Section 40A(3) of the Income Tax Act
Updated: Oct 2
In today’s digital age, the Income Tax Act promotes transparency and accountability in financial transactions by discouraging large cash payments. Section 40A(3) plays a crucial role in this effort, aiming to curb the practice of making substantial cash payments in business transactions, thereby reducing the risk of tax evasion. According to this provision, any payment exceeding Rs. 10,000 made in cash to a single person on a single day is not allowed as a deductible expense when calculating taxable income, unless it falls under specific exceptions outlined in Rule 6DD.
This section is particularly important for businesses, as non-compliance can lead to the disallowance of significant expenses, resulting in higher tax liabilities. In this blog, we will explore the key aspects of Section 40A(3), its exceptions, and how it impacts businesses and tax planning.
Table of Content
What is Section 40A(3) of the Income Tax Act?
A 2009 change to Section 40A, known as Section 40A(3), limits the amount of cash payments or receipts that can exceed a specific threshold. This clause prohibits a single person from deducting taxes on expenses above Rs. 10,000 that are paid for in cash in a single day. Any form of transaction other than bank drafts, account payee checks, electronic payment systems, and approved electronic means is subject to this daily restriction. The cap under Section 40A(3) is raised to Rs. 35,000 in cases where transporters are paid in cash to hire, lease, or operate goods vehicles.
Any payment you make that exceeds the Rs. 10,000/35,000 cap will be rejected. Furthermore, if you pay for an expense that you have already accrued and have previously claimed as a deduction on an accrual basis in a previous year, that amount will be considered as your income and subject to taxation under the heading "profits and gains of business or profession" [Section 40A(3A)]. The year before the one when you made such a payment is the time when your tax liability will be due.
Illustration: On three separate days, A Ltd. pays cash for stationery totalling Rs. 15,000, Rs. 16000, and Rs. 19000. A total of Rs. 40,000 has been spent. The amount cannot be deducted from the company's overall revenue calculation because the daily cash outlay exceeds Rs. 10,000. If the same organisation makes three separate cash purchases for stationery on different days totalling Rs. 8,000, Rs. 9,000, and Rs. 10,000, the entire amount spent will be deductible as long as it stays under the daily cap of Rs. 10,000.
Amendments to Section 40A(3)
Before April 1, 2009, the Income Tax Act's Section 40A(3) placed restrictions on assessees who spent more than Rs. 20,000 in a single day and made payments using methods other than bank drafts or checks sent to the account payee. It prevented people from deducting these costs. Additionally, the clause mentioned that these payments would be considered the individual's business profits for the prior year if they were claimed as tax deductions by the individual. Section 40A(3) has been amended to lower the cash limit for business transactions from Rs. 20,000 to Rs. 10,000 in a single day. If a payment was to be regarded as profits from a business or profession, the same threshold was applicable. In addition, using the electronic clearing system was one of the approved payment methods.
Permissible Modes of Payment under Section 40A(3)
No deduction will be taken even if the expense surpasses Rs 10,000 (or Rs 35,000) if the payment was made using a demand draft, account payee cheque, electronic money transfer (ECS), digital payment methods or other approved electronic methods. Likewise, payments made using IMPS, UPI, RTGS, NEFT, and credit/debit cards are also permissible. Only payments made with cash or bearer checks are prohibited.
Rule 6DD Exceptions to Section 40A(3)
The government has established specific circumstances in which the aforementioned clause will not be applicable because there may be real-world situations in which monetary payment is not always feasible. In some circumstances, when a taxpayer makes payments, the aforementioned disallowance does not happen. These conditions and situations are covered by Rule 6DD, which was added on October 10, 2008, by Notification No. SO2431(E). The following is a list of the Income Tax Act's Section 40A(3) exceptions:
Payments made with lawful cash to the federal government or any state government are not subject to disallowances. Payments for things like sales tax, GST, customs, excise duty, freight costs, reservations for trains, etc. are exempt from this rule.
Payments to the Reserve Bank of India, State Bank of India, and any banking company above the Rs. 10,000 limit may be made in non-specific ways (cash or bearer checks). Additionally, cash payments to any cooperative bank, land mortgage bank, primary agricultural credit society, primary credit society, or LIC are also accepted.
Those who are legally permitted to provide currency services, such as authorised dealers and money changers, are likewise exempt from Rule 6DD. This exclusion is limited to purchases made from such dealers of foreign currency and travellers' checks.
Employers who provide retrenchment compensation, gratuities, or any other terminal benefits to workers or their heirs are exempt from the limitations outlined in § 40A (3). There are two requirements, though. First, the total amount cannot exceed Rs. 50,000. Second, it ought to be paid in the event of a worker's passing, retirement, resignation, or termination.
Employers paying salaries to workers temporarily deployed at any location besides their regular place of duty or who spend more than 15 days on a ship are exempt from this rule. A bank account accessible at such a location cannot belong to employees.
Certain payment methods are exempt from disallowances under Section 40A(3) of the Income Tax Act. These include telegraphic or postal money transfers between banks, letters of credit by banks, a bill of exchange payable to the bank, and book conversion between different bank accounts. Any bank, banking society, banking firm, and any bank outside of India that is defined in this section is referred to as a "bank."
Payments made by reducing the buyer's responsibility for goods or services the seller has previously provided are exempt from disallowance.
If you buy any produce from dairy farms, henhouses, horticulture, apiculture, fisheries, or animal husbandry, there are no payment thresholds under Section 40A(3). But the farmer, grower, or producer of these items must get the cash. Sellers of these products by third parties are not covered by this exclusion.
The disallowance of Rs. 10,000 under § 40A(3) does not extend to butchers or manufacturers of meat. These individuals have to be in the business of butchering animals in order to sell raw meat or animal carcasses to wholesalers, retailers, or facilities that process meat. A veterinary doctor's certification and profession declaration are required.
Paying for produce from producers who don't use electricity for processing or manufacturing can be done with cash.
In a town or village that is not bank-served, a payment is made to anyone who regularly resides there or conducts business there.
Payment upon an employee's retirement, layoff, resignation, dismissal, or death is another possibility. If the payment in these circumstances does not exceed Rs. 50,000, it is given to the employee or his legal heir.
Compliance Requirements for Section 40A(3)
To avoid financial fines, all people and business entities should abide by the guidelines in Section 40A(3). Among the essential filing prerequisites are:
Daily accurate maintenance of all cash payment records, particularly those that total more than ₹10,000.
Information on the recipient of each cash payment, including name, address, PAN, payment history, etc.
A deliberate attempt to guarantee that, at the time of ITR filing, no prohibited expenses are added to the taxable income.
A list of all of the necessary cash payments and maintain any supporting documentation close at hand so you may show it to the tax authorities at any time.
Also, examine and comprehend every exemption under Section 40A(3) to make sure you meet the requirements and don't owe extra money in taxes.
Section 40A(3) and Section 40A(3A): A Comparison
Any assessee who pays someone more than Rs. 10,000 in a single day, via any means other than an account payee check, bank draft or electronic clearing system, is subject to Section 40A(3). In this scenario, tax deductions for the incurred costs are not permitted. However, Section 40A(3A) outlines what happens if an expense is recorded in the prior year but paid for in the next year. Any payment made to an individual in a single day that isn't made by an account payee check, bank draft, or electronic funds transfer (ECS) and totals more than Rs. 10,000 will be considered profit from business or profession. In the next year, income tax is due on such income.
Section 40A(3) of the Income Tax Act: Key Case Laws
Here, we explore a few landmark cases that shed light on the application of Section 40A(3) of the Income Tax Act, with practical examples:
Case 1: CIT Vs. K.K.S K. Leather Processor P Ltd [2008] 160 Taxman 251 (Madras)
In this case, the court ruled in favor of the taxpayer, permitting cash payments made on a bank holiday or Sunday as an exception. Since the payment occurred when banks were closed, no disallowance under Section 40A(3) was imposed.
Case 2: Attar Singh Gurmukh Singh Vs. ITO, 191 ITR 667 (SC)
The Supreme Court clarified that Section 40A(3) is applicable to payments made for acquiring stock-in-trade or other business materials. However, the court emphasized that the provision is not intended to restrict business activities. Taxpayers may submit evidence to the Assessing Officer demonstrating why it was impractical to use the prescribed modes of payment.
Case 3: Harshila Chordia v. ITO [2008] 298 ITR 349 (Rajasthan)
The Rajasthan High Court's Division Bench ruled that the exceptions under Rule 6DD are not exhaustive. Thus, Section 40A(3) should be interpreted with flexibility. If a taxpayer can prove the authenticity of the transaction, disallowance under this section may not be applicable.
Case 4: A. Daga Royal Arts Vs. ITO [2018] 94 taxmann.com 401 (Jaipur Tribunal)
The Jaipur Tribunal noted that even with amendments to Rule 6DD (j), the Supreme Court’s ruling on considering the necessity of cash payments remains valid. The tribunal highlighted that Rule 6DD may not cover all exceptional circumstances, and authorities should have mechanisms to permit exceptions when cash payments are unavoidable.
These cases illustrate how courts and tribunals have interpreted Section 40A(3) to balance compliance with practical business realities.
Conclusion
In summary, only one individual may deduct tax on costs paid in cash that total more than Rs. 10,000 in a single day under Section 40A(3) of the Income Tax Act. The income tax department is unable to track payments made from some sources, so they are restricted or disallowed. The purpose of this part is to reduce tax evasion and the flow of illicit funds into India.
FAQ
Q1. What is Section 40A (3) as per the Income Tax Act?
Payments to an individual in excess of Rs. 10,000 per day are not eligible for tax deductions under Section 40A(3) unless they are done by account payee check, bank draft or electronic funds transfer (ECS).
Q2. Can a salary be paid in cash above Rs.10,000?
Yes, you can deduct taxes from salary payments made in cash exceeding Rs. 10,000 in certain extraordinary circumstances. You may pay up to Rs. 50,000 in cash for any employee termination benefits in order to be eligible. Moreover, you can pay employees' salaries with cash in remote locations without access to bank accounts.
Q3. Are cash expenses of more than Rs.10,000 tax-exempt?
Section 40A(3) states that you cannot claim a tax deduction for cash expenses exceeding Rs. 10,000 that you pay to a single person on a single day.
Q4. What is the exception to Section 40A(3)?
Rule 6DD states the circumstances in which the disallowance under Section 40A (3) is not applicable. This covers money paid to banks, the government, licenced dealers, and other entities.
Q5. What if an expense is allowed on the due basis and later paid in cash next year?
According to section 40A(3A), if an assessee pays an expense that exceeds Rs 10,000 in cash or by bearer cheque in a subsequent year after it is allowed in that year, it is considered a profit from business or profession and will be subject to tax in that year.
Q6. Is capital expenditure included under section 40A(3)?
No, the prohibition on cash payments only applies to expenses tied to revenue. Investment in capital is not covered in this section.
Q7. What is the cash payment limit as per income tax?
Payments made in cash to an individual in excess of Rs.10,000 in a single day are not eligible for tax deductions. When cash payments are made to transporters for the purpose of hiring, leasing, or operating goods vehicles, the cap outlined in Section 40A(3) is increased to Rs. 35,000.
Q8 What is the reduced cash payment limit under the Income Tax amendment?
If more than Rs. 10,000 is paid in a single day this year by a method other than an account payee demand draft, cheque, or electronic clearing system through a bank account. The monetary cap for the assessment year 2018–19 has also been lowered from Rs. 20,000 to Rs. 10,000.
Q9. How much salary can be paid in cash?
It's not required that salary payments be made using cheques. However, a payer is not permitted to spend more than Rs 20,000 in cash in a single day under section 40A(3). Thus, no one should get payment for their salary in cash.
Q10. Does Section 40A(3) apply to payments made to non-residents?
Yes, Section 40A(3) applies to payments made to both residents and non-residents. Cash payments exceeding Rs. 10,000 to any person, including non-residents, are subject to disallowance unless they meet the prescribed exceptions under Rule 6DD.
Q11. Are payments to related parties subject to Section 40A(3)?
Yes, payments made to related parties are also subject to the cash payment limit of Rs. 10,000 under Section 40A(3). If the payment exceeds this limit, it will not be allowed as a tax deduction unless it is made via account payee cheque, bank draft, or electronic transfer.
Q12. Is petty cash subject to Section 40A(3)?
Yes, petty cash expenses are also subject to the Rs. 10,000 limit. Any individual payment exceeding Rs. 10,000 in cash on a single day to a single person will be disallowed unless it qualifies for the exceptions mentioned in Rule 6DD.
Q13. Does Section 40A(3) apply to payments for personal expenses?
No, Section 40A(3) applies only to business and professional expenses. Personal expenses made in cash are not covered by this section but may be subject to scrutiny under other provisions of the Income Tax Act.
Q14. What are the consequences of making payments in cash above the limit under Section 40A(3)?
Payments made in cash exceeding Rs. 10,000 will be disallowed as a deductible expense when computing taxable income, resulting in a higher tax liability for the taxpayer. Additionally, the taxpayer may face penalties or interest charges for non-compliance.
Q15. Are charitable contributions subject to Section 40A(3)?
No, charitable donations are not subject to Section 40A(3). However, such donations must meet the conditions specified in Section 80G for the donor to claim a tax deduction.
Q16. Can TDS be deducted on cash payments exceeding Rs. 10,000 under Section 40A(3)?
Yes, even if a payment is made in cash exceeding Rs. 10,000, TDS must still be deducted as per the applicable sections of the Income Tax Act. However, the payment itself will be disallowed under Section 40A(3) for tax deduction purposes.
Q17. How does Rule 6DD impact Section 40A(3) compliance?
Rule 6DD outlines the specific circumstances under which payments in cash exceeding Rs. 10,000 will not be disallowed. These include payments to banks, government bodies, certain institutions, and in cases of business necessity where no banking facilities are available.
Q18. Is Section 40A(3) applicable to payments for goods and services provided by individuals?
Yes, Section 40A(3) applies to all payments for goods and services in the course of business, regardless of whether they are made to individuals, companies, or other entities. Cash payments exceeding Rs. 10,000 in a day will be disallowed unless they meet the exceptions provided in Rule 6DD.
Q19. How does Section 40A(3) impact audit reports under Section 44AB?
In cases where a taxpayer is required to submit a tax audit report under Section 44AB, any violations of Section 40A(3), including cash payments exceeding Rs. 10,000, must be disclosed in the audit report. Non-compliance with Section 40A(3) can lead to penalties and increased scrutiny from tax authorities.
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