Disallowance under section 40A(3) in Genuine Cases
As per provisions of Income Tax Act, revenue expenditure incurred in cash exceeding certain monetary threshold is not allowable as deduction as per sub-section (3) of section 40A of the Act except in specified circumstances as referred to in Rule 6DD of the Income-tax Rules, 1962. The threshold limit prescribed is Rs 10000 per day per person. Further, the specified modes of payment are account payee cheque drawn on a bank or account payee bank draft or use of electronic clearing system through a bank account. Rule 6DD reads as follows:
No disallowance under sub-section (3) of section 40A shall be made and no payment shall be deemed to be the profits and gains of business or profession under sub-section (3A) of section 40A where a 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, exceeds ten thousand rupees in the cases and circumstances specified hereunder, namely:
(a) where the payment is made to—
(1) the Reserve Bank of India or any banking company as defined in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949);
(2) the State Bank of India or any subsidiary bank as defined in section 2 of the State Bank of India (Subsidiary Banks) Act, 1959 (38 of 1959);
(3) any co-operative bank or land mortgage bank;
(4) any primary agricultural credit society or any primary credit society as defined under section 56 of the Banking Regulation Act, 1949 (10 of 1949);
(5) any primary agricultural credit society or any primary credit society as defined under section 56 of the Banking Regulation Act, 1949 (10 of 1949);
(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—
(1) any letter of credit arrangements through a bank;
(2 a mail or telegraphic transfer through a bank;
(3) a book adjustment from any account in a bank to any other account in that or any other bank;
(4) a bill of exchange made payable only to a bank;
(5) the use of electronic clearing system through a bank account;
(6) a credit card;
(7) a debit card.
Explanation:- For the purposes of this clause and clause (g), the term “bank” means any bank, banking company or society referred to in sub-clauses (i) to (iv) of clause (a) and includes any bank [not being a banking company as defined in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949)], whether incorporated or not, which is established outside India;
(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 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;
(1) agricultural or forest produce; or
(2) the produce of animal husbandry (including livestock, meat, hides and skins) or dairy or poultry farming; or
(3) fish or fish products; or
(4) the products of horticulture or apiculture
to the cultivator, grower or producer of such articles, produce or products;
(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;
(1) 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—
(2) 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;
(3) does not maintain any account in any bank at such place or ship;
(j) where the payment was required to be made on a day on which the banks were closed either on account of holiday or strike;
(k) 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;
(l) where the payment is made by an authorised dealer or a money changer against purchase of foreign currency or travellers cheques in the normal course of his business.
Explanation —For the purposes of this clause, the expressions “authorised dealer” or “money changer” means a person authorised as an authorised dealer or a money changer to deal in foreign currency or foreign exchange under any law for the time being in force.
Section 40A(3) is an anti tax-evasion measure. It’s purpose is to digitalise economy and restrict the use of black money for payments. By requiring payments to be made by an account payee instrument, it is possible to verify the genuineness of the transaction thereby mitigating the risk of evasion. The Government may catch the fictitious transactions by introducing this, but what about the genuine transactions?
In the case of CIT v. Choudhary & Co court held that the purpose of introducing this section is not that the cash payment can never be made, where the circumstances show the transaction as genuine, there would be no disallowance.
Earlier i.e. before 25-07-1995 there was a clause (j) in Rule 6DD that required assessing officer to consider exceptional circumstances if sufficient evidence is produced before him and allow the expenditure. However, after omission of this clause, STILL courts continue to say that the list in Rule 6DD is not exhaustive (Rajasthan High Court: Smt Harshila Chordia v. ITO)
In the case of Anupam Tele Services v. ITO the assessee was an agent and he deposited cash in the principal’s account as required by the principal. It was held that since the identity of the agent, nor the principal were in doubt the rigors of Section 40A(3) must be lifted.
So, it is clear that there is difference as to what is given in the rule 6DD post-amendment and the results of the case laws.