Certain deductions allowed on actual payment basis only
[As per the Income Tax Act, 2025 (this Act) w.e.f. 1st April, 2026.]
Section 37(1) of Income Tax Act 2025
37(1) The following sums payable, as specified in sub-section (2), shall be allowed as deduction while computing the income chargeable under section 26 only in the tax year in which such sums are actually paid irrespective of––
- (a) any provision to the contrary in this Act; or
- (b) method of accounting regularly followed; or
- (c) the tax year in which the liability was incurred.
Section 37(2) of Income Tax Act 2025
37(2) The sums payable by an assessee referred to in sub-section (1), shall be––
- (a) tax, duty, cess, surcharge or fee, by whatever named called, levied under any law in force;
- (b) contribution of the employer to a provident fund or superannuation fund or gratuity fund or any fund for the welfare of employees;
- (c) amount payable by employer in lieu of any leave at the credit of the employee;
- (d) any sum referred to in section 32(a);
- (e) interest on loans or borrowings from specified financial entities as per the terms and conditions of the agreement governing such loans or advances;
- (f) amount payable to the Indian Railways for use of railway assets; or
- (g) amount payable by the assessee to a micro or small enterprise beyond the time limit specified in section 15 of the Micro, Small and Medium Enterprises Development Act, 2006.
Section 37(3) of Income Tax Act 2025
37(3) In case the amounts specified in sub-section (2), except the sum referred to in clause (g) thereof, are paid after the end of the tax year in which the liability was incurred, but on or before the due date of filing of return of income under section 263(1) for such tax year, the deduction towards such sum shall be allowed in such tax year.
Section 37(4) of Income Tax Act 2025
37(4) If interest on loans or advances specified in sub-section (2)(e) is converted into a loan or advance or debenture or any other instrument by which the liability to pay is deferred to a future date, then it shall not be deemed to have been actually paid.
Section 37(5) of Income Tax Act 2025
37(5) If a deduction in respect of any sum payable under sub-section (2) has already been allowed in any tax year when such liability was incurred, it shall not be allowed again in any subsequent tax year when paid.
Section 37(6) of Income Tax Act 2025
37(6) The provisions of this section shall not apply to a sum received by the assessee from any employee as contribution towards any of the funds referred to in section 2(49)(o).
Section 37(7) of Income Tax Act 2025
37(7) For the purposes of this section, “specified financial entities” means a public financial institution or State Finance Corporation or State Industrial Investment Corporation or notified class of non-banking financial companies or scheduled banks or co-operative banks (other than a primary agricultural credit society or a primary co-operative agricultural and rural development bank).
FAQs on Section 37 of Income Tax Act 2025
1. What does Section 37 of the Income Tax Act, 2025, deal with?
It deals with expenses that are allowed as a deduction only on an actual payment basis, regardless of the accounting method or the year the liability is incurred.
2. From which date is Section 37 applicable?
It is effective from 1st April 2026.
3. Does Section 37 override the accounting method followed by the assessee?
Yes, deductions under this section are allowed only on actual payment, regardless of whether the assessee follows cash or accrual accounting.
4. Can deductions be claimed based on provision or accrual of expense under this section?
No, expenses under this section can only be claimed when they are actually paid.
5. What types of payments are covered under Section 37(2)?
Payments like taxes, employer contributions to employee welfare funds, leave encashment, interest on loans from specified entities, dues to Indian Railways, and payments to micro/small enterprises.
6. Are payments towards GST or income tax deductible under this section?
Only taxes that are not disallowed elsewhere in the Act and are actually paid may be deductible.
7. Is leave encashment payable to employees covered under this section?
Yes, it is covered under Section 37(2)(c) and is allowed only on actual payment basis.
8. What if the payment is made after the end of the tax year but before the return filing due date?
As per Section 37(3), such payment will still be allowed as a deduction in the year liability was incurred.
9. Can interest converted into a debenture or loan be treated as ‘paid’?
No. As per Section 37(4), such conversions do not qualify as actual payments and are therefore not deductible.
10. Can deductions be claimed again in the year of actual payment if already claimed on accrual basis?
No. Double deduction is not allowed under Section 37(5).
11. Are employee contributions received by the employer also governed by this section?
No, Section 37(6) excludes contributions received from employees (they are governed by Section 2(49)(o)).
12. What is the rule regarding payments to micro or small enterprises?
Any amount payable beyond the due date under MSMED Act, 2006, is disallowed unless actually paid.
13. Is the timing of payment to MSMEs critical for deduction eligibility?
Yes. Delays beyond the prescribed limit under Section 15 of MSMED Act lead to disallowance.
14. What are “specified financial entities” under this section?
These include public financial institutions, scheduled/co-operative banks, State Finance Corporations, and notified NBFCs.
15. Are primary agricultural credit societies treated as specified financial entities?
No, they are excluded from the definition.
16. Is a bank transaction necessary for claiming the deduction?
While not always mandatory, actual payment typically implies banking or digital mode, especially for audit and evidence purposes.
17. How can one ensure compliance under this section?
Track due dates, especially for MSME payments and statutory dues, and ensure timely actual payment, not just accounting entries.
Section 37 ensures that certain specified expenses are deductible only on actual payment, overriding accounting methods or accrual-based provisions. It emphasizes fiscal discipline, particularly for statutory dues, employee-related contributions, and payments to MSMEs.
Delayed payments beyond statutory timelines, unless paid before return filing due date, can result in disallowance of deduction. The section also blocks misuse through conversion of interest into other instruments. In short, timely and actual payment is the key to claiming deductions under this provision.
