Additional Employee Cost Deduction under the Income Tax Act 2025 (Section 146)
Section 146 of the Income Tax Act 2025 gives a business a deduction of 30% of the additional employee cost it incurs in a tax year. It is available to an assessee whose accounts are subject to tax audit under section 63, for three consecutive tax years starting with the year the new employment is provided. An accountant's report in Form 34 must be furnished along with the return.
This article was written for tax year 2026-27, with the Act as amended by the Finance Act, 2026 and the Income-tax Rules, 2026. It explains who qualifies, which employees count, how the cost is measured, and how to claim. If you remember an older "extra employment" deduction from the 1961 Act, check the old-law mapping separately; this guide works only from the text of the 2025 Act and the Rules.
What is the additional employee cost deduction under section 146?
If your gross total income includes profits and gains from business, section 146(1) allows a deduction equal to 30% of the additional employee cost incurred in the course of that business in the tax year. The deduction applies to an assessee "to whom section 63 applies", which is the tax audit section.
Under section 63(1), Table Sl. No. 1, that covers a person whose business sales, turnover or gross receipts exceed Rs 1 crore in a tax year (Rs 10 crore if cash receipts and cash payments each stay within 5% of the totals), or whose professional gross receipts exceed Rs 50 lakh. Table Sl. No. 2 also covers presumptive-income cases where lower profits are claimed. Section 146 itself speaks of profits from business, so the deduction is tied to the business income.
How many years can the deduction be claimed?
Section 146(2): three consecutive tax years, beginning with the tax year in which the employment is provided. A hire made in tax year 2026-27 can therefore be claimed in 2026-27, 2027-28 and 2028-29, if every condition is met in each year.
What is "additional employee cost"?
Section 146(5)(a) defines it in two ways:
- Existing business: the total emoluments paid or payable to additional employees employed during the tax year.
- New business, first year: the emoluments paid or payable to the employees employed during that year (section 146(5)(a)(ii)).
The cost is treated as nil for an existing business in two situations: (A) there is no increase in the number of employees over the number employed on the last day of the preceding tax year, or (B) emoluments are paid otherwise than by an account payee cheque, account payee bank draft, electronic clearing system through a bank account, or another prescribed electronic mode.
Which payment modes are allowed?
Rule 48 lists the "other electronic modes" for section 146(5)(a)(ii)(B): credit card, debit card, net banking, IMPS, UPI, RTGS, NEFT, BHIM Aadhaar Pay, and certain Tier-III full-KYC central bank digital currency wallets. Paying salary in cash puts the additional employee cost at nil for an existing business.
Who is an "additional employee"?
Section 146(5)(b): an employee employed during the tax year whose employment increases the total number of employees on the last day of the preceding tax year. The following are excluded:
| Excluded employee | Reference |
|---|---|
| Total emoluments exceed Rs 25,000 per month | 146(5)(b)(i) |
| Government pays the entire contribution under the notified Employees' Pension Scheme | 146(5)(b)(ii) |
| Employed for less than 150 days, if the assessee manufactures apparel, footwear or leather products | 146(5)(b)(iii) |
| Employed for less than 240 days in the tax year, for any other assessee | 146(5)(b)(iv) |
| Does not participate in a recognised provident fund | 146(5)(b)(v) |
For the 150-day and 240-day cases there is a carry-forward: if the employee completes that number of days in the immediately succeeding tax year, the employee is deemed an additional employee of that succeeding year.
What counts as "emoluments"?
Section 146(5)(c): any sum paid or payable to an employee in lieu of employment, by whatever name called. Two things are left out: employer contributions to pension, provident or other funds mandated by law, and lump sums at termination, superannuation or voluntary retirement, such as gratuity, severance pay, leave encashment, voluntary retrenchment benefits and commutation of pension.
When is the deduction not allowed?
Section 146(3) denies the deduction if:
- the business is formed by splitting up, or the reconstruction, of an existing business;
- the business is acquired from another person, or as a result of a business reorganisation; or
- the assessee does not furnish the accountant's report before the specified date in section 63.
Section 146(4) relaxes the first condition for an undertaking re-established, reconstructed or revived after extensive damage from a natural calamity, riot, accidental fire or explosion, or enemy action, as described in section 140(4), if the revival happens within three years from the end of the tax year of discontinuance.
How do you claim it? Form 34 and the specified date
Rule 68 says the accountant's report required under section 146(3)(c) is furnished in Form No. 34, along with the return of income. Under section 63, the "specified date" is one month before the due date for furnishing the return, so the report has to be ready earlier than the return itself.
How is the deduction calculated? Two worked examples
Example 1: existing business, tax year 2026-27
Assumptions: Sharma Traders Ltd is subject to tax audit. It had 40 employees on 31 March 2026. During 2026-27 it hires 4 new staff on 1 April 2026, each at Rs 20,000 a month, all in the recognised provident fund, all paid by NEFT. It also hires one employee on Rs 30,000 a month. The business is not a split-up or acquired business. Form 34 is furnished on time.
| Step | Working | Amount (Rs) |
|---|---|---|
| 1. Headcount rises? | 45 on the last day of 2026-27 vs 40 a year earlier | Yes, cost is not nil |
| 2. Exclude the Rs 30,000 employee | Emoluments exceed Rs 25,000 a month, section 146(5)(b)(i) | Excluded |
| 3. Emoluments of 4 additional employees | 4 x 20,000 x 12 | 9,60,000 |
| 4. Deduction at 30% | 9,60,000 x 30% | 2,88,000 |
Employer provident fund contributions are not part of emoluments (section 146(5)(c)(i)), so they are not added to the Rs 9,60,000. If the same four employees continue and every condition is met in 2027-28 and 2028-29, the claim could be repeated for those two years. Check how the headcount test applies to those later years for the facts of the case before projecting a three-year total.
Example 2: new business, first year
Assumptions: Meena starts a new manufacturing business on 1 June 2026 and it is subject to tax audit. She employs 5 people from 1 June 2026 at Rs 22,000 a month each, all in a recognised provident fund and paid by bank transfer, and all work through 31 March 2027. Days from 1 June 2026 to 31 March 2027: 304, which is more than 240.
| Step | Working | Amount (Rs) |
|---|---|---|
| 1. First year of a new business | Section 146(5)(a)(ii) applies, no headcount comparison needed | - |
| 2. Emoluments for 10 months (June to March) | 5 x 22,000 x 10 | 11,00,000 |
| 3. Deduction at 30% | 11,00,000 x 30% | 3,30,000 |
Real-life scenarios
Ravi joins late. A garment manufacturer hires Ravi on 1 October 2026 at Rs 18,000 a month, in addition to its headcount on 31 March 2026 and with PF participation. By 31 March 2027 he has worked 182 days, which is above the 150-day limit for apparel manufacturers, so he can count as an additional employee for 2026-27. Had the same hire been in a trading business, the 240-day limit would apply, and he would fall short.
Anita is hired in September. A trading firm hires Anita on 1 September 2026 at Rs 18,000 a month. She has 212 days of employment in 2026-27, so she is not an additional employee that year. If she is employed for at least 240 days in 2027-28, section 146(5)(b)(iv) deems her an additional employee of 2027-28.
Cash salaries. A trader with 12 staff adds 3 people and pays all salaries in cash. Because emoluments are paid otherwise than by an account payee cheque, draft or permitted electronic mode, the additional employee cost is nil for this existing business, and there is nothing to deduct.
Is the deduction available under the new tax regime?
Yes for the Chapter VIII deduction in section 146. Section 202(2)(a)(xii), which lists the deductions not allowed under the new regime for individuals, HUFs and certain other persons, carves out section 146 from the Chapter VIII bar. Section 146 itself sets no overall rupee cap on the deduction. The only per-employee limit is the Rs 25,000 a month emoluments ceiling in the definition of additional employee.
Common mistakes
- Counting an employee who earns more than Rs 25,000 a month.
- Including employer PF contributions or gratuity in "emoluments".
- Missing the 240-day (or 150-day for apparel, footwear and leather) test for staff who joined late in the year.
- Paying salary in cash, which makes the cost nil for an existing business.
- Forgetting the headcount comparison. The base is the number of employees on the last day of the preceding tax year.
- Furnishing Form 34 after the specified date. That alone denies the deduction.
Quick reference
| Item | Rule | Reference |
|---|---|---|
| Deduction rate | 30% of additional employee cost | Section 146(1) |
| Years | 3 consecutive tax years | Section 146(2) |
| Salary ceiling per employee | Rs 25,000 a month | Section 146(5)(b)(i) |
| Minimum employment | 240 days (150 days for apparel, footwear, leather) | Section 146(5)(b)(iii), (iv) |
| Report | Form 34, before the specified date | Rule 68; section 63 |
| Payment modes | Account payee cheque or draft, ECS, or rule 48 electronic modes | Section 146(5)(a)(ii)(B); rule 48 |
How do CA firms track this across clients?
The deduction depends on facts that sit in different places: payroll data, joining dates, payment modes and the audit report. Finexo's practice management software helps a CA firm keep track of which audit clients need Form 34 and by when. It does not compute the deduction or file the report for you.
Where this is in the Act
- Section 146: deduction in respect of additional employee cost
- Section 63: tax audit and the "specified date"
- Section 140(4): re-establishment after damage or destruction (cross-referred in section 146(4))
- Rule 48: other electronic modes of payment
- Rule 68: report under section 146 in Form No. 34
This article explains the Income Tax Act 2025 (as amended by the Finance Act, 2026) and the Income-tax Rules, 2026. It is general information, not tax advice. Confirm the position for a specific case with a qualified chartered accountant.
Frequently Asked Questions
What is the deduction for additional employee cost under the Income Tax Act 2025?
Section 146 allows 30% of the additional employee cost incurred in business for three consecutive tax years, starting with the year the employment is provided. It applies to an assessee to whom section 63 (tax audit) applies.
Which employees are not counted as additional employees?
Those earning more than Rs 25,000 a month, those for whom the Government pays the entire EPS contribution, those employed for fewer than 240 days (150 days for apparel, footwear and leather), and those not in a recognised provident fund.
Can I claim the deduction if I pay salaries in cash?
For an existing business, no. Section 146(5)(a)(B) makes the additional employee cost nil if emoluments are not paid by account payee cheque or draft, ECS through a bank account, or a prescribed electronic mode.
Is the section 146 deduction available under the new tax regime?
Section 202(2)(a)(xii) excludes Chapter VIII deductions under the new regime but carves out section 146, so the additional employee cost deduction is not barred there. Section 146 has no overall cap; only employees earning up to Rs 25,000 a month count.
Which form is needed to claim the deduction?
Form No. 34, the accountant's report, under rule 68. It must be furnished before the specified date in section 63, which is one month before the due date of the return.
Does a late joiner count if he works less than 240 days?
Not in the joining year. If the employee completes 240 days in the next tax year, section 146(5)(b)(iv) deems him an additional employee of that succeeding year.