Sub-section (1) makes the section override anything to the contrary in any other provision relating to computation of income under "Profits and gains of business or profession".
Sub-section (2) is the related-party disallowance. Where the assessee incurs expenditure for which payment has been or is to be made to a "specified person" and the Assessing Officer is of opinion that it is excessive or unreasonable having regard to the fair market value of the goods, services or facilities, the legitimate needs of the business or profession, or the benefit derived by or accruing to the assessee, so much of the expenditure as he considers excessive or unreasonable is not allowed as a deduction.
Sub-section (3) defines who a specified person is. The Table in clause (a)(i) pairs the assessee in column B with the person in column C: an individual with any relative; a company with any director or his relative; a firm with a partner or his relative; an association of persons with a member or his relative; a Hindu undivided family with a member or his relative. Clauses (a)(ii) to (iv) widen it to a person having substantial interest in the assessee's business or profession and that person's directors, partners, members and their relatives, and any other company in which the first company has substantial interest; to a company, firm, association or Hindu undivided family whose director, partner or member has such an interest; and to a person in whose business or profession the assessee, or its directors, partners, members or their relatives, has substantial interest. Clause (b) defines substantial interest: where the business is carried on by a company, beneficial ownership at any time during the tax year of shares carrying not less than 20% of the voting power, excluding shares entitled to a fixed rate of dividend; in any other case, beneficial entitlement at any time during the tax year to not less than 20% of the profits.
Sub-sections (4) to (8) deal with the mode of payment. Sub-section (4) disallows the expenditure where any payment, or the aggregate of payments, made in a day to a person exceeds Rs. 10000 and is not made through specified banking or online mode. Sub-section (5) is the mirror rule for a liability deducted earlier: where a deduction was taken in a preceding tax year and the payment is made in a subsequent year, exceeding Rs. 10000 in a day to a person and not through specified banking or online mode, the payment is deemed to be income under "Profits and gains of business or profession" of that subsequent year. Sub-section (6) reads Rs. 10000 as Rs. 35000 for payments for plying, hiring or leasing of goods carriages. Sub-section (7) allows sub-sections (4) and (5) to be disapplied in cases and circumstances as may be prescribed, having regard to the banking facilities available, business expediency and other relevant factors. Sub-section (8) protects the complying payer: nothing in any other law or in any contract about the mode of payment applies to a payment made through specified banking or online mode in compliance with sub-sections (4) to (7), and no plea may be raised in any suit or proceeding that payment was not made or tendered in cash or in another mode.
Sub-section (9) disallows any deduction or allowance for marked to market loss or other expected loss, except as allowable under section 32(1)(h).
Why it is there
Two forms of leakage are addressed. Payments to people close to the assessee can move profit out at a price no unrelated party would accept, so sub-section (2) allows the excess to be tested against three objective yardsticks and disallowed. Cash leaves no trail, so sub-sections (4) to (6) cap daily cash expenditure per person and sub-section (5) closes the obvious escape of taking the deduction in one year and paying cash in another. Sub-section (8) then makes sure that a payer who does comply cannot be forced back into cash by a contract or another law, and sub-section (9) keeps unrealised losses out of the computation except where section 32(1)(h) allows them.
Who it applies to
Every assessee computing income under "Profits and gains of business or profession"
A relative of an individual assessee, a director of a company, a partner of a firm, a member of an association of persons or of a Hindu undivided family, and their relatives
A person holding not less than 20% of the voting power or of the profits of the assessee's business or profession, and entities connected with him
A person paid for plying, hiring or leasing of goods carriages
The Assessing Officer forming the opinion that expenditure is excessive or unreasonable
The figures, and what each one turns on
Read the condition in the same row. A figure quoted without it is a wrong answer with a citation attached.
What
Figure
The condition on it
Where
Substantial interest where the business is carried on by a company
Not less than 20% of the voting power
Beneficial ownership of shares at any time during the tax year, excluding shares entitled to a fixed rate of dividend whether or not carrying a right to participate in profits
Sub-section (3)(b)(i)
Substantial interest in any other case
Not less than 20% of the profits
Beneficial entitlement at any time during the tax year to that share of the profits of the business or profession
Sub-section (3)(b)(ii)
Cash payment ceiling for a deduction
Rs. 10000
Any payment or aggregate of payments made in a day to a person, not made through specified banking or online mode; the expenditure by way of such payments is disallowed
Sub-sections (4) and (5)
Raised ceiling for goods carriages
Rs. 35000
Read in place of Rs. 10000 only where the payment is made for plying, hiring or leasing of goods carriages
Sub-section (6)
What this means in practice
Sub-section (4) disallows "the expenditure by way of such payments", not the excess over the limit — a single cash payment of Rs. 45000 loses the whole Rs. 45000, not Rs. 35000 of it. The test is applied per person per day and it aggregates, so breaking one bill into several cash payments to the same person on the same day does not help. Sub-section (5) is not another disallowance but a deeming of income: pay an earlier year's already-deducted liability in cash above the limit and the payment itself becomes business income of the year of payment. The Rs. 35000 figure is narrow — sub-section (6) confines it to plying, hiring or leasing of goods carriages. On the related-party side, being a specified person does not by itself cost the deduction: sub-section (2) disallows only "so much of the expenditure as considered excessive or unreasonable", and the yardsticks are the three in clauses (a) to (c). Substantial interest under sub-section (3)(b) is tested at any time during the tax year, so a holding that existed for part of the year is enough.
An example
Illustrative only, and invented for this page. The figures are chosen to show the rule biting, not taken from any real matter.
A company pays a director's relative 30 lakh rupees for consultancy in a year when comparable services are available for 18 lakh. The relative is a specified person under the Table at Sl. No. 2, and the Assessing Officer may disallow the 12 lakh he considers excessive having regard to fair market value — the remaining 18 lakh stands. Separately, the same company pays a supplier 45,000 rupees in cash in one day: the whole 45,000 is disallowed under sub-section (4), and even if the payment had been for hiring a goods carriage the raised limit of 35,000 in sub-section (6) would not have saved it.
Where you meet this section
In an assessment order under the business head — the related-party disallowance under sub-section (2) and the cash-payment disallowance under sub-section (4) are two of the most common additions — and in the show-cause that precedes it, asking for the basis of a payment to a related party or for evidence of the mode of payment.
The words themselves
so much of the expenditure as considered excessive or unreasonable by him shall not be allowed as a deduction
Section 36(2), Income-tax Act, 2025.
any payment or aggregate of payments made in a day to a person exceeds Rs. 10000 and is not made through specified banking or online mode, then the expenditure by way of such payments shall not be allowed as a deduction
Section 36(4), Income-tax Act, 2025.
the figures "Rs. 10000" shall be read as "Rs. 35000" in case the payment is made for plying, hiring or leasing of goods carriages
Section 36(6), Income-tax Act, 2025.
What people get wrong
Disallowing only the amount above Rs. 10000. Sub-section (4) disallows the expenditure by way of such payments, that is the whole payment.
Splitting a bill into several cash payments on the same day. Sub-section (4) applies to any "payment or aggregate of payments made in a day to a person".
Applying Rs. 35000 to transport expenses generally. Sub-section (6) substitutes it only for payment for plying, hiring or leasing of goods carriages.
Disallowing the entire payment to a specified person. Sub-section (2) disallows only so much as the Assessing Officer considers excessive or unreasonable on the yardsticks in clauses (a) to (c).
Testing substantial interest at the year end. Sub-section (3)(b) is satisfied by a holding or entitlement at any time during the tax year, and the 20% share test leaves out shares entitled to a fixed rate of dividend.
Overlooking sub-section (5). Paying an earlier year's deducted liability in cash above the limit does not merely fail a deduction — the payment is deemed to be business income of the year of payment.
Claiming an expected or marked to market loss under a general provision. Sub-section (9) bars it except as allowable under section 32(1)(h).
What this replaced
The correspondence is the Income Tax Department’s own, from its comparison utility for the 1961 and 2025 Acts. A renumbering is the easy half; whether the words changed is the half that decides cases.
40A - Expenses or payments not deductible in certain circumstances
Rules of the Income-tax Rules, 2026 that work section 36. Where the rule’s own heading names the section we say so; the rest are marked on reading the rule, which is our derivation and not the department’s. A rule that serves the section silently and that we have missed will not appear here.
Rule 26 — Cases and circumstances in which a payment or aggregate of payments exceeding ten thousand rupees may be made to a person in a day, otherwise than by specified banking and online mode or through such other electronic mode as provided in rule 48 — on reading the rule
A circular binds the department, not you and not a court. Every one below was written under the 1961 Act; it reaches this section because the department’s own concordance carries the provision it names to this one.
Circular No. 27/2017 — Clarification on cash sale of agricultural produce by cultivators/agriculturists 2017-11-03
Circular No. 10/2008 — Clarification Regarding the Meaning of the Expression 'Fish or Fish Products' Used in Sub-clause (iii ) of Clause (f) of rule 6DD 2008-12-05
Circular No. 3/2008 — Explanatory Notes to the Provisions of the Finance Act, 2007 2008-03-12
Circular No. 4/2006 — Clarification Regarding the Meaning of the Expression "The Produce of Animal Husbandry’ Used in Sub-clause (ii) of Clause (f) of r 2006-03-29
Circular No. 522 — 384. Monetary ceilings prescribed in section 40A(3)/269SS/269T - Raised to Rs. 10,000, Rs. 20,000 and Rs. 20,000, respectively, by 1988-08-18
Circular No. 250 — 381. Payment made during the period when cheque clearing operations by banks suspended - Whether covered under sub-section (3) 1979-01-11
Circular No. 220 — 383. Circumstances when Income-tax Officer can relax requirement of making payments in excess of Rs. 2,500 by crossed cheques unde 1977-05-31
Circular No. 169 — Provision for estimated service gratuity payable to its employees -Deduction under section 37(1) and section 40A(7) after its inse 1975-06-23
Circular No. 146 — Provision for estimated service gratuity payable to its employees -Deduction under section 37(1) and section 40A(7) after its inse 1974-09-26
Circular No. 47 — Provision for estimated service gratuity payable to its employees -Deduction under section 37(1) and section 40A(7) after its inse 1970-09-21
Circular No. 34 — Section 40A l Expenses or Payments NOT Deductible 1970-03-05
Circular No. 33 — Section 40A l Expenses or Payments NOT Deductible 1969-12-29
A notification is made under a power the Act gives and, within that power, is law. These too were made under the 1961 Act and are placed here by the department’s concordance.
Notification No. 98 — Income-tax (Eighth Amendment) Rules, 2008 - Insertion of rule 18DDA and Form No. 10CCBD 2008-10-22
Notification No. 58 — Amendment of the Income-tax Rules under section 40A of the Income-tax Act, 1961 2005-02-17
Notification No. 806(E) — A notification under section 40A of the Income-tax Act, 1961 2000-09-06
Read this before you rely on it. Every decision below was decided under the Income-tax Act, 1961. It appears here because it is tagged to a 1961 provision that the department’s own mapping carries to section 36. That is an inference we have drawn, not a holding on the new section: where the words changed in the move, the reasoning may not survive. Treat this as the place to start looking, not as authority on the 2025 Act.
Attar Singh Gurmukh Singh v ITOSupreme CourtHelps departmenttagged s.40A(3) I paid cash for stock purchases. Can the AO disallow it under 40A(3), and is that section even valid?
CIT v Textool Co LtdSupreme CourtHelps taxpayertagged s.40A(7) We paid our gratuity money straight to lic while the fund's approval was still pending. Will s.36(1)(v) be denied?
Price Waterhouse Coopers Pvt Ltd v CITSupreme CourtHelps taxpayertagged s.40A(7) You forgot to add back something your own audit report flagged. Is that concealment?
Shree Choudhary Transport Company v ITOSupreme CourtHelps departmenttagged s.40A(3) The AO has disallowed lorry hire I had already paid, not amounts still outstanding. Can section 40(a)(ia) reach sums actually paid?
V.M. Salgaocar & Bros P Ltd v CITSupreme CourtHelps taxpayertagged s.40A(5) For old years, was an interest-free loan from my employer taxable as a perquisite?
CIT (E) v IILM FoundationHigh CourtHelps taxpayertagged s.40A(2)(a) Our trust pays a salary to its chairperson, who is a trustee. Does that cost us the s.11 exemption?
CIT v Banwari Lal BanshidharHigh CourtHelps taxpayertagged s.40A(3) The Assessing Officer rejected my books and estimated my income by applying a gross profit rate. Can he also disallow my cash purchases under section…
CIT v Ratanlal Vyaparilal JainHigh CourtHelps taxpayertagged s.40A(3) Does the jewellery instruction explain the source of the gold, or only stop the department seizing it?
PCIT v Future First Info Services P LtdHigh CourtHelps taxpayertagged s.40A(2) The AO says I short-deducted TDS on director remuneration. Can he disallow the payment under 40(a)(ia)?
PCIT v Mahabir Jute Mills LtdHigh CourtHelps taxpayertagged s.40A(3) The Assessing Officer disallowed my cash payments under section 40A(3) and an ad hoc slice of expenditure, then used those two findings to reject my…
Smt Harshila Chordia v ITOHigh CourtHelps taxpayertagged s.40A(3) The Assessing Officer has added my cash sale receipts under section 68 as unexplained cash credits. Can cash taken from customers against delivery of…
Vaduganathan Talkies v ITOHigh CourtHelps departmenttagged s.40A(3) The purchases are genuine and I can name every payee. Does that answer a s.40A(3) disallowance?
A. Daga Royal Arts v ITOITATHelps taxpayertagged s.40A(3) The AO disallowed cash paid at the registrar's office for land. Is Rule 6DD the only way out?
Patel Kenwood P Ltd v ITOITATHelps taxpayertagged s.40A(2)(b) The AO disallowed rent I pay to relatives just because they are related. Is that enough?
Specified domestic transactionstagged s.40A(2) Do I still have to benchmark payments to my own directors and group companies under transfer pricing?
Read with
Section 32
What this page does not tell you. It does not reproduce the section. Everything above was written from the section’s own text as the Income Tax Department publishes it — the text is here, and nothing here is advice on your facts. Where a figure matters, read the sub-section it comes from.