Tax Compliance and Non-Deductibility of certain expenditure: Clause 35 of the Income Tax Bill, 2025 vs. Section 40 of the Income-tax Act, 1961

Clause 35 Amounts not deductible in certain circumstances.

Income Tax Bill, 2025

Clause 35 of the Income Tax Bill, 2025, and Section 40 of the Income-tax Act, 1961, are both pivotal provisions that govern the non-deductibility of certain expenses while computing income under the head "Profits and gains of business or profession." These provisions are instrumental in ensuring compliance with tax obligations, preventing tax evasion, and aligning with international tax standards. This article provides a comprehensive analysis of Clause 35 of the Income Tax Bill, 2025, and a comparative study with the existing Section 40 of the Income-tax Act, 1961.

Objective and Purpose

The primary objective of Clause 35 of the Income Tax Bill, 2025, is to delineate specific expenses that are not deductible when calculating taxable income under business or professional income. This clause aims to ensure that taxpayers do not reduce their taxable income through deductions that are not aligned with the legislative intent. The provision is designed to prevent tax avoidance strategies and ensure equitable tax collection. Similarly, Section 40 of the Income-tax Act, 1961, serves the same purpose and has been a cornerstone in the Indian tax regime for decades.

Detailed Analysis

Clause 35 of the Income Tax Bill, 2025

• Sub-Clause (a): Prohibits the deduction of taxes paid on income, including surcharges or cess. This aligns with the principle that taxes paid should not reduce taxable income.
• Sub-Clause (b): Addresses non-deductibility of 30% of payments to residents where tax is deductible but not deducted or paid. It allows subsequent deduction when taxes are paid, ensuring compliance with tax deduction at source (TDS) provisions.
• Sub-Clause (c): Disallows salary payments outside India or to non-residents if TDS is not complied with, reinforcing the importance of TDS in cross-border transactions.
• Sub-Clause (d): Focuses on equalisation levy on payments to non-residents for specified services, ensuring adherence to digital economy taxation principles.
• Sub-Clause (e): Disallows state-imposed charges on state undertakings, preventing state-level tax avoidance.
• Sub-Clause (f): Governs remuneration and interest payments in partnerships, ensuring they are authorized by partnership deeds and within specified limits.
• Sub-Clause (g): Similar to partnerships, this sub-clause addresses payments in associations or bodies, ensuring compliance with internal agreements.

Section 40 of the Income-tax Act, 1961

• Sub-Clause (a): Similar to Clause 35(a), it disallows deduction of taxes on income, emphasizing the same principle of non-deductibility of taxes.
• Sub-Clause (ia): Corresponds to Clause 35(b), focusing on non-deductibility of certain payments to residents when TDS is not complied with, with provisions for subsequent deduction.
• Sub-Clause (ib): Aligns with Clause 35(d), addressing equalisation levy on non-resident payments, ensuring compliance with digital service taxation.
• Sub-Clause (ii): Prohibits deduction of taxes levied on business profits, similar to Clause 35(a), reinforcing the non-deductibility of such taxes.
• Sub-Clause (iii): Similar to Clause 35(c), it disallows salary payments outside India or to non-residents without TDS compliance.
• Sub-Clause (iv): Aligns with Clause 35(f), governing payments in partnerships, ensuring they are within authorized limits.
• Sub-Clause (v): Corresponds to Clause 35(g), addressing payments in associations or bodies, ensuring compliance with internal agreements.

Practical Implications

The provisions under Clause 35 and Section 40 have significant implications for businesses and tax practitioners. They necessitate meticulous compliance with TDS provisions and adherence to partnership agreements to avoid disallowance of deductions. Businesses must ensure proper documentation and timely payment of taxes to claim deductions in subsequent years. The emphasis on equalisation levy also highlights the growing importance of digital economy taxation.

Comparative Analysis

While both Clause 35 and Section 40 serve similar purposes, Clause 35 introduces more detailed provisions, particularly regarding digital economy taxation and state-imposed charges. The emphasis on equalisation levy in Clause 35 reflects the evolving tax landscape, adapting to global digital taxation norms. The provisions in Clause 35 are more comprehensive in addressing cross-border transactions and state-level tax avoidance strategies.

Conclusion

Clause 35 of the Income Tax Bill, 2025, and Section 40 of the Income-tax Act, 1961, are crucial in ensuring compliance with tax obligations and preventing tax avoidance. While both provisions share similar objectives, Clause 35 introduces more detailed and comprehensive measures, particularly in addressing digital economy taxation and state-level charges. Businesses and tax practitioners must stay abreast of these provisions to ensure compliance and optimize tax planning strategies.

Full Text:

Clause 35 Amounts not deductible in certain circumstances.

Dated: 7-3-2025