Section 40A(3) of the Income Tax Act, 1961, plays a crucial role in regulating cash expenditures in business or profession. This section imposes restrictions on the deduction of expenses incurred in cash, particularly when payments exceed a specified threshold. Understanding the provisions of Section 40A(3) is essential for taxpayers to ensure compliance with income tax regulations.
As per Section 40A(3), of the Income Tax Act, 1961,
Where the assesse 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 or through such other electronic mode as may be prescribed, exceeds ten thousand rupees,] no deduction shall be allowed in respect of such expenditure.
Where any liability for any expenditure incurred is allowed as a deduction on accrual basis in the relevant assessment year, and subsequently during any previous year, the assesse makes payment in respect of, 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, the payment so made shall be deemed to be the profits and gains of business or profession and according chargeable to income tax as income of the subsequent year, if the payment or aggregate of payments made to a person in a day, exceeds Rs. 10,000. [(Section 40A(3A)].
The above limit or Rs. 10,000 is applicable from assessment 2018-19, before that it was of Rs. 20,000. In the Finance Act 2017, it has been increased.
However, no disallowance shall be made and no payment shall be deemed to be the profit and gain of business or profession, 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, or use of electronic clearing system through a bank account, or through such other electronic mode as may be prescribed, exceeds Rs. 10,000 in cases and circumstances prescribed under Rule 6DD of the Income tax Rules, 1962. Text clauses of Rule 6DD is as under:
(a) where the payment is made to-
(i) the Reserve Bank of India or any banking company as defined in section 5 clause c of the Banking Regulation Act, 1949 (10 of 1949);
(ii) the State Bank of India or any subsidiary bank as defined in Section 2, of State Bank of India (Subsidiary Banks) Act 1959 (38 0f 1959);
(iii) any co-operative bank or land mortgage bank;
(iv) any primary agricultural credit society or any primary credit society as defined under section 56 of the Banking Regulation Act,1949(10 of 1949);
(v) the Life Insurance Corporation of India established under section 3 of the Life Insurance Corporation Act, 1956 (31 of 1956);
(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-
(i) any letter of credit arrangement through a bank;
(ii) a mail or telegraphic transfer through a bank;
(iii) a book adjustment from any account in a bank to any other account in that or other bank;
(iv) a bill of exchange made payable only to a bank;
(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 assesse to such payee;
(e) where the payment is made for all purchases of-
(i) agricultural or forest produce; or
(ii) the produce of animal husbandry or diary 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, produce or products;
(f) where the payment is made for the purchase of the products manufactured or process 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 payments is not served by the bank;
(h) where any payment is made to an employee of the assesse 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 Rs. 50,000.
(i) where the payment is made by an assesse by way of salary to employee after deducting the income tax from salary in accordance with the provisions of section 192 of the Act, and when such employee-
(i) is temporarily posted for a continues period of 15 days or more in a place other than the normal place of duty or on a ship;
(ii) does not maintain any account in any bank at such place or ship.
So the above types of payments are exception for section 40A(3) and (3A).
Conclusion: Section 40A(3) of the Income Tax Act, 1961, is a critical provision aimed at regulating cash expenditures in business or profession. It discourages large cash transactions by disallowing deductions for such expenses exceeding Rs. 10,000. However, there are exceptions under Rule 6DD that allow specific cash payments. Taxpayers should remain informed about these provisions to ensure compliance with income tax regulations and avoid disallowance of expenditures incurred in cash.
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