Form 3CD Clause 23 for AY 2026-27: Related Party Payments & Section 40A(2)(b)
Updated: Sep 28
CBDT changed the AY 2026–27 due dates on 28 September: for the specified ordinary audit category, the report moved from 30 September to 21 October 2026 and the related ITR moved from 31 October to 21 November 2026. Form 3CEB remains separate. Official Income Tax Department announcement
Direct answer: Clause 23 of Form 3CD requires the tax auditor to report particulars of payments made to persons specified in section 40A(2)(b) of the Income-tax Act, 1961. For AY 2026-27, the practical task is not merely to identify related parties: the audit file should reconcile the complete specified-person population, the nature and amount of payments, and the commercial evidence supporting pricing. Section 40A(2) permits the Assessing Officer to disallow only the excessive or unreasonable portion, having regard to fair market value, legitimate business needs and the benefit derived.
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Why Clause 23 matters for AY 2026-27
Related-party expenditure is one of the areas where tax-audit reporting, transfer-pricing style evidence and financial-statement related-party controls frequently overlap. Clause 23 does not itself make a payment disallowable. It creates a disclosure trail for payments to specified persons. The substantive disallowance power sits in section 40A(2).
For FY 2025-26 / AY 2026-27, the Income Tax Department has confirmed that tax audit continues under the Income-tax Act, 1961 using Form 3CA or Form 3CB together with Form 3CD. The ordinary tax-audit report due date is 21 October 2026 for cases whose return is due on 21 November 2026.
Who is a specified person under section 40A(2)(b)?
The list varies with the constitution of the assessee. A useful tax-audit control is to prepare the specified-person master before testing transactions. The Income Tax Department’s current guidance identifies, among others, the following categories:
For a company: directors, relatives of directors, and persons in whose business the company, a director or a director’s relative has substantial interest.
For a firm: partners, relatives of partners, and persons in whose business the firm, a partner or a partner’s relative has substantial interest.
For an individual: relatives and persons in whose business the individual or a relative has substantial interest.
For an AOP/BOI or HUF: relevant members, relatives and entities in which the prescribed persons have substantial interest.
The Department’s guidance explains the substantial-interest test as at least 20% beneficial ownership of voting shares in a company, or at least 20% beneficial entitlement to profits in other cases, at any time during the relevant previous year.
What should be reported in Clause 23?
The reporting exercise should begin from the complete population of payments made or payable to specified persons. In practice, auditors and finance teams should reconcile the related-party master against the general ledger, vendor master, payroll and director/partner ledgers, reimbursement accounts, rent and professional-fee accounts, loans and interest, purchases of goods, service arrangements and year-end provisions.
A common error is to rely only on the related-party disclosure in the financial statements. That list may be prepared under accounting standards or the Companies Act and may not perfectly match the statutory definition in section 40A(2)(b). Clause 23 therefore needs a separate tax-law mapping.
Does every related-party payment become disallowable?
No. Section 40A(2) does not create an automatic disallowance merely because the payee is related. The Assessing Officer may disallow the portion considered excessive or unreasonable having regard to three statutory benchmarks: the fair market value of the goods, services or facilities; the legitimate needs of the business or profession; and the benefit derived or accruing from the expenditure.
That distinction is important for both audit reporting and litigation strategy. Clause 23 disclosure identifies the transaction. The tax position should then be supported by commercial evidence rather than by a generic statement that the price is “reasonable”.
Practical documentation: what should support the payment?
A current specified-person register showing the relationship and the basis on which section 40A(2)(b) applies.
Agreements, engagement letters, board or partner approvals and invoices explaining the commercial purpose of the payment.
Benchmarking material such as external quotations, comparable vendor pricing, market rent evidence or internal procurement comparisons where relevant.
Evidence of actual services or benefit: deliverables, correspondence, time records, reports, usage records or other contemporaneous support.
A ledger reconciliation covering opening provisions, current-year charges, reversals, reimbursements and year-end accruals.
Consistency with financial-statement related-party disclosures, TDS returns and transfer-pricing documentation where those regimes also apply.
Worked example
Assume ABC Pvt. Ltd. pays ₹24 lakh to a company controlled by a director’s relative for management services. The entity is a specified person under section 40A(2)(b). Clause 23 reporting should capture the payment. Separately, ABC should retain the agreement, scope of work, evidence of services and a pricing benchmark. If comparable market evidence supports ₹20 lakh but the company cannot substantiate the additional ₹4 lakh, that differential may become the focus of a section 40A(2) examination. The existence of the relationship alone does not automatically disallow the full ₹24 lakh.
Clause 23 vs transfer pricing: do not mix the two tests
Domestic related-party reporting under Clause 23 should not be mechanically equated with international transfer pricing. Some transactions may also enter the specified domestic transaction regime where the statutory conditions are met, and international transactions can trigger an entirely separate section 92E / Form 3CEB framework. The practical control is to map each related-party transaction to the correct statutory regime rather than assuming one report replaces another.
7-point pre-filing checklist for Clause 23
Freeze the specified-person master using the tax-law definition, not only the accounting related-party list.
Reconcile the master to all vendor, employee, director, partner and journal-entry ledgers.
Identify payments, accruals and reimbursements separately.
Review material transactions for fair-value and commercial-purpose evidence.
Tie amounts to TDS returns and financial-statement disclosures where applicable.
Document differences between the tax-law specified-person list and accounting related parties.
Complete the review before finalising Form 3CD so the return computation and audit file use the same transaction population.
Frequently asked questions
Is Clause 23 only for companies?
No. Section 40A(2)(b) contains specified-person rules for individuals, companies, firms, AOPs/BOIs and HUFs. The relationship test changes with the constitution of the assessee.
Does Clause 23 require the auditor to decide the exact disallowance?
Clause 23 requires reporting of payments to specified persons. The statutory power to determine whether expenditure is excessive or unreasonable rests with the Assessing Officer under section 40A(2). The audit file should nevertheless contain sufficient evidence to support the reported transactions and the taxpayer’s position.
What is the substantial-interest threshold?
The Income Tax Department’s current guidance explains the test as 20% beneficial ownership of voting shares for a company, or 20% beneficial entitlement to profits for other businesses or professions.
Which law applies to FY 2025-26 tax audits filed after 1 April 2026?
The Income Tax Department has expressly confirmed that FY 2025-26 / AY 2026-27 tax audits remain under the Income-tax Act, 1961 and continue to use Forms 3CA/3CB with Form 3CD.
Related PGT & Associates guides
Primary references
How PGT & Associates can help
For businesses preparing for AY 2026-27 tax audit, a focused pre-filing review of related-party masters, ledgers, pricing support and Form 3CD disclosures can reduce avoidable inconsistencies before the report and return are filed. PGT & Associates assists businesses with tax-audit readiness, Form 3CD reconciliations and related direct-tax compliance.
Disclaimer: This article is for general professional information and does not constitute legal or tax advice. Applicability depends on the facts, transaction structure and law in force for the relevant period. Obtain case-specific advice before taking or refraining from action.
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