Disallowance of unreasonable related-party payments

Payments to specified RELATED PARTIES (directors, relatives, sister concerns) that the AO finds EXCESSIVE / UNREASONABLE compared to fair market value are DISALLOWED as a deduction to the extent of the excess. Burden is on the AO to demonstrate excessiveness.

Key points

• §40A(2)(a) empowers the Assessing Officer to disallow any expenditure paid to a related party listed in §40A(2)(b) — typically directors, partners, their RELATIVES (spouse, brother, sister, lineal ascendants and descendants), sister concerns, and any entity in which the assessee or such relative has SUBSTANTIAL INTEREST (≥ 20% beneficial ownership).
• DISALLOWANCE applies to the extent the AO considers the payment (a) excessive having regard to fair market value of the goods / services / facilities, OR (b) excessive having regard to the legitimate needs of the business, OR (c) excessive having regard to the benefit derived by the assessee.
• ONUS is on the AO to bring evidence of excessiveness;
• the assessee may rebut.
• Disclosed in Clause 23 of Form 3CD.
• §40A(2) is independent of the §92 transfer-pricing rules (which apply to specified domestic transactions ≥ ₹20 Cr — separate test, separate procedure).

Reference: §40A(2), ITA 1961 — under ITA 2025 (FY 26-27 onwards), this is §36(2)