The Last Return Under a
65-Year-Old Law.
Close Your Books Right.

Why FY 2025–26 Demands Exceptional Attention at Book Closure

On 1 April 2026, India's Income Tax Act, 1961 was repealed. The new Income Tax Act, 2025 — leaner, restructured, and digitally oriented — now governs all taxation from FY 2026–27 onwards. But FY 2025–26, the year just closed, remains entirely governed by the old Act.

This creates an unusual and consequential situation. The ITR you file for AY 2026–27 will be filed, processed, and potentially scrutinised under provisions of a law that has ceased to exist for new transactions. Assessment orders, demand notices, and disallowances arising from this return will continue to cite sections of the 1961 Act for years to come. The department's scrutiny selection, AI-driven AIS matching, and automated processing will all evaluate your return against the full force of the old law's provisions.

There is no grace for the transition. Every provision of the 1961 Act — its disallowances, its deemed incomes, its documentation requirements — applies in full to FY 2025–26. And because the new ITR forms for AY 2026–27 continue under the old Act's structure (brand-new ITR forms under the 2025 Act apply only from FY 2026–27), the return itself will look familiar. But the exposure, if books are closed carelessly, will not be.

Part A — Closing the Books: What Must Be Done Before Filing

Closing books for tax purposes is not the same as closing them for accounting or Companies Act purposes. The tax closing process requires deliberate review of every provision that the Income Tax Act, 1961 uses to add back, disallow, or deem income. These are the areas that consistently generate demands and disallowances — and which must be addressed at the book-closure stage, not discovered during assessment.

1. TDS Compliance — Section 40(a)(ia) and Section 40(a)(i)

This is the single largest source of disallowances in corporate and professional assessments. Any expenditure on which TDS was required but not deducted — or deducted but not deposited — is disallowed in full. For FY 2025–26, the disallowance under Section 40(a)(ia) for domestic payments and Section 40(a)(i) for foreign remittances continues with full force under the old Act.

Before closing books, verify: every vendor payment above threshold has been matched against the TDS ledger. Contractual payments, rent, professional fees, commission, interest, and royalties must all be cross-checked. The Form 26AS and AIS data of your vendors, if accessible, should be used to validate what TDS has actually been reflected. Where TDS was deducted late but has been paid with interest before filing, Section 40(a)(ia) allows a partial cure — but only if the TDS is actually paid. Mere accrual of liability does not resolve the disallowance.

2. The Section 43B Wall — Deductions Only on Actual Payment

Section 43B disallows certain expenditures unless actually paid before the due date of the return (or in some cases, before the end of the financial year). The list of Section 43B items includes: taxes, duties and cess, employer contributions to PF/ESI/gratuity funds, bonus and commission to employees, interest on borrowings from financial institutions, and — critically since the MSME amendment — payments due to MSME vendors.

MSME payments under Section 43B(h) deserve special attention for FY 2025–26. Any amount due to a registered MSME supplier that has not been paid within the prescribed period (15 days where no agreement exists; 45 days where an agreement exists) must be disallowed in the year of accrual and allowed only in the year of actual payment. This provision has been active since FY 2023–24 but enforcement at the assessment stage has sharpened considerably in FY 2025–26. Many businesses are still not tracking MSME registration status of their vendors — a gap that will surface in assessments.

Before book closure: reconcile all unpaid statutory liabilities, ensure all bonus and exgratia payments have actually been made (not just provided), and audit the MSME status of your trade creditors outstanding beyond the permitted period.

3. Section 14A — Disallowance for Exempt Income

Where a business earns exempt income — dividends, tax-free bonds, mutual fund income exempt under Section 10(35) — Section 14A disallows the expenses attributable to earning that exempt income, including a proportionate allocation of interest expenses computed under Rule 8D.

For FY 2025–26, this provision has two layers of risk. First, dividend income is fully taxable from FY 2020–21, which has reduced the Section 14A exposure for most corporates. However, where a company holds a large investment book generating income that is exempt (tax-free bonds, certain PPF-type instruments, mutual fund LTCG under the grandfathered pool), Section 14A still applies. Second, the Assessing Officer retains discretion to apply Rule 8D — which uses a formula linking investment value to total assets — regardless of whether the assessee's own calculation results in a lower figure. This algorithmic disallowance must be anticipated and rebutted proactively.

4. Section 36(1)(iii) — Interest on Capital Borrowed for Non-Business Use

Interest on loans taken for business purposes is allowable under Section 36(1)(iii). But where borrowed funds have been used to give interest-free loans to related parties — subsidiaries, group companies, directors — the department attributes a portion of the borrowing cost to the interest-free advance and disallows it. This is a recurring addition in assessments of closely held companies and holding-subsidiary structures.

Review your loan and advance ledgers at year-end: where interest-free loans to related parties exist alongside borrowings, document the commercial rationale for such advances clearly. If the advance was made from own funds and not from borrowed capital, maintain a clear fund-flow analysis. This documentation, prepared at book closure, is far more persuasive than post-notice explanations.

5. Deemed Dividend — Section 2(22)(e)

Section 2(22)(e) treats certain payments by closely held companies to their substantial shareholders (holding 10% or more of voting power) — or to companies in which such shareholders hold 20% or more — as deemed dividend. This applies to loans, advances, and payments made by the company for the benefit of such shareholders.

The provision is frequently triggered in family-owned businesses where inter-company loans or director advances are routed through the company's accounts. Deemed dividend under Section 2(22)(e) is taxable in the hands of the shareholder at the applicable rate, and it creates a mismatch between what the company has reported as a loan and what the department reassesses as income in the shareholder's hands. Before closing books, ensure all loans to related shareholders carry proper documentation, business purpose, and market-rate interest terms.

6. Cash Payment Limits — Section 40A(3) and Section 269ST

Section 40A(3) disallows any business expenditure exceeding ₹10,000 paid in cash to a single party in a single day. The disallowance is 100% of the cash payment that violates this limit. Section 269ST independently prohibits receipt of ₹2 lakh or more in cash from a single person in a day or in a single transaction, with a penalty of 100% of the amount received on the payer.

At book closure, run a report of all cash payments exceeding ₹10,000 in a day and all cash receipts exceeding ₹2 lakh. Any violation under 40A(3) must be added back voluntarily in the return to avoid a scrutiny addition. Any Section 269ST exposure must be disclosed and addressed — penalty proceedings can follow even after assessment.

7. Depreciation — Rates, Block Continuity, and Scrapping

FY 2025–26 is the last year under Schedule II of the Companies Act and the Income Tax depreciation table as they exist under the old Act. Any revision to depreciation rates or asset classification under the New Act would apply from FY 2026–27. For this year, the critical actions at book closure are: reconcile the asset register with the depreciation schedule; ensure all additions are entered in the register with correct commissioning dates; verify that any assets scrapped or sold during the year are properly removed from the block; and claim additional depreciation under Section 32(1)(iia) for eligible manufacturing assets — this is one of the provisions that may not have a direct analog in the new Act and should be fully availed this year.

8. Carry Forward of Losses — Timely Return Filing is Non-Negotiable

Losses under several heads — business losses, speculative losses, capital losses, losses from owning and maintaining racehorses — can be carried forward and set off against future income, but only if the return is filed on time. The due date for return filing is the hard gate. A return filed after the due date forfeits the right to carry forward losses (except house property losses and unabsorbed depreciation, which have more flexible rules).

For FY 2025–26 in particular, where businesses may have incurred large capital losses on market corrections, or where there are brought-forward losses from pandemic years still being absorbed, the timing of the return is critical. Ensure that the assessment of loss carry-forward entitlements is completed well before the due date, and that the return is filed on time even if all deductions are not finalised.

9. Deduction Claims — Documentation Before Filing

Every deduction claimed in the return requires documentary support before the return is filed, not when a notice arrives. Key deductions to review and document at book closure include: Section 80G donations (valid approval certificates, 80G receipts showing the assessee's PAN); Section 80JJAA (incremental employment deduction — payroll data supporting new hires); Section 80IC / 80IE / 10AA for units in specified zones (registration certificates, activity conditions); and Section 35(1)(ii)/(iia) for scientific research contributions (Form 10CCC and DSIR recognition certificates of the institution).

The most common reason these deductions are denied at assessment is not ineligibility — it is the absence of contemporaneous documentation. The certificate that was not obtained before the return was filed cannot easily be produced later.

10. MAT Computation — Section 115JB

If a company's tax liability computed under the normal provisions is less than 15% of book profits, Minimum Alternate Tax under Section 115JB applies. Book profits are computed by adjusting the net profit as per the P&L account with prescribed additions and reductions. Common adjustments include: income-tax expense added back, provisions for doubtful debts added back if not written off, deferred tax adjustments, and exempt incomes reduced from book profits.

At book closure, ensure the MAT computation is prepared alongside the regular tax computation. Where MAT credit (excess MAT paid over normal tax in earlier years) is available, it must be tracked and claimed. The MAT credit entitlement provision under Section 115JAA is one of the provisions that has been carried forward into the new Act — so balances do continue — but the computation and claim for FY 2025–26 must be accurately made under the old Act's method.

Part B — What Demand Notices and Disallowances to Expect

Filing a return is the beginning of the assessment process, not the end of it. The department's processing infrastructure — combining the ITBA system, AIS data, TDS data, and AI-driven risk scoring — examines every return filed for AY 2026–27. Here is a structured view of the notices and disallowances most likely to emerge from this year's returns.

Notice Category 1 — Section 143(1)(a): Automated Prima Facie Adjustments

Notice Category 2 — Section 143(2): Scrutiny Assessment

A Section 143(2) notice initiates a full scrutiny assessment. The risk of receiving this notice is driven partly by CASS (Computer Assisted Scrutiny Selection) risk scoring. For AY 2026–27, the following return profiles carry elevated CASS risk based on historical patterns:

Notice Category 3 — Section 148 / 148A: Reopening of Assessment

The threat of re-assessment under Section 148 does not arise only from the current year's return. For FY 2025–26, assessees with prior-year assessments that are "live" under the old Act must monitor for Section 148A notices for AY 2022–23 through AY 2025–26 — years that remain within the department's extended jurisdiction (up to 10 years in cases involving income escaping assessment above ₹50 lakh). The AIS data for FY 2025–26, once processed, may surface transactions from earlier years that were not previously visible to the department.

Notice Category 4 — Specific Disallowances Likely to Be Raised

The GST–ITR Cross-Check: An Increasingly Powerful Scrutiny Tool

Perhaps the most significant development in assessment scrutiny for AY 2026–27 is the integration between GST data and income tax data. The GSTN and ITBA systems now share data at the PAN level. The department's systems compare your aggregate GSTR-1 turnover, your GSTR-3B declared turnover, and the gross receipts or sales figure in your ITR. A material mismatch — commonly arising from timing differences, exempt supply treatment, or GST-excluded transactions — is an automatic flag.

Before filing the ITR, prepare a formal reconciliation statement explaining the difference between GST turnover and income tax gross receipts. Common differences include: rental income (taxable under GST but under income from house property in ITR), export income (zero-rated under GST), interest income (exempt from GST but taxable in ITR), and year-end invoicing timing differences. Document this reconciliation — it is the first document any Assessing Officer will ask for in a scrutiny.

The Transition Risk Unique to This Year

Beyond the routine disallowances, FY 2025–26 carries a transition-specific risk that no prior year has presented. Because the new Income Tax Act, 2025 came into force on 1 April 2026, there is a natural tendency — among both assessees and some practitioners — to treat the old Act's provisions as already less important. This is a dangerous assumption.

The Income Tax department will process and assess AY 2026–27 returns entirely under the old Act. Its appellate machinery — CIT(A), ITAT, High Courts — will adjudicate disputes arising from this year under the old Act's provisions. The limitation periods for re-assessment, appeals, and rectification all run from the old Act's timelines. A demand raised from an AY 2026–27 scrutiny may not be finally resolved until AY 2030–31 or later — long after the old Act's academic interest has faded but its practical legal force remains very much alive.

The most productive approach is to treat the closing of FY 2025–26 as you would any high-stakes year-end: with a systematic provision-by-provision review, contemporaneous documentation, proactive reconciliation against AIS and GST data, and a return filed with full disclosure rather than minimum disclosure. The assessees who approach this transition year carefully will be the ones who spend the next five years without a notice on their table.

The Last Return Under the Old Act Is Not the Time to Cut Corners

At R. Mahesh & Associates, we have guided clients through every major change in India's tax landscape over two decades — from the introduction of e-filing, to GST, to the faceless assessment regime. Each transition year has been an opportunity for assessees who prepared carefully, and a source of sustained litigation for those who did not.

FY 2025–26 is different only in that it is the final chapter of a 65-year-old law. The obligations it imposes are no less real for being the last. Every disallowance under Section 40(a)(ia), every MSME addition under Section 43B(h), every deemed dividend under Section 2(22)(e) — these arise from the books you are closing right now. The choices made at this stage determine what the next five years look like.

Close your books with the same rigour you would demand of the last submission under any law — because that is precisely what this is.