to capture relatives, directors, partners, members and entities/persons with at least 20% beneficial interest.
  • Cash/non-bank payments exceeding Rs.10,000 in a day are not allowable deductions (Rs.35,000 for goods carriages); such payments may be taxed as income if previously deducted and paid later.
  • Exceptions to the cash restrictions may be prescribed, considering banking availability and business expediency.
  • The clause overrides other Act provisions for computation; it also limits pleas based on other laws/contracts where compliance is by specified banking/online mode.
  • Not stated in the document: effective/applicability date, procedural safeguards for AO discretion, detailed prescribed exceptions, and interaction with transfer pricing or comparable provisions.

Full Text:

Section 36 Expenses or payments not deductible in certain circumstances.

Topics

Acts Income Tax
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