Section 40A(3)/(3A) Restrictions on Cash Expenditure (Capital & Revenue)

ANALYSIS OF SECTION 40A(3) AND 40A(3A)

(a) Analysis of sec 40A(3) of the Act.

Where payment is made in the year in which expenditure is incurred, 100% disallowance if the payment is in excess of Rs. 10,000 and not by A/c payee cheque/draft/ECS. [Sec 40A(3)]

There are following two conditions for the applicability of this section. If both of these two conditions are satisfied, then the provisions of this section will be applicable.

Condition 1

The assessee incurs any expenditure exceeding Rs.10000/-which is allowable for computing income under the head business or profession. 

Condition 2

The assessee has made payment or aggregate of payments in a day exceeding Rs.10000/- in cash. If the above two conditions are satisfied, then whole of the expenditure shall be disallowed under this section. In case where payment is made to the transporters for plying, hiring or leasing goods carriages, then amount of Rs.10000/- shall be increased to Rs.35000/ in the above two conditions. It is to be noted that if payment exceeding Rs.10000/- is made to a passenger transport company in cash for carrying on passengers, then the enhanced limit will not be applicable as the enhanced limit is only for transporters for plying, hiring or leasing goods carriages.

Example: Where expenditure of shop expenses for Bill raised on 11/11/2020 is made on 03/03/2021 by cash amounting to Rs 30,000and then the payment of Rs. 30,000 will not be allowed as a deduction for the PY 2020-21.

It is to be noted that the provisions of sec 40A(3) of the Act come into play where the payment or the aggregate of payments made to a single person on a single day against single bill exceeds Rs. 10,000 then the disallowance of such expenditure will be covered by Sec 40A(3). Thus for disallowance u/s 40A(3) of the Act, the amount of the bill raised and the payment or payment(s) made to the person on a single day both  must exceed Rs 10,000/-.If a person  makes payment of two different bills (none of them exceeds Rs. 10,000) at the same time to the same person in cash, provision of sec. 40A(3) is not attracted.

X paid to Y Rs. 12,000 in cash in a single day against his Bill No.482 of Rs. 7,000 and Bill No.572 of Rs. 5,000. Nothing shall be disallowed under this section.

KEY POINTS TO BE NOTED

From the study of the provisions of this section ,we draw following conclusions:

a) an allowance has been made in the assessment for any year in respect of any liability incurred by the assessee for any expenditure; and

b) subsequently during any previous year the assessee makes any payment in violation of this provision, then, the payment so made shall be deemed to be the profits and gains of business or profession of such subsequent year [Sec. 40A(3A)]

• If an assessee makes payment of two different bills (none of them exceeds Rs.10,000 / Rs. 35,000) at the same time in cash to the same person, provision of sec. 40A(3) is not attracted.
• If an assessee makes payment of a single bill (exceeding Rs. 10,000 / Rs. 35,000) on different days to the same person in cash, provision of sec. 40A(3) is not attracted, provided any of the payment does not exceed Rs. 10,000 / Rs. 35,000.
• Where payment is made over Rs.10,000/Rs. 35,000 at a time, partly by account payee cheque & partly in cash but the payment in cash alone at one time does not exceed Rs.10,000 (Rs.35,000), assessee is not attracted by sec. 40A(3).
• The provision of sec. 40A(3) is attracted only when such expenditure is claimed as deduction u/s 30 to 37.
• If part of the expenditure is already disallowed under any provision of this Act, then disallowance shall be calculated on the allowed portion of the expenditure. In case of a transaction where both the above sections are applicable at the same time, then first disallow the excess u/s 40A(2) and if the balance is more than Rs. 10,000, then disallow u/s 40A(3) of the Act.

EXAMPLE: X purchased goods from his brother of  Rs.14,000 (market value of which is Rs. 8,000) and paid in cash. Rs. 6,000 shall be disallowed u/s 40A(2) and nothing shall be disallowed u/s 40A(3) as allowed expenditure does not exceed Rs. 10,000.

WHEN PAYMENT IS MADE PARTLY IN CASH AND PARTLY BY CHEQUE – LIMIT APPLIES TO CASH PORTION OF PAYMENT

It is to be noted that where the payment has been made partly in cash and partly by way of post-dated cheques, Section 40A(3) will apply only if the cash payment exceeded the prescribed limit.

Where payment is made partly in cash, and the balance by way of delivery of post-dated bearer cheques, the payment of the money mentioned in the cheques would be taken to have been made on the date on which the cheques matured and were encashed. They were not payments made on the date on which the cheques were issued or given. Hence, the provisions of section 40A(3) will be attracted only if the cash portion of the payments exceeded the prescribed limit. – [H.A. Nek Mohd. & Sons v. CIT (1982) 135 ITR 501 (All.)]

Questions	Answers A.Y. 2022-23
An expenditure of Rs. 40,000 is incurred for purchase of stationary against Bill no.2 from M/s XYZ Ltd on 01/01/22.The assessee makes separate payments of Rs.15,000 Rs.16,000 and Rs.9,000 all by cash, to the person concerned in a single day.	Since the aggregate amount of payment made to a person in a day, in this case, is Rs. 40,000. Since, the aggregate payment by cash exceeds Rs. 10,000, Rs. 40,000 will not be allowed as a deduction in computing the total income of the taxpayer in accordance with the provisions of the Act.
An expenditure of Rs. 30,000 is incurred for purchase of stationary against Bill No 1, 2 & 3 from M/s XYZ Ltd on 01/01/22, 28/01/22 & 01/02/22 for Rs. 10,000 each. The assessee makes separate payments of Rs. 10,000, Rs. 6,000, Rs. 5,000 and Rs. 9,000 all by cash at different times, to the person concerned on a single day.	Since the aggregate amount of payment made to a person in a day, in this case, is Rs. 30,000 however since the payment is on account of three bills, none of which is in excess of Rs. 10,000, thus the entire payment will be allowed.
An expenditure of Rs. 37,000 is incurred for purchase of stationary against Bill No 1 & 2 from M/s XYZ Ltd on 01/01/22 and 01/02/22 for Rs. 28,000 and Rs. 9,000 respectively. The assessee makes separate payments of Rs. 15,000, Rs. 13,000 and Rs. 9,000 all by cash, to the person concerned in a single day.	Since the aggregate amount of payment made to a person in a day, in this case, is Rs. 37,000 however since the payment is on account of two bills, one of which exceeds Rs. 10,000, thus only Rs. 28,000 will be disallowed.
An expenditure of Rs. 60,000 is incurred freight against Bill no 2 from M/s NITCO Roadways on 01/05/21. The assessee makes separate payments of Rs. 24,000, Rs. 36,000 on 01/09/21 and 01/10/21 respectively.	In this case since the payment madeon01/09/2021 is not in excess of the limit of Rs 35,000 thus it will not be disallowed, however the payment made on 01/10/2021 shall be disallowed as it exceeds the limit of 35,000. Thus out of expenditure of Rs 60,000 only Rs 24,000 will be allowed as a deduction.
X purchases goods worth Rs. 30,000 from G against one bill but makes payment of Rs.18,000& Rs.12,000 at different times on the same date.	Section 40A(3) shall be applicable and Rs.30,000 shall be disallowed
X makes a payment of Rs. 40,000 as donation by cheque to National Defence Fund.	Section 40A(3) shall not be applicable. As donation is not allowable as deduction under section 30 to 37 but allowable under section80G from Gross Total Income.
X makes a purchase of goods of Rs.60,000 and makes payment of Rs. 45,000 by account payee cheque and Rs.15,000 in cash.	Section 40A(3) will be applicable as the payment in cash exceeds Rs. 10,000. Hence, Rs.15,000 shall be disallowed.
X makes a purchase of goods of Rs.60,000 on 14.2.2022 and makes the payment as under: (i) Rs. 30,000 by account payee cheque on 15.2.2022 (ii) Rs 15,000 in cash on 15.2.2022 (iii) Rs 15,000 in cash on 16.2.2022	Section 40A(3) will be applicable as the payment in cash exceeds Rs.10,000. Hence, Rs.30,000 shall be disallowed.
X purchases a machine for Rs. 1,20,000 and makes the payment of Rs. 70,000 by account payee cheque and Rs. 50,000 in cash.	Although section 40A(3) is not applicable but second proviso to section 43(1) shall be applicable and Rs. 50,000 shall be ignored while computing the actual cost of the asset
X, a dealer of machines purchases a machine for Rs.1,20,000 and makes the payment by crossed cheque.	Entire Rs. 1,20,000 shall be disallowed as payment is not by account payee cheque
X makes an advance of Rs.30,000 on 14.8.2021 by crossed cheque for purchase of goods and delivery of the goods is made on 20.9.2021.	Rs.30,000 shall be disallowed as the payment is made by crossed cheque
X pays a salary of Rs.14,000 by crossed cheque to an employee.	Rs. 14,000 shall be disallowed as the payment exceeds Rs 10,000 and it has been made by acrossed cheque.
X purchases goods in cash from his brother for Rs. 40,000whose market value is Rs. 35,000.	Rs. 5,000 will be disallowed under section 40A(2) and Rs. 35,000 shall be disallowed under section 40A(3)
X is a consignee agent (Kachha arhatiya) and makes payment of Rs 1,50,000 in cash for goods received by him for sale on commission or consignment basis.	No, because such a payment is not an expenditure deductible in computing the business income of the agent.
X is a commission agent (Pukka arhatiya) and makes payment of Rs.40,000 in cash on his own account and not on commission basis.	Yes, Rs 40,000 shall be disallowed purchases of goods in cash for ₹40,000 on his own account and not on commission basis.
X purchases goods in cash for Rs40,000/- from Y, a villager and makes payment to Y in his village where no banking facility is available.	No. As per rule 6DD, it is permissible.
In case given in above scenario what will be answer, if X makes the payment to Y (the villager) in town where banking facility is available.	Yes, Rs 40,000 shall be disallowed.
X makes a payment in cash amounting to Rs. 35,000 to a transporter on 5.10.2021.	Nothing shall be disallowed as payment is made to a transporter which can be made otherwise than by an account payee cheque upto ₹35,000.
Payment made in cash during the day for Rs. 45,000 of 3 different bills each bill amount is less than 20,000 but more than 10,000.	Entire amount of ₹45,000 shall be disallowed because the expenditure as well as payment of each bill exceed 10,000.
X makes a payment of Rs. 20,000 in cash for transport charges on goods to a passenger transport company.	Rs. 20,000 shall be disallowed since the payment is made to passenger transport company and not to a transporter for plying, hiring or leasing goods carriages.
Mr. X has made cash payments for purchases and expenditure as below: On 30.07.2021- Rs. 1,50,000 (due to strike by bank staff) On 18.08.2021- Rs. 2,50,000 (due to cash demanded by supplier) On 30.09.2021- Rs. 1,25,000 (Half yearly closing for bank; a bank holiday)	Payments made on a bank holiday or on a day when bank is on a strike are not covered under rule 6DD. Hence cash payments made for purchases on 30.07.2021- Rs. 1,50,000 and on 30.09.2021- Rs. 1,25,000 are disallowed. Cash payment made on 18.08.21 for Rs. 2,50,000 is also disallowed.

ANALYSIS OF SEC 40A(3A) OF THE ACT.

Where payment is made in the subsequent years (after deduction has been claimed in an earlier year):

where an expenditure has been allowed as a deduction in an earlier year on due basis and if in any subsequent year the payment in respect of such expenditure is in excess of Rs 10,000/- and not by an account payee cheque, account payee bank draft or ECS – then the payment shall be deemed to be income under the head business & profession for the previous year in which payment is made.

There are following two conditions for the applicability of this section. If both of these two conditions are satisfied, then the provisions of this section will be applicable.

Condition 1

The assessee had claimed deduction in respect of an expenditure exceeding Rs.10000/- in any of the earlier years.

Condition 2

The assessee has made payment of the liability (Condition No.1)in cash in subsequent year and payment is exceeding Rs.10000/-in a day.

If both conditions are satisfied, the payment so made shall be deemed to be the business income of the previous year in which payment is made.

Example: Where expenditure of shop expenses for Bill raised on 01/05/2020 is made on 3/05/2021 by cash amounting to Rs. 30,000then the expenditure of Rs 30,000 was due in PY 2020-21 and would have been claimed as a deduction in that year assuming that the assessee follows mercantile system of accounting, in this case for the PY 2020-21 we cannot ‘disallow’ the payment since it is not allowable in that year, thus it will be treated as income of PY 2021-22. 

ACQUISITION OF STOCK-IN-TRADE/RAW MATERIALS

It is to be noted that  the term `expenditure` for the purpose of section 40A(3) will cover payments made for acquisition of stock-in-trade or raw materials. This view has since received the stamp of approval from the Supreme Court in the case of Attar Singh Gurmukh Singh v. ITO [1991] 191 ITR 667. The Supreme Court observed :

“. . . it may be stated that the word `expenditure` has not been defined in the Act. It is a word of wide import. Section 40A(3) refers to the expenditure incurred by the assessee in respect of which payment is made. It means that all outgoings are brought under the word `expenditure` for the purpose of the section. The expenditure for purchasing stock-in-trade is one of such outgoings. The value of the stock-in-trade has to be taken into account while determining the gross profits under section 28 on principles of commercial accounting. The payments made for purchases would also be covered by the word `expenditure` and such payments can be disallowed if they are made in cash in the sum exceeding the amount specified under section 40A(3). The rule also contemplates payments made for stock-in-trade and raw materials.Section40A(3) is therefore attracted to payments made for acquiring stock-in-trade and other materials.

DISALLOWANCE UNDER SECTION 40A(3) NOT ATTRACTED WHERE BOOKS OF ACCOUNTS ARE REJECTED.

-In ITO v. Sadhwani Brothers (2012) 44 (II) ITCL 371 (Jp ‘B’- Trib) : (2011) 142 TTJ (Jp ‘B’- Trib) 26, it was held that since the books of accounts were rejected therefore, provisions of section 40A(3) were not applicable. 

PLAN TO APPLY FLAT RATE OF PROFIT TO AVOID DISALLOWANCE.

As observed in New Narayan Builder v. ITO (1992) 43 TTJ (Ahd-Trib) 508, the restriction contained in section 40A(3) relating to allowability of any expenditure would come into play and when such expenditure is otherwise treated as allowable under section 30 to 37. If the income of the assessee is determined by applying flat profit rate, the question of considering the allowability of different items expenses claimed by the assessee does not arise at all. This has been also affirmed by Ahmedabad Bench of Tribunal in Hynop Food & Oil Industries (P) Ltd v. CIT (1994) 48 ITD 202 (Ahd-Trib). But in ITO v, D.D hazare (1994) 48 ITD 595 (Bom-Trib), it was held that where profit are estimated by rejecting books of account, it does not bar disallowance under section 40A(3). According to CIT v. Padam Chand Bhansali (2004) 85  TTJ (Jod-Trib) 215, no addition can be made where income has to be computed by applying net profit rate .

ADVANCE PAYMENT IS NOT OUT OF AMBIT OF EXPENDITURE.

It is to be noted that in a case where the payments were made by way of advances and were ultimately treated as discharging the liability to pay the price of the goods purchased, the payments so made must be considered to fall within the expression `expenditure` incurred for payment of price of goods. According to Vijay Kumar Ajit Kumar v. CIT (1991) 55 Taxman 388 (All), merely because a payment in excess of prescribed limit is made prior to delivery of goods, it cannot be argued that it constitutes an advance and not expenditure so as to invoke provisions of section 40A(3).

Even if the payments were made by way of advances and were ultimately treated as discharging the liability to pay the price of the goods purchased, the payments so made must be considered to fall within the expression `expenditure` incurred for payment of price of goods – [Kejriwal Iron Stores v. CIT (1988) 169 ITR 12 (Raj.)]

Mr. X has given an advance to Y of Rs. 2,50,000 in cash on 20.02.2021 for supply of goods. The goods are supplied on 30.06.2021 for Rs. 2,50,000, and the advance is adjusted against the delivery of goods. In this case, section 40A (3) will be attracted and Rs. 2,50,000 will be disallowed is Assessment Year 2022-23.However in Assessment Year 2021-22 a sum of Rs.2,50,000/- will be added in the income of Mr. Y  U/S 269ST as he has received the payment of Rs.2 ,50,000/- in cash in a single day.

PURCHASE OF FISH OR FISH PRODUCT FROM ANY MIDDLEMAN.–CIRCULAR NO. 10/2008, DT 5-12-2008,

The circular provides as under:

a. The expression ‘fish or fish products used in rule 6DD(e)(iii) would include other marine products such as shrimp, prawn, cuttlefish, squid, crab, lobster etc.

b. 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 sea shore itself and then sells the fish or fish products to traders, exporters etc.

b) It is further clarified that the above exception will not be available on the payment for the purchase of fish or fish products from a person who is not proved to be a ‘producer’ of these goods and is only a trader, broker or any other middleman, by whatever name called

c) In Orchid Marine v. ITO 2014 TaxPub (DTI 4022 (Coch-Trib), on facts of the case, since the fish was admittedly purchased from a person other than fisherman or producer, the exact role of that middle man has to be examined in view of Circular No. 10/2008, dt. 5-12-2008.

d) Where assessee purchased fish from fishermen or headman of fishermen which fell under exceptional circumstances as prescribed in rule 6DD(e), Tribunal was justified in holding that section 40A(3) was not attracted to facts of the case.- Vide CIT v. Blue Water Foods & Exports (P.) Ltd. 2015 TaxPub(DT) 1630 (Karn-HC).

Thus one should plan to purchase fish or fish product from producer himself instead of any middleman.

During the year ended 31/03/21, Geojit Marine Products Ltd. Has made payment in cash to the tune of Rs.60,000/- on a single day to local fishermen, who regularly supply to them lobsters and crabs. Will such cash payments be hit by the provisions of section 40A(3) of the Income –tax Act, 1961? Will your answer be different, if such cash payments are made to a hawker who supplies lobsters and crabs?

CIRCULAR NO. 10/2008:‘fish or fish products’ would include ‘other marine products such as shrimp, prawn, cuttlefish, squid, crab, lobster, etc.’.

The ‘producers’ of ‘fish or fish products’ would include, besides the fishermen, any headman of fishermen, who sorts the catch of fish brought by fishermen from the sea, and then sells to traders, exporters, etc.

Circular No 6/2006: dt 06/10/2006 –exemption will not be given if (recipient) is not a producer of the goods

BOTH EXPENDITURE AND PAYMENT MUST EXCEED RS.10000/- 

It is to be noted that section40A(3) will not hit if purchase from single person and value of each invoice is less than Rs 10000/-. In a case, where an assessee makes payment of two different bills (none of them exceeds Rs. 10,000) at the same time in cash (or by bearer cheque or by crossed cheque or by crossed demand draft), section 40A(3) is not applicable even if the aggregate payment is more than Rs. 10,000. To attract the disallowance under section 40A(3), both the amount of the bill and the amount of payment exceed Rs. 10,000. In other words ,we can say that if purchase is effected from a single person by way of several bills/invoices and if value of each bill/invoice is less than Rs. 10,000 then payments made to settle each bill/invoice would not be hit by provisions of section 40A(3), as each bill/invoice has to be considered as a separate contract. The provisions of sec 40A(3) or 40A(3A) are in nature of permanent disallowance and it applies qua each expenditure. Therefore, for each expenditure one has to look at the payment or aggregate payment made in a day. For two different expenditure, if the payment is made to same person and if the payment is made in cash does not exceed the limit as prescribed qua each expenditure though cumulatively it exceeds, then no disallowance can be made. IN THE ITAT COCHIN BENCH Raja & Co. vs Deputy Commissioner of Income-tax, Central Circle, Trichur IT APPEAL NO. 534 (COCH.) OF 2011

Example: Mr. A purchases certain goods from Y Ltd. On credit on June 11, 2021 for Rs. 8,000, on June 29, 2021 for Rs. 7,000 and on July 10 2021 for Rs 9,000. The total payment of Rs. 24,000 is made by a crossed cheque on August 1, 2021.

Though the amount of payment exceeds Rs. 10,000, nothing shall be disallowed.  To attract disallowance, the amount of bill as well as the amount of payment should be more than Rs.10,000.

TAX IMPLICATIONS WHERE LIABILITIES ARE PAID OFF BY WAY OF BOOK ADJUSTMENT

As per Rule 6DD(d), 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 case:

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.

Let’s understand this through an example:

Scenario-1

Party X purchases goods from Party Z for Rs.1,00,000/- and also sale goods to Z Rs. 2,00,000 Therefore, for X, party Z is its creditor and debtor both. If X does not pay for the purchases made from Z and adjust the credit balance with Z’s debit balance outstanding as a debtor, then such type of adjustment does not contravene the section 40A(3) & 40A(3A)  as per the exception provided in the rule 6DD.

In this case Journal entry will be:

Z  Creditor A/c  Dr. 1,00,000/-

Z  Debtor A/c    Cr. 1,00,000/-

Relevant Case Law Rule 6DD: Held that, where the payments were effected to a customer on account of adjustment resulting out of an exchange of old jewellery with new jewellery, then it does get covered under the exception clause (d) of rule 6DD—DCIT v. Kirtilal Kalidas Jewellers (P.) Ltd. [2012] [ITAT]

Scenario-2

Where Party X purchases goods from Party A for Rs.1,00,000/- and sale goods to Party B for Rs.2,00,000/- . X set off outstanding balance of A with the balance of B through passing journal entry in his books as given below:

A Creditor A/c Dr.  – Rs.1,00,000/-

B Debtor A/c   Cr. –  Rs.1,00,000/-

The above transaction is in contravention of section 40A(3) & 40A(3A), since in this case the payment by book adjustment was not made to Party A directly who supplied the goods or services to Party X and thus the liability incurred for the purchase expense has been setoff through the mode other than specified in these sections.

Relevant Case Law Rule 6DD: Exception will not apply in cases where book adjustments were not made directly in the accounts of the supplier—CIT v. Kishan Chand Maheswari Dass [1980] 121 ITR 232 (Punj. & Har. High Court).

IS SEC.40A(3) APPLICABLE IN CASE OF CASH-SPENT IN FOREIGN CURRENCY EQUIVALENT TO AN AMOUNT EXCEEDING  Rs.10000/-?

The expression in section 40A(3) means disallowance of expenditure incurred exceeding the particular amount in rupee terms. Therefore, even if the expenditure is incurred in cash and in foreign currency, still the provision of section 40A (3) would be applicable if it exceeds the specified quantum in rupee term. Therefore, merely because the expression rupee had been mentioned in section 40A (3) of the Act, it would not debar applicability of the provision to the expenditure incurred in cash in foreign currency.

In the case of Ramlord Apparels [TS-451-ITAT-2020(Mum)], Mumbai ITAT upholds Sec.40A(3) disallowance with respect to exhibition charges incurred in foreign currency by assessee-firm during AY 2014-15, holds that merely because the expression rupee” has been mentioned in section 40A(3) of the Act, it would not debar applicability of the provision to the expenditure incurred in cash in foreign currency.”; AO rejected assessee’s submission that the provisions of section 40A(3) would not be applicable to the expenditure incurred in cash in foreign currency as it refers to expenditure incurred in rupees and not in foreign currency, states that The mention of the word rupee” in section 40A(3) cannot be interpreted in a limited or narrow sense to mean only cash expenditure incurred in rupee.”; Explains that cash expenditure may be incurred in various countries having different currencies and thus it would not have been possible for the legislature to mention the currency of all the countries in the world in section 40A(3).It is further stated that the provision has to be interpreted in a manner to mean cash expenditure equivalent to more than a particular amount in a day.

 As regards assessee’s contention that the provisions of the Act would not be applicable to expenditure incurred abroad, ITAT notes that the expenditure was booked in India and that too in rupee terms, thus holds that .

Therefore, the Assessing Officer has all the powers to examine the allowability of such expenditure under the provisions of the Act .

IS SEC.40A(3) APPLICABLE IN CASE OFACQUISITION OF DISTRIBUTION RIGHTS?

Where any amount is paid by a film distributor for acquiring distributorship of a film, they were paid in the course of the distributor`s business to acquire the stock-in-trade, and hence, would fall within the concept of `expenditure` under section 40A(3). – [Akash Films v. CIT (1991) 190 ITR 32 (Kar.)]

DOES A CROSSED CHEQUE SATISFIES SEC 40A(3) COMPLIANCE?

Only ‘account payee’ cheque satisfies Sec 40A(3) compliance. ITAT Rejects assessee’s stand that payment by “cross cheque” is sufficient compliance of Sec 40A(3) of the Act; Expense disallowance u/s 40A(3) upheld since purchase payment exceeding the specified sum not made by an “account payee cheque”, but by crossed cheque; Crossed cheque can be negotiated and can be credited by drawee bank to bank account of a person other than the payee; Amendments u/s 40A(3) have been carried out for strict enforcement and compliance; Rejects assessee’s claim that purchases being genuine, disallowances u/s 40A(3) ought to be deleted; Reliance placed on Pune ITAT ruling in T G Mutha vs. ITO :ITAT Rjt

In the case of Rajmoti Industries [TS-500-ITAT-2013(Rjt)], ITAT explained that “the amendments made in section 40A(3) are intended to enable the Income-tax authorities to track the transactions between the assessee and the payee in order to ensure that they are properly recorded and accounted for not only by the assessee but by the payee also. The aforesaid object would be completely frustrated if an assessee claiming deduction of expenditure was allowed to make payments in respect thereof in a manner different from the one prescribed in section 40A(3). The legislative policy, which is so clearly and unambiguously expressed in section 40A(3), cannot be allowed to be diluted so as to frustrate the object that it seeks to achieve. Unquestionably, the amendments have been carried out in section 40A(3) for strict enforcement and compliance.

Rejecting the assessee’s contentions, ITAT observed that the CBDT Circular (supra) refers to the instructions issued by the RBI to the bank. In this instruction, difference between crossed cheque and account payee cheque has been brought out. Differentiating the two kinds of cheques, ITAT explained that, “while account payee cheque is credited by the drawee bank to the bank account of the payee and none else, crossed cheque can be negotiated and thus can be credited by the drawee bank to the bank account of a person other than the payee.”

ITAT also noted that the definition of “cheque” u/s 6 read with Sec. 5 of the Negotiable Instrument Act covers account payee cheque and therefore, payments made by a crossed cheque could not be considered as payment by account payee cheque, which is the requirement of law.

WHETHER THE PROVISIONS OF SEC 40A(3) APPLICABLE ON THE TRANSACTIONS BETWEEN MOBILE RECHARGE-VOUCHER SELLERS AND THE TELECOMMUNICATION COMPANY?

Sec 40A(3) inapplicable to purchase of mobile recharge vouchers made by assessee-distributor; Transaction resulted in a principle-agent relationship. In this case, no question of purchase arises because the expenditure and income arising was only in nature of commission/ remuneration against services rendered, therefore, no question of disallowance of any “expenditure” u/s 40A(3) irrespective of payment mode.  Fact that purchase of mobile recharge vouchers were not made from ultimate service provider but from franchisee/ distributor immaterial, does not change nature of relationship in transaction involving mobile recharge voucher supply;

In the case of Doshi Vijaykumar Motilal[TS-347-ITAT-2014(PUN)], ITAT opined that “In our view, the aforesaid aspect of the matter has been appropriately dealt with by the Cochin Bench of the Tribunal… and it was held that the value of SIM cards, recharge coupons, etc. do not represent sale of goods but was only a service rendered by the service provider which was liable to Service tax. Following the aforesaid view, the Cochin Bench of the Tribunal held that the distributor or the franchisee is all the time acting only for and on behalf of the service provider as a part of the service chain, and thus the payments made inter-se the chain only result in commission income. The relevant portion of the decision of the Cochin Bench of the Tribunal has been extracted in the earlier para, which clearly shows that the aforesaid objection raised by the Revenue has been found to be untenable. We also hold so.”

ITAT also rejected Revenue’s contention that purchase of mobile recharge vouchers were not effected from ultimate service provider but from a franchisee/distributor stating that “In our considered opinion, the aforesaid fact-situation will not make a difference to the nature of the relationship, which has been brought out by the Cochin Bench of the Tribunal, in a transaction involving the supply of mobile recharge vouchers.”

NO DISALLOWANCE UNDER SECTION 40A(3) ON CASH PAYMENT MADE TO PRODUCERS FOR PURCHASE OF RAW SKINS AND HIDES

Where assessee made cash payments to producers of raw skins and hides exceeding Rs. 20,000, payment would be covered in rule 6DD(e) and no disallowance would be made under section 40A(3). [In favour of assessee] (Related Assessment year 2010-11) – [PCIT v. Standard Leather (P) Ltd. (2022) 137 taxmann.com 124 (Cal.)]

DISALLOWANCE U/S40A(3) IN CASE OF UNACCOUNTED TRANSACTIONS:-

 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 / bank draft exceeds Rs. 10,000/- no deduction of such expenditure is allowed u/s. 40A(3) of the Act. The said section is quite unambiguous and simple in terms of language but what acquires significance is its implementation in a peculiar circumstance where books of accounts are not prepared and incriminating loose papers in the form of noting, etc. about unaccounted sale / purchase transactions are found in the course of search and seizure action.

For example. In a situation where certain loose sheets/documents containing a noting of unaccounted sale transactions are found and seized in the course of search, the Assessing Officer has the detail of unaccounted sales and under the provisions of Act, he is required to make a proper and just estimate of income earned by the assessee on such unaccounted sales by bringing on record material in the form of comparables in support of his estimate of profit earned by the assessee. In other words, in such a situation, the Act, under the provisions of section 2(24) r.w.s. 5, mandates the Assessing Officer to correctly assess the income earned by the assessee. However, currently, divergent and extravagant views have been taken by few of the Assessing Officers. It has been seen in such situations that the Assessing Officers have taxed the entire unaccounted sales by disallowing the unaccounted purchases under the guidance of section 40A(3). This results in taxing the entire unaccounted sales which is not “income” as defined u/s. 2(24) of the Act. An Assessing Officer is allowed to tax only the element of income and not the total turnover by applying the provision of section 40(A)(3) of the Act which actually results in absurdity and is unlawful.

The Hon’ble Apex Court in CIT v. Shoorji Vallabhdas & Co. [1962] 46 ITR 144 (SC) has held that income tax is a tax only on income. The real income theory has not only been accepted but in fact propounded by the Hon’ble Apex courts as well as various High Courts time and again. The Assessing Officer to protect itself from these embarrassments tries to disallow purchases u/s. 40A(3) of the Act. It is significant to note that though the purchase is stated to be disallowed u/s. 40A(3), the resultant addition amounts to taxation of the entire sale proceeds thereby grossly disregarding the settled law laid down by the Hon’ble Apex Court. Therefore, such an action of the Assessing Officer is completely against the spirit of the law laid down by the Apex Court.

Further, the following ingredients to invoke provision of section 40A(3) of the Act needs to be met cumulatively:-

• Payment of expenditure is made in cash
• Payment exceeds Rs. 10,000/-
• Payment is made to a person in a day

Thus, the burden of proof to prove the existence of cumulative ingredients as per section 40A(3) lies heavily on the Assessing Officer and if the same is not evident from the loose sheets, there does not arise any question of making disallowance under the said section unless the onus is appropriately discharged by the Assessing Officer. It is true that section 40A(3) does not make any distinction between the transactions recorded in the books of accounts or not recorded in the books of accounts. However, it is also true that if no books of accounts are maintained as per the provisions of section 145 of the Act, the Assessing Officer is duty bound to make the best judgment assessment u/s. 144 of the Act which requires him to take into account all relevant material which he has gathered to determine the amount of income earned. Hence, in a given situation, a significant question arises as to whether any expense can be disallowed when the books of accounts have not been maintained and income is to be estimated on the basis of incriminating material found in the course of search. In fact, when the income is to be estimated, then there cannot be any locus standi of a specific claim of expenditure made. The question is simple and clearly answered in unanimity by various Hon’ble High Courts that no disallowance u/s 40A(3) is warranted when income is estimated – [Indwell Constructions v. CIT (1998) 232 ITR 776 (AP); CIT v. Purshottamlal Tamrakar (270 ITR 3140) (MP); CIT v. Banwarilal Banshidhar (1998) 148 CTR 533 (All.)]. Accordingly, once the Assessing Officer estimates income, he is debarred from making disallowance under the normal provisions of the Act.

The Kerala High Court in the case of CIT v. PD Abrahm (2012) 252 CTR 407 has held that unaccounted expenditure can be set off against unaccounted income which again supports the real income theory.

There also prevails a decision of the Hon’ble Gujarat High Court in the case of Hynoup Food and Oil Industries reported at 290 ITR 702 which has taken a contrary view against the assessee. However, considering the various divergent views of the courts, the Hon’ble Pune ITAT in the case of Shri Narendra Mithailal Agrawal (ITA no. 811 & 808/ PN/2010) has followed the decision of the Hon’ble Supreme Court in the case of CIT v. Vegetable Products Ltd (1973) 88 ITR 192 (SC) and has rendered the verdict in favour of the assessee.

CASH PAYMENTS EXCEEDING PRESCRIBED LIMITS – SCRAP FROM RAILWAYS-NO DISALLOWANCE COULD BE MADE

Where payment is made to the Government and, under  the rules framed by it, such payment is required to be made in legal tender.

The CBDT have clarified that payments made to the Railways on account of freight charges or for booking of wagons, and payments towards sales tax/excise duty are to be considered under this clause. – [CBDT’s Circular No. 34, dated 05.03.1970]

Where the assessee purchased scrap from Railways (Union of India), even though cash was paid in excess of Rs. 20,000 in regard to a single transaction, the expenditure in question could not be disallowed by invoking the provisions of section 40A(3). – [CIT v. Venkatesh v. Kabade (2014) 223 Taxman 116 (Karn)]

Cash payments by assessee for scarp purchase from railway being part of Union of India has to treated as legal tender and payment cannot be disallowed under section 40A(3) of the Act.

[Devendrappa Kalal v. CIT ITA  5018/2012 (18.09.2013) (Kar)]

Cash payments made by the assessee to the State Government who was granted the contract to collect royalty on behalf of the Government cannot be disallowed under section 40A(3) in view of rule 6DD(b).

[CIT v. Kalyan Prasad Gupta (2011) 239 CTR 447 (Raj)]

NO DISALLOWANCE U/S 40A(3) IF ULTIMATE PAYMENTS MADE TO LABOURERS WERE BELOW THRESHOLD LIMIT.

Assessee filed a return of income, and his case was selected for scrutiny. During assessment proceedings, Assessing Officer (AO) found that assessee had made a payment of Rs. 18,00,000 to labourers in cash. Consequently, AO made disallowances under Section 40A(3).

Aggrieved by order of AO, assessee preferred an appeal before CIT(A). Assessee submitted that the payment was made for expenses incurred in project sites wherein many labour charges were paid to the number of labourers working at the project sites. It was not the payment made to a single person. It was a transfer entry for labour charges paid to various workers at the site. In support of his claim, assessee produced the site ledger details of labour payments. CIT(A) examined the attendance register and ledger copy of labour charges and observed that all the payments made were below Rs. 20,000 per transaction. However, CIT(A) could not find a valid reason for paying the sum of Rs. 18,00,000 on a single day. Therefore, CIT(A) confirmed the addition made by AO.

ITAT Held

On further appeal, Vishakhapatnam ITAT held that AO did not disbelieve the genuineness of the expenditure. The grievance of AO was only for making the payment on a single day. Assessee stated that the entire payment was not made on the same day, and it was only the transfer entry of the payments made at the sites. Assessee had produced the attendance register and the acquaintance register, wherein it is seen that the payment was made to several labourers, which the recipient duly acknowledged on revenue stamp. All the payments were below Rs. 20,000 to each individual. Assessee stated that the cash payment was made at the agency area to labourers, where free mobility was unavailable.

Accordingly, ITAT held that disallowance under Section 40A(3) attracts if the assessee makes the payment in excess of Rs. 20,000 in a day to any person with regard to the expenditure incurred. Since each payment was less than Rs. 20,000, the question of application of section 40A(3) does not arise. Hence, the addition made by AO was deleted.

No section 40A(3) disallowance if cash payment made to Companies in which 100% shareholding is held by State Govt

Assessee was engaged in business of purchase/sale of wine on retail basis. Assessee purchased wine from two entities, namely, RSGSML and RSBCL by making cash payments exceeding Rs. 20,000. Assessing Officer disallowed said payments on ground of contravention of the provisions of section 40A(3). On appeal, the Commissioner (Appeals) held that the provisions of section 40A(3) would not stand triggered regarding the payments in question for reasons that the assessee had made the payments to the State Government undertakings and the payments were made in legal tender, i.e., in Indian currency, thus, by virtue of the exception carved out in rule 6DD(b), said amounts were not liable to be disallowed under section 40A(3). It was noted that both of aforesaid undertakings were State Government companies wherein 100 per cent shareholding was held by State Government and there was an existence of deep and pervasive control of State Government. Over them Full control of their working, policy and framework was vested with State Government; therefore, these two undertakings could safely be brought within meaning of ‘State’. Further, payments in question were made by assessee in Indian currency, therefore, it could be concluded that same was made by way of ‘legal tender’. Since payments in question were made by assessee to State Government entities by way of legal tender, same were covered by exception contemplated in rule 6DD(b), and, therefore, same could not be disallowed under section 40A(3). The order of the Commissioner (Appeals) was to be upheld. [In favour of assessee] (Related Assessment year : 2014-15) – [DCIT v. Vinod Arora (2022) 137 taxmann.com 450 (ITAT Amritsar)].

NON APPLICABILITY OF SEC 40A(3) IN CASE OF PRESUMPTIVE TAXATION

It is to be noted that section 44AD of the Act begins with a non-obstante clause “(1) Notwithstanding anything to the contrary contained in sections 28 to 43C”… Therefore by virtue of the non-obstante clause, Section 44AD of the Act has a superior position vis-à-vis the other provisions of the Income Tax Act 1961. Nevertheless, Section 44AD(2) of the Act also specifically mentions that any deductions allowable under Section 30 to 38 shall be deemed to have been given full effect. Therefore, there are no specific deductions available for the assessee opting for presumptive taxation under Section 44AD of the Act.

Therefore, Section 44AD (1) determines the taxability by invoking a deeming clause. Further, the section is titled as “Special provision for computing profits and gains of business on presumptive basis”. Hence one may infer that Section 44AD is a self-contained code by its own means devoid of Section 28 to 43C as both chargeability and computation are embedded in it.

Having inferred that Section 44AD(1) is a separate code by itself wherein it determines the profit computation without referring to Section 29 of the Act. Section 44AD(2) of the Act specifically mentions that the deduction allowable under Section 30 to 38 of the Act are deemed to have been allowed. Such a provision, prima facie appears unnecessary especially considering that Section 44AD (1) begins with a non-obstante clause “(1) Notwithstanding anything to the contrary contained in sections 28 to 43C” which on a literal reading specifies that Section 44AD will override all the other provisions relevant for computing profits and gains from business i.e., Sections 28 to 43C of the Act, even if the same are contrary.

It is to be noted here that the non-obstante clause stresses on the term contrary. However, a similar non-obstante clause employed in the newly inserted Section 44ADA of the Act (Special provision for computing profits and gains of profession on presumptive basis), mentions “Section 44ADA. (1) Notwithstanding anything contained in sections 28 to 43C”. On a comparison of Section 44AD and Section 44ADA of the Act, the term ‘contrary’ is absent in the latter section. Now,question arises that whether the term ‘contrary’ used in Section 44AD is superfluous. However it does not appear to be superfluous since the proviso to Section 44AD(2) prior to Finance Act 2016 amendment, specifically mentioned that while determining the income deemed to be profits and gains of business under Section 44AD of the Act, deduction under Section 40(b) shall be allowed subject to the limits specified.

Therefore, Section 44AD of the Act which appears to be a separate self-contained code, specifically uses the term contrary in its non-obstante clause so as to enable the eligible assessee to avail the deduction under Section 40(b) of the Act prior to Finance Act 2016.

The new Section 44ADA of the Act does not provide for any deduction while determining the presumptive profits and this may be considered the reason for the absence of the word contrary in the non obstante clause.

It means section 28 to 43C of Income Tax Act, 1961 is not applicable on eligible assessee carrying on eligible business. Hence, no disallowance/no deemed income under Section 40(a), 40A, 40A(3), 40A(3A), 41 can be made. It has been specifically provided that if the taxable income is to be calculated at eight percent or six percent of turnover or gross receipts, then in that case provisions of section 28 to 43C are not to be taken into consideration for the purpose of computing taxable income. It is pertinent to note whether any adverse inference can be drawn by which any amount that would have been added, while calculating taxable income, such amount can be added while calculating income on presumptive basis. By exclusion clause in respect of section 28 to 43C it seems that no disturbance can be made on account of provisions of sec 28 to 43C if the total income is arrived at on the presumptive basis.

Q: Mr. X has paid Rs.15,000 for purchase of goods in cash. Can disallowance be made u/s. 40A(3) ?

Ans- No disallowance can be made under section 40A(3) for the same.

Q: Mr. X has paid Rs.38,000 to transporter for freight in cash. Can disallowance be made u/s. 40A(3)?

Ans- No disallowance can be made under Section 40A(3).

DISALLOWANCE OF CAPITAL EXPENDITURE EXEEDING RS. 10,000/- IN CASH

Disallowance of Depreciation where cash payment exceeding Rs. 10,000 is made for purchase of asset

• Clause (1) of section 43 defines “actual cost” for the purposes of claiming depreciation
• The cost in acquisition of any asset or part thereof 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 an account payee bank draft or use of electronic clearing system through a bank account, exceeds ten thousand rupees, such expenditure shall be ignored for the purposes of determination of actual cost.

FROM THE AMENDMENTS IN DEFINITION FOLLOWING POINTS ARE CLEAR

It is to be noted that if the payment is made in a single day exceeding Rs.10,000 for the acquisition of the capital asset in cash, then such payment shall not be considered as the cost of acquisition.

• Accordingly no depreciation will be available on such amount paid in cash.
• Further, such amount will not be considered as the cost of acquisition, when the asset is subsequently sold.

KEY POINTS TO BE NOTED:

1. Land is Non Depreciable asset hence this amendment will not trigger whatsoever. However, the provisions of sec 269SS and 269ST will be applicable.

2. Applicability of sec 50

Section 50 would not be applicable if depreciation was never allowed:

If the assessee had not claimed depreciation on any capital asset, which was not in use, he could not be burdened with the provisions of section 50. The basic requirement for the applicability of sec 50 is that the assets should form part of the block of assets in respect of which depreciation had been allowed under the Act.

In the absence of any depreciation being allowed to the assessee in any of the previous years, deeming provisions of section 50 cannot be invoked. 

WHAT IF PAYMENT IS OUTSTANDING AT THE END OF THE YEAR?

In case payment for the asset is made in cash after the end of previous year but before the date of return filing, depreciation on the asset purchased will not be allowed. The consideration paid in cash will not be added in cost of acquisition as per the provisions of Sec 43(1).

The scenario will be different where the payment for acquisition of asset is made in cash after the date of return filing. The assessee would have claimed depreciation in the return filed for the earlier previous year. Later, he has paid the acquisition price in cash. Now the question arises whether the depreciation claimed earlier would be disallowed or not. There is no provision to add back the depreciation allowed earlier on account of payment made in cash. Sec 40A(3A) states that any expenditure allowed in earlier previous will be deemed as income of the previous year in which payment is made in cash. However, the same provisions are not applicable for the depreciation allowed earlier.

EXAMPLE : Mr. X purchases computers of Rs. 3,00,000 on 1.04.2021 and pays the entire amount in cash.

> Since payment of Rs. 3,00,000/- is made by cash, it shall not be considered as part of actual cost of plant and machinery. The actual cost of plant and machinery shall be taken to be NIL and NIL shall be added to WDV of Block of assets.

Note: As per section 269ST, the seller of machinery is liable to pay penalty of Rs. 3,00,000 for accepting cash of Rs.2,00,000 or more. The Penalty shall be under section 271DA.

EXAMPLE :  Suppose in Example 1, Mr. X makes payments as under:

DATES	MODE OF PAYMENT	AMOUNT	TAX TREATMENT
12.04.2021	Cash	Rs. 5,000 x  5 times = Rs. 25,000	Payment made on 12.04.2021 of Rs. 25,000 shall not be considered for determining actual cost since aggregate payments in cash in a day exceeds Rs. 10,000.
03.05.2021  TO 12.05.2021	Cash	Rs. 10,000 every day  x 10 days = Rs. 1,00,000	Payment of Rs. 1,00,000 made by cash from 03.05.2021 to 12.05.2021 shall be considered for determining actual cost since aggregate payments in a day do not exceed Rs. 10,000
22.06.2021	Account Payee Cheque	Rs. 2,25,000	Payment of Rs. 2,25,000 shall be added to WDV of Block of assets.

Therefore Rs. 3,25,000/- shall be considered as actual cost and Rs. 3,25,000/- shall be added to WDV of Block of assets.

Note: Sec. 43(1) defines original cost to mean actual cost of asset as reduced by portion of cost as met directly or indirectly by any other person or authority. Financial Act, 2017 has inserted a second proviso to exclude expenditure incurred in acquisition of any asset or part thereof from actual cost of asset, if the payment in respect of such expenditure is made to a person in a day, exceeding Rs. 10,000 otherwise than by a specified mode. It is to be noted that when a capital asset is acquired and freight is paid on the same in cash exceeding Rs.10,000/-and upto Rs.35,000/-on a single day, the freight will not be included in the cost of acquisition of the asset. This is due to the reason that the enhanced limit of Rs.35,000/- is not applicable for the acquisition of capital asset. 

WHETHER PAYMENTS IN RESPECT OF PAST EXPENDITURE TO BE INCLUDED IN COST?

The language of the second proviso is “where the assessee incurs any expenditure in respect of which payments or aggregate payments made to a person in a day exceed ten thousand rupees, such expenditure shall be ignored for the purposes of determination of actual cost.”

As stated above, the language employed in the amendment is “incurs”, signifying present tense and implying that it would apply to any expenditure which is incurred after the amendment is made effective, as per one view. As per the other view, it may also mean that both the event of incurring the expenditure and the payment thereof should be after the date on which the amendment is made effective. As per yet another view, it may mean that the expenditure may be incurred in past, that is, prior to the effective date of amendment, but, if the payment is made after the effective date of amendment, the provision would apply. Having regard to the provision, its language and the desire to be prospective, it appears that the first view or second view is preferable. The other view would require reworking of the actual cost in respect of the past and to what extent it should be done or not may be difficult as well as impractical.

ACTUAL COST OF ASSET IN CASE OF WITHDRAWAL OF DEDUCTION IN TERMS OF SECTION 35AD(7B) R/W 43(1):

Disallowance of Cash Payments under Section 35AD & Restrictions on Claim of Depreciation of Disallowed Capital Expenditure

Presently under section 35AD investment linked deduction is available in respect of capital expenditure laid out for certain specified businesses. An amendment  has been made to curb the incurring of any expenditure in cash on such expenditure which is eligible for deduction under section 35AD and accordingly an expenditure of above Rs. 10,000/- in aggregate made to a person in a day shall not qualify for deduction under the provisions of the said section. It is to be noted that under the existing provisions of the Act revenue expenditure incurred in cash exceeding Rs. 10,000 is disallowed under section 40(A)(3) except in specific circumstances referred in Rule 6DD of Income Tax Rules, 1962. There is no clarification on disallowance of capital expenditure incurred in Cash under section 35AD of the Act.  In order to discourage cash transactions even for capital expenditure ,the Act has been amended to clause (f) of Section 35AD(8) of Act whereby any capital expenditure in respect of which aggregate payment made to a person in a day otherwise then by account payee cheque, draft or ECS through bank account exceeding Rs. 10,000/- , same shall be disallowed.  Furthermore, as per the provisions of section 35AD(7B) if any asset, in respect of which deduction has been allowed earlier, is put to use for the purpose other than the specified business, then the expenditure allowed as reduced by depreciation calculated in terms of section 32, shall be added back to the income of the assessee in the year in which the asset is so used for purpose other than specified business.

There was no clarity as to what would be the actual cost of such asset for the purpose of section 43. Accordingly, a proviso is being sought to be inserted to Explanation 13 in the section 43 in lines with the provisions of section 35AD(7B)which will provide that the actual cost of such asset shall be the actual cost to the assessee, as reduced by depreciation that would have been allowable if the asset had been used for such purpose (i.e. for other than the specified business) since the date of its acquisition.

The above provisions can be summarized in the following manner:

• Capital Expenditure is required to be incurred in banking Channel to allow 100% Deduction.
• It is now provided that the Actual cost where deduction was allowed under section 35AD This proviso will revive the actual cost if section 35AD(7B) is revoked and thereby previous deduction are withdrawn.
• Capital asset in respect of which deduction allowed under 35AD is deemed to be the income of the assessee as per 35AD(7B)
• The actual Cost of the asset to the assessee shall be the actual cost as reduced by an amount equal to the amount of depreciation calculated at the rate in force that would have been allowable had the asset been used for the purpose of busines

Example:

Plant and Machinery of Rs. 45,50,000 purchased and payments made as under:			Rs. 1,00,000 paid on 05.10.21 and Rs. 60,000 Paid on 12.10.21  will not be allowed under section 35AD. 100% of Rs. 43,90,000 will be allowed under section 35AD.
05.10.21  07.10.21   09.10.21   12.10.21   13.10.21	1,00,000 6,000 4,000 60,000 43,80,000	20 cash payments of Rs. 5,000 each Cash payment Cash payment Cash payment Payment by account payee cheque
Revenue expenditure of Rs. 1,50,000 paid as under:			Revenue expenditure in any case is not allowed under section 35AD but it is allowed under section 30 to 37. In this case, Rs. 75,000 shall be disallowed under section 40A(3) And Rs. 75,000 shall be allowed under sections 30 to 37(1).
07.10.21   09.10.21    12.10.21	75,000 70,000 5,000	Cash payment Payment by account payee cheque Cash payment

 SECTION 40A(3) OVERRIDES THE ENTIRE INCOME TAX ACT

Section 40A(3) overrides the entire Income tax Act and therefore, it overrides section 35 also. Therefore, payments made for scientific research shall be disallowed under section 40A(3) if such payments are made exceeding Rs. 10,000 otherwise than by an account payee cheque or account payee bank draft or use of electronic clearing system through a bank account or through such electronic mode as may be prescribed.

S. NO. 21(D) – DISALLOWANCE / DEEMED INCOME U/S 40A(3)/ 40A(3A)

Cash expenditure limit per person per day has been decreased from AY 2018-19 from Rs. 20000/- to Rs. 10000/-.

• For reporting under this sub-clause, the tax auditor should obtain a list of all cash payments. This list should be verified by the tax auditor with the books of account in order to ascertain whether the conditions for specified exemption granted under clauses (a) to (l) of Rule 6DD are satisfied or the payments are made under prescribed threshold limit.
• Where on account of voluminous entries, it is not possible to verify each payment, the tax auditor should obtain suitable management representation from the assessee to the effect that the payments for expenditure referred to in section 40A(3) and section 40A(3A) were made by account payee cheque drawn on a bank or account payee bank draft, as the case may be.
• In case the reporting has been done solely on the basis of the management representation from the assessee, the fact shall be reported as an observation in clause (3) of Form No. 3CA and clause (5) of Form No.3CB.

In case expenditure is incurred in earlier previous years, but payment is made in the previous year under tax audit, then also the limits discussed above needs to be verified and payments made in excess of the limits would be deemed to be income of current previous year u/s 40A(3A) and is to be reported in clause 21(d)(B). 

DISCLOSURES IN TAX AUDIT REPORT

PARTICULARS OF AMOUNT INADMISSIBLE U/S 40A(3)

S NO.	DATE OF PAYMENT	NATURE OF PAYMENT	MODE OF PAYMENT	AMOUNT OF DISALLOWANCE/ DEEMED INCOME	NAME OF THE PAYEE	PAN OF THE PAYEE

Reporting has to be done on the basis of the certificate of the assessee, the fact shall be reported as an observation in clause (3) of form no.3CA and clause (5) of Form No.3CD as the case may be 

Recommended Disclosure: In respect of payments by cheque/draft for the expenses covered under this clause, we have to state that it is not possible for us to verify whether the payments in excess of Rs 10,000/35,000 have been made otherwise than by account payee cheque / bank draft since the necessary evidence is not in the possession of the assessee.

However the assessee has certified that all such payments relating to expenditure covered u/s40A(3) / (3A) of the Act read with Rule 6DD, were made either by account payee cheques drawn on a bank or by account payee bank drafts.

Q3. Mr.Raj makes cash payment of Rs.13,000/- to Mr. Arjun for purchase of goods on 01.06.2021. Payment is made for following purchases:

Purchases Date	Amount	Accounted in
15/09/2019	7000	F.Y. 2019-20
01/06/2020	6000	F.Y. 2020-21

What is the amount of disallowance? Whether reporting required?

Ans. Invoices for purchase amount to Rs. 7,000 and Rs. 6,000, both of which are below Rs.10,000. The expenditure of Rs. 7,000 would have been allowed in P.Y. 2019-20. For two different expenditure, if the payment is made to same person and if the payment is made in cash does not exceed the limit as prescribed qua each expenditure though cumulatively it exceeds, then no disallowance can be made as held in ITAT COCHIN BENCH Raja & Co. v. Deputy Commissioner of Income-tax, Central Circle, Trichur IT APPEAL NO. 534 (COCH.)OF 2011.

Therefore, no amount shall be disallowed u/s 40A(3) and no amount shall be deemed as income u/s 40A(3A). There is no requirement to report this in Form 3CD.

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PROVISIONS OF SECTION 40A(3/3A)

(3) 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[or through such other electronic mode as may be prescribed], exceeds ten thousand rupees, no deduction shall be allowed in respect of such expenditure.

(3A) 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 (hereinafter referred to as subsequent year) the assessee makes payment in respect thereof, 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 ⁴⁰[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 accordingly 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 ten thousand rupees:

Provided that no disallowance shall be made and no payment shall be deemed to be the profits and gains of business or profession under sub-section (3) and this sub-section 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 ten thousand rupees, in such cases and under such circumstances as may be prescribed, having regard to the nature and extent of banking facilities available, considerations of business expediency and other relevant factors :

Provided further that in the case of payment made for plying, hiring or leasing goods carriages, the provisions of sub-sections (3) and (3A) shall have effect as if for the words “ten thousand rupees”, the words“thirty-five thousand rupees” had been substituted.

Rule 6DD

[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 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 prescribed in rule 6ABBA.]

6DD. 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 ²[account payee bank draft or use of electronic clearing system through a bank account or through such other electronic mode as prescribed under rule 6ABBA, exceeds ten thousand rupees] .

(a) where the payment is made to—

(i) the Reserve Bank of India or any banking company as defined in clause I of section 5 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 the State Bank of India (Subsidiary Banks) Act, 1959 (38 of 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;

where the payment is made by—

(i) any letter of credit arrangements 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 any other bank;

(iv) a bill of exchange made payable only to a bank;

(v) to (vii) 3[ *** ]

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;

(c)  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;

(d) where the payment is made for the purchase of—

(i)  agricultural or forest produce; or

(ii) the produce 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, produce or products;

(e) 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;

(f) 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;

(g) 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;

(h) 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—

(i)  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

(ii) does not maintain any account in any bank at such place or ship;

(i)  Where the payment was required to be made on a day on which the banks are closed either due to holiday or strike (this clause is omitted w.e.f. 29.01.2020)

(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;

(j) where the payment is made by an recognized dealer or a money changer against purchase of foreign currency or recognize cheques in the normal course of his business.

Explanation. For the purposes of this clause, the expressions “recognized dealer” or “money changer” means a person recognized as an recognized dealer or a money changer to deal in foreign currency or foreign exchange under any law for the time being in force.

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