Chapter IV - Computation of Total Income
Section 37
Section 37: certain deductions allowed only on actual payment
Section 37 overrides the accounting method otherwise followed by the assessee, and provides that certain specified sums are deductible while computing business income only in the tax year they are actually paid - not the year the liability was incurred.
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This article is for general information. Refer to the Income-tax Act, 2025 as amended by the Finance Act, 2026 and the Taxation and Other Laws (Amendment) Act, 2026 for the official provisions. If you need professional advice for your situation, contact Bizeneed.
Statutory text
Bare law
(1) The sums payable, as specified in sub-section (2), which are otherwise allowable as a deduction under this Act, shall be allowed as a 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.
(2) The sums payable for the purposes of 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 advances or borrowings from specified financial entities as per the terms and conditions of the agreement governing such loans or advances or borrowings; (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.
(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.
(4) If interest on loans or advances or borrowings 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.
(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 it is paid.
(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).
(7) For the purposes of this section, “specified financial entities” means a public financial institution or State Financial Corporation or State Industrial Investment Corporation or such class of non-banking financial companies as may be notified by the Central Government or a scheduled bank or a co-operative bank (other than a primary agricultural credit society or a primary co-operative agricultural and rural development bank).
(8) For the purposes of sub-section (2)(a), “the sum payable” means a sum for which the assessee has incurred liability in the tax year even though such sum might not have been payable within that year under the relevant law.
Introduction
For the liabilities listed here, an accrual entry alone does not establish the deduction year. The actual payment date, and whether the return-date proviso applies to that category, determine timing.
Key takeaways
Actual payment rule
Specified business liabilities, though otherwise deductible, are allowed in the tax year of actual payment rather than merely when accrued.
Return-date exception
Payment by the return-filing due date can preserve the earlier-year deduction for the listed categories to which the proviso applies; the statutory MSME payment category is excluded from that exception.
The sums covered
Section 37(2) lists the sums that must be deducted on an actual-payment basis:
- Tax, duty, cess, surcharge or fee (however named) levied under any law in force.
- Employer's contribution to a provident fund, superannuation fund, gratuity fund, or any employee welfare fund.
- Amount payable by the employer in lieu of any leave standing to an employee's credit (leave encashment).
- Any sum referred to in Section 32(a) (bonus or commission to an employee).
- Interest on loans, advances or borrowings from specified financial entities, as per the terms of the relevant agreement.
- Amount payable to Indian Railways for use of railway assets.
- Amount payable by the assessee to a micro or small enterprise beyond the time limit specified under section 15 of the Micro, Small and Medium Enterprises Development Act, 2006.
Payment before the return-filing due date still counts
Section 37(3) provides relief: if these amounts (other than the MSME-dues item) are paid after the end of the relevant tax year but on or before the due date for filing the return under section 263(1), the deduction is still allowed for that earlier tax year.
What does NOT count as "actually paid"
Section 37(4) clarifies that if interest on loans/advances/borrowings from specified financial entities is converted into a loan, advance, debenture or other instrument that defers the liability to a future date, it is not treated as actually paid.
Section 37(5) prevents double deduction - if a deduction for a sum was already allowed in the year the liability was incurred, it cannot be allowed again in a later year when it is actually paid.
Who counts as "specified financial entities"
Section 37(7) defines "specified financial entities" as a public financial institution, State Financial Corporation, State Industrial Investment Corporation, notified classes of non-banking financial companies, a scheduled bank, or a co-operative bank (excluding a primary agricultural credit society or primary co-operative agricultural and rural development bank).
Step-by-step flow for applying Section 37
- 1
Is the sum one of those listed in Section 37(2)?
Taxes, duties, cess or fees; employer contributions to PF, superannuation, gratuity or welfare funds; leave encashment; bonus or commission under Section 32(a); interest to specified financial entities; amounts payable to Indian Railways for use of railway assets; amounts payable to a micro or small enterprise beyond the MSMED Act time limit.
- No: Section 37 does not restrict it.
- Yes: Go to the next step.
- 2
Was it actually paid during the tax year?
- Yes: Deductible in this tax year.
- No: Go to the next step.
- 3
Is it the MSE payment under clause (g)?
- Yes: Allowed only in the year actually paid; the return due date relief in Section 37(3) does not apply.
- No: Go to the next step.
- 4
Was it paid on or before the Section 263(1) return due date?
- Yes: Allowed in the year the liability was incurred (Section 37(3)).
- No: Allowed only in the year of actual payment.
- 5
Interest converted into a loan, debenture or other deferred instrument?
Under Section 37(4) this is not treated as actual payment.
Practical checklist
Do
- Maintain a category-by-category ledger of statutory liabilities and actual payment dates.
- For an unpaid year-end item, test the return-filing due-date proviso and its exceptions before finalising the tax computation.
Avoid
- Do not apply the return-date relaxation to the delayed MSME payment category.
- Do not claim a deduction twice when a liability accrued in one year and was paid in another.
Illustrative example
Worked example: unpaid MSE supplier and bank interest
Hypothetical facts (illustration only, not a real taxpayer): At the end of the tax year a company owes ₹4 lakh to a registered micro enterprise beyond the time limit under section 15 of the MSMED Act, 2006, and ₹2 lakh of interest to a scheduled bank. It pays the bank interest before the return due date and pays the supplier only in the next tax year.
Bank interest
Interest to a specified financial entity is covered by Section 37(2)(e). It was paid before the Section 263(1) due date, so Section 37(3) allows it in the year the liability was incurred.
MSE supplier
The amount falls under Section 37(2)(g). Section 37(3) does not extend to clause (g), so it is deductible only when actually paid.
No double claim
Section 37(5) prevents claiming the same sum again in a later year if it was already allowed.
Outcome
- Bank interest: deductible in the current year.
- MSE payable: deductible in the next tax year, when it is paid.
Glossary
- Actual-payment basis
- Deduction timing tied to payment rather than accounting accrual for the specified liabilities.
- MSME payment
- A payment to a micro or small enterprise subject to the separate statutory timing rule in this section.
Frequently asked questions
Can a business deduct a statutory due like GST or PF before it is actually paid?
Only if it is paid on or before the due date for filing the tax return for that year (under Section 263(1)). If paid later, the deduction is allowed only in the year of actual payment, per Section 37(1) and (3).
Does converting interest into a new loan or debenture count as payment?
No. Section 37(4) specifically states that converting interest payable to specified financial entities into a loan, advance, debenture or similar instrument that defers payment is not treated as "actually paid".
Are dues to small enterprises covered by this actual-payment rule?
Yes - Section 37(2)(g) covers amounts payable to a micro or small enterprise beyond the time limit specified in section 15 of the MSME Development Act, 2006, though the return-due-date relief in Section 37(3) does not apply to this particular item.
Need help applying this provision to your situation?
Get your statutory-dues deductions checked by our tax audit teamLast updated 10 October 2026