Disallowed Business Expenses: Sections 35 and 36 Checklist (Income Tax Act 2025)

Under the Income Tax Act 2025, section 35 and section 36 list business expenses that are not allowed as a deduction even if you actually incurred them. The common triggers are TDS not deducted or not deposited (30% of the sum is disallowed for a resident payee, the whole sum for a non-resident), a cash payment above Rs 10,000 to one person in a day (the whole expense is disallowed), partner remuneration and interest above the limits, and excessive payments to related parties. This guide is a checklist for anyone who keeps books for a business or profession, with the section number next to every rule. Figures are as amended by the Finance Act, 2026, and the examples use tax year 2026-27.

Which business expenses are not deductible under sections 35 and 36?

Both sections apply to income under the head "Profits and gains of business or profession". Section 35 says the amounts it lists are not allowed "irrespective of any other provision of Chapter IV-D". Section 36(1) says the same for its own list. So an expense that is otherwise a genuine business cost can still be refused.

Provision	What is disallowed	How much
Section 35(a)	Tax paid on income, employer-paid tax referred to in Schedule III (Table Sl. No. 10), foreign tax for which relief is available under section 159 or 160, including surcharge and cess	Full amount
Section 35(b)(i)	Payment to a resident where TDS was due but not deducted, or deducted but not paid by the return due date	30% of the sum
Section 35(b)(ii)	Interest, royalty, fees for technical services or other sums payable outside India, or to a non-resident (not a company) or a foreign company, where TDS was not deducted or not paid on time	Full sum
Section 35(b)(iii)	Payment to an employees' provident or other fund without effective arrangements for TDS on taxable payments from the fund	The payment
Section 35(c)	Salary payable outside India or to a non-resident, where TDS was due and not deducted or not paid	Full amount
Section 35(d)	Royalty, licence fee, service fee, privilege fee, service charge or similar charge levied exclusively on, or appropriated from, a State Government undertaking by the State Government	Full amount
Section 35(e)	Firm: remuneration to a non-working partner; remuneration or interest not authorised by the deed; remuneration above the cap; interest above 12% simple per annum	The excess or the whole item
Section 35(f)	AOP or BOI (other than a company, co-operative society or registered society): interest, salary, bonus, commission or remuneration to a member	The payment (with an interest set-off rule)
Section 36(2)	Payment to a "specified person" that the Assessing Officer finds excessive or unreasonable	The excess portion
Section 36(4), (5), (6)	Payment above Rs 10,000 in a day to one person, not by a specified banking or online mode	Full expenditure; or deemed income if paid later
Section 36(9)	Marked to market loss or other expected loss, except as allowable under section 32(1)(h)	The loss

How do I check an expense against these sections?

Run each large or unusual payment through four questions in this order. The diagram shows the same checks and what each one costs.

What happens if TDS is not deducted or not paid? (Section 35(b))

TDS means tax deducted at source: you hold back tax from a payment and deposit it with the government. If the payee is a resident and tax was deductible under Chapter XIX-B but you did not deduct it, or deducted it and did not pay it by the due date in section 263(1), then 30% of that sum is disallowed (section 35(b)(i)). For a payment to a non-resident (other than a company), a foreign company, or any payment outside India, the whole sum is disallowed (section 35(b)(ii)).

The "due date in section 263(1)" is the due date for filing your income tax return for that tax year. Section 263(1)(c) sets it as a date in the following financial year:

Who	Due date for the return
Company; any assessee (other than a company) whose accounts must be audited under the Act or another law; partner of such an audited firm	31 October
Business or profession income, accounts not required to be audited; partner of such a firm	31 August
Any other assessee	31 July
Where section 172 applies (Table Sl. No. 1)	30 November

The disallowance is not permanent. Under section 35(b)(i)(A), if the tax is deducted in a later year, or deducted in the same year but paid after the due date, the 30% is allowed in the tax year in which the tax is actually paid. Section 35(b)(ii)(I) does the same for the non-resident limb.

Is there a way out if the payee has already paid tax?

Yes. If you failed to deduct tax but you are not treated as an "assessee in default" under section 398(2), you are deemed to have deducted and paid the tax on the date the payee filed the return (section 35(b)(i)(B)). Section 398(2) applies when the payee has filed the return under section 263, included the amount in income, and paid the tax due on it, and you furnish a certificate to that effect from an accountant in the prescribed form.

Worked example 1: contractor paid without TDS (tax year 2026-27)

Assumptions: Meena runs a trading business with no tax audit. During tax year 2026-27 she pays a resident contractor Rs 4,00,000 for repairs. TDS was deductible; she does not deduct it. Her net profit as per books, after charging this Rs 4,00,000, is Rs 11,00,000. Her return due date is 31 August 2027.

Step	Working	Amount (Rs)
1. Sum on which TDS was missed	Contractor payment	4,00,000
2. Disallowed under 35(b)(i)	30% of 4,00,000	1,20,000
3. Profit after this adjustment	11,00,000 + 1,20,000	12,20,000
4. If she deducts and pays the tax in tax year 2027-28	Deduction of 1,20,000 allowed in 2027-28	(1,20,000)

The other adjustments in her return are left out here, so Rs 12,20,000 is only the effect of this one item. Compare this with the same default on a payment to a non-resident: the whole Rs 4,00,000 would be disallowed.

Real-life example: a late deposit

Ravi, a small manufacturer with audited accounts, deducts TDS on a freight bill of Rs 2,00,000 to a resident transporter in February 2027 but deposits the tax only in November 2027, after his return due date of 31 October 2027. Section 35(b)(i) disallows 30% of the freight bill in 2026-27. When he deposits the tax, the same 30% becomes allowable in the year of deposit. The cost is a timing difference plus any interest for late payment, not a lost deduction forever. See TDS on rent under the Income Tax Act 2025 for how one common TDS category works.

What are the limits on partner remuneration and interest in a firm? (Section 35(e))

For a firm assessed as a firm, these are not deductible:

• Salary, bonus, commission or remuneration to a partner who is not a working partner (section 35(e)(i)). A working partner is an individual actively engaged in conducting the affairs of the firm's business or profession (section 35(e)(v)(B)).
• Remuneration to a working partner, and interest to any partner, that is not authorised by the partnership deed for the period concerned, or that relates to a period before the date of the deed (section 35(e)(ii)).
• Aggregate remuneration to all working partners above the cap below (section 35(e)(iii)).
• Interest to a partner above 12% simple interest per annum (section 35(e)(iv)).

Slice of book profit	Maximum remuneration to all working partners
First Rs 6,00,000	Rs 3,00,000 in case of a loss, or 90% of book profit, whichever is higher
Balance	60% of the balance

Book profit means the net profit shown in the profit and loss account for the tax year, computed as per Chapter IV-D, increased by the total remuneration to all partners if it was deducted in arriving at that net profit (section 35(e)(v)(A)).

Worked example 2: firm with working partners (tax year 2026-27)

Assumptions: A firm's book profit (as defined above) is Rs 20,00,000. Its deed authorises remuneration of Rs 16,00,000 in total to its working partners, and 15% simple interest on partner capital. Partners' capital is Rs 10,00,000 and the firm pays interest on it for the full year. No partner is a "partner in a representative capacity".

Step	Working	Amount (Rs)
1. Cap on first Rs 6,00,000	Higher of 3,00,000 and 90% of 6,00,000 = 5,40,000	5,40,000
2. Cap on balance	Balance = 20,00,000 - 6,00,000 = 14,00,000; 60% of 14,00,000	8,40,000
3. Total remuneration cap	5,40,000 + 8,40,000	13,80,000
4. Remuneration disallowed	16,00,000 - 13,80,000	2,20,000
5. Interest paid at 15%	15% of 10,00,000	1,50,000
6. Interest allowed at 12%	12% of 10,00,000	1,20,000
7. Interest disallowed	1,50,000 - 1,20,000	30,000
8. Total disallowed under 35(e)	2,20,000 + 30,000	2,50,000

Section 35(f) applies a similar bar to an association of persons or body of individuals (other than a company, co-operative society or society registered under the Societies Registration Act, 1860 or a corresponding law). Interest, salary, bonus, commission or remuneration paid to its member is disallowed. Where a member has both received interest from and paid interest to the body, only the excess interest paid by the body is disallowed.

When is a cash payment of more than Rs 10,000 disallowed? (Section 36(4) to (8))

Section 36(4) disallows expenditure where a payment, or the total of payments made in a day to one person, exceeds Rs 10,000 and is not made through a specified banking or online mode. For plying, hiring or leasing of goods carriages the figure is Rs 35,000 (section 36(6)).

Section 36(5) covers the second route. If you claimed a deduction in an earlier tax year for a liability and later pay it in cash (above the same limits), the payment is treated as business income in the year you pay it. Section 36(8) adds that where a payment is made through a specified banking or online mode in compliance with these sub-sections, no plea can be raised under any other law or contract that it was not made in cash or another mode.

The words "specified banking or online mode" are not spelled out in section 36 itself. Rule 26(1) separately refers to "such other electronic mode as provided in rule 48", and rule 48 lists: credit card, debit card, net banking, IMPS, UPI, RTGS, NEFT, BHIM Aadhaar Pay, and certain central bank digital currency wallets. Treat the full list in rule 48 as the reference for the electronic modes.

Which cash payments are exempt from section 36(4) and (5)?

Section 36(7) allows exceptions by rule, and rule 26(1) lists them. Among them:

• payments to the Reserve Bank of India, banks as defined, State Bank of India or its subsidiary banks, co-operative banks, land mortgage banks, primary agricultural credit societies or primary credit societies, and the Life Insurance Corporation of India;
• payments to the Government that must be made in legal tender under its rules;
• payments by letter of credit, mail or telegraphic transfer through a bank, book adjustment between bank accounts, or a bill of exchange payable only to a bank;
• adjustment against a liability the payee owes you for goods or services you supplied;
• purchases of agricultural or forest produce, produce of animal husbandry, dairy, poultry, fish or fish products, and horticulture or apiculture products, from the cultivator, grower or producer;
• products of a cottage industry made without the aid of power, bought from the producer;
• payment in a village or town without any bank on the payment date, to a person who ordinarily resides or carries on business there;
• gratuity, retrenchment compensation or similar terminal payment to an employee or heir, if the total does not exceed Rs 50,000;
• salary (after TDS under section 392) to an employee posted for 15 or more continuous days at a place or ship where the employee has no bank account;
• payment to an agent who must pay cash for goods or services on your behalf;
• an authorised dealer or money changer buying foreign currency or travellers cheques in the normal course.

Worked example 3: cash payments in one day (tax year 2026-27)

Case	Payments in a day to one person	Result
A	Rs 9,500 cash to a stationery vendor	Within Rs 10,000: allowed
B	Rs 6,000 cash in the morning + Rs 7,000 cash in the evening to the same vendor = Rs 13,000	Aggregate exceeds Rs 10,000: Rs 13,000 disallowed
C	Rs 18,000 by UPI	Specified electronic mode: allowed
D	Rs 30,000 cash to a truck owner for hiring a goods carriage	Within Rs 35,000: allowed
E	Rs 36,000 cash to a truck owner for hiring a goods carriage	Above Rs 35,000: Rs 36,000 disallowed

The test is per person per day, so payments on different days are tested separately. A genuine instalment on another day stands on its own; a bill split across days only to stay under the limit can be questioned on the facts.

Real-life example: the cash purchase that cost the deduction

Ravi, a textile trader, buys Rs 25,000 of stock from a small vendor who asks for cash. He pays it all in one day. The Rs 25,000 expenditure is not allowed as a deduction under section 36(4), even though the purchase is real and recorded. If the vendor were a cultivator selling his own produce and Ravi were buying agricultural produce, rule 26(1)(e) would take the payment outside section 36(4). Paying by UPI or NEFT would also have avoided the issue.

What are excessive payments to related parties? (Section 36(2) and (3))

If you pay a "specified person" and the Assessing Officer considers the amount excessive or unreasonable having regard to fair market value of the goods, services or facilities, the legitimate needs of the business or profession, or the benefit you derive, the excess is not allowed (section 36(2)). Section 36(3) defines the specified person by who you are:

If the assessee is	Specified person includes
Individual	Any relative
Company	Any director or his relative
Firm	Partner or his relative
Association of persons	Member or his relative
Hindu undivided family	Member of the family or his relative

The definition also reaches anyone with a "substantial interest" in your business, their directors, partners, members and relatives, and businesses in which you or your relatives hold a substantial interest (section 36(3)(a)(ii) to (iv)). Substantial interest means beneficial ownership of shares carrying at least 20% of voting power in a company, or a right to at least 20% of profits in any other case, at any time during the tax year (section 36(3)(b)).

Real-life example: warehouse rent to a director's brother

Neha Traders Private Limited pays Rs 90,000 a month for a warehouse owned by its director's brother. Similar warehouses in the area rent for Rs 60,000. The Assessing Officer can treat Rs 30,000 a month as excessive, so Rs 3,60,000 for the year (Rs 30,000 x 12). The company can answer with rent agreements, valuation reports or evidence of the warehouse's special features. Section 36(2) depends on the officer's opinion, so documents decide the outcome.

Is marked to market loss deductible? (Section 36(9))

No deduction is allowed for marked to market loss or any other expected loss, except as allowable under section 32(1)(h). A loss you have only estimated on a year-end valuation, and not realised, is added back unless that specific provision covers it.

What do the audit rules say? (Rule 47)

The report of audit under section 63 is furnished in Form No. 26. Part A applies to a person who must get accounts audited under another law; Part B applies to other persons carrying on business or profession; Parts C and D carry further particulars (rule 47(1) and (2)). If a payment made after you furnish the report requires you to recalculate the disallowance under section 35 or 37, the report can be revised by obtaining a revised report from an accountant and furnishing it before the end of the relevant financial year succeeding the tax year (rule 47(3)). That is the practical route when a TDS default is cured after the audit report is filed.

What else is not deductible under section 34?

Sections 35 and 36 are not the only gate. Section 34(1) allows only expenditure laid out "wholly and exclusively" for the business or profession, and it excludes capital expenditure and the assessee's personal expenses. Section 34(2) says the following never count as such an expenditure:

• Expenditure for a purpose that is an offence or is prohibited by law (section 34(2)(a)). Section 34(3) extends this to offences under laws in or outside India, benefits given in breach of rules governing the recipient, compounding an offence, and settling notified contravention proceedings.
• Corporate social responsibility spending under section 135 of the Companies Act, 2013 (section 34(2)(b)).
• Advertisements in a souvenir, brochure, tract or pamphlet published by a political party (section 34(2)(c)).

Which deductions are allowed only when actually paid? (Section 37)

Section 37 is a timing rule, not a permanent disallowance. Even if you follow the mercantile method, the sums in section 37(2) are deductible only in the tax year they are actually paid:

Sum payable (section 37(2))	Note
Tax, duty, cess, surcharge or fee under any law	Clause (a)
Employer contribution to provident, superannuation, gratuity or employee welfare fund	Clause (b)
Leave encashment payable to an employee	Clause (c)
Interest on loans from specified financial entities, per the loan terms	Clause (e); interest converted into a loan or instrument is not "paid" (37(4))
Amount payable to Indian Railways for railway assets	Clause (f)
Amount owed to a micro or small enterprise beyond the time limit in section 15 of the MSMED Act, 2006	Clause (g); no grace to the return due date

For every item except the MSME dues, a payment made after the year end but on or before the return due date under section 263(1) is still allowed in the year the liability arose (section 37(3)). A deduction already allowed is not allowed again on payment (section 37(5)). Section 37 also covers the sum referred to in section 32(a).

Example: Meena owes a micro-enterprise supplier Rs 80,000 for goods and pays it after the section 15 MSMED time limit, in the next tax year. Under section 37(2)(g) the deduction waits for the year of actual payment, even if she pays before her return due date.

Is cash paid for buying an asset also restricted?

Yes. Under section 39(2), a payment or aggregate of payments above Rs 10,000 in a day to one person for acquiring an asset, made other than by a specified banking or online mode, is excluded from the asset's actual cost. That cost drives depreciation, so a cash purchase can reduce your claim even though section 36(4) deals with expenses.

Quick reference: limits, thresholds and relief

Item	Figure	Where
TDS default, resident payee	30% of the sum disallowed	Section 35(b)(i)
TDS default, non-resident / outside India	Whole sum disallowed	Section 35(b)(ii)
Relief when TDS is paid late	Allowed in the year tax is paid	Section 35(b)(i)(A), (ii)(I)
Partner interest cap	12% simple per annum	Section 35(e)(iv)
Working partner remuneration cap	Rs 3,00,000 / 90% of the first Rs 6,00,000; 60% of the balance	Section 35(e)(iii)
Cash limit, one person, one day	Rs 10,000	Section 36(4)
Cash limit, goods carriage hire	Rs 35,000	Section 36(6)
Deduction only on payment (tax, employer fund contributions, leave pay)	Allowed if paid by the return due date	Section 37(2), (3)
Cash for asset purchase, one person, one day	Above Rs 10,000 excluded from actual cost	Section 39(2)
Substantial interest	At least 20% voting power or profits	Section 36(3)(b)

Common mistakes

1. Treating the due date for TDS deposit as the test. Section 35(b) tests against the return due date in section 263(1), not the monthly TDS deposit date. Check the return due date for each client, not only the TDS calendar.
2. Counting cash per bill instead of per person per day. Two payments to the same person on the same day are added together (section 36(4)).
3. Forgetting the carry-forward of relief. After a 35(b) disallowance, the deduction comes back in the year the tax is paid. Missing that claim is a common leak.
4. Paying a non-working or unauthorised partner. Remuneration without a clause in the deed, or interest above 12%, is disallowed regardless of the profit.
5. Ignoring the audit report after a cure. If you pay the tax or cure a cash payment after the report is filed, a revised report may be needed (rule 47(3)).
6. Paying relatives at above-market rates without papers. Section 36(2) turns on fair market value, so keep quotations, agreements and comparables.

Where this is in the Act

• Section 35: amounts not deductible (clauses (a) to (f)); Section 35(b) links to sections 263(1) and 398(2).
• Section 34: general conditions; offences, CSR and political-party advertisements excluded (34(2), (3)).
• Section 37: deductions on actual payment basis; section 39(2): cash payments for assets.
• Section 36: expenses or payments not deductible; sub-sections (2) and (3) specified persons, (4) to (8) cash payments, (9) marked to market loss.
• Section 263(1)(c): due dates for filing the return.
• Section 398(2): no "assessee in default" if the payee has paid the tax.
• Rule 26: cases where payments above Rs 10,000 can be made otherwise than by specified modes.
• Rule 47: Form No. 26 audit report and revised report.
• Rule 48: other electronic modes of payment.

For a CA firm, the hard part is catching these before the return goes in: which clients have TDS that was not deposited, which paid cash vouchers cross Rs 10,000 in a day, and which firms have partner remuneration above the cap. Finexo's practice management software helps you track client tasks and deadlines such as TDS deposits and audit-report dates in one place. It does not compute disallowances or file returns for you.

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.