Analysis of Section 40A(3) and 40A(3A)

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

Where payment is made in the year the expenditure is incurred: 100% disallowance of payment if 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.

Example: Where expenditure of shop expenses for Bill raised on 11/11/2019 is made on 03/03/2020 by cash amounting to Rs. 30,000, then the payment of Rs. 30,000 will not be allowed as a deduction for the PY 2019-20

Payments made on a single day: where the payment or the aggregate of payments made to a single person on a single day against one bill exceeds Rs 10,000 then the disallowance of such expenditure will be covered by Sec 40A. Thus for disallowance u/s 40A(3) the amount of the bill raised and the payment or payment(s) made to the person on a single day both exceed Rs 10,000.

Illustrations for Sec 40A(3)

(i) An expenditure of Rs. 40,000 is incurred for purchase of stationary against Bill no 2 from M/s XYZ Ltd on 01/01/20. The assessee makes separate payments of Rs. 15,000, 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.

(ii) An expenditure of Rs. 30,000 is incurred for purchase of stationary against Bill No 1, 2 & 3from M/s XYZ Ltd on 01/01/20, 28/01/20 & 01/02/20 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

(iii) An expenditure of Rs. 37,000 is incurred for purchase of stationary against Bill No 1 & 2 from M/s XYZ Ltd on 01/01/20 and 01/02/20 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

Example: An expenditure of Rs. 60,000 is incurred freight against Bill no 2 from M/s NITCO Roadways on 01/05/19.The assessee makes separate payments of Rs. 24,000, Rs. 36,000 on 01/09/19 and 01/10/19 respectively. In this case since the payment made is not in excess of the limit of Rs 35,000 thus it will not be disallowed, however the payment made on 01/10/19 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

(b) 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.1 0000/-in a day

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

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 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 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.- 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). X has given an advance to Mr. Y of Rs. 2,50,000 in cash on 15.03.2020 for supply of goods. The goods are supplied on 29.05.2020 for Rs. 2,50,000, and the advance is adjusted. Section 40A (3) will be attracted and Rs. 2,50,000 will be disallowed is Assessment Year 2021-22. Further, it is to be noted that in A.Y. 2020-21 Mr. Y has received Rs. 2,50,000 in cash in contravention of Sec 269ST. He shall be subject to penalty u/s 271 DA of the Act.

Illustration: A Ltd. purchases goods on credit from a relative of a director on June 20, 2018 for Rs. 50,000(market value: Rs 42,000). The amount is paid by a crossed cheque on June 25, 2018.

Out of the payment of Rs. 50,000 Rs. 8,000 (being the excess payment to a relative) shall be disallowed under section 40A (2). As the payment is made by a crossed cheque and the remaining amount exceeds Rs. 10,000, 100% of the balance (i.e., Rs. 42,000) shall be disallowed under section 40A(3).

1. Purchase of stock-in-trade, whether expenditure to be covered by section 40A(3).- In Attar Singh Gurumukh Singh, etc. v. ITO(1991) 191 ITR 667(SC), Supreme Court held that the word ‘expenditure‘ has got its wide import. The expenditure for purchasing stock-in-trade is one of the outgoings. The value of the stock-in-trade has to be taken into account while determining the gross profit under section 28 as per the principles of commercial accounting. The payment made for purchasing stock-in-trade would also be covered by the word expenditure and such payment can be disallowed if they are made in cash in a sum exceeding the amount specified in section 40A(3). Rule 6DD also contemplates payments made for stock-in-trade and raw material.

2. 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 avoid purchase of fish or fish product from any middleman.-

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.

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

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

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 31/03/20, 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.

Section 40A(3) will not hit if purchase from single person and value of each invoice is less than Rs 10000

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 Sec 40A(3) or 40A(3A) is 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. v. 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, 2018 for Rs. 8,000, on June 29, 2018 for Rs. 7,000 and on July 10 2018 for Rs 9,000. The total payment of Rs. 24,000 is made by a crossed cheque on August 1, 2018.

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.

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