Section 37 of the Income-tax Act, 2025 allows specified sums only in the year they are actually paid. Payment before the return due date under section 263(1) saves the deduction — except for amounts payable to micro and small enterprises, which must be paid within the MSMED Act time limit.
What section 37 does
Section 37 is the successor to section 43B of the Income-tax Act, 1961 — the provision that overrides your method of accounting for a specific list of payments. Whatever your books say, these sums are deductible only in the year they are actually paid.
The list in sub-section (2) runs to seven items, and clause (g) is the one that has caused the most disruption in recent years: amounts payable to a micro or small enterprise beyond the time limit in section 15 of the MSMED Act, 2006.
The critical asymmetry is in sub-section (3). For every item except clause (g), paying before the return due date under section 263(1) preserves the deduction in the year the liability arose. For MSME dues, that relaxation does not apply — miss the MSMED time limit and the deduction shifts to the year of actual payment.
The Income-tax Act, 2025 takes effect from 1 April 2026 and applies from tax year 2026-27. The Income-tax Act, 1961 continues to govern every year up to 31 March 2026, including assessments, appeals and penalties for those years, because of the repeal and savings provision in section 536. Figures quoted here are the amounts written into the Act as enacted (with the Gazette corrigenda of 3 September 2025); the annual Finance Act can change rates and thresholds.
Old Act and new Act, side by side
The table below shows what the Income-tax Act, 1961 did and where the same ground is covered in the Income-tax Act, 2025.
| Income-tax Act, 1961 | What it did | Income-tax Act, 2025 |
|---|---|---|
| 43B | Specified sums allowed only on actual payment | 37(1) and 37(2) |
| 43B, first proviso | Payment before return due date saves the deduction | 37(3) |
| 43B(h) | MSME dues beyond the MSMED time limit | 37(2)(g), excluded from the 37(3) relaxation |
| 43B, Explanation 3C/3D | Interest converted into a loan is not payment | 37(4) |
| 36(1)(va) | Employee contributions — outside this section | 37(6) |
Section 37 sub-section by sub-section
Read this alongside the bare text — each heading below is a sub-section of the section as enacted.
Sub-section (1) — the override
Sums specified in sub-section (2) that are otherwise allowable are deductible only in the tax year in which they are actually paid, irrespective of any provision to the contrary in the Act, the method of accounting regularly followed, or the year in which the liability was incurred. Mercantile accounting does not help here.
Sub-section (2) — the seven categories
(a) Tax, duty, cess, surcharge or fee by whatever name called, levied under any law in force; (b) employer's contribution to a provident, superannuation or gratuity fund, or any fund for employee welfare; (c) amount payable by the employer in lieu of leave at the employee's credit; (d) any sum referred to in section 32(a); (e) interest on loans, advances or borrowings from specified financial entities as per the governing agreement; (f) amount payable to the Indian Railways for use of railway assets; and (g) amount payable to a micro or small enterprise beyond the time limit in section 15 of the MSMED Act, 2006.
Sub-section (3) — the return-due-date relaxation, and its exception
Where the amounts in sub-section (2) — except clause (g) — are paid after the end of the tax year in which the liability was incurred but on or before the due date for filing the return under section 263(1), the deduction is allowed in that earlier tax year. The exclusion of clause (g) is the single most important sentence in this section: MSME dues get no such grace.
Sub-section (4) — converting interest into a loan is not payment
If interest covered by clause (2)(e) is converted into a loan, advance, debenture or any other instrument by which the liability to pay is deferred, it is not deemed to have been actually paid. Restructuring an overdue interest liability does not unlock the deduction.
Sub-section (5) — no double deduction
If a deduction for a sum in sub-section (2) has already been allowed in the year the liability was incurred, it cannot be allowed again in the later year of payment.
Sub-section (6) — employee contributions are outside this section
The section does not apply to a sum received by the assessee from an employee as a contribution to any of the funds referred to in section 2(49)(o). Employee contributions are governed separately, and the strict due-date rule for depositing them is not relaxed by section 37.
Sub-sections (7) and (8) — two definitions that decide scope
Specified financial entities means 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 other than a primary agricultural credit society or a primary co-operative agricultural and rural development bank. And for clause (2)(a), 'the sum payable' means a sum for which liability was incurred in the tax year even if it was not payable within that year under the relevant law.
Worked example
A company follows the mercantile system. Its tax year 2026-27 accounts carry the following unpaid balances at 31 March 2027. Assume the return due date under section 263(1) is 31 October 2027.
| Liability outstanding on 31 March 2027 | Amount | Paid on | Deduction year |
|---|---|---|---|
| GST payable | ₹40,00,000 | 20 August 2027 — before the return due date | 2026-27 — sub-section (3) |
| Employer's provident fund contribution | ₹8,00,000 | 15 December 2027 — after the return due date | 2027-28 — year of payment |
| Interest to a scheduled bank on a term loan | ₹22,00,000 | Converted into a fresh term loan | Neither — sub-section (4) says this is not payment |
| Payable to a micro enterprise, MSMED limit expired | ₹35,00,000 | 5 September 2027 — before the return due date | 2027-28 — clause (g) is excluded from sub-section (3) |
| Payable to a small enterprise, paid within the MSMED limit | ₹18,00,000 | Within the section 15 time limit | 2026-27 — clause (g) never triggered |
The MSME row is the trap. The company paid ₹35,00,000 well before the return due date, exactly as it would for GST — but because clause (g) is carved out of sub-section (3), the deduction still moves to 2027-28. The only way to keep it in 2026-27 was to pay within the MSMED Act time limit, which is generally 45 days where there is a written agreement and 15 days otherwise.
Compliance checklist and due dates
- Identify every vendor's Udyam registration status and whether they are micro or small; the clause (g) rule turns on it.
- Track the MSMED section 15 time limit per invoice — payment before the return due date does not save the deduction.
- For all other clause (2) items, pay on or before the section 263(1) due date and retain the challan.
- Reconcile the statutory dues ledger to challans at year end so the sub-section (3) claim can be evidenced.
- Do not restructure overdue bank interest expecting a deduction — sub-section (4) blocks it.
- Keep employee contributions out of this section entirely; sub-section (6) excludes them.
- Check the definition in sub-section (7) before claiming interest to a lender — not every NBFC is a specified financial entity.
Common mistakes
- Assuming the return-due-date relaxation applies to MSME dues. Sub-section (3) expressly excludes clause (g).
- Treating a conversion of interest into a loan as payment.
- Claiming the deduction twice — once on accrual and again on payment. Sub-section (5) prevents it.
- Applying section 37 to employee contributions, which sub-section (6) puts outside the section.
- Claiming interest paid to a lender that does not meet the sub-section (7) definition.
- Overlooking sub-section (8): for taxes and duties, the liability counts even if it was not payable within the year under the relevant law.
This is an explanatory guide, not tax advice, and it does not reproduce the section in full. Read the bare text of the section before you rely on it, and check for later amendments, the Income-tax Rules made under the new Act, and CBDT circulars and notifications.