Section 40 of Income Tax Act 1961: Amounts Not Deductible

Section 40 restricted specified deductions while computing income under the head "Profits and gains of business or profession". It operated even where an expense might otherwise have qualified under the general business deduction provisions.

What did Section 40 provide?

Section 40 began with a non-obstante rule overriding the deductions otherwise available under Sections 30 to 38 of the Income-tax Act, 1961. In practical terms, an expenditure could satisfy the ordinary rules for business expenditure but still be wholly or partly disallowed if it fell within Section 40.

The provision covered, among other matters, failure to comply with tax deduction at source requirements, certain taxes, specified payments involving State Government undertakings, remuneration and interest paid by firms to partners, and specified payments by associations of persons or bodies of individuals to their members.

Payments to non-residents: Section 40(a)(i)

For years governed by the 1961 Act, Section 40(a)(i) dealt with interest, royalty, fees for technical services and other sums chargeable to tax that were payable outside India, or payable in India to a non-resident or foreign company, where tax was deductible under Chapter XVII-B.

The provision also contained relief where the payer was not treated as an assessee in default because the payee had fulfilled the conditions prescribed in the proviso to Section 201(1).

Payments to residents: Section 40(a)(ia)

Section 40(a)(ia) applied to sums payable to residents on which tax was deductible at source under Chapter XVII-B. Where the required tax was not deducted, or after deduction was not paid by the due date specified in Section 139(1), 30% of the relevant sum was disallowed.

If the tax was deducted or paid later in accordance with the provision, the corresponding 30% could be allowed in the year in which the statutory condition was satisfied. Relief was also available in the specified circumstances where the payer was not deemed to be an assessee in default under Section 201.

Under the Income Tax Act, 2025, the same basic 30% resident-payment rule continues in Section 35(b)(i), with the new Act using its own TDS and return-filing section references.

Taxes and other amounts covered by Section 40(a)

Tax on business profits

Section 40(a)(ii) disallowed a rate or tax levied on the profits or gains of a business or profession, or assessed on the basis of those profits. The explanations also addressed taxes for which relief was available under Sections 90, 90A or 91.

Wealth-tax

Section 40(a)(iia) dealt with wealth-tax and taxes of a similar character as defined in that provision. Although the Wealth-tax Act, 1957 ceased to impose wealth-tax from assessment year 2016-17, the historical clause remained relevant to the statutory text for periods to which it applied.

State Government undertakings

Section 40(a)(iib) covered specified amounts such as royalty, licence fee, service fee, privilege fee, service charge or other fee or charge levied exclusively on a State Government undertaking, as well as specified amounts appropriated from such an undertaking by the State Government.

Salary payable outside India or to a non-resident

Section 40(a)(iii) restricted deduction for salary payments payable outside India or to a non-resident where the applicable tax had neither been paid nor deducted as required under Chapter XVII-B.

Payments to employee funds

Section 40(a)(iv) addressed payments to provident or other funds established for employees where effective arrangements had not been made to secure deduction of tax from taxable payments made by the fund.

Employer-paid tax on non-monetary perquisites

Section 40(a)(v) disallowed tax actually paid by an employer in the circumstances referred to in Section 10(10CC).

Historical equalisation levy clause

The former Section 40(a)(ib) dealt with consideration for specified services where equalisation levy was deductible but had not been deducted or paid within the prescribed time. This clause is of historical relevance and should be read with the amendments to the equalisation levy regime applicable to the particular period involved.

Section 40(b): remuneration and interest paid by a firm to partners

Section 40(b) restricted deductions claimed by a firm for salary, bonus, commission, remuneration and interest paid to partners. The principal conditions included the status of the partner, authority under the partnership deed, the period covered by the deed, the rate of interest and the ceiling on remuneration to working partners.

Who is a working partner?

A "working partner" means an individual who is actively engaged in conducting the affairs of the business or profession of the firm of which the individual is a partner.

Interest to partners

Interest authorised by and paid in accordance with the partnership deed was subject to the statutory ceiling. Interest exceeding 12% simple interest per annum was not deductible to the extent of the excess.

Maximum deductible remuneration to working partners

For the period governed by the amended limit effective from 1 April 2025, the ceiling is:

For earlier assessment years, the limits applicable for the relevant year must be checked. The older version of this page showed the former Rs. 3,00,000 / Rs. 1,50,000 thresholds, which were replaced with effect from 1 April 2025.

Meaning of book profit

For this purpose, "book profit" broadly refers to the net profit shown in the profit and loss account for the relevant period, computed under the business-income provisions and increased by the aggregate remuneration paid or payable to partners where that remuneration had already been deducted in computing the net profit.

Section 40(ba): payments by AOP or BOI to members

Section 40(ba) dealt with an association of persons or body of individuals, subject to the exclusions stated in the provision. It restricted deduction for interest, salary, bonus, commission or remuneration paid by the association or body to a member. The explanations contained special rules for netting certain interest payments and for members acting in a representative capacity.

Current law: Section 35 of Income Tax Act 2025

From 1 April 2026, the Income Tax Act, 2025 applies to Tax Year 2026-27 onward. Its Section 35 is titled "Amounts not deductible in certain circumstances" and consolidates the principal business-income disallowance rules corresponding to Section 40 of the 1961 Act.

Important terms

Royalty

For the relevant non-resident payment rule under the 1961 Act, "royalty" took its meaning from the royalty definition referred to in Section 9(1)(vi). The precise tax treatment depends on the nature of the payment, the charging provisions and, where relevant, an applicable tax treaty.

Fees for technical services

"Fees for technical services" was linked to the definition under Section 9(1)(vii) for the purposes of Section 40(a)(i). Whether a particular payment falls within that expression depends on the facts and the applicable statutory or treaty provisions.

Tax deduction at source

TDS is the statutory mechanism under which a payer must deduct tax from specified payments and deposit it with the Central Government. Under the 1961 Act these rules were principally contained in Chapter XVII-B. Under the 2025 Act, the corresponding TDS framework is reorganised in Chapter XIX-B.

Practical points

Before claiming a business deduction that may fall within these provisions, identify the tax year, determine whether the 1961 Act or 2025 Act governs the income, verify whether TDS was required, check the date of deduction and deposit, and review the partnership deed or other governing document where partner or member payments are involved.

Section 40 and its successor provisions operate as computation rules. A disallowance under these provisions does not by itself answer every question concerning the taxability of the recipient, TDS default, interest, penalty or prosecution; those consequences are governed by their respective provisions.

Official resources

For the current law and transition guidance, refer to the Income Tax Department - Income Tax Act 2025, official guidance on the scope and transition to the new Act, and Income Tax Department TDS compliance guidance.

Note: This article is a general legal and tax information resource. The applicable provision should always be checked for the relevant tax year and facts.