Section 40A(2) is an over-riding sections which provide that even if an expenditure or allowance comes within the purview of any other section, there treatment should only be done as laid down in Section 40A(2).
Section 40A(2): Disallowance of expense on Payments to Relatives
Section 40A(2) provides power to the Income Tax Officer that in case any expenditure has been incurred and the payment has been made or is to be made to certain specified persons and he is of the opinion that such expenditure is excessive or unreasonable with regard to the fair market value of the goods, services or facilities provided, he may disallow such expense as he considers to be excessive or unreasonable.
For example: If a Company is paying Salary of Rs. 1 Crores to the 18 year old Daughter of the Director and she does not have any prior experience, the assessing officer may consider this Salary as excessive and may disallow this expense in part or in full. However, while disallowing the same he will have to consider the fair market value of the same i.e. if some other person had provided this service – how much compensation would the company given that person.
For an amount to be disallowed as an expense under Section 40A(2), the following 3 conditions are to be satisfied:-
- The payment is in respect of any expenditure
- The payment has been made or is to be made to a specified person in respect of such expenditure
- The payment for the expenditure is considered excessive or unreasonable having regard to the fair market value of the goods, services or facilities provided.
If all the above conditions are fulfilled, the Income Tax Officer can disallow the expenditure to the extent he considers it excessive or unreasonable.
Specified Persons for the purpose of Section 40A(2)
The specified persons for different categories of taxpayers for the purpose of Section 40A(2) are as under:-
| Category of Taxpayer | Specified Persons |
| 1. Individual | a. Any Relative; b. Any person in whose business or profession, the individual himself or his relative has substantial interest |
| 2. Company, Firm, AOP or HUF | a. Any Director of the Company, Partner of the firm, or member of the association, or family or any relative of such director, partner or member; b. Any Person in whose business or profession the assessee or director or partner or member of the assessee or any relative of such person has a substantial interest |
| 3. All Assessees | a. Any Individual who has substantial interest in the business or profession of the Assessee b. A Company, Firm, AOP, or HUF having a substantial interest in business or profession of the assessee or any director, partner or member of any such person or any relative of any such director, partner or member c. A Company, firm, AOP or HUF of which a director, partner or member has a substantial interest in the business or profession of the assessee or any director, partner, or member of any such person or any relative of any such director partner or member |
Meaning of Substantial Interest for purpose of Section 40A(2)
A person shall be deemed to have substantial interest in a business or profession, if:-
- In a case where business or profession is carried on by a company, such person is, at any time during the previous year, the beneficial owner of shares carrying not less than 20% of the voting power
- In any other case, such person is, at any time during the previous year beneficially entitles o not less than 20% of the profits of such business or profession
Meaning of Relative for the purpose of Section 40A(2)
The meaning of Relative has not been mentioned anywhere in Section 40A(2). In such cases, where the meaning of a word is not mentioned in that section, we rely on the definition of that word given in Section 2.
As per Section 2(41), relative in relation to an individual means:-
- Husband,
- Wife,
- Brother or Sister,
- Linear ascendant or descendant of that individual
It is important to note here that relatives of spouse of the individual would not be considered and only the relatives of that person himself would be considered.
