Ensuring Fair Tax Practices: An Analysis of Clause 36 in the Income Tax Bill, 2025 vs. Section 40A of the Income Tax Act, 1961

Clause 36 Expenses or payments not deductible in certain circmstances.

Income Tax Bill, 2025

Introduction

Clause 36 of the Income Tax Bill, 2025, introduces provisions regarding the non-deductibility of certain expenses or payments under the head "Profits and Gains of Business or Profession." This clause is significant as it aims to prevent the deduction of excessive or unreasonable expenses, ensuring that only genuine business expenses are deductible. This provision is crucial in maintaining the integrity of tax computations and preventing tax evasion through inflated expenses.

Objective and Purpose

The legislative intent behind Clause 36 is to curb the practice of inflating business expenses to reduce taxable income. By disallowing deductions for payments deemed excessive or unreasonable, the provision ensures that tax liabilities are calculated based on actual business needs and fair market values. This aligns with broader policy considerations of promoting transparency and fairness in tax administration.

Detailed Analysis

Clause 36 is structured to address specific scenarios where expenses may be disallowed:

1. Excessive or Unreasonable Payments to Specified Persons:

- Subsection (2) empowers the Assessing Officer to disallow deductions for payments to "specified persons" if deemed excessive or unreasonable. The criteria include fair market value, business needs, and benefits derived.

- The definition of "specified person" is detailed in Subsection (3), covering relatives, directors, partners, and entities with substantial interest in the business.

2. Payments Exceeding Thresholds Not Made Through Banking Channels:

- Subsection (4) disallows deductions for payments exceeding Rs. 10,000 not made through specified banking or online modes, promoting transparency and traceability.

- Subsection (5) deems such payments as income if they relate to liabilities deducted in previous years.

3. Exceptions and Special Cases:

- Subsection (6) increases the threshold to Rs. 35,000 for payments related to goods carriages.

- Subsection (7) allows exceptions based on prescribed circumstances, considering business expediency and banking facilities.

4. Legal Supremacy of Banking Transactions:

- Subsection (8) establishes the precedence of banking transactions over other laws or contracts, ensuring compliance with the specified modes of payment.

Practical Implications

Clause 36 impacts various stakeholders by enforcing stricter compliance requirements. Businesses must ensure that payments to specified persons are justified and within reasonable limits. The emphasis on banking transactions necessitates robust financial practices and documentation. Non-compliance could result in increased tax liabilities and potential penalties.

Comparative Analysis with Section 40A of the Income Tax Act, 1961

Clause 36 of the Income Tax Bill, 2025, shares similarities with Section 40A of the Income Tax Act, 1961, but introduces refinements and updates:

1. Scope and Definitions:

- Both provisions address excessive payments to related parties, but Clause 36 provides a more detailed definition of "specified persons" and "substantial interest."

2. Payment Modes and Thresholds:

- While both provisions emphasize banking transactions, Clause 36 updates the thresholds and includes provisions for online modes, reflecting modern financial practices.

3. Exceptions and Flexibility:

- Clause 36 offers more flexibility with exceptions based on business expediency, which is less pronounced in Section 40A.

4. Legal Precedence:

- Clause 36 explicitly overrides other laws regarding payment modes, reinforcing the importance of banking transactions.

Conclusion

Clause 36 of the Income Tax Bill, 2025, represents a significant step towards ensuring fair and transparent tax practices. By refining the provisions of Section 40A, it aligns with contemporary business environments and financial practices. Future developments may include further clarifications on exceptions and the integration of evolving digital payment methods.

 

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Full Text:

Clause 36 Expenses or payments not deductible in certain circmstances.

 

Dated: 7-3-2025