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Section 40A(3): What You Should Know About Inadmissible Expenses in Income Tax
Every day, both individuals and organisations face several expenses. Due to the prevalence of cash transactions prior to the 2016 demonetization, it was more challenging to identify the source of revenue, and this resulted in widespread tax evasion. The purpose of Section 40A(3) is to discourage tax evasion and encourage electronic payments. The Income Tax Act prohibits all transactions that total more than Rs. 10,000 in a single day as an expense. In this comprehensive guide, we will elucidate everything you need to know about section 40A(3), disallowances, and exceptions from this article.
What is Section 40A(3) of the Income Tax Act?
In 2009, Section 40A was changed to Section 40A (3). It limits cash payments and receipts above a particular amount. The clause prohibits tax deductions for expenses paid in cash in a single day that exceed Rs. 10,000. Any form of transaction other than bank drafts, account payee checks, electronic payment systems, and approved electronic means is subject to this daily restriction.
Section 40A(3) addresses exceptions and the disallowance of cash-only expenses. The purpose of this part is to promote tax responsibility, decrease tax evasion, and disincentivize cash transactions.
When carriers are paid in cash to hire, lease, or ply goods vehicles, the cap under Section 40(3) is raised to Rs. 35,000. Additionally, commission agents are exempt from the restrictions for items they receive in exchange for commissions or consignments. This is so that the commission agents are unable to deduct such costs.
You won't be able to claim this payment as a business expense if you make it. If your application for this kind of deduction is approved, it will be filed under the heading "profits and gains of business or profession." The year before the one in which you made such a payment is when your tax liability will become due.
This exemption is solely applicable to costs paid by businesses, enterprises, and organisations. Payments paid in cash for any expenses over Rs. 10,000 are not eligible for deduction. The Capital Gains Act applies to assets acquired by an organisation, such as land and machinery, which do not fall within the expense category.
Modes of Payment Allowed Under Section 40A(3)
No disallowance will occur even if the expenditure exceeds Rs 10,000 (or Rs 35,000) if the payment was made using one of the following approved electronic methods:
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An account payee check
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A demand draft
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ECS or digital payment channels
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Other approved methods
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Credit and debit card payments, IMPS, UPI, RTGS, NEFT, and others
In summary, only payments made with cash or bearer checks are prohibited.
Amendment to Section 40A (3)
A taxpayer who spent more than Rs. 20,000 in a single day and paid for it with a method other than a bank draft or cheque payable to the assessee was subject to limitations under the previous version of Section 40A (3) of the Income Tax Act, which became effective on April 1, 2009. It prevented those people from deducting these kinds of costs.
It further says that if a person claims tax deductions for these payments, those deductions will be considered the person's business profits for the preceding year.
Section 40A (3) was amended, reducing the maximum amount of cash that might be used for business transactions from Rs. 20,000 to Rs. 10,000 in a single day. If a payment was to be considered profits from a business or profession, the same cap applied. In addition, using the electronic clearing system was included in the list of approved payment methods.
Exceptions Under Rule 6DD of Income Tax
According to Income Tax Act Rule 6DD, the following extraordinary circumstances will allow a payment over Rs 10,000 to be made in cash or by bearer cheque:
Payment to the Government: This includes payments made to state and federal governments for customs, direct tax, GST, and other taxes. It also includes payments that aren't related to taxes. For instance, if the scrap is paid for in cash to the Indian railways, it comes under a 6DD exception.
Payment given to banking and other credit institutions: This include the Reserve Bank of India, LIC, banks, the government, land mortgage banks, primary agriculture credit societies, and cooperative banks.
Payments using the banking system to make a payment: These inlcude any letter of credit, through mail or telegram, a bank-payable bill of exchange, ECS usage, credit/debit card, rearranging books within the same bank or between different banks, using credit and debit cards.
Payment by Book Entries: The payee's account is credited with the amount owed to the assessee for the provision of goods or services. This payment is made through book adjustments.
Funds Transferred to a Licenced Dealer: The individuals authorised by law to provide currency services, such as money changers and authorised dealers, are likewise exempt from Rule 6DD. This exclusion exclusively covers purchases made from such dealers of foreign currency and travellers' checks.
Reimbursements to Workers at Low Pay: Employers may continue to provide retrenchment compensation, gratuities, and other terminal benefits to their employees or their heirs without being subject to the limits outlined in § 40A (3). There are two requirements, though. First, the total amount cannot exceed Rs. 50,000. Second, it ought to be paid when an employee retires, resigns, is fired, or passes away.
Salary Disbursements in Remote Areas: Employers who pay salaries to workers temporarily deployed at any location other than their regular place of duty or who spend 15 days or longer on a ship are exempt from this rule. A bank account that is accessible at such a location cannot belong to the employee.
Buying Agricultural or Animal Products: If you buy any produce from henhouses, dairy farms, apiculture, horticulture, fisheries, or animal husbandry, there are no payment restrictions under Section 40A (3). But the producer, grower, or farmer of these items must receive the cash. For third parties selling these products, the exception does not apply.
Buying Products from the Cottage Industry: Producers who do not utilise power for processing or manufacturing can accept cash payments for their goods.
Difference between Section 40A (3) and Section 40A (3a)
Section 40A (3) applies to 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. The incurred costs are not eligible for tax deductions in such a situation.
However, Section 40a (3a) outlines what happens in the event that an expense is recorded in the prior year but paid for in the next year. Any payment over Rs. 10,000 paid to a single individual in a single day by a mechanism other than an account payee check, bank draft, or electronic funds transfer will be considered a profit from business or profession. This type of revenue is payable to income tax in the subsequent year.
Frequently asked questions
Q
What is Section 40A (3) under the Income Tax Act?
A
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).
Q
Are cash expenses of more than Rs.10,000 tax-exempt?
A
According to Section 40A(3), you are not eligible to deduct taxes on cash expenses paid to a single individual in a single day that exceed Rs. 10,000.
Q
Can a salary be paid in cash above Rs.10,000?
A
Under certain exceptional circumstances, you are able to deduct taxes from salary payments made in cash exceeding Rs. 10,000. To be qualified, you may pay up to Rs. 50,000 in cash for any employee termination benefits. Moreover, in isolated areas without access to bank accounts, you can pay employees' salaries in cash.
Q
What is the exception to Section 40A(3)?
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Rule 6DD outlines the circumstances in which the disallowance under s. 40A (3) is not applicable. This covers payments to approved dealers, the government, and banking institutions, among others.
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What is the disallowance under Section 40A(3)?
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Payments made in cash or through other non-specified methods exceeding Rs. 10,000 are not eligible for tax deductions under Section 40A (3).
Q
What is the cash payment limit for FY 2022-23?
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The daily cash payment limit that is eligible for tax deductions under Section 40A (3) is Rs. 10,000.
Q
What is the cash payment limit for transporters?
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When carriers are paid in cash to hire, lease, or ply goods vehicles, the cap under Section 40(3) is raised to Rs. 35,000.
Q
What are inadmissible expenses?
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A list of items that are not allowed in determining an assessee's taxable income is provided by Section 40A. In determining the assessee's business income, certain amounts will not be deductible if specific requirements are not met.
Prachi Jain
Chartered Accountant
Prachi Jain is a Chartered Accountant with a passion for simplifying finance and tax-related matters through her insightful and informative blogs. With a background in finance and a deep understanding of tax regulations, Prachi has established herself as a trusted source of financial wisdom. Prachi is committed to empowering her readers with the knowledge they need to make informed financial decisions. Her expertise and dedication shine through in every blog post, helping her audience navigate the intricacies of finance and taxes with confidence. Follow Prachi Jain's blog for practical insights and guidance on managing your finances effectively.
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