by Section 36 of the Income-tax Act, 2025 deals with general deductions allowed while computing income under the head “Profits and Gains of Business or Profession.” It covers specified business expenditures and payments that may be deducted from business or professional income, subject to prescribed conditions and restrictions. The section aims to ensure that legitimate expenses incurred in connection with earning business income receive appropriate tax treatment. Deductibility depends upon the nature, purpose and circumstances of the expenditure and compliance with statutory requirements. Therefore, Section 36 plays an important role in determining the taxable profits of a business or profession under the Act.
Section 36 Expense Disallowed if Payment is made in excess of 10,000 in cash/other than Prescribed Mode:
1. Cash Payment Exceeding ₹10,000
Under Section 36 of the Income-tax Act, 2025, where an assessee incurs expenditure and makes a payment or aggregate of payments exceeding ₹10,000 to a person in a day otherwise than through the prescribed banking or electronic modes, such expenditure is generally not allowed as a deduction while computing business or professional income. The provision aims to encourage traceable and transparent transactions and discourage substantial business payments in cash. The limit is applied with reference to payments made to a particular person on a particular day. However, prescribed exceptions and circumstances may permit cash payments exceeding the limit without attracting disallowance.
2. Prescribed Modes of Payment
To avoid disallowance under Section 36, payments exceeding the prescribed limit should generally be made through permitted modes such as an account-payee cheque, account-payee bank draft, electronic clearing system through a bank account, or other prescribed electronic modes. These methods create an identifiable banking trail and improve transparency in business transactions. Where payment exceeding ₹10,000 is made otherwise than through the prescribed mode, the expenditure may be disallowed, subject to applicable exceptions. Therefore, businesses should ordinarily use approved banking or electronic channels for high-value payments and maintain proper documentary evidence of such payments to establish compliance with the requirements of the Income-tax Act, 2025.
3. Aggregate Payments in a Day
The limit of ₹10,000 applies not merely to a single payment but also to the aggregate of payments made to one person in a day. Therefore, splitting one liability into several smaller cash payments does not necessarily avoid the restriction. For example, if an assessee pays ₹6,000 and ₹7,000 in cash to the same supplier on the same day, the aggregate payment becomes ₹13,000. Since the total exceeds ₹10,000 and payment is made otherwise than through a prescribed mode, the expenditure may attract disallowance, subject to prescribed exceptions. This rule prevents artificial splitting of payments merely to remain below the statutory monetary threshold.
4. Payment to Transport Operators
A higher monetary limit applies in specified cases involving payments made for plying, hiring or leasing goods carriages. In such cases, the prescribed cash-payment threshold is generally ₹35,000, instead of the ordinary ₹10,000 limit. Therefore, payment or aggregate payments made to a person in a day for the specified transport activity may be allowed up to this higher threshold, subject to the statutory requirements. If the payment exceeds the applicable limit and is made otherwise than through the prescribed mode, the expenditure may be disallowed. This special threshold recognises the practical payment requirements associated with the goods transport business.
5. Subsequent Cash Payment of Earlier Liability
Where an expenditure was allowed on the basis of an accrued liability in an earlier tax year but payment is subsequently made in excess of ₹10,000 otherwise than through a prescribed mode, the Act provides for an appropriate tax adjustment. The amount may be treated as business income in the year in which the non-compliant payment is made, subject to the applicable provisions and exceptions. This prevents an assessee from obtaining a deduction initially and later settling the liability through a payment method that violates the statutory requirement. Thus, the provision ensures continuing compliance with the prescribed payment modes even where expenditure and actual payment occur in different tax years.
Certain Payment can be allowed only upon Actual Payment:
1. Tax, Duty, Cess, Surcharge or Fee
Any sum payable by an assessee by way of tax, duty, cess, surcharge or fee, by whatever name called, under any law is covered by Section 37(2)(a). Such expenditure, if otherwise allowable, is deductible on an actual payment basis. Thus, merely creating a liability in the books does not by itself entitle the assessee to deduction. However, except for the specifically excluded MSME category, Section 37(3) allows the deduction in the relevant tax year where payment is made after year-end but on or before the due date for filing the return of income under Section 263(1).
2. Employer’s Contribution to Employee Welfare Funds
Under Section 37(2)(b), an employer’s contribution to a provident fund, superannuation fund, gratuity fund or any other fund for employees’ welfare is covered by the actual-payment rule. The deduction is therefore linked to payment rather than merely the accrual of liability. Where the contribution is paid after the end of the relevant tax year but on or before the due date for filing the return under Section 263(1), Section 37(3) permits deduction in that tax year. This provision ensures that employers actually discharge their employee-welfare fund obligations before obtaining the corresponding deduction while computing profits and gains of business or profession.
3. Leave Encashment
Under Section 37(2)(c), an amount payable by an employer in lieu of leave standing to the credit of an employee is deductible according to the actual-payment rule. Accordingly, a mere provision for leave encashment in the books does not ordinarily satisfy Section 37. The deduction becomes available when the amount is actually paid, subject to the return-filing due-date relief provided by Section 37(3). Therefore, if the amount is paid after the close of the tax year but on or before the applicable return-filing due date, it can be allowed in that tax year. This provision links deduction with the actual discharge of the employer’s liability.
4. Bonus or Commission to Employees
Under Section 37(2)(d) read with Section 32(a), a sum payable to an employee as bonus or commission for services rendered is covered by the actual-payment provisions. Where such bonus or commission is otherwise deductible, it must satisfy the payment requirements of Section 37. If payment is made after the end of the tax year but on or before the due date of filing the return under Section 263(1), deduction can be allowed for that tax year under Section 37(3). The provision ensures that a mere outstanding liability for employee bonus or commission does not indefinitely provide a deduction without actual discharge of the payment obligation.
5. Interest Payable to Specified Financial Entities
Under Section 37(2)(e), interest payable on loans, advances or borrowings from specified financial entities is subject to deduction on an actual-payment basis. Specified entities include prescribed public financial institutions, State Financial Corporations, specified NBFCs, scheduled banks and certain co-operative banks. Deduction is generally available when the interest is actually paid, subject to Section 37(3). Further, under Section 37(4), conversion of unpaid interest into a loan, advance, debenture or another instrument that merely defers payment is not treated as actual payment. Therefore, the assessee must actually discharge the interest liability to obtain the deduction under this provision.
6. Payment to Indian Railways
Under Section 37(2)(f), any amount payable by an assessee to Indian Railways for the use of railway assets is covered by the actual-payment rule. Therefore, even where the liability has been recognised in the accounts, deduction depends upon satisfaction of the payment requirement prescribed by Section 37. Section 37(3) provides relief where the payment is made after the end of the tax year but on or before the applicable due date for filing the return of income. This provision ensures that expenditure relating to the use of railway assets is allowed as a deduction only when the assessee appropriately discharges the corresponding payment obligation.
7. Payment to Micro or Small Enterprises
Under Section 37(2)(g), an amount payable to a micro or small enterprise beyond the time limit specified under Section 15 of the MSMED Act, 2006 is subject to a special actual-payment rule. Unlike most other payments covered by Section 37, the return-filing due-date relief under Section 37(3) does not apply to this category. Therefore, where payment is made beyond the statutory MSME time limit, deduction is available according to the special actual-payment requirement rather than merely by paying before the income-tax return due date. This provision encourages timely payment to micro and small enterprises and strengthens payment discipline toward eligible MSME suppliers.
