Section 37 provides that certain business expenses are allowed as deductions only when they are actually paid.

Section 37(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 u/s 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.

Certain expenses listed in sub-section (2) are deductible only in the tax year in which they are actually paid, irrespective of:

• any contrary provision in the Act;
• the accounting method followed; or
• the year in which the liability arose.

This provision applies even if the assessee follows the mercantile system of accounting.

Ex

XYZ Ltd. has GST liability of ₹3,00,000 for FY 2026-27.

• Liability booked: March 2027
• Paid: July 2027

Deduction is available in Tax Year 2027-28, not in 2026-27.

Section 37(2)

The sums payable for the purposes of sub-section (1), shall be–

(a) Taxes, duty, cess, surcharge or fee

tax, duty, cess, surcharge or fee, by whatever named called, levied under any law in force;

(b) Employer's contribution to employee welfare funds

contribution of the employer to a provident fund or superannuation fund or gratuity fund or any fund for the welfare of employees;

(c) Leave encashment

amount payable by employer in lieu of any leave at the credit of the employee;

(d) bonus or commission paid

any sum referred to in section 32(a);

(e) Interest on Loans from Specified Financial Entities

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) Payment to Micro or Small Enterprise

amount payable by the assessed to a micro or small enterprise beyond the time limit specified in section 15 of the MSME Development Act, 2006.

Section 37(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

Notified class of NBFC by CG 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).

Section 37(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.

Section 37(3)

In case the amounts specified in sub-section (2), except 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 u/s 263(1) for such tax year,

the deduction towards such sum shall be allowed in such tax year.

If the amounts covered u/s 37(2) (except Section 37(2)(g) relating to delayed payment to MSMEs)

are paid after the end of the tax year but on or before the due date of filing the return, the deduction will still be allowed in the same tax year in which the liability was incurred.

This grace period extension does not apply to MSME payments mentioned in clause (g). MSME dues must strictly follow the MSMED Act deadlines to be eligible.

Ex

For the tax year ending March 31, 2026, a company owes an employee bonus of ₹5,00,000. The due date to file their tax return is October 31, 2026.

• Scenario A: If they pay the bonus on October 15, 2026, they can claim the deduction in the 2025-26 tax return.
• Scenario B: If they pay it on November 5, 2026 (after the filing deadline), they lose the deduction for 2025-26 and can only claim it in the next year's return (2026-27).

Section 37(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.

If interest payable to a specified financial entity is converted into a loan, advance, debenture or any other financial instrument,

such conversion shall not be treated as actual payment.

Ex

XYZ Ltd. owes ₹10 lakh as interest to a bank.

Instead of paying cash, the bank converts the interest into another loan.

Since no actual payment has been made, no deduction is allowed u/s 37.

Section 37(5)

If a deduction in respect of any sum payable u/ss (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.

Ex

For the tax year ending March 31, 2026, a company owes an employee bonus of ₹5,00,000. The due date to file their tax return is October 31, 2026.

If they pay the bonus on October 15, 2026, they can claim the deduction in the 2025-26 tax return.

Same amount shall be allowed as deduction in tax year 2026-27

Section 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).