Section 40A(3) of Income Tax Act

Introduction

Section 40A(3) of the Income Tax Act outlines provisions related to the disallowance/ inadmissible expenses of cash payments in certain situations. This section aims to promote transparency and accountability in financial transactions, particularly in business expenditure. It restricts the deductibility of expenses exceeding a specified limit when they are not paid through prescribed electronic modes or financial instruments. In this article, we will explore the key aspects of Section 40A(3), its exceptions, and its implications.

Applicability

If a business makes any payment(s) or expenditure(s) to -

• A single person
• In a single day
• Other than by account payee cheque or an account payee bank draft(i.e., Makes payment via cash)
• Exceeding Rs 10,000/-

then such expenditure will not be allowed as a deduction under section 40A(3) of the Income Tax Act.

Modes of payment allowed

• An account payee cheque or
• Demand draft or
• ECS or digital payment
• Payments through Cards (Debit, credit), IMPS, UPI, RTGS, NEFT etc.
• Other prescribed electronic modes.

The Threshold Limit

According to Section 40A(3), if the payment or aggregate of payments for an expenditure to a person in a day exceeds Rs. 10,000, it must be made by specific payment methods to be considered for deduction. However, for payments related to plying, hiring, or leasing goods carriages, a higher threshold of Rs. 35,000 is applicable.

Exceptions

Section 40A(3) does not apply to all types of payments. Several exceptions [Rule 6DD ] and situations exist where the disallowance provision does not come into play.

Some notable exceptions include:

1. Payments to Specified Institutions
   There is no disallowance for payments made in non-specified modes to institutions like RBI, banking companies, co-operative banks, and more.
2. Payments in Legal Tender to the Government
   No disallowance for payments required to be made to the government in legal tender, such as freight charges or taxes.
3.  Payments by Specified Modes
   Payments are made through letter of credit, telegraphic transfers, book adjustments, or bills of exchange payable to a bank.
4. Payments by Book Adjustment / Book Entries
   Payments are made by adjusting against the liability incurred for goods or services provided.
5. Payments for Agriculture or Animal Produce
   No disallowance for payments made to producers of agricultural, animal husbandry, horticulture, or apiculture products.
6.  Payments for Cottage Industry Products
   Payments for products manufactured in cottage industries without power aid.
7. Payments in Remote Places
   Cash payments in areas not served by banks are exempted.
8. Terminal Payments to Low-Paid Employees
   Payments like gratuity, retrenchment compensation, or similar benefits up to Rs. 50,000.
9. Payment of Salary at Remote Places
   Salary payments to employees temporarily posted in remote locations without a bank account.
10. Payments to Agents
    Payments made by any person to their agent for goods or services in cash.
11. Payments by Authorized Dealers
    Authorized dealers and money changers are exempt from disallowance for cash payments in their normal business operations.
12. Purchase of Animals
    Exemption for individuals buying animals from farmers for slaughter and meat sale, subject to specific conditions.

Implications of Non-Compliance

If a taxpayer claimed a deduction for an expense in previous years and subsequently made a payment in violation of Section 40A(3), the payment may be treated as business income in the year it was made.

Conclusion

Section 40A(3) of the Income Tax Act aims to promote transparency and accountability in financial transactions. It restricts the deductibility of expenses exceeding specified limits when not paid through prescribed modes. Understanding these provisions and exceptions is crucial for businesses and individuals to ensure compliance with tax regulations.

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