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Section 37 Income Tax Act 2025: Which Expenses Are Deductible Only on Actual Payment?

Section 37 requires specified business liabilities to be actually paid before a deduction can be claimed. It also provides a limited return-filing-date relaxation for most categories, but not for delayed payments to micro and small enterprises.

Current legal position: The Income-tax Act, 2025 came into force on 1 April 2026. Section 37 broadly replaces section 43B of the Income-tax Act, 1961. It should not be confused with section 37 of the 1961 Act, which concerns general business expenditure.

What does Section 37 provide?

Under section 37(1), sums listed in section 37(2), if otherwise deductible, are generally deductible in computing business or professional income under section 26 only in the tax year of actual payment. This rule operates despite a contrary provision, the accounting method followed, or the year in which the liability arose. Merely recording a payable or making a provision does not establish payment.

Which payments are covered by Section 37(2)?

Section 37(2)(a): Taxes and statutory levies

Tax, duty, cess, surcharge or fee, by whatever name called, levied under a law in force, is subject to the actual-payment condition if otherwise deductible. This does not independently make income tax deductible where another provision disallows it.

Section 37(2)(b): Employer contributions

Employer contributions to a provident fund, superannuation fund, gratuity fund or another employee welfare fund are covered. Employee contributions deducted from wages are subject to separate rules and are expressly excluded from this section by subsection (6).

Section 37(2)(c): Leave encashment

An amount payable by an employer in lieu of leave standing to an employee's credit is deductible subject to the actual-payment rule.

Section 37(2)(d): Sums under Section 32(a)

The provision also includes sums referred to in section 32(a). The conditions of that underlying deduction must be satisfied independently.

Section 37(2)(e): Interest to specified financial entities

Interest on loans, advances or borrowings from specified financial entities, in accordance with the governing agreement, is covered. Converting unpaid interest into another borrowing or instrument does not constitute payment.

Section 37(2)(f): Indian Railways

Amounts payable to Indian Railways for use of railway assets are subject to actual payment.

Section 37(2)(g): Delayed payments to micro or small enterprises

Payments to a micro or small enterprise beyond the time limit under section 15 of the Micro, Small and Medium Enterprises Development Act, 2006 are covered. Unlike the other categories, this clause does not receive the return-filing-date relaxation in subsection (3).

Can payment after the tax year still qualify?

Yes, for clauses (a) to (f), subject to section 37(3). If an eligible liability is paid after the tax year ends but on or before the due date for filing the return under section 263(1), the deduction can be claimed for the tax year in which the liability arose. Clause (g), relating to delayed micro and small enterprise payments, is specifically excluded from this relaxation.

Important: The return-filing deadline exception is not a general extension of every statutory payment deadline. Other provisions, including employee contribution rules, may still impose independent conditions.

How does Section 37 affect MSME payments?

Section 15 of the MSMED Act requires payment to qualifying micro and small suppliers within the written agreed period, which cannot exceed 45 days from the relevant acceptance date. Without a written agreement, the statutory period is generally 15 days. Where payment exceeds the applicable section 15 limit, section 37(2)(g) applies and the deduction is available in the tax year of actual payment, not merely because payment occurs before the income-tax return due date.

The statutory clause refers to micro and small enterprises; it does not automatically extend to medium enterprises. Classification, supplier status, the nature of the supply and the relevant acceptance date should be checked from records.

Key definitions and special rules

Actual payment: A real discharge of the liability. Under section 37(4), conversion of interest covered by section 37(2)(e) into a loan, advance, debenture or another deferred-payment instrument is not treated as actual payment.

Specified financial entities (section 37(7)): A public financial institution, State Financial Corporation, State Industrial Investment Corporation, notified classes of non-banking financial companies, scheduled bank, or qualifying co-operative bank, excluding the specified primary agricultural and rural development institutions.

Sum payable (section 37(8)): For taxes and levies under section 37(2)(a), a sum for which liability arises during the tax year, even if it is not due for payment within that year under the relevant law.

Employee contributions (section 37(6)): Amounts received from employees as contributions to funds referred to in section 2(49)(o) are outside section 37; their deduction treatment must be determined under the applicable separate provisions.

No double deduction (section 37(5)): An amount already deducted when the liability arose cannot be deducted again when it is subsequently paid.

Practical illustrations

Example 1: Statutory fee paid before return due date

A deductible statutory fee for tax year 2026-27 remains unpaid on 31 March 2027 but is paid before the applicable return filing due date. Subject to the other deduction conditions, section 37(3) permits deduction for tax year 2026-27.

Example 2: Delayed micro enterprise invoice

A qualifying micro enterprise's invoice is paid after the deadline under section 15 of the MSMED Act, but before the income-tax return filing date. The return-date concession does not apply; the deduction is generally allowed in the tax year in which payment is actually made.

Example 3: Interest converted to a new loan

A business converts unpaid interest owed to a covered bank into a fresh loan balance. Under section 37(4), the conversion by itself is not actual payment and does not establish eligibility for deduction.

Frequently asked questions

Is Section 37 of the 2025 Act the same as Section 37 of the 1961 Act?

No. Section 37 of the 2025 Act concerns deductions on an actual-payment basis. The broadly corresponding old provision is section 43B of the 1961 Act. General business expenditure is dealt with under section 34 of the 2025 Act.

Does Section 37 allow all unpaid expenses if paid before filing the return?

No. The return-date relaxation applies to the specified sums in section 37(2)(a) to (f), subject to their other conditions, not to every business expense or the delayed MSME payment category under clause (g).

Does the provision apply to medium enterprises?

The delayed-supplier-payment clause specifically refers to micro or small enterprises, not medium enterprises.

Can unpaid bank interest be claimed after converting it into a debenture?

No. Section 37(4) states that such conversion into a deferred-payment instrument does not amount to actual payment.

Legislation and official references

Income-tax Act, 2025 - official amended text India Code Income Tax e-Filing Portal

Updated: 10 November 2026. This article is an educational explanation; the statutory text and applicable notifications govern in case of doubt.