Clause 23 explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.
Clause 23 reports payments to persons specified under section 40A(2)(b) — relatives, directors, partners, members, and entities connected through a substantial interest of not less than 20% — transaction-wise, with name, PAN and relationship.
From the ICAI Guidance Note on Tax Audit (Revised 2026), the concluding edition under the Income-tax Act, 1961. For tax years under the Income-tax Act, 2025 the corresponding provision must be identified afresh, and the particulars move to Form No. 26 under rule 47 of the Income-tax Rules, 2026.
Who the specified persons are for clause 23
Paragraph 43.1 sets out the six categories in section 40A(2)(b) whose payments clause 23 captures:
| Where the assessee is | Specified persons | |
|---|---|---|
| (i) | An individual | Any relative of the assessee, as defined in section 2(41) |
| (ii) | A company, firm, AOP or HUF | Any director, partner or member, or any relative of such director, partner or member |
| (iii) | Any assessee | Any individual having a substantial interest in the business or profession of the assessee, or any relative of such individual |
| (iv) | Any assessee | A company, firm, AOP or HUF having a substantial interest in the assessee's business; or any director, partner or member of it, or any relative of such person; or any other company in which the first-mentioned company has a substantial interest |
| (v) | Any assessee | A company, firm, AOP or HUF of which a director, partner or member has a substantial interest in the assessee's business; or any director, partner or member of that entity, or any relative of such person |
| (vi) | Any assessee | Any person carrying on a business or profession in which the assessee, or a relative of the assessee (individual case), or the assessee, its director, partner or member, or a relative of such person (company, firm, AOP or HUF case), has a substantial interest |
Substantial interest — the 20% test
The Explanation to section 40A(2)(b): a person is deemed to have a substantial interest in a business or profession if:
- (a) where the business is carried on by a company — such person is, at any time during the previous year, the beneficial owner of shares carrying not less than twenty per cent of the voting power, not being shares entitled to a fixed rate of dividend, whether with or without a right to participate in profits; and
- (b) in any other case — such person is, at any time during the previous year, beneficially entitled to not less than twenty per cent of the profits of such business or profession.
Both limbs are tested at any time during the year, not at the year end — so a holding that crossed 20% for part of the year brings the person in for the whole year. And the test is beneficial ownership of voting power, not registered shareholding, and it excludes fixed-rate dividend shares. A register of members alone will not answer it.
What the auditor reports, and what he does not
Paragraph 43.2 opens with a scope point: the section enjoins on the Assessing Officer the power to fix the quantum of disallowance. Under clause 23, the particulars of payments stated to be made to persons covered under section 40A(2)(b) should be examined — clause 23 is a disclosure of the payments, not a determination that any part of them is excessive or unreasonable.
The five-step method
Paragraph 43.2 lists the steps:
- Obtain the full list of specified persons as contemplated in the section. Information furnished by the assessee should be cross verified from other data available — the members register, the list of directors, and the register of concerns in which directors are interested for companies; and the list of members, directors and trustees for co-operative societies and trusts.
- Obtain details of payments made to the specified persons.
- Scrutinise all items of payments to those persons.
- Localise the area of enquiry, because locating all such payments can be difficult and time-consuming:
- Call for all contracts or agreements entered into by the assessee, list out those with specified persons, and segregate the payments made under them.
- For credit purchases and expenses, scrutinise the appropriate ledger accounts to identify dealings with specified persons.
- For cash purchases and expenses, scrutinise the purchase or expense account. Where volumes are huge, it may be necessary to restrict the scrutiny to payments above certain monetary limits, depending on the size of the concern and the volume of business.
- In a large company, where it may not be possible to verify the list of all persons covered, the information supplied by the assessee can be relied upon — by reference to Circular No. 143 dated 20 August 1974, in which the Board clarified that a tax auditor can rely upon the list of persons covered under section 13(3) as given by the managing trustee of a public trust. Where the auditor so relies, it would be advisable to make an appropriate disclosure.
AS-18 is a starting point, not the answer
Paragraph 43.2(v): the tax auditor may refer to the details given in the annual accounts for related party transactions as per AS-18, if available, for examining the particulars reported. But he should consider the difference in the definitions of "related party" as per AS-18 and "persons specified" in section 40A(2)(b).
The two populations overlap without coinciding. AS-18 turns on control and significant influence; section 40A(2)(b) turns on a fixed 20% beneficial voting power or profit entitlement, plus the enumerated relationships of directors, partners, members and relatives. A person can be a specified person without being an AS-18 related party, and the reverse.
The TAQRB observations on clause 23
- "Name and PAN of person covered under section 40A(2)(b) were not reported in certain cases."
- "Amounts reported under this clause did not reconcile with the corresponding figures in the annual report."
- "Consolidated amounts were reported instead of transaction-wise details for each specified person under section 40A(2)(b)."
The second finding is the AS-18 comparison run in reverse: a reviewer with the annual report can compare the related party note against clause 23 and see a difference. Where there is a legitimate difference between the annual report and clause 23 — because the two definitions differ — it needs to be explicable from the working papers.
The clause 23 working paper
Paragraph 43.3 recommends the format used by the e-filing utility: name of the related person · PAN of the related person · Aadhaar number of the related person, if available · relation · date · nature of transaction · payment made (amount).
Note the date and nature of transaction columns — they are what make the reporting transaction-wise rather than a single annual total per person.
Worked example
| Payee | Specified person? | Reporting |
|---|---|---|
| Managing director's spouse, consultancy fees | Yes — relative of a director | Transaction-wise, with PAN and relation |
| Company X, which held 22% of the assessee's voting power for four months of the year | Yes — substantial interest at any time during the year | Report |
| Company Y, holding 18% throughout | No | Not reported |
| Preference shareholder with a fixed dividend rate holding 30% | No — fixed-rate dividend shares are excluded | Not reported |
| A joint venture disclosed as a related party under AS-18, no 20% link and no director in common | No | Not reported; explain the difference from the AS-18 note |
| Twelve monthly rent payments to a partner's HUF | Yes | Twelve rows, not one consolidated figure |
Audit checklist
- Obtain the list of specified persons and cross-verify it against members registers, director lists and registers of interested concerns.
- Test substantial interest on beneficial voting power or profit entitlement at any time during the year, excluding fixed-rate dividend shares.
- Work from contracts and agreements first, then ledgers, then cash purchase and expense accounts.
- Where volumes require it, set a monetary threshold for scrutiny and document it.
- Report clause 23 transaction-wise, with date, nature, name, PAN and relation.
- Reconcile against the AS-18 related party note, and explain legitimate differences.
- Where you rely on the assessee's list in a large company, make an appropriate disclosure.
- Do not express a view on whether the payments are excessive or unreasonable — that is the Assessing Officer's power.
Common mistakes
- Using the AS-18 related party list as the section 40A(2)(b) population.
- Testing the 20% holding at the year end only.
- Reporting one consolidated amount per specified person.
- Omitting the PAN and the relationship.
- Relying on the assessee's list without any disclosure.