Section 146 explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.
Section 146 gives a business a deduction of 30% of the "additional employee cost" it incurs in a tax year, for three consecutive tax years. It applies only to an assessee to whom the tax-audit provision of section 63 applies, and it is closed by several conditions. This article, written as per the Income-tax Act, 2025 (30 of 2025) as amended by the Finance Act, 2026, goes through the section sub-section by sub-section.
Section 146(1) allows a deduction of 30% of additional employee cost incurred in the course of business, where the assessee is one to whom section 63 applies and the gross total income includes business profits. The deduction runs for three consecutive tax years from the tax year in which the employment is provided. It is denied if the business was formed by splitting up or reconstruction, was acquired by transfer or reorganisation, or if the accountant's report is not furnished before the specified date.
Where section 146 sits and what the Act is checked against
Section 146 is in Chapter VIII (deductions in computing total income), in the group of provisions for certain incomes. It follows the deduction for start-ups and the other incentives that precede it in that Chapter; see our guide to the start-up and industrial undertaking deductions for the neighbouring sections. For the wider Chapter, read Chapter VIII of the Income-tax Act, 2025.
The Act came into force on the 1st April, 2026, save as otherwise provided (section 1(3)). Later amendments, rules and notifications should be checked before you rely on this article. If you are planning headcount and want the deduction mapped to your payroll, our tax planning advisory team can help.
Section 146(1): the deduction
Section 146(1) is "subject to the conditions specified in sub-sections (2) and (3)". If the gross total income of an assessee, "to whom section 63 applies", includes any profits and gains derived from business, a deduction equal to 30% of additional employee cost incurred in the course of that business in the tax year is allowed.
Three things follow from the wording:
- Who qualifies. Only an assessee to whom section 63 applies. Our post on section 63 (tax audit) explains that section. The other conditions of this section are tied to section 63 as well (see sub-section (3)(c)).
- What is deducted. 30% of the additional employee cost. The cost must be "incurred in the course of such business".
- When. In the tax year in which the cost is incurred, and for the period set by sub-section (2).
Section 146(2): three consecutive tax years
The deduction is allowed for three consecutive tax years, beginning from the tax year in which the employment is provided. The count starts from the year of employment, not from the year in which the business started. A person who is taken on in one tax year therefore opens a three-year window.
Section 146(3): when the deduction is not allowed
The deduction under sub-section (1) is not allowed if:
| Clause | Condition |
|---|---|
| (a) | the business is formed by splitting up, or the reconstruction, of an existing business |
| (b) | the business is acquired by the assessee through transfer from any other person or as a result of any business reorganisation |
| (c) | the assessee does not furnish the report of an accountant, before the specified date as referred to in section 63, giving the particulars in the report, as may be prescribed |
On clause (c), the Act leaves the particulars of the report to the Income-tax Rules, 2026; see our rule-wise guides for that detail. The point to carry from the section itself is the timing: the report must be furnished before the specified date referred to in section 63.
Section 146(4): the revival exception
The condition in sub-section (3)(a), the splitting-up or reconstruction bar, does not apply to an undertaking formed as a result of the re-establishment, reconstruction or revival by the assessee of the business of an undertaking referred to in section 140(4). It applies "in the circumstances and within the period specified in said section". Section 140 is the start-up deduction section, the one before this in the Chapter, so the exception works only if those circumstances and that period are met.
Section 146(5): definitions
"Additional employee cost" - clause (a)
Additional employee cost means:
- (i) the total emoluments paid or payable to additional employees employed during the tax year; or
- (ii) emoluments paid or payable to employees employed during the tax year, where that year is the first year of a new business.
And it is nil in the case of an existing business if either:
- (A) there is no increase in the number of employees from the total number employed as on the last day of the preceding tax year; or
- (B) emoluments are paid otherwise than by an account payee cheque or account payee bank draft, or by use of electronic clearing system through a bank account, or through such other electronic mode as may be prescribed.
So for an existing business, headcount must go up over the number on the last day of the preceding tax year, and the pay must travel through banking channels. Cash salaries in the year switch the additional employee cost to nil for that year, in the way the clause is worded.
"Additional employee" - clause (b)
An additional employee is an employee employed during the tax year whose employment increases the total number of employees employed by the employer as on the last day of the preceding tax year. The clause then excludes five groups:
| Excluded employee | Rule as printed |
|---|---|
| (i) high emoluments | total emoluments exceed Rs. 25000 per month |
| (ii) Government-funded pension contribution | the Government pays the entire contribution under the Employees' Pension Scheme notified as per the Employees' Provident Funds and Miscellaneous Provisions Act, 1952 (19 of 1952) |
| (iii) short employment, apparel/footwear/leather | employed for less than one hundred and fifty days, for an assessee engaged in manufacturing of apparel, footwear or leather products |
| (iv) short employment, any other assessee | employed for less than two hundred and forty days during the tax year |
| (v) no provident fund | does not participate in a recognised provident fund |
In clauses (iii) and (iv), there is a carry-over. If the employee is employed for that number of days in the immediately succeeding tax year, he is deemed an additional employee of the succeeding tax year, and section 146 applies accordingly. A person who joins late in a year and falls short of the day count is therefore not lost for good.
Clause (ii) refers to another law (the 1952 Act on provident funds); the reader should check that law for the scheme named. The Act explains nothing more about it here.
"Emoluments" - clause (c)
Emoluments means any sum paid or payable to an employee in lieu of his employment, by whatever name called. It does not include:
- (i) employer contributions paid or payable to any pension or provident fund or any other fund for the benefit of the employee, as mandated by any law; and
- (ii) lump sum payments at the time of termination of service, superannuation or voluntary retirement, such as gratuity, severance pay, leave encashment, voluntary retrenchment benefits, commutation of pension and the like.
A worked example
The figures below, except the Rs. 25000 limit and the 30% rate, are invented for the example.
Meera Garments Private Limited, a manufacturer of apparel whose accounts are subject to section 63, had 40 employees on the last day of the preceding tax year. In the current tax year it employs 5 new people, each paid Rs. 20000 per month through bank transfer and each employed for the full year. All five participate in a recognised provident fund.
- Each is under the Rs. 25000 per month ceiling, is not within the Government-pension exclusion, has worked more than one hundred and fifty days and is in a recognised provident fund. Headcount has increased, and pay is through banking channels, so the cost is not nil.
- Emoluments for the year: 5 x Rs. 20000 x 12 = Rs. 12,00,000. Employer provident fund contributions are left out of emoluments under clause (c)(i).
- Deduction under section 146(1): 30% of Rs. 12,00,000 = Rs. 3,60,000.
- The deduction is available for the tax year of employment and the two tax years that follow, which makes three consecutive tax years, provided the accountant's report is furnished before the specified date.
If one of the five were paid Rs. 26000 per month, that person would be excluded as an additional employee, and the cost of the other four alone would count.
Need help with the additional employee cost deduction?
Working out which hires count, keeping payments within banking channels and getting the accountant's report in on time all affect whether the deduction survives. Our tax planning advisory service reviews headcount movement against the conditions of section 146 before the return is prepared.
Key takeaways
- The deduction is 30% of additional employee cost, for three consecutive tax years from the year of employment.
- Only an assessee to whom section 63 applies can claim it.
- Splitting up, reconstruction, acquisition by transfer and a missing accountant's report each shut the deduction out.
- For an existing business the cost is nil if headcount did not rise over the last day of the preceding tax year, or if pay is not through banking or prescribed electronic channels.
- Employees above Rs. 25000 per month, those not in a recognised provident fund and those who fall short of the day counts are not additional employees (subject to the carry-over to the next tax year).
Read next
- Sections 141 and 142: deductions for industrial undertakings and housing projects
- Section 147: deduction for Offshore Banking Units and IFSC units
- Section 63 of the Income-tax Act, 2025: tax audit
- Chapter VIII of the Income-tax Act, 2025
Disclaimer: Based on the Income-tax Act, 2025 (30 of 2025) as amended by the Finance Act, 2026, as consulted on 2 October 2026. It explains the words of the Act only; the Income-tax Rules, 2026, notifications, circulars, later amendments and the way the tax authorities and courts apply these provisions should be checked. This article is general information, not legal advice; check the official text before acting.