Clause 21 of Tax Audit Report: Form 3CD Disallowable Expenses | AY 2026-27
Updated: Sep 28
Clause 21 of tax audit report is the Form 3CD disclosure block for specified expenses and amounts that may be inadmissible or require tax-audit reporting. For AY 2026-27, businesses and professionals subject to tax audit continue to use the existing Form 3CD framework, so the practical focus is to reconcile the books with the relevant disallowance provisions before the audit report is filed.
Update — 28 September 2026: CBDT changed the specified AY 2026–27 tax-audit report deadline from 30 September to 21 October 2026, and the related audited return deadline from 31 October to 21 November 2026. The separate Form 3CEB timeline is unchanged. Official Income Tax Department announcement.
Free AY 2026–27 Form 3CD working paper and audit checklist
Request the free Form 3CD working paper and audit checklist through the no-payment form to organise clause checks and reconciliations.
Clause 21 of Tax Audit Report: What Must Be Checked?
The review should not be treated as a mechanical ledger extract. Clause 21 requires the tax auditor to identify specified items such as capital or personal expenditure and expenditure connected with offences, prohibited conduct, penalties or other listed disallowance categories, and to reconcile the reported amounts with the tax computation and supporting records.
Freshness Check — 4 September 2026
Current Income Tax Department material for FY 2025-26 / AY 2026-27 continues to use Forms 3CA or 3CB together with Form 3CD for tax audit. The normal tax-audit report due date shown by the Department is 21 October 2026, subject to any later statutory extension or notification.
Direct answer: For AY 2026-27, Clause 21 of Form 3CD is one of the most important disallowance-reporting clauses in a tax audit. It brings together capital and personal expenditure, specified penalties and prohibited expenditure, inadmissible amounts under section 40, partner remuneration disallowances, cash-payment disallowances under section 40A(3)/(3A), gratuity and employer-fund provisions, contingent liabilities, section 14A expenditure, and interest covered by the proviso to section 36(1)(iii). Because FY 2025-26 still falls under the Income-tax Act, 1961, the existing Form 3CA/3CB with Form 3CD continues to apply for AY 2026-27.
Why Clause 21 deserves a separate reconciliation
Clause 21 is not a single-number disclosure. It is a collection of disallowance and inadmissibility tests that cut across the profit and loss account, TDS workings, partner ledgers, cash-payment data, exempt-income computations and capitalisation schedules. A clean tax audit therefore needs a Clause 21 reconciliation that begins with the general ledger and ends with the return computation.
The Income Tax Department’s current Form 3CD guidance confirms that Form 3CD is the statement of particulars furnished under section 44AB. For FY 2025-26 / AY 2026-27, the Department has also confirmed that the old-law forms—Form 3CA or Form 3CB with Form 3CD—continue to apply even though filing happens after 1 April 2026.
What is reported under Clause 21?
1. Clause 21(a): expenditure debited to profit and loss account
Clause 21(a) asks for amounts debited to the profit and loss account that are in the nature of capital expenditure, personal expenditure, advertisement expenditure covered by section 37(2B), expenditure connected with an offence or prohibited activity, and specified penalties or fines. The current Income Tax Department material expressly maps these categories to Clause 21(a).
Practical control: scan expense ledgers for legal settlements, regulatory penalties, compounding fees, political-publication advertisements, personal-use expenses booked through business accounts, and repairs or project costs that may actually be capital in nature. Do not rely only on ledger names; review narration and supporting documents.
2. Clause 21(b): inadmissible expenditure under section 40(a)
This sub-clause is especially sensitive because it interacts with TDS compliance. Broadly, payments to non-residents and residents can suffer disallowance where the applicable withholding-tax requirements are not complied with. The Income Tax Department’s business-income guidance states that section 40(a)(i) can lead to 100% disallowance for specified payments to non-residents in cases of TDS default, while section 40(a)(ia) generally disallows 30% of specified resident payments where the statutory conditions are not met.
Practical control: reconcile the expense ledger with TDS ledgers, challans, Form 26Q/27Q data and the tax-audit Clause 34 working. Any mismatch between Clause 21(b) and Clause 34 is an immediate audit-review flag.
3. Clause 21(c): inadmissible partner or member payments
For firms, LLPs and relevant associations, Clause 21(c) captures interest, salary, bonus, commission or remuneration debited to the profit and loss account that is inadmissible under section 40(b) or 40(ba). The working should not be a copy of the partner ledger; it should reconcile the partnership deed, book profit computation, authorised remuneration terms and the statutory ceiling.
4. Clause 21(d): section 40A(3) and 40A(3A) cash-payment testing
Clause 21(d) requires examination of payments covered by section 40A(3) and 40A(3A), read with Rule 6DD. The Income Tax Department states that, subject to exceptions, a payment or aggregate payment to a person in a day exceeding ₹10,000 can trigger disallowance when made otherwise than through prescribed banking or electronic modes; a higher ₹35,000 threshold applies in specified goods-carriage cases.
Practical control: run a vendor-and-date-wise aggregation, not merely a voucher-wise filter. Multiple cash vouchers to the same party on the same day can cross the threshold even when each individual voucher is below it.
5. Clauses 21(e) to 21(i): the often-missed disclosures
Clause 21(e): provision for gratuity not allowable under section 40A(7).
Clause 21(f): employer contributions or payments not allowable under section 40A(9).
Clause 21(g): particulars of contingent liabilities.
Clause 21(h): deduction inadmissible under section 14A in relation to exempt income.
Clause 21(i): interest inadmissible under the proviso to section 36(1)(iii), broadly involving borrowing cost attributable to acquisition of an asset for the period up to the asset being put to use.
AY 2026-27: old Form 3CD still applies
This transition point matters. The Income Tax Department has confirmed that tax audit for FY 2025-26 / AY 2026-27 continues under the Income-tax Act, 1961 using Form 3CA or Form 3CB with Form 3CD. The ordinary tax-audit report due date is 21 October 2026, while transfer-pricing cases generally follow the later statutory timeline. For Tax Year 2026-27 under the Income Tax Act, 2025, the Department has prescribed the new unified Form 26 instead.
A practical Clause 21 reconciliation workflow
Freeze the trial balance and obtain the final general ledger before starting clause-level review.
Create a Clause 21 mapping sheet linking each sub-clause to relevant ledger groups and tax provisions.
Run keyword and narration scans for penalty, fine, settlement, compounding, personal, capital, donation, political advertisement and similar risk terms.
Reconcile section 40(a) items with TDS deduction, deposit and return-filing records.
For firms/LLPs, recompute section 40(b) admissibility from the deed and book profit—not from ledger totals alone.
Aggregate cash payments vendor-wise and date-wise, then separately test Rule 6DD exceptions.
Reconcile gratuity, employer-fund provisions, contingent liabilities and exempt-income expenses with financial-statement notes and computation schedules.
Cross-reference Clause 21 with the ITR computation so that reported inadmissible amounts are not omitted from the return adjustment.
Worked example
Assume a company debits ₹2,40,000 as a regulatory penalty, ₹6,00,000 as a resident professional fee on which TDS was not deducted, and ₹18,000 in cash to one supplier on the same day without a Rule 6DD exception. The three items do not belong in one bucket. The penalty requires review under Clause 21(a); the professional fee requires section 40(a)(ia) analysis under Clause 21(b); and the cash payment requires section 40A(3) testing under Clause 21(d). A single “tax disallowance” journal at year end does not substitute for clause-wise reporting.
Common Clause 21 mistakes
Treating the clause as a year-end tax-computation exercise instead of an audit trail from the books.
Checking individual cash vouchers but not daily aggregate payments to the same person.
Reporting TDS disallowance in Clause 21(b) without reconciling Clause 34.
Assuming every penalty is automatically identical for tax purposes without reading the underlying statute and nature of the payment.
Ignoring contingent liabilities because they are not part of the current-year tax provision.
Failing to distinguish capital expenditure from repairs merely because an amount is debited to the profit and loss account.
For firms and LLPs, accepting partner-remuneration ledger totals without testing section 40(b) limits.
FAQs
Is Clause 21 applicable for AY 2026-27?
Yes. FY 2025-26 / AY 2026-27 continues to use the existing Form 3CD under the Income-tax Act, 1961.
Does every amount reported in Clause 21 automatically become a disallowance?
No. Clause 21 contains different reporting requirements and statutory tests. The underlying provision, facts, exceptions and computation must be examined separately.
Why should Clause 21 be reconciled with Clause 34?
Because section 40(a) disallowances frequently depend on TDS compliance, while Clause 34 separately reports TDS/TCS obligations and defaults. Inconsistent numbers invite avoidable questions.
What is the tax-audit due date for AY 2026-27?
For ordinary tax-audit cases, the Income Tax Department currently confirms 21 October 2026. Transfer-pricing cases generally follow the later applicable statutory timeline.
Professional takeaway
Clause 21 is best treated as a multi-ledger reconciliation rather than a disclosure formality. Businesses preparing for the AY 2026-27 tax-audit season should resolve classification, withholding, cash-payment and partner-remuneration issues before the audit report is finalised. That reduces late adjustments, return mismatches and avoidable tax-audit qualifications.
Primary references
Income Tax Department — Form 3CD guidance: https://wmstatic-prd.incometaxindia.gov.in/web/guest/w/form-3cd
Income Tax Department — Items reportable in the Tax Audit Report: https://www.incometaxindia.gov.in/documents/20117/11892059/Items%2Breportable%2Bin%2Bthe%2BTax%2BAudit%2BReport_en.pdf
Income Tax Department — Business or Profession / disallowance guidance: https://www.incometaxindia.gov.in/w/business-or-profession
ICAI — Guidance Note on Tax Audit under Section 44AB (Revised 2026): https://publication.icai.org/publication/968
Need help with AY 2026-27 tax-audit readiness?
PGT & Associates assists businesses and professionals with tax-audit readiness, Form 3CD reconciliations, TDS reviews and tax-computation support. For a focused review of high-risk clauses before filing, contact the firm through www.pgtandassociates.com.
Disclaimer: This article is for general professional information and does not constitute legal or tax advice. Applicability depends on the facts, the law in force and any subsequent CBDT notification, circular, judicial decision or extension.
Clause 21 of Tax Audit Report: FAQs
What is Clause 21 of tax audit report?
It is the Form 3CD reporting section dealing with specified expenses and amounts that need disclosure because the Income-tax Act contains particular allowability or disallowance rules for them.
Does reporting an amount in Clause 21 automatically mean it is disallowed?
Not by itself. Form 3CD is an audit-reporting mechanism. The tax treatment of an item follows the applicable substantive provision, facts and supporting evidence; the audit report should accurately identify and reconcile the prescribed particulars.
What is the tax audit report due date for AY 2026-27?
The Income Tax Department currently shows 21 October 2026 as the tax-audit report due date for the ordinary non-transfer-pricing tax-audit cycle, subject to any subsequent official extension.
Related Form 3CD Guidance
For related PGT guidance, see the Tax Audit Clauses AY 2026-27 hub, the dedicated Clause 21(c) partner remuneration guide, and the Clause 22 Form 3CD MSME guide.
Advanced AY 2026–27 Form 3CD toolkit — ₹300
The ₹300 Advanced Form 3CD toolkit includes 51 clause workspaces, Excel working papers, statutory guides and client PBC templates to organise audit evidence; the form accepts order enquiries.
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