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EXPENSES OR PAYMENTS NOT DEDUCTIBLE IN CERTAIN CIRCUMSTANCES [SECTION 40A]
(1) Payments to relatives and associates
Section 40A (2) provides that where the assessee incurs any expenditure in respect of which a payment has been or is to be made to a specified person [See column (2) of Table below) so much of the expenditure as is considered to be excessive or unreasonable shall be disallowed by the Assessing Officer. While doing so he shall have due regard to:
(a) the fair market value of the goods, service, or facilities for which the payment is made; or
(b) the legitimate needs of the business or profession carried on by the assessee; or
(c) the benefit derived by or accruing to the assessee from such a payment.
| Assessee | Specified Person | |||
| (1) | (2) | |||
| Individual |
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| Company, Firm, HUF, or AOP |
any relative of such director, partner or member or
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| All assessees | The following are specified persons: | |||
| A person who has a substantial interest in the assessee’s business | Other related persons of such person, who have a substantial interest in the assessee’s business | |||
| Company/ AOP/ Firm/ HUF |
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(2) Payments more than ` 10,000 made otherwise than through prescribed modes
According to section 40A (3), where the assessee incurs any expenditure, in respect of which payment or aggregate of payments made to a person in a day otherwise than by an account payee cheque drawn on a bank or by an account payee bank draft or use of the electronic system through a bank account or through such other prescribed electronic modes exceeds
` 10,000, such expenditure shall not be allowed as a deduction.
The prescribed electronic modes are credit card, debit card, net banking, IMPS (Immediate payment Service), UPI (Unified Payment Interface), RTGS (Real Time Gross Settlement), NEFT (National Electronic Funds Transfer), and BHIM (Bharat Interface for Money) Aadhar Pay [CBDT Notification No. 8/2020 dated 29.01.2020].
The provision applies to all categories of expenditure involving payments for goods or services which are deductible in computing the taxable income.
Example 14:
If, in respect of expenditure of ` 32,000 incurred by X Ltd., 4 cash payments of ` 8,000 are made on a particular day to one Mr. Y – one in the morning at 10 a.m., one at 12 noon, one at 3 p.m. and one at 6 p.m., the entire expenditure of ` 32,000 would be disallowed under section 40A (3), since the aggregate of cash payments made during a day to Mr. Y exceeds ` 10,000.
Payments in excess of ` 10,000 made otherwise than through prescribed modes deemed to be the income of the subsequent year if expenditure has been allowed as deduction in any previous year on a due basis:
In case of an assessee following the mercantile system of accounting, if expenditure has been allowed as deduction in any previous year on the due basis, and payment has been made in a subsequent year otherwise than by account payee cheque or accounts payee bank draft or use of electronic clearing system through a bank account or through such other prescribed electronic modes such as credit card, debit card, net banking, IMPS (Immediate payment Service), UPI (Unified Payment Interface), RTGS (Real Time Gross Settlement), NEFT (National Electronic Funds Transfer), and BHIM (Bharat Interface for Money) Aadhar Pay, then the payment so made shall be deemed to be the income of the subsequent year if such payment or aggregate of payments made to a person in a day exceeds ` 10,000 [Section 40A(3A)].
Increase in limit of cash payment, where payment made to transport operator: This limit of
` 10,000 has been raised to ` 35,000 in case of payment made to transport operators for plying, hiring or leasing goods carriages. Therefore, payment or aggregate of payments up to ` 35,000 in
a day can be made to a transport operator otherwise than by way of account payee cheque or account payee bank draft or use of electronic clearing system through a bank account or through
such other prescribed electronic modes such as credit card, debit card, net banking, IMPS
(Immediate payment Service), UPI (Unified Payment Interface), RTGS (Real Time Gross Settlement), NEFT (National Electronic Funds Transfer), and BHIM (Bharat Interface for Money) Aadhar Pay. In all other cases, the limit would continue to be ` 10,000.
Cases where disallowances would not be attracted:
Loan transactions: It does not apply to loan transactions because advancing loans or repayments of the principal amount of a loan do not constitute an expenditure deductible in computing the taxable income. However, interest payments of amounts exceeding ` 10,000 at a time are required to be made by account payee cheques or drafts or electronic clearing system or through other prescribed electronic modes such as credit card, debit card, net banking, IMPS (Immediate payment Service), UPI (Unified Payment Interface), RTGS (Real Time Gross Settlement), NEFT (National Electronic Funds Transfer), and BHIM (Bharat Interface for Money) Aadhar Pay as interest is a deductible expenditure.
Payment made by commission agents: This requirement does not apply to payments made by commission agents for goods received by them for sale on a commission or consignment basis because such a payment is not an expenditure deductible in computing the taxable income of the commission agent.
For the same reason, this requirement does not apply to advance payment made by the commission agent to the party concerned against the supply of goods.
However, where a commission agent purchases goods on his own account but not on a commission basis, the requirement will apply. The provisions regarding payments by
account payee cheque or draft or electronic clearing system or through such other prescribed electronic modes such as credit card, debit card, net banking, IMPS (Immediate payment Service), UPI (Unified Payment Interface), RTGS (Real Time Gross Settlement), NEFT (National Electronic Funds Transfer), and BHIM (Bharat Interface for Money) Aadhar Pay apply equally to payments made for goods purchased on credit.
Cases and circumstances in which a payment or aggregate of payments exceeding ten thousand rupees may be made to a person in a day, otherwise than by an account payee cheque/ account payee bank draft/ use of ECS through a bank account or through such other prescribed electronic modes [Rule 6DD]:
As per this rule, no disallowance under section 40A(3) shall be made and no payment shall be deemed to be the profits and gains of business or profession under section 40A(3A) where payment or aggregate of payments made to a person in a day, otherwise than by an account payee cheque drawn on a bank or account payee bank draft or use of electronic clearing system through a bank account or through such other prescribed electronic modes such as credit card, debit card, net banking, IMPS (Immediate payment Service), UPI (Unified Payment Interface), RTGS (Real Time Gross Settlement), NEFT (National Electronic Funds Transfer), and BHIM (Bharat Interface for Money) Aadhar Pay, exceeds `10,000 in the cases and circumstances specified hereunder, namely:
(a) where the payment is made to
(i) the Reserve Bank of India or any banking company.
(ii) the State Bank of India or any subsidiary bank.
(iii) any co-operative bank or land mortgage bank.
(iv) any primary agricultural credit society or any primary credit society.
(v) the Life Insurance Corporation of India.
(b) where the payment is made to the Government and, under the rules framed by it, such payment is required to be made in legal tender.
(c) where the payment is made by
(d) where the payment is made by way of adjustment against the amount of any liability incurred by the payee for any goods supplied or services rendered by the assessee to such payee.
(e) where the payment is made for the purchase of –
(i) agricultural or forest produce; or
(ii) the production of animal husbandry (including livestock, meat, hides, and skins) or dairy or poultry farming; or
(iii) fish or fish products; or
(iv) the products of horticulture or apiculture, to the cultivator, grower, or producer of such articles, products, or products.
Notes –
(i) The expression ‘fish or fish products (iii) above would include ‘other marine products such as shrimp, prawn, cuttlefish, squid, crab, lobster, etc.’.
(ii) The ‘producers’ of fish or fish products for the purpose of Rule 6DD(e) would include, besides the fishermen, any headman of fishermen, who sorts the catch of fish brought by fishermen from the sea, at the seashore itself and then sells the fish or fish products to traders, exporters, etc.
However, the above exception will not be available on the payment for the purchase of fish or fish products from a person who is not proven to be a ‘producer’ of these goods and is only a trader, broker, or any other middleman, by whatever name is called.
(f) where the payment is made for the purchase of the products manufactured or processed without the aid of power in a cottage industry, to the producer of such products.
(g) where the payment is made in a village or town, which on the date of such payment is not served by any bank, to any person who ordinarily resides, or is carrying on any business, profession, or vocation, in any such village or town.
(h) where any payment is made to an employee of the assessee or the heir of any such employee, on or in connection with the retirement, retrenchment, resignation, discharge, or death of such employee, on account of gratuity, retrenchment compensation, or similar terminal benefit and the aggregate of such sums payable to the employee or his heir does not exceed fifty thousand rupees.
(i) where the payment is made by an assessee by way of salary to his employee after deducting the income tax from salary in accordance with the provisions of section 192 of the Act, and when such employee –
(a) is temporarily posted for a continuous period of fifteen days or more in a place other than his normal place of duty or on a ship: and
(b) does not maintain any account in any bank at such place or ship.
(j) where the payment is made by any person to his agent who is required to make payment in cash for goods or services on behalf of such person.
(k) where the payment is made by an authorized dealer or a money changer against the purchase of foreign currency or traveler’s cheques in the normal course of his business.
Note: Where any payment in respect of any expenditure is required to be made by an account payee cheque/ account payee bank draft or use of electronic clearing system through a bank account or through such other prescribed electronic modes in order that such expenditure may not be disallowed as a deduction under section 40A(3), then the payment may be made by such cheque or draft or electronic clearing system or through such other prescribed electronic modes.
No person is allowed to raise, in any suit or other proceeding, a plea based on the ground that the payment was not made or tendered in cash or in any other manner.
This is notwithstanding anything contained in any other law for the time being in force or in any contract.
(3) Disallowance of provision for gratuity
Section 40A (7) provides that no deduction would be allowable to any taxpayer carrying on any business or profession in respect of any provision (whether called as the provision or by any other names) made by him towards the payment of gratuity to his employers on their retirement or on the termination of their employment for any reason.
The reason for this disallowance is that, under section 36(1)(v), the deduction is allowable in computing the profits and gains of the business or profession in respect of any sum paid by a taxpayer in his capacity as an employer in the form of contributions made by him to an approved gratuity fund created for the exclusive benefit of his employees under an irrevocable trust. Further, section 37(1) provides that any expenditure other than the expenditure of the nature described in sections 30 to 36 laid out or expended, wholly and exclusively for the purpose of the business or profession must be allowed as a deduction in computing the taxable income from the business.
A reading of these two provisions clearly indicates that the intention of the legislature has always been that the deduction in respect of gratuity be allowable to the employer either in the year in which the gratuity is actually paid or in the year in which contributions to an approved gratuity fund are actually made by the employer.
This provision, therefore, makes it clear that any amount claimed by the assessee towards the provision for gratuity, by whatever name called would be disallowable in the assessment of the employer even if the assessee follows the mercantile system of accounting.
However, no disallowance would be made as per section 40A (7) in the case where any provision is made by the employer for the purpose of payment of sum by way of contribution to an approved