Indian income tax law | Business deductions
Section 40 of the Income-tax Act, 1961: Amounts Not Deductible
Section 40 restricts deductions for specified business expenses, including payments with tax deducted at source (TDS) defaults, taxes on profits, certain employee-related payments, and partnership-firm remuneration or interest. The correct treatment depends on the assessment year and the relevant statutory conditions.
Meaning and scope of Section 40
Section 40 begins with a non-obstante provision: despite deductions otherwise available under Sections 30 to 38, the listed payments are disallowed when the specified statutory conditions apply. It must be read with Sections 37, 40A, 43B, Chapter XVII-B and the relevant Income-tax Rules. It does not make every payment mentioned in the section automatically nondeductible.
Section 40(a)(i) and 40(a)(ia): TDS-related disallowances
Payments to non-residents: Section 40(a)(i)
Where interest, royalty, fees for technical services or another sum chargeable to tax is payable outside India or to a specified non-resident or foreign company, failure to deduct or deposit applicable tax at source can result in disallowance. A deduction may become available in the year in which the withheld tax is subsequently paid, as provided by the statute. First determine whether the sum is chargeable to Indian tax, taking account of Section 195 and any applicable tax treaty.
Payments to residents: Section 40(a)(ia)
For covered resident payments, the disallowance under the 1961 Act is generally 30 percent of the amount if required TDS was not deducted or, after deduction, was not deposited by the due date under Section 139(1). The law provides subsequent-year relief and a deemed-compliance mechanism in qualifying cases where the resident payee has reported and paid tax, subject to the conditions of Section 201(1) and prescribed certification.
Definitions: Royalty and fees for technical services draw on Section 9(1); commission or brokerage, rent, professional services and work use the relevant TDS-section definitions. Determine the TDS obligation before applying Section 40.
Other amounts restricted under Section 40(a)
- Section 40(a)(ii): taxes imposed on profits or gains of a business or profession are generally not deductible, including the statutory explanations concerning foreign-tax relief.
- Section 40(a)(iib): specified fees, charges or appropriations levied exclusively on, or taken from, a State Government undertaking by the State Government are disallowed.
- Section 40(a)(iii): salary payable outside India or to a non-resident is disallowed in specified cases when tax has neither been paid nor deducted.
- Section 40(a)(iv): contributions to specified employee funds are restricted unless effective arrangements exist for TDS on taxable payments from the fund.
- Section 40(a)(v): specified employer-paid tax on non-monetary employee perquisites is not deductible.
- Section 40(a)(ib): the historical equalisation-levy rule requires careful checking against the levy provisions and their subsequent changes or repeal for the relevant period.
- Historical clauses: provisions relating to fringe benefit tax and wealth-tax reflect earlier tax regimes; do not assume they create a present-day liability.
Section 40(b): Payments to partners of a firm
Remuneration paid to a non-working partner is disallowed. Remuneration to a working partner and interest to partners must be authorised by, and comply with, the partnership deed; retroactive authorisation is restricted. Interest above 12 percent simple interest per annum is disallowed to the extent of the excess.
Working partner means an individual actively engaged in the conduct of the firm's business or profession. Book profit is computed using the statutory definition in Explanation 3 to Section 40(b), not merely the unadjusted accounting profit.
| Book-profit portion | Maximum allowable remuneration |
|---|---|
| First Rs. 6,00,000 of book profit, or loss | Rs. 3,00,000 or 90% of book profit, whichever is higher |
| Balance of book profit | 60% of the balance |
Important historical correction: the uploaded source states the earlier Rs. 3,00,000 slab and Rs. 1,50,000 floor. Finance (No. 2) Act, 2024 increased these figures for assessment year 2025-26 onwards. Check the applicable year before using either schedule.
Section 40(ba): Associations of persons and bodies of individuals
Specified payments of interest, salary, bonus, commission or remuneration by an association of persons or body of individuals to its members are restricted, subject to the statutory exclusions and explanations dealing with net interest and representative capacity.
Practical illustrations
Example 1: Resident contractor payment
A business incurs Rs. 2,00,000 of expense subject to TDS but fails to comply with the withholding requirement. If Section 40(a)(ia) applies, the initial disallowance is generally Rs. 60,000 (30% of Rs. 2,00,000). Subsequent relief depends on compliance and the applicable provisions.
Example 2: Interest paid to a partner
A firm pays 15% annual interest on a partner's eligible capital account, with valid deed authorisation. Section 40(b) generally limits the deductible interest rate to 12% simple interest; the excess 3 percentage points is disallowed, subject to the facts and applicable year.
Records and compliance checklist
- Identify the assessment or tax year and the legislation applicable to it.
- Review invoices, contracts, nature of services and payee residential status.
- Reconcile TDS liability, deduction dates, challans, returns and certificates.
- For foreign payments, assess chargeability, treaty provisions and Section 195.
- For firms, retain the partnership deed, working-partner details and a book-profit computation.
- Consider Sections 40A and 43B separately, as additional restrictions may apply.
Official legal and administrative references
Consult the Income Tax Department for legislation, circulars and guidance; India Code for central Acts; and the e-Gazette of India for notified legislative changes. The Income Tax e-Filing portal provides tax-compliance services. Use the text applicable to the relevant period rather than relying on an older reproduction.
Frequently asked questions
What is Section 40 of the Income-tax Act, 1961?
It lists specified expenses and payments that cannot be deducted while computing business or professional income, despite general deduction provisions.
What is the disallowance for failure to deduct TDS on payments to residents?
Under Section 40(a)(ia), 30 percent of a covered resident payment is generally disallowed when applicable TDS is not deducted or deposited by the specified deadline, subject to statutory relief.
What happens if TDS on a non-resident payment is not deposited?
Section 40(a)(i) generally disallows the relevant chargeable sum until the withholding-tax conditions are met, subject to the law and applicable treaty.
How much partner remuneration is deductible?
For relevant years from assessment year 2025-26, Section 40(b) generally permits up to Rs. 3,00,000 or 90 percent of book profit, whichever is higher, on the first Rs. 6,00,000 of book profit or in case of a loss, plus 60 percent of the balance, subject to deed and working-partner conditions.
Is income tax a deductible business expense?
No. Taxes levied on business profits are generally disallowed under Section 40(a)(ii).
Original Section 40 text and amendment notes (historical reference)
The following material is preserved from the original webpage for research and continuity. It contains superseded provisions and older limits, and should not be treated as the consolidated law for every assessment year.
Notwithstanding anything to the contrary in 1 section 30 to 38, the following amounts shall not be deducted in computing the income chargeable under the head Profits and gains of business or profession,
(a) in the case of any assessee
2 (i) any interest (not being interest on a loan issued for public subscription before the 1st day of April, 1938), royalty, fees for technical services or other sum chargeable under this Act, which is payable,
(A) outside India; or
(B) in India to a non-resident, not being a company or to a foreign company, on which tax is deductible at source under Chapter XVII-B and such tax has not been deducted or, after deduction, has not been paid 3 on or before the due date specified in sub-section (1) of section 139:
4 Provided that where in respect of any such sum, tax has been deducted in any subsequent year, or has been deducted during the previous year but paid after the due date specified in sub-section (1) of section 139, such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid.
Explanation. For the purposes of this sub-clause,
(A) royalty shall have the same meaning as in Explanation 2 to clause (vi) of sub-section (1) of section 9;
(B) fees for technical services shall have the same meaning as in Explanation 2 to clause (vii) of sub-section (1) of section 9;
(ia) 5 thirty per cent of any sum payable to a resident, on which tax is deductible at source under Chapter XVII-B and such tax has not been deducted or, after deduction, 6 has not been paid on or before the due date specified in sub-section (1) of section 139:
7 Provided that where in respect of any such sum, tax has been deducted in any subsequent year, or has been deducted during the previous year but paid after the due date specified in sub-section (1) of section 139, 8thirty per cent of such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid:
9 Provided further that where an assessee fails to deduct the whole or any part of the tax in accordance with the provisions of Chapter XVII-B on any such sum but is not deemed to be an assessee in default under the first proviso to sub-section (1) of section 201, then, for the purpose of this sub-clause, it shall be deemed that the assessee has deducted and paid the tax on such sum on the date of furnishing of return of income by the resident payee referred to in the said proviso.
Explanation. For the purposes of this sub-clause,
(i) commission or brokerage shall have the same meaning as in clause (i) of the Explanation to section 194H;
(ii) fees for technical services shall have the same meaning as in Explanation 2 to clause (vii) of sub-section (1) of section 9;
(iii) professional services shall have the same meaning as in clause (a) of the Explanation to section 194J;
(iv) work shall have the same meaning as in Explanation III to section 194C;
10 (v) rent shall have the same meaning as in clause (i) to the Explanation to section 194-I;
(vi) royalty shall have the same meaning as in Explanation 2 to clause (vi) of sub-section (1) of section 9;
11 (ib) any consideration paid or payable to a non-resident for a specified service on which equalisation levy is deductible under the provisions of Chapter VIII of the Finance Act, 2016, and such levy has not been deducted or after deduction, has not been paid on or before the due date specified in sub-section (1) of section 139:
Provided that where in respect of any such consideration, the equalisation levy has been deducted in any subsequent year or has been deducted during the previous year but paid after the due date specified in sub-section (1) of section 139, such sum shall be allowed as a deduction in computing the income of the previous year in which such levy has been paid;
12 (ic) any sum paid on account of fringe benefit tax under Chapter XIIH;
(ii) any sum paid on account of any rate or tax levied on the profits or gains of any business or profession or assessed at a proportion of, or otherwise on the basis of, any such profits or gains.
13 Explanation 1.For the removal of doubts, it is hereby declared that for the purposes of this sub-clause, any sum paid on account of any rate or tax levied includes and shall be deemed always to have included any sum eligible for relief of tax under section 90 or, as the case may be, deduction from the Indian income-tax payable under section 91.
14 Explanation 2.-For the removal of doubts, it is hereby declared that for the purposes of this sub-clause, any sum paid on account of any rate or tax levied includes any sum eligible for relief of tax under section 90A;
15 (iia) any sum paid on account of wealth-tax.
Explanation.-For the purposes of this sub-clause, "wealth-tax" means
wealth-tax chargeable under the Wealth-tax Act, 1957 (27 of 1957), or any tax of
a similar character chargeable under any law in force in any country outside
India or any tax chargeable under such law with reference to the value of the
assets of, or the capital employed in, a business or profession carried on by
the assessee, whether or not the debts of the business or profession are allowed
as a deduction in computing the amount with reference to which such tax is
charged, but does not include any tax chargeable with reference to the value of
any particular asset of the business or profession;
16 (iib) any amount-
(A) paid by way of royalty, licence fee, service fee, privilege fee, service charge or any other fee or charge, by whatever name called, which is levied exclusively on; or
(B) which is appropriated, directly or indirectly, from, a State Government undertaking by the State Government.
Explanation.-For the purposes of this sub-clause, a State Government undertaking includes-
(i) a corporation established by or under any Act of the State Government;
(ii) a company in which more than fifty per cent of the paid-up equity share capital is held by the State Government;
(iii) a company in which more than fifty per cent of the paid-up equity share capital is held by the entity referred to in clause (i) or clause (ii) (whether singly or taken together);
(iv) a company or corporation in which the State Government has the right to appoint the majority of the directors or to control the management or policy decisions, directly or indirectly, including by virtue of its shareholding or management rights or shareholders agreements or voting agreements or in any other manner;
(v) an authority, a board or an institution or a body established or constituted by or under any Act of the State Government or owned or controlled by the State Government;
17 (iii) any payment which is chargeable under the head "Salaries", if it is payable-
(A) outside India; or
(B) to a non-resident,
and if the tax has not been paid thereon nor deducted therefrom under Chapter
XVII-B;
(iv) any payment to a provident or other fund established for the benefit of
employees of the assessee, unless the assessee has made effective arrangements
to secure that tax shall be deducted at source from any payments made from the
fund which are chargeable to tax under the head "Salaries";
18 (v) any tax actually paid by an employer referred to in clause (10CC) of
section 10;
19 (b) in the case of any firm assessable as such,-
(i) any payment of salary, bonus, commission or remuneration, by whatever name called (hereinafter referred to as "remuneration") to any partner who is not a working partner; or
(ii) any payment of remuneration to any partner who is a working partner, or of interest to any partner, which, in either case, is not authorised by, or is not in accordance with, the terms of the partnership deed; or
(iii) any payment of remuneration to any partner who is a working partner, or of interest to any partner, which, in either case, is authorised by, and is in accordance with, the terms of the partnership deed, but which relates to any period (falling prior to the date of such partnership deed) for which such payment was not authorised by, or is not in accordance with, any earlier partnership deed, so, however, that the period of authorisation for such payment by any earlier partnership deed does not cover any period prior to the date of such earlier partnership deed; or
(iv) any payment of interest to any partner which is authorised by, and is in accordance with, the terms of the partnership deed and relates to any period falling after the date of such partnership deed in so far as such amount exceeds the amount calculated at the rate of 20 twelve per cent. simple interest per annum; or
(v) any payment of remuneration to any partner who is a working partner, which is authorised by, and is in accordance with, the terms of the partnership deed and relates to any period falling after the date of such partnership deed in so far as the amount of such payment to all the partners during the previous year exceeds the aggregate amount computed as hereunder:-
21 (a) on the first Rs. 3,00,000 of the Rs. 1,50,000 or at the rate of 90 per cent. book-profit or in case of a loss of the book-profit, whichever is more;
(b) on the balance of the book-profit at the rate of 60 per cent:
Provided that in relation to any payment under this clause to the partner during the previous year relevant to the assessment year commencing on the 1st day of April, 1993, the terms of the partnership deed may, at any time during the said previous year, provide for such payment.
Explanation 1.-Where an individual is a partner in a firm on behalf, or for the benefit, of any other person (such partner and the other person being hereinafter referred to as "partner in a representative capacity" and "person so represented", respectively),-
(i) interest paid by the firm to such individual otherwise than as partner in a representative capacity, shall not be taken into account for the purposes of this clause;
(ii) interest paid by the firm to such individual as partner in a representative capacity and interest paid by the firm to the person so represented shall be taken into account for the purposes of this clause.
Explanation 2.-Where an individual is a partner in a firm otherwise than as partner in a representative capacity, interest paid by the firm to such individual shall not be taken into account for the purposes of this clause, if such interest is received by him on behalf, or for the benefit, of any other person.
Explanation 3.-For the purposes of this clause, "book-profit" means the net profit, as shown in the profit and loss account for the relevant previous year, computed in the manner laid down in Chapter IV-D as increased by the aggregate amount of the remuneration paid or payable to all the partners of the firm if such amount has been deducted while computing the net profit.
Explanation 4.-For the purposes of this clause, "working partner" means an individual who is actively engaged in conducting the affairs of the business or profession of the firm of which he is a partner;
22 (ba) in the case of an association of persons or body of individuals other than a company or a co-operative society or a society registered under the Societies Registration Act, 1860 (21 of 1860), or under any law corresponding to that Act in force in any part of India, any payment of interest, salary, bonus, commission or remuneration, by whatever name called, made by such association or body to a member of such association or body.
Explanation 1.-Where interest is paid by an association or body to any member thereof who has also paid interest to the association or body, the amount of interest to be disallowed under this clause shall be limited to the amount by which the payment of interest by the association or body to the member exceeds the payment of interest by the member to the association or body.
Explanation 2.-Where an individual is a member of an association or body on behalf, or for the benefit, of any other person (such member and the other person being hereinafter referred to as "member in a representative capacity" and "person so represented", respectively),-
(i) interest paid by the association or body to such individual or by such individual to the association or body otherwise than as member in a representative capacity, shall not be taken into account for the purposes of this clause;
(ii) interest paid by the association or body to such individual or by such individual to the association or body as member in a representative capacity and interest paid by the association or body to the person so represented or by the person so represented to the association or body, shall be taken into account for the purposes of this clause.
Explanation 3.-Where an individual is a member of an association or body otherwise than as member in a representative capacity, interest paid by the association or body to such individual shall not be taken into account for the purposes of this clause, if such interest is received by him on behalf, or for the benefit, of any other person.
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24 * * * * *.
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1. Subs. by s. 13, ibid., for section 30 to 39 (w.e.f. 1-4-1989).
2. Subs. by Act 23 of 2004, s. 11, for sub-clause (i) (w.e.f. 1-4-2005).
3. Subs. by Act 25 of 2014, s. 14, for certain words, brackets and figures (w.e.f.
1-4-2015).
4. Subs. by s. 14, ibid., for the proviso (w.e.f. 1-4-2015).
5. Subs. by s. 14, ibid., for certain words and brackets (w.e.f. 1-4-2015).
6. Subs. by Act 14 of 2010, s. 12, for certain words, brackets and figures (w.e.f.
1-4-2010).
7. Subs. by s. 12, ibid., for proviso (w.e.f. 1-4-2010).
8. Ins. by Act 25 of 2014, s. 14 (w.e.f. 1-4-2015).
9. Ins. by Act 23 of 2012, s. 11 (w.e.f. 1-4-2013).
10. Ins. by Act 29 of 2006, s. 8 (w.e.f. 1-4-2006).
11. Ins. by Act 28 of 2016, s. 22 (w.e.f. 1-6-2016).
12. Ins. by Act 18 of 2005, s. 13 (w.e.f. 1-4-2006).
13. Ins. by Act 21 of 2006, s. 10 (w.e.f. 1-4-2006).
14. Ins. by Act 21 of 2006, s. 10 (w.e.f. 1-6-2006).
15. Ins. by Act 41 of 1972, s. 2 (w.e.f. 1-4-1962).
16. Ins. by Act 17 of 2013, s. 8 (w.e.f. 1-4-2014).
17. Subs. by Act 32 of 2003, s. 19, for sub-clause (iii) (w.e.f. 1-4-2004).
18. Ins. by Act 20 of 2002, s. 20 (w.e.f. 1-4-2003).
19. Subs. by Act 18 of 1992, s. 16, for clause (b) (w.e.f. 1-4-1993). Earlier
amended by Act 67 of 1984, s. 10 (w.e.f. 1-4-1985), Act 4 of 1988, s. 13 and 3
of 1989, s. 95 (w.e.f. 1-4-1989).
20. Subs. by Act 20 of 2002, s. 20, for "eighteen per cent." (w.e.f. 1-6-2002).
21. Subs. by Act 33 of 2009, s. 15, for Items (1) and (2) (w.e.f. 1-4-2010).
22. Ins. by Act 3 of 1989, s. 9 (w.e.f. 1-4-1989).
23. Clause (c) omitted by Act 4 of 1988, s. 13 (w.e.f. 1-4-1989).
24. Clause (d) omitted by Act 26 of 1988, s. 11 (w.e.f. 1-4-1989).