Introduction
The treatment of cash payments exceeding ₹10,000 to electricity boards under Section 40A(3) of the Income Tax Act, 1961 has been a subject of debate, even during tax audit I found many of the professionals asking me what action they should take if it is found that a client have made payment of electricity bill in cash.
Section 40A(3) restricts cash payments beyond a specified limit (INR 10,000 as on the date of publication of this article) to ensure transparency and traceability of financial transactions. However, Rule 6DD provides certain exemptions, one of which is for payments made to the government.
Before moving forward, let’s discuss in detail about section 40A(3) of income tax act?
Section 40A(3) lays down provisions to restrict tax evasion by ensuring that high-value business transactions are made through banking channels, thus preventing the use of cash. It deals with the disallowance of expenses for which payments are made in cash beyond a certain limit.
Bare act of Section 40A(3):
(3)(a): Where the assessee incurs any expenditure in respect of 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, exceeds ₹10,000 (ten thousand rupees), no deduction shall be allowed in respect of such expenditure.
(3)(b): Where an allowance has been made in the assessment for any year in respect of any liability incurred by the assessee for any expenditure, and subsequently during any previous year the assessee makes payment in respect thereof, otherwise than by an account payee cheque or account payee bank draft or use of electronic clearing system through a bank account, no deduction shall be allowed in respect of such payment if the payment or aggregate of payments made to a person in a day exceeds ₹10,000 (ten thousand rupees).
Provisos to Section 40A(3):
Proviso 1: Payments that are made in exceptional or unavoidable circumstances (as may be prescribed) shall not be disallowed. Rule 6DD of the Income Tax Rules, 1962, mentions such list of exceptions.
Proviso 2: No disallowance shall be made in cases and under circumstances as may be prescribed, having regard to the nature and extent of banking facilities available, considerations of business expediency, and other relevant factors.
Rule 6DD and “Government” Definition:
Rule 6DD states that no disallowance shall be made under Section 40A(3) if the payment is made to the government. However, the term “government” is not clearly defined in the Income Tax Act.
Interpretations from other statutes, such as the GST Act and the General Clauses Act, suggest that public sector undertakings or boards, including electricity boards, are not classified as government entities. Therefore, on a strict interpretation, electricity boards may fall outside the purview of the exception in Rule 6DD.
What are the Exceptions under Rule 6DD?
Rule 6DD of the Income Tax Rules provides specific exceptions where cash payments exceeding ₹10,000 would not be disallowed. Some common exceptions include the payments made to the government (such as taxes, duties) where it is not possible to make payment by cheque, which is causing confusion in this case, next is payments made in areas without proper banking facilities, third is the payments made on days when the banking system is non-functional due to holidays or strikes and last one is payments to producers of agricultural produce, forest produce, livestock, etc., if the buyer operates in areas where banking facilities are not readily available.
In the above cases, the disallowance will not apply even if the payments in cash exceed the threshold limit of Rs. 10,000.
Now let’s discuss the relevant Case Laws by respective Income tax applicate tribunals(ITAT):
First one is Kolkata ITAT of 2017
This confusing issue of whether payments made to electricity boards are subject to disallowance under Section 40A(3) has been the subject of significant debate, as electricity boards, while government-controlled entities, are not strictly classified as “government” under certain tax definitions.
One of the main case where this issue was addressed is the decision by the Kolkata ITAT in 2017, which involved the West Bengal State Electricity Distribution Company (WBSEDCL).
Background of the case:
The taxpayer in this case had made cash payments exceeding the limit of ₹10,000 to WBSEDCL for electricity usage. The assessing officer gave him a notice and invoked Section 40A(3) of the Income Tax Act, 1961, which disallowed such expenditure which was incurred by an assessee as the cash payment exceeded ₹10,000.
The taxpayer contended that WBSEDCL, being a state-controlled electricity board, effectively functions as a government entity and, therefore, the payment should not be disallowed under Rule 6DD, which provides exceptions to Section 40A(3) for payments made to the government.
The decision of ITAT
The Kolkata ITAT ruled in favour of the taxpayer, holding that payments made to WBSEDCL could not be disallowed under Section 40A(3). The Tribunal reasoned that although WBSEDCL was not strictly the “government” in a legal sense, it was a government-controlled entity, and its functioning was closely aligned with the interests of the state government. Therefore, for practical purposes, WBSEDCL could be treated similarly to a government department.
Main reasons were The Tribunal took into account that electricity boards like WBSEDCL are fully owned and controlled by the state government. Their operations and policies are dictated by the state, making them an integral part of the government’s functioning, even though they are incorporated as separate legal entities. Hence in this case the ITAT highlighted the substance over form doctrine, emphasizing that even though electricity boards are structured as corporations, their role in delivering essential services like electricity places them within the ambit of state operations.
Also organisations like WBSEDCL provides essential public services, which is a fundamental government function, hence payments for such services are, compulsory and cannot be delayed or avoided. This distinguishes payments made to electricity boards from other typical business transactions that Section 40A(3) seeks to regulate.
The Tribunal also examined Rule 6DD(b), which allows for exceptions when payments are made to the government. While WBSEDCL is not technically the “government”, but ITAT found that it performs functions similar to a governmental entity, especially in terms of public utility. Therefore, disallowing cash payments to such an entity would defeat the intent of the rule, which is to allow payments to essential public bodies.
Also in this case the ITAT relied on the principle set in Smt. Sapna Sanjay Raisoni v. ITO by the Pune ITAT, where cash payments made to the Maharashtra State Road Transport Corporation were allowed under Rule 6DD(b). The MSRTC, much like WBSEDCL, is a government-controlled entity providing essential services. In that case, the Pune ITAT had ruled that MSRTC was effectively “government” for the purposes of Rule 6DD, and similar reasoning was applied here.
In the above case of Smt. Sapna Sanjay Raisoni vs ITO, the Pune ITAT ruled, relying on a Supreme Court decision, that the Maharashtra State Road Transport Corporation which is a state government-owned corporation, was effectively a “government” for the purposes of Rule 6DD. This case implies that certain state-controlled corporations could qualify for the exemption from disallowance under Rule 6DD(b), that totally depends on the form and context.
The analysis made by ITAT:
The Tribunal recognized that although MSRTC is technically a corporation, it is wholly owned and controlled by the Maharashtra State Government. MSRTC provides essential public services such as transportation, and the government has significant control over its functioning, making it effectively a governmental entity.
Hence it held that the intent of Rule 6DD(b) is to provide exceptions for payments made to the government and government-controlled entities. Since MSRTC was functioning as an arm of the state government, the cash payments made to it should be exempt under Rule 6DD(b), which allows for payments made to the government without being disallowed by applying the principle of substance over form, emphasizing that MSRTC’s role as a public utility and its control by the state government justified treating it as part of the government for tax purposes, even if it was registered as a separate corporation.
Next one we see in both the above cases is there is no Malafide Intention of the assessee in making cash payments to WBSEDCL as well as MSRTC. The nature of the business and the urgency of the transactions required immediate payments, making it impractical to adhere to banking channel payments in all instances.
The ITAT cited one of the decisions of the Hon’ble Supreme Court in the case of Jaswant Singh Charan Singh, which held that Punjab State Electricity Board (PSEB), although a corporation, could be considered a government entity for the purposes of Rule 6DD. This precedent reinforced the view that entities like MSRTC should be treated as government entities for the purposes of tax exemptions under Rule 6DD.
Other case laws of High court and Supreme court:
– Attar Singh Gurmukh Singh v. ITO (1991) of Supreme Court with citations [1991] 191 ITR 667 (SC)
The court ruled that the objective of Section 40A(3) is to eliminate the proliferation of black money and tax evasion. It emphasized that this provision does not prohibit cash transactions altogether but disallows cash expenses as deductions unless justified under Rule 6DD exceptions. The ruling underscored the intent of the legislature to encourage transactions through banking channels for better transparency.
– CIT v. Aloo Supply Company (1980) of Gauhati High Court with citations [1980] 121 ITR 680 (Gau)
The Gauhati High Court ruled that cash payments made in rural areas, where banking facilities were inadequate, were not subject to disallowance. The court stressed that Rule 6DD must be interpreted in a way that accommodates the practical difficulties faced by businesses.
– CIT v. Madhav Govind Dulshete (1982) of Bombay High Court with citations [1982] 137 ITR 145 (Bom)
The Bombay High Court ruled in Favor of the assessee, observing that the payments were made to a transporter operating in remote areas, where banking facilities were unavailable. The court held that such payments qualified for the exceptions under Rule 6DD.
– CIT v. Kishan Chand Maheshwari Dass (1980) of Punjab and Haryana High Court with citations [1980] 121 ITR 232 (P&H)
The court ruled that the disallowance was justified under Section 40A(3) as the taxpayer failed to show any valid reason for not using banking channels.
My opinion and analysis
Any payment made in cash to electricity board fully owned and controlled by government shall not be disallowed but if the payment is made to organisations like Tata and Adani for getting electricity connection or services shall be disallowed if it is made in cash if the amount exceeds INR 10,000 as per rule 6DD
We require a clarification from the government, either expanding Rule 6DD or providing a clear definition of government entities, would greatly resolve this ambiguity
Conclusion:
Payments made in cash to government-controlled entities like electricity boards (e.g., WBSEDCL) may not be disallowed under Section 40A(3) if the entity performs essential public functions and is effectively part of the government’s operations.
Courts, including the Kolkata ITAT and Pune ITAT, have adopted a substance over form approach, recognizing such boards as quasi-government bodies under Rule 6DD(b), allowing exemptions for cash payments. However, cash payments to private entities like Tata or Adani for similar services would not qualify for such exemptions and would be disallowed if they exceed ₹10,000. Clarity from the government on this issue would help resolve ongoing ambiguity.
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