Section 40A(3) and Section 40A(2) are both anti-tax evasion measure which disallow certain expenses if they are not in compliance with the guidelines laid by the Income Tax Act. Both these sections are over-riding sections and if any expenditure or allowance comes under the purview of any other section, there treatment should only be done as per provisions laid down in these sections.
- Recommended Read: Section 40A(2): Disallowance of certain payments made to Relatives
Section 40A(3): Disallowance of Expenses
Section 40A(3)(a) of the Income Tax Act provides that any expenditure incurred in respect of which payment is made in a sum exceeding Rs. 20,000/- in a single day otherwise than by an account payee cheque drawn on a bank or by an account payee bank draft, shall not be allowed as a deduction.
Section 40A(3)(b) also provides for deeming a payment as profits and gains of a business or profession if the expenditure is incurred in a particular year but the payment is made in any subsequent year in a sum exceeding Rs 20,000/- otherwise than by an account payee cheque or by an account payee bank draft.
By requiring payments to me made by an account payee instrument, it is possible to verify the genuineness of the transaction thereby mitigating the risk of evasion of income tax.
It is pertinent to be noted that Section 40A(3) only disallows for any expenditure incurred. Therefore, purchase of capital assets is not covered under the purview of this Section
There are certain other exceptions as well to the provisions stated in Section 40A(3)(a) and in Section 40A(3)(b). These provisions have been stated in Rule 6DD
Rule 6DD: Exceptions to provisions of Section 40A(3)
No disallowance of expenses exceeding Rs. 20,000 in a day made otherwise than by an account payee cheque or account payee bank draft should be made in case of the following expenses:-
1. Where the Payment is made to:-
- Reserve Bank of India or any banking company;
- State Bank of India or any subsidiary bank;
- Any co-operative Bank or Land Mortgage Bank;
- Any primary agricultural credit society or any primary credit society;
- Life Insurance Corporation of India;
2. Where the payment is made to the Govt and, under the rules framed by it, such payment is required to be made in legal tender;
3. Where the payment is made by
- Any Letter of Credit Arrangements through a Bank
- A Mail or telegraphic transfer through a Bank
- A Book adjustment from any account in a bank to any other account in that or any other bank
- A Bill of exchange made only payable to a Bank
- The use of electronic clearing system through a Bank Account
- A Credit Card
- A Debit Card
4. 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
5. Where the payment is made to the cultivator, grower or producer for the purchase of the following
- Agricultural or Forest produce; or
- Produce of Animal Husbandry (including livestock, meat, hides and skins)
- Fish or Fish Products; or
- Products of Horticulture of Apiculture
6. 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;
7. Where the payment is made in a village or town, which on the date of such payment is 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
8. 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 Rs 50,000
9. 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 the Income Tax Act , and when such employee:-
- Is temporarily posted for a continuous period of 15 days or more in a place other than his normal place of duty or on a ship; and
- Does not maintain any account in any bank at such place or ship
10.Where the payment was required to be made on a day on which the banks were closed either on account of holiday or strike. It is pertinent to note here that such payment would be allowed as an expense only when it has been proved that the payment was required to be made on the day on which the bank was closed and the payment could not have been made on a working day.
11. Where the payment is made by any person to his agent who is required to make payments in cash for goods or services on behalf of such person
12. Where the payment is made by an authorised dealer or a money changer against purchase of foreign currency or travellers cheque in the normal course of business