Disallowance of depreciation & capital expenditure on cash payment

Disallowance of depreciation under section 32 and capital expenditure under section 35AD on cash payment

As we all are aware of the fact that section 40A(3) restriction on cash payment is only applicable on revenue expenditure and not on Capital expenditure. This loophole is used adversely by many taxpayers by incurring capital expenditure in cash. So to control this black money flow in the market through capital expenditure Government has come up with some strong and effective solutions. What all are the solutions or you can say changes made by government into the Income tax Act to control these activities? We will discuss this through this article.

Under the existing provisions of the Act, revenue expenditure incurred in cash exceeding certain monetary threshold is not allowable 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. However, there is no provision to disallow the capital expenditure incurred in cash. Further, section 35AD of the Act , inter-alia provides for investment linked deduction on the amount capital expenditure incurred, wholly or exclusively for the purposes of business, during the previous year for a specified business except capital expenditure incurred for acquisition of any land or goodwill or financial instrument.

In order to discourage cash transactions even for capital expenditure, Government has made little changes in the provisions of section 43 of the Act to provide that where an assessee incurs any expenditure for acquisition of any asset in respect which 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 or use of electronic clearing system through a bank account or through such other electronic mode as may be prescribed, exceeds ten thousand rupees, such expenditure shall be ignored for the purposes of determination of actual cost of such asset. In short, this change has hit the taxpayer in two major ways, first is the value of asset has been decreased and another way is he can’t claim depreciation on that capital expenditure which is incurred in cash so ultimately profit will be increased and he will end up paying more taxes.

Further, second major change is made in section 35AD of the Act to provide that 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 an account payee bank draft or use of electronic clearing system through a bank account or through such other electronic mode as may be prescribed, exceeds ten thousand rupees, no deduction shall be allowed in respect of such expenditure. The impact of this change is that any expenditure which is eligible for Section 35AD is mostly very huge expenditure so in case just by incurring this in cash will loose the opportunity of claiming deduction u/s 35AD. Which will drastically increase the tax burden of the taxpayers hence at the end they will not go for cash mode and government will win the motive of making this amendment.

So these two very small but effective changes which has been made by the Government has help our industry a lot to curb the black money flow in the market. I hope this article is useful since many people are unaware of these facts.

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(Republished with Amendments by Team Taxguru)