Expenses disallowed under Section 40A(3) and Section 40A(3A) of the Income Tax Act, 1961

Section 40A(3) was introduced as a provision designed to counter evasion of tax through claims for expenditure shown to have been incurred in cash with a view to frustrating proper investigation by the Department as to the identity of the payee and the reasonableness of the payment.

Section-40A(3) provides that where assessee incurs any expenditure in respect of which a payment or aggregate of payments made to a person in a day, otherwise than by an account payee cheque drawn on a bank or account payee bank draft or payment made by use of electronic clearing system through a bank account or through such other electronic mode as may be prescribed” exceeds Rs. 10 000/- (Rs. 20,000/- upto assessment year 2017-18), the whole of such expenditure shall not be allowed as deduction in computing profits and gains of business or profession. (Now applicable to charitable trusts also for the purposes of determining the application of income). That is to say that payment of expenditure exceeding Rs. 10,000/- in cash will be disallowed.

However, if the payments are made for plying, hiring or leasing carriages for goods such as lorries, trucks etc. then the limit is extended to Rs 35,000/- (Rs. 20,000 - upto 30.09.2009).

Text of Section 40A(3)

EXPENSES OR PAYMENTS NOT DEDUCTIBLE IN CERTAIN CIRCUMSTANCES

[1][(3) Where the assessee incurs any expenditure in respect of which a payment or aggregate of payments made to a person in a day, otherwise than by an account payee cheque drawn on a bank or account payee bank draft, [2][or use of electronic clearing system through a [3][bank account] or through such other electronic mode as may be prescribed], exceeds ten thousand rupees,] no deduction shall be allowed in respect of such expenditure.]

KEY NOTE

1. Sub-sections (3) and (3A) substituted for sub-section (3) by the Finance Act, 2008, with effect from 01.04.2009. Prior to its substitution, sub-section (3), as amended by the Direct Tax Laws (Amendment) Act, 1987, with effect from 01.04.1988/01.04.1989, Finance Act, 1995, with effect from 01.04.1996, Finance (No. 2) Act, 1996, with effect from 01.04.1997, Taxation Laws (Amendment) Act, 2006, with effect from 13.07.2006 and the Finance Act, 2007, with effect from 01.04.2008, read as under :

“(3)(a) Where the assessee incurs any expenditure in respect of which payment is made in a sum exceeding twenty thousand rupees otherwise than by an account payee cheque drawn on a bank or account payee bank draft, no deduction shall be allowed in respect of such expenditure;

(b) Where an allowance has been made in the assessment for any year in respect of any liability incurred by the assessee for any expenditure and subsequently during any previous year (hereinafter referred to as subsequent year) the assessee makes payment in respect thereof, otherwise than by an account payee cheque drawn on a bank or account payee bank draft, the payment so made shall be deemed to be the profits and gains of business or profession and accordingly chargeable to income-tax as income of the subsequent year if the amount of payment exceeds twenty thousand rupees:

PROVIDED that no disallowance shall be made and no payment shall be deemed to be the profits and gains of business or profession under this sub-section where any payment in a sum exceeding twenty thousand rupees is made otherwise than by an account payee cheque drawn on a bank or account payee bank draft, in such cases and under such circumstances as may be prescribed, having regard to the nature and extent of banking facilities available, considerations of business expediency and other relevant factors.”

2. Substituted for “exceeds twenty thousand rupees,” by the Finance Act, 2017, with effect from 01.04.2018.

3. Substituted for the words "bank account" wherever they occur, the words "bank account or through such other electronic mode as may be prescribed" by the Finance (No. 2) Act, 2019, with effect from 01.04.2020

Limit for disallowance of expenditure made otherwise than by an account payee cheque or account payee bank draft

S. No.

Disallowance of cash expenditure exceeding

(i)

For transport operators journeys for plying, hiring or leasing goods carriages,

Rs. 35,000

(Rs. 20,000 - upto 30.09.2009).

(ii)

For others

Rs. 10,000

[Rs. 20,000/- upto assessment year 2017-18]

Burden of proof

Whereas the burden of proof for establishing that payments exceeding rupees twenty thousand are made to a person in a day otherwise than by an account payee cheque drawn on a bank or account payee bank draft lies on revenue the burden of establishing that the case falls under the exclusionary provisions of Rule 6DD lies on the assessee.

Meaning of ‘expenditure’

The `expenditure` referred to in section 40A(3) is not confined to expenditure that could be claimed as a deduction under section 37, but refers to any payment made by the assessee and taken into account in computing the total income under the provisions of the Act - Sajowanlal Jaiswal v. CIT (1976) 103 ITR 706 (Ori.). Thus, though the provision appears under the provisions relating to the computation of business income, it will apply to all payments made by an assessee, irrespective of the head of income under which they are classifiable. The provision will apply to salary payments, payments for rent, and the like. In fact, the CBDT had clarified at the time of introduction of the provision that it will apply also for the purposes of computation of income under `other sources` - Circular No. 6-P, dated 06.07.1968 . The following clarifications/rulings in respect of certain specific types of payments must also be kept note of.

Meaning and scope of word ‘expenditure’ for purposes of Section 40A(3)

Section 40A(3) refers to the expenditure incurred by the assessee in respect of which payment is made. It means all outgoings are brought under the word ‘expenditure’ for the purpose of the sub-section. The expenditure for purchasing the stock-in-trade is one of such outgoings. - [Attar Singh Gurmukh Singh v. ITO (1991) 191 ITR 667 (SC)]

Even if the payments were made by way of advances and were ultimately treated as discharging the liability to pay the price of the goods purchased, the payments so made must be considered to fall within the expression ‘expenditure’ incurred for payment of the price of the goods. - [Kejriwal Iron Stores v. CIT (1988) 169 ITR 12 (Raj)]

When Expenditure Claimed on Due Basis

When expenses is allowed as businesses expenditure on due basis for a previous year, and the liability is settled in the subsequent period otherwise than by account payee cheque or any other banking mode for a aggregate of payment to a person made in a day exceeds 10,000 rupees, then such payment will be deemed to be business income of the previous year in which payments are made.

In other words, if any deductions are allowed for expenses in a previous year for which payment is made in subsequent year otherwise than an account payee cheque or bank draft or any other banking mode then it shall be deemed to be income under the head “profits and gains of business or profession” in the year in which such aggregate payments are made to a person in a day is in excess of 10,000 rupees.

Conditions

No deduction is allowed if the following conditions are satisfied:

(a) The assessee incurs any expenditure which is otherwise deductible under other provisions of the Act for computing business/ profession income (i.e., expenditure for purchase of raw material, trading goods, expenditure on salary, etc.). The amount of expenditure exceeds Rs. 10,000.

(b) A payment (or aggregate of payments made to a person in a day) in respect of the above expenditure exceeds Rs. 10,000.

(c) The above payment is made otherwise than by an account payee cheque or an account payee demand draft (i.e. it is made in cash or by a bearer cheque or by a crossed cheque or by a crossed demand draft).

KEY NOTE

(i) If aggregate payment in a day (otherwise than by an account payee cheque/ draft) to the same person in respect of an expenditure exceeds Rs. 10,000, it will be disallowed under section 40A(3), even if none of each payment in a day exceeds Rs. 10,000.

(ii) If an assessee makes payment of two different bills (none of them exceeds Rs. 10,000) at the same time in cash (or by bearer cheque or by crossed cheque or by crossed demand draft), section 40A(3) is not applicable even if the aggregate payment is more than Rs. 10,000. To attract the disallowance under section 40A(3), both the amount of the bill and the amount of payment exceed Rs. 10,000.

(iii) Where the assessee makes payment over Rs. 10,000 at a time, partly by an account payee cheque and partly in cash (or bearer cheque or crossed cheque or by crossed demand draft) to some parties and this payment in cash (or by bearer cheque or crossed cheque or crossed demand draft) alone at one time does not exceed Rs. 10,000, section 40A(3) is not attracted. d. Provision of section 40A(3) does not apply in respect of an expenditure which is not to be claimed as deduction under sections 30 to 37.

(iv) Section 40A(3) only empowers Assessing Officer to disallow deduction claimed as expenditure in respect of which payment is not made by crossed cheque or crossed bank draft.

Aggregate Payment has to be seen

After the amendment with effect from 2009-10, if a person makes more than one different purchases for cash from same person in excess of Rs. 10,000 (upto Assessment year 2017-18 – Rs. 20,000/-) in a single day even though on separate cash memos, such aggregate payment will be disallowed under section 40A(3). For example if A makes three purchases of Rs. 9,000 each from the same person during different time of the day and obtains three different cash memos, yet the transaction will be covered by section 40A(3) and such expenditure will be disallowed.

Section 40A(3) extends to single payments or aggregate of payments made to a single person in a day. Therefore, if A makes a payment to B, of Rs. 10,000, Rs. 15,000, and Rs. 18,000 in cash in one single day, then the aggregate amount of Rs. 43,000 will be disallowed. Even the purchase of goods falls under the term expenditure. This section shall not apply to expenses which is not to be claimed as deduction under section 30 to 37.

FOR EXAMPLE

Assume a taxpayer has incurred an expenditure of Rs. 25,000/-. The taxpayer makes separate payments of Rs. 8,000/-, Rs. 8,000/- and Rs. 9,000/- all by cash, to the person concerned in a single day. The aggregate amount of payment made to a person in a day, in this case, is Rs. 25,000/-. Since, the aggregate payment by cash exceeds Rs. 10,000/-, Rs. 25,000/- will not be allowed as a deduction in computing the total income of the taxpayer in accordance with the proposed amendment.

Acquisition of stock-in-trade/raw materials

In a series of decisions by various High Courts, it was held that the term `expenditure` for the purpose of section 40A(3) will cover payments made for acquisition of stock-in-trade or raw materials. This view has since received the stamp of approval from the Supreme Court in the case of Attar Singh Gurmukh Singh v. ITO (1991) 191 ITR 667. The Supreme Court observed :

". . . it may be stated that the word `expenditure` has not been defined in the Act. It is a word of wide import. Section 40A(3) refers to the expenditure incurred by the assessee in respect of which payment is made. It means that all outgoings are brought under the word `expenditure` for the purpose of the section. The expenditure for purchasing stock-in-trade is one of such outgoings. The value of the stock-in-trade has to be taken into account while determining the gross profits under section 28 on principles of commercial accounting. The payments made for purchases would also be covered by the word `expenditure` and such payments can be disallowed if they are made in cash in the sum exceeding the amount specified under section 40A(3). . . The rule also contemplates payments made for stock-in-trade and raw materials. …. Section 40A(3) is therefore attracted to payments made for acquiring stock-in-trade and other materials. . . ." (pp. 673-674)

The Supreme Court did not agree with the contrary view taken by the Gauhati High Court in the case of CIT v. Hardware Exchange (1991) 190 ITR 61.

Acquisition of distribution rights

Where any amount is paid by a film distributor for acquiring distributorship of a film, they were paid in the course of the distributor`s business to acquire the stock-in-trade, and hence, would fall within the concept of `expenditure` under section 40A(3). – [Akash Films v. CIT (1991) 190 ITR 32 (Kar.)]

Advances for purchases - Even if the payments were made by way of advances and were ultimately treated as discharging the liability to pay the price of the goods purchased, the payments so made must be considered to fall within the expression `expenditure` incurred for payment of price of goods – [Kejriwal Iron Stores v. CIT (1988) 169 ITR 12 (Raj.)]

Loan transactions

The CBDT have clarified that, since advancing of loans and repayment of loans do not constitute deductible items in computing the taxable income, the connected payments will not constitute `expenditure` for the purpose of section 40A(3), and hence the disallowance will not operate. However, where interest is paid on loans, the payment must satisfy the requirement of section 40A(3), as interest is a deductible expenditure - Refer Question 2 in Press Note, dated 02.05.1969, and Letter F. No. 1(22)/69-TPL (Pt.), dated 18.04.1969.

Meanings of `Cheque` and `Bank`

The CBDT have clarified that the word `cheque`, which is not defined in the Income-tax Act, will have the same meaning as in section 6 of the Negotiable Instruments Act, viz., `a bill of exchange drawn on a specified banker and not expressed to be payable other than on demand`. It has also been clarified that the word `bank` as used in section 40A(3) is wide enough to include any person carrying on the business of banking, and thus would include a co-operative land mortgage bank or any other co-operative society carrying on the business of banking. Indigenous money-lenders` banks are also `bank`, provided they are specifically notified under section 49A of the Banking Regulations Act – [Circular No. 6-P, dated 06.07.1968].

How to apply monetary limit

When more than one payment is made on the same day - Section 40A(3) as amended w.e.f. 01.04.2009 clearly specify that where the assessee incurs any expenditure in respect of which a payment or aggregate of payments made to a person in a day, otherwise than on account payee cheque or bank draft exceed twenty thousand rupees no deduction shall be allowed in respect of such expenditure. Therefore, if payment is made in parts which is less than 10,000 but aggregate in a day exceeds Rs. 10,000/- the whole of the payment will be disallowed.

Exception to Provision of Section 40A(3) [Rule 6DD]

The provisions of section 40A(3) are subject to exceptions as provided in Rule 6DD of the Income-tax Rules, 1962.

Section 40A(3) is not applicable [Rule 6DD]

Text of Rule 6DD

CASES AND CIRCUMSTANCES IN WHICH A PAYMENT OR AGGREGATE OF PAYMENTS EXCEEDING TEN THOUSAND RUPEES MAY BE MADE TO A PERSON IN A DAY, OTHERWISE THAN BY AN ACCOUNT PAYEE CHEQUE DRAWN ON A BANK OR ACCOUNT PAYEE BANK DRAFT OR USE OF ELECTRONIC CLEARING SYSTEM THROUGH A BANK ACCOUNT OR THROUGH SUCH OTHER ELECTRONIC MODE AS PRESCRIBED IN RULE 6ABBA.

6DD. No disallowance under sub-section (3) of section 40A shall be made and no payment shall be deemed to be the profits and gains of business or profession under sub-section (3A) of section 40A where a payment or aggregate of payments made to a person in a day, otherwise than by an account payee cheque drawn on a bank or account 2[account payee bank draft or use of electronic clearing system through a bank account or through such other electronic mode as prescribed under rule 6ABBA, exceeds ten thousand rupees]

(a)

where the payment is made to—

(i)		the Reserve Bank of India or any banking company as defined in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949);
(ii)		the State Bank of India or any subsidiary bank as defined in section 2 of the State Bank of India (Subsidiary Banks) Act, 1959 (38 of 1959);
(iii)		any co-operative bank or land mortgage bank;
(iv)		any primary agricultural credit society or any primary credit society as defined under section 56 of the Banking Regulation Act, 1949 (10 of 1949);
(v)		the Life Insurance Corporation of India established under section 3 of the Life Insurance Corporation Act, 1956 (31 of 1956);

(b)		where the payment is made to the Government and, under the rules framed by it, such payment is required to be made in legal tender;
(c)		where the payment is made by—

(i)		any letter of credit arrangements through a bank;
(ii)		a mail or telegraphic transfer through a bank;
(iii)		a book adjustment from any account in a bank to any other account in that or any other bank;
(iv)		a bill of exchange made payable only to a bank;
(v) to (vii)		[Omitted vide Notification No. 08/2020-Income-Tax, dated 29.01.2020]

		Explanation.—For the purposes of this clause and clause (g), the term “bank” means any bank, banking company or society referred to in sub-clauses (i) to (iv) of clause (a) and includes any bank [not being a banking company as defined in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949)], whether incorporated or not, which is established outside India;
(d)		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;
(e)		where the payment is made for the purchase of—

(i)		agricultural or forest produce; or
(ii)		the produce of animal husbandry (including livestock, meat, hides and skins) or dairy or poultry farming; or
(iii)		fish or fish products; or
(iv)		the products of horticulture or apiculture,

		to the cultivator, grower or producer of such articles, produce or products;
(f)		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;
(g)		where the payment is made in a village or town, which on the date of such payment is not 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;
(h)		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 fifty thousand rupees;
(i)		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 section 192 of the Act, and when such employee—

(i)		is temporarily posted for a continuous period of fifteen days or more in a place other than his normal place of duty or on a ship; and
(ii)		does not maintain any account in any bank at such place or ship;

(j)		[Omitted vide Notification No. 08/2020-Income-Tax, dated 29.01.2020]
(k)		where the payment is made by any person to his agent who is required to make payment in cash for goods or services on behalf of such person;
(l)		where the payment is made by an authorised dealer or a money changer against purchase of foreign currency or travellers cheques in the normal course of his business.
		Explanation.—For the purposes of this clause, the expressions “authorised dealer” or “money changer” means a person authorised as an authorised dealer or a money changer to deal in foreign currency or foreign exchange under any law for the time being in force.]

KEY NOTE

Rule 6DD(j) was Omitted with effect from 01.09.2019. Prior to its omission read as “where the payment was required to be made on a day on which the banks were closed either on account of holiday or strike”;

1. Payment made to institutions like RBI, SBI etc. [Rule 6DD(a)]

Where the payment is made to

(i) Reserve Bank of India or any banking company as defined in section 5(c) of Banking Regulation Act, 1949;

(ii) State Bank of India or any subsidiary bank as defined in section 2 of SBI (Subsidiary Banks) Act, 1959;

(iii) any co-operative bank or land mortgage bank;

(iv) any primary agricultural credit society or any primary credit society as defined under section 56 of the Banking Regulation Act, 1949;

(v) Life Insurance Corporation of India.

Rule 6DD(a) applies only for payments to institutions referred to therein and not for payment made to any party’s account maintained in such institutions – Payments made in cash to the account of the suppliers maintained with banks did not qualify for deduction.

[CIT v. K. Abdu & Co. 170 Taxman 297 (Ker)]

2. Payment to Government Rule 6DD(b)

Where payment is made to the Government and, under the rules framed by it, such payment is required to be made in legal tender.

The CBDT have clarified that payments made to the Railways on account of freight charges or for booking of wagons, and payments towards sales tax/excise duty are to be considered under this clause. - [CBDT’s Circular No. 34, dated 05.03.1970]

Cash payments exceeding prescribed limits – Scrap from Railways-No disallowance could be made

Where the assessee purchased scrap from Railways (Union of India), even though cash was paid in excess of Rs. 20,000 in regard to a single transaction, the expenditure in question could not be disallowed by invoking the provisions of section 40A(3). - [CIT v. Venkatesh v. Kabade (2014) 223 Taxman 116 (Karn)]

Cash payments by assessee for scarp purchase from railway being part of Union of India has to treated as legal tender and payment cannot be disallowed under section 40A(3) of the Act.

[Devendrappa Kalal v. CIT ITA 5018/2012 (18.09.2013) (Kar)]

Cash payments made by the assessee to the State Government who was granted the contract to collect royalty on behalf of the Government cannot be disallowed under section 40A(3) in view of rule 6DD(b).

[CIT v. Kalyan Prasad Gupta (2011) 239 CTR 447 (Raj)]

3. Payment by certain modesRule 6DD(c)

Where the payment is made by

(i) any letter of credit arrangements through a bank;

(ii) a mail or telegraphic transfer through a bank;

(iii) a book adjustment from any account in a bank to any other account in that or any other bank;

(iv) a bill of exchange made payable only to a bank;

(v) the use of electronic clearing system through a bank account;

(vi) a credit card;

(vii) a debit card.

KEY NOTE

“Bank” means any bank, banking company or society referred to in (i) to (iv) of rule 6DD(a) and includes any bank [not being a banking company as defined in section 5(c) of the Banking Regulation Act, 1949], whether incorporated or not, which is established outside India.

4. Adjustment in books Rule 6DD(d)

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.

Payments 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. This exemption is held to operate only when the adjustment is made directly in the payee’s account, and that the prohibition in Section 40A(3) is attracted to cases where book adjustments are not so directly made.

[CIT v. Kishan Chand Maheshwari Dass (1980) 121 ITR 232 (P & H)]

5. Purchase of certain products Rule 6DD(e)

Where the payment is made for the purchase of -

(i) agricultural or forest produce; or

(ii) the produce of animal husbandry (including livestock, meat, hides and skins) or dairy or poultry farming; or

(iii) fish or fish products; or

(iv) the products of horticulture or apiculture, to the cultivator, grower or producer of such articles, produce or products.

Payments made to farmers or kacha Aarartias - No disallowance can be made

Tribunal held that once the payment is treated as having been made to a farmer, section 40A(3) will not come into play and the disallowance was rightly deleted by CIT(A). Payments to Kacha Aaratia is to be taken as a payment to framer as such Aaratia is a de facto agent of the farmer and does not receive payment in his own right and therefore, such payment cannot be disallowed. (Related Assessment year 2008-09)

[ITO v. Ram Prakash (2014) 164 TTJ 7 (ITAT Agra)(UO)]

Section 40(A(3) has no application where interest is credited to creditor’s account and there is no cash payment.

CIT v. Muthoot Bankers (2000) 162 CTR (Ker) 414 (Ker)]

Words ‘cultivator, grower or producer’ occurring at the end of Rule 6DD(e) qualify the words occurring in all the preceding four sub-clauses and not only in sub-clause (iv). Thus, the exemption is confined to grower or producer of forest produce and not available for purchases made from others.

[CIT v. Pehlaj Rai Daryanmal (1991) 190 ITR 242 (All)]

Scope of clause (e) of rule 6DD

There is limited area within which payments by book adjustment can be considered to fall within the exception to the rule of prohibition contained in section 40A(3). According to clause (e) of rule 6DD it is the expenditure in respect of which the payment by way of book adjustment is made to the payee who directly supplied the goods or services to the assessee, that falls outside the mischief of rule of prohibition in section 40A(3). The payments by book adjustments in the accounts of third parties would be hit by the prohibition contained in section 40A(3) - [CIT v. Kishanchand Maheshwari Dass (1980) 121 ITR 232 (P&H)]

Rule 6DD(e)(ii) provides relief from the operation of Section 40A(3), inter alia, where the payment exceeding a sum of Rs. 2,500 is made for the purchase of produce of animal husbandry to the producers of such articles. Where, however, the purchases were of hides and skins and the assessee had failed to establish that the payments were made to the producer, the aforesaid relief would not be available. - [Ideal Tannery v. CIT (1979) 117 ITR 34 (All)]

Hoshiarpur District Co-operative Milk Producers Union Ltd. cannot be considered to be a producer of milk as its constitution does not permit individual producers to be its members and consequently, payment made by the assessee to the said union cannot be treated as payment made to producer of milk. - [Chanchal Dogra v. ITO (2012) 67 DTR 108 (HP)]

Payments to arhatiyas do not fall for exclusion under this sub-clause. [CBDT’s Circular No. 34, dated 05.03.1970]

Payment made in advancing loans and returning the principal amount of borrowed money not covered by Section 40A(3)

Advancing of loans or repayment the principal amount of the loan do not constitute expenditure deductible in computing the taxable income. However, interest payments made in contravention of provisions of Section 40A(3) are disallowable, as interest is a deductible expenditure.

[Press Note : Dated 02.05.1969, issued by Ministry of Finance]

PAYMENTS FOR AGRICULTURAL PRODUCE

Under this sub-clause, payments for the purchase of agricultural or forest produce is excluded, only where the payments are to be made to the cultivator/grower/producer. If the produce undergoes change and then sold, the exclusion will operate.

For example, payments made to a grower or producer of kapas ginned by him, or to a grower of paddy which has been converted by him into rice and then sold, the exclusion will still operate.

[Press Note, dated 02.05.1969]

Payments to middlemen for the purchase of agricultural produce do not as such come under this sub-clause. - [Letter F. No. 1/22/69-TPL (Pt.), dated, 18.04.1969]

6. Cottage industry Rule 6DD(f)

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. No bank service Rule 6DD(g)

Where the payment is made in a village or town, which on the date of such payment is not 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.

KEY NOTE

Cash payments exceeding prescribed limits - No bank account at place of purchase - Genuineness of purchases was not doubted - Disallowance was held to be not justified.

The assessee, engaged in wholesale trade of iron and steel, purchased goods and made payment in cash. The Assessing Officer made addition on the ground that the payments exceeded Rs. 20,000, in contravention of provisions of section 40A(3) of the Income-tax Act, 1961. The Commissioner (Appeals) confirmed the order of the Assessing Officer. On appeal : Held, allowing the appeal, that it was submitted that the assessee had no bank account at the place of purchase and the cash payments were made on the demand of the seller. The genuineness of the purchases had not been doubted by the Assessing Officer. The disallowance of expenses under section 40A(3) was not justified. (Related Assessment year 2008-2009 )

[Radha Shyam Panda v. ITO (2015) 37 ITR 386 (ITAT Cuttack)]

8. Terminal benefit to employee - Rule 6DD(h)

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. Temporary posting of employee - Rule 6DD(i)

Where the payment is made by an assessee by way of salary to his employee after deducting the income-tax from salary as per section 192, and when such employee

(i) 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

(ii) does not maintain any account in any bank at such place or ship.

10. When bank is closed either on account of holiday or strike [Rule 6DD(j)]

This clause (j) was inserted with effect from 1-12-1995, so as to exclude payments required to be made on a day on which the banks were closed either on account of holiday or strike. Prior to 01.12.1995 also, the exclusion was available under executive instructions – CBDT’s Circular No. 250, dated 11.01.1979 and Letter F. No. 142(14)/70-TPL, dated 28.09.1970.

Expenses or payments not deductible - Cash payments exceeding prescribed limits – Mere genuineness of payment cannot be the ground allow the claim, unless the assesse establishes exceptional circumstances

The Tribunal held that the assessee has not been able to demonstrate that its case is covered by either of the exceptions under Rule 6DD. Mere finding of the purchase transactions as genuine would not take the same beyond the scope of the disallowance under section 40A(3). The exception contemplated by sub-rule (j) of Rule 6DD to relax the rigours of Section 40A (3) in certain situations was omitted from the statue by an amendment. Hence the same cannot come to the rescue of the assessee whose case is covered by the post amended section 40A (3) read with rule 6DD hence the disallowance was upheld. (Related Assessment year 2009-10)

[International Ships Stores Suppliers v. JCIT (2017) 183 TTJ 161 : 162 ITD 73 : 145 DTR 1 (ITAT Mumbai)]

Payments in cash exceeding specified limit-Payment for purchase of land on Sunday - Exceptional circumstances - Covered under rule 6DD(j) - Disallowance not proper

The assessee proposed to purchase land and fixed the date for registration of sale deed on March 28, 2010. The assessee had made the payment on the date of registration, which was a Sunday. The Assessing Officer disallowed the cash payment under section 40A(3) of the Income-tax Act, 1961, on the view that though the assessee had plenty of time before March 28, 2010, the payment had been made on Sunday and the assessee had not shown any exceptional circumstances why it was necessary to make the payment on Sunday. The Commissioner (Appeals) confirmed the order of the Assessing Officer. On appeal: Held, allowing the appeal, that admittedly, it was realised later on that March 28, 2010 was Sunday and in order to execute the sale deed, the assessee paid cash on that date itself. When an agreement provided for a payment on or before a particular date, it was not necessary that just to meet the technical requirement of income-tax provisions, payment should be made earlier. The payment made on March 28, 2010, which fell on a Sunday was covered by the exception provided under rule 6DD(j) of the Income-tax Rules, 1962. The disallowance was to be deleted. (Related Assessment year 2010-2011)

[Hi Tech Land Developers and Builders v. Add. CIT (2015) 38 ITR 355 (ITAT Chandigarh)]

Cash payments exceeding prescribed limits – Cash payment made due to ‘exceptional or unavoidable circumstances’ was not supported with any evidences, will attract provisions of Section 40A(3)

Assessee carried on the business of purchase and sale of suitcases. The assessee made cash payments cash exceeding Rs. 10000 for the purchases made during the year. The Assessing Officer and the CIT(A) did not accepted the explanation given by the assessee and disallowed the same under section 40A(3). Before the Tribunal the assessee contended that the situation falls under ‘exceptional or unavoidable circumstances’ and was entitled to benefit under Rule 6DD(j). The Tribunal held that suppliers of assessee, who were delivering goods to him invariably insisted on spot payment of cash to lorry drivers, and decided in favour of the assessee. The High Court held that there must be some evidence to corroborate the explanation furnished by the assessee. The submissions by the assessee were false and the Tribunal has decided purely on surmises and conjectures. Hence the question decided in favour of the revenue. (Related Assessment year 1995 - 96) - [CIT v. Singamsetty Subba Rao (2014) 357 ITR 529 : 220 Taxman 81 (Mag.) (AP)]

Cash payments exceeding prescribed limits - Nodisallowance for cash payments even if Rule 6DD(j) exception does not apply if there is no dispute as to genuineness of payment and business compulsion - Disallowance was deleted

Though there was no dispute regarding the genuineness of the payments made, the Assessing Officer made a disallowance under section 40A(3) on the ground that the exception in Rule 6DD did not apply.On facts, though the case of the assessee did not fall within the exclusion clause in Rule 6DD (j), section 40A(3) will not apply because (a) there is no doubt as to the genuineness of the payment nor the identity of the payee, (b) the assessee was compelled to pay cash owing to the insistence of its principal and if it had not abided by the direction, the business would have suffered & (c) the exceptions in Rule 6DD are not exhaustive and the rule must be interpreted liberally. Purchase of recharge vouchers by cash was held to be allowable. (Related Assessment year 2006-07)

[Anupam Tele Services v. ITO (2014) 366 ITR 122 : 268 CTR 121 : 222 Taxman 318 : 100 DTR 411 (Guj)]

It was held that where income from an undisclosed business is brought to tax, provisions of s. 40A(3) and all other relevant provisions come into play—Evidence of genuineness of the payment and the identity of the payee are the first and foremost requirements for the applicability of r. 6DD(j)—When these two factors are established, only then the question as to whether the payment in cash was made in exceptional or unavoidable circumstances can be examined.

[CIT v. Hynoup Food & Oil Ind. (P) Ltd. (2005) 199 CTR 350 (Guj)]

Provisions of Section 40A(3) are applicable to illegal business and also business carried out outside books of accounts

Since the profits and gains derived from an illegal business like smuggling are liable to be taxed in accordance with the provisions of the Act including section 40A(3) the fact that in a business like smuggling it is not practicable to comply with provisions of section 40A(3) of making payments by crossed cheque or bank drafts in respect of purchases made of smuggled goods would not prevent operation of the said section and the fact that it was not possible to establish identity of the parties from whom purchases were made would not exempt the assessee from obligation to establish such identity under rule 6DD(j)

[S. Venkata Subbarao v. CIT (1988) 173 ITR 340 (AP)]

11. Payment to agent Rule 6DD(k)

Where the payment is made by any person to his agent who is required to make payment in cash for goods or services on behalf of such person.

Cash payments exceeding prescribed limits – Purchases from agriculturists

The assessee was a firm dealing and trading in purchase of cotton, cotton seeds, processing of cotton seeds and extracting cotton seeds oil, etc. Assessing Officer disallowed the payment by applying the provisions of section 40(A)(3). Addition was deleted by CIT(A) and Tribunal . On appeal by revenue the Court held that where both authorities relying on cogent evidences concluded that purchases were made from agriculturists as also through common agents, case was correctly held to be falling under exception provided under clauses (e) and (k) of rule 6DD of Income tax Rules. (Related Assessment years 2006 - 07 & 2007 - 08)

[CIT v. A. C. Industries (2014) 225 Taxman 55 (Mag) : 43 taxmann.com 290 (Guj)]

Lorry drivers - Cash payment in excess of prescribed limits to person other than agent of the assessee is not allowable

The assessee made payments towards lorry freight in cash and claimed the expenditure as a deduction. The Assessing Officer disallowed the expenses on the ground that the payments were made through cash and the payments exceeded the limit prescribed under section 40A(3). The assessee filed affidavits before the CIT(A) from the lorry owners stating that they collected the lorry freight in cash through the driver of the lorry concerned, in which the goods were transported. The assessee contended that the cash payments for goods and services were made through agents, viz., the lorry drivers. Hence, cash payment for lorry freight paid to the lorry drivers cannot be disallowed. The CIT(A) however held that the claim of the assessee that the lorry drivers acted as agents of the assessee was farfetched and hence confirmed the disallowance. The Tribunal confirmed the findings of the CIT(A). The High Court observed that there was hardly any material to prove that the lorry drivers acted as agents of the assessee. The High Court held that the assessee’s only claim before the authorities was that the driver acted in dual capacity, for which there is no evidence and hence the payments made to the lorry drivers of the supplier were not payments to agent of assessee and hence rule 6DD(k) could not be invoked. (Related Assessment year 2008-09)

[P. K. Ramasamy Nadar & Bros. v. ITO (2014) 272 CTR 357 : 221 Taxman 362 (Mad)]

12. Foreign currency Rule 6DD(l)

Where the payment is made by an authorised dealer or a money changer against purchase of foreign currency or travelers cheques in the normal course of his business.

KEY NOTE

“Authorised dealer” or “money changer” means a person authorised as an authorised dealer or a money changer to deal in foreign currency or foreign exchange under any law for the time being in force

Payments made to farmers or kacha Aarartias - No disallowance can be made

[ITO v. Ram Prakash (2014) 164 TTJ 7 (ITAT Agra)(UO)]

Section 40(A(3) has no application where interest is credited to creditor’s account and there is no cash payment.

CIT v. Muthoot Bankers (2000) 162 CTR (Ker) 414 (Ker)]

[CIT v. Pehlaj Rai Daryanmal (1991) 190 ITR 242 (All)]

Scope of clause (e) of rule 6DD

Payments to arhatiyas do not fall for exclusion under this sub-clause. [CBDT’s Circular No. 34, dated 05.03.1970]

Text of Rule 6ABBA

OTHER ELECTRONIC MODES

6ABBA. The following shall be the other electronic modes for the purposes of clause (d) of first proviso to section 13A, clause (f) of sub-section (8) of section 35AD, sub-section (3), sub-section (3A), proviso to subsection (3A) and sub-section (4) of section 40A, second proviso to clause (1) of Section 43, sub-section (4) of section 43CA, proviso to sub-section (1) of section 44AD, second proviso to sub-section (1) of section 50C, second proviso to sub-clause (b) of clause (x) of sub-section (2) of section 56, clause (b) of first proviso of clause (i) of Explanation to section 80JJAA, section 269SS, section 269ST and section 269T, namely:−

(a) Credit Card;

(b) Debit Card;

(c) Net Banking;

(d) IMPS (Immediate Payment Service);

(e) UPI (Unified Payment Interface);

(f) RTGS (Real Time Gross Settlement);

(g) NEFT (National Electronic Funds Transfer), and

(h) BHIM (Bharat Interface for Money) Aadhar Pay”;

Payments to Government [Clause (b) of rule 6DD]

Under clause (b) of rule 6DD, payments to Government are exempt from the operation of section 40A(3) if, under the rules framed by Government, such payment is required to be made in legal tender. The CBDT have clarified that payments made to the Railways on account of freight charges or for booking of wagons, and payments towards sales tax/excise duty are to be considered under this clause. [CBDT Circular No. 34, dated 05.03.1970]

Contractual payments

Where a manufacturer of tobacco had entered into an agreement in 1957 with a labour contractor for packing and despatching tobacco, and the agreement required that payments must be made in cash, it was held that the payments so made fell within the exception under this clause, since the agreements as well as the payments were found bona fide. – [CIT v. Ahmad Hussain (1984) 150 ITR 373 (All.)]

Payments by book adjustment [Clause (d)] - Clause (d) of rule 6DD exempts payment 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. This exemption is held to operate only when the adjustment is made directly in the payee`s account, and that the prohibition in section 40A(3) is attracted to cases where book adjustments are not so directly made. – [CIT v. Kishan Chand Maheshwari Dass (1980) 121 ITR 232 (P&H)]

Payments for agricultural produce [Clause (e)]

Under this sub-clause, payments for the purchase of agricultural or forest produce are excluded, only where the payments are to be made to the cultivator/grower/producer. If the produce undergoes change and then sold, the exclusion will operate. For example, payments made to a grower or producer of kapas ginned by him, or to a grower of paddy which has been converted by him into rice and then sold, the exclusion will still operate – [Press Note, dated 02.05.1969]

Consequences in violation of Provisions

No deduction is allowable in computation of income from business or profession in respect of which a payment or aggregate of payments made to a person in a day, otherwise than by a crossed account payee cheque or an account payee bank draft /use of electronic clearing system through a bank account exceeding ₹ 10,000/-. This results increase in taxable income, in computation of profits and gains from business or profession

Section 40A(3A) further provides (that in case an allowance is made in the assessment for any year on the basis of incurred liability, but in the subsequent year or years, assessee makes a payment exceeding Rs 10,000 (upto Assessment year 2017-18 - Rs 20,000/-) in a day, otherwise than by an account payee cheque or account payee bank draft or use of electronic clearing system through a bank account, in respect of such liability, then the payment so made shall be deemed to be the profit of the year in which such payment is made.

The limit of Rs. 35,000 in case of plying, hiring or leasing of goods carriage is also applicable to section 40A(3A).

Thus payment in excess of Rs. 10,000 in a day in respect of any expenditure incurred in the current year or in the previous years otherwise than by an account payee cheque or account payee bank draft or use of electronic clearing system through a bank account will be disallowed while calculating profits of an assessee.

Text of Section 40A(3A)

(3A) Where an allowance has been made in the assessment for any year in respect of any liability incurred by the assessee for any expenditure and subsequently during any previous year (hereinafter referred to as subsequent year) the assessee makes payment in respect thereof, otherwise than by an account payee cheque drawn on a bank or account payee bank draft, [1][or use of electronic clearing system through a , [2][bank account] or through such other electronic mode as may be prescribed], the payment so made shall be deemed to be the profits and gains of business or profession and accordingly chargeable to income-tax as income of the subsequent year if the payment or aggregate of payments made to a person in a day, exceeds [3][ten] thousand rupees:

PROVIDED that no disallowance shall be made and no payment shall be deemed to be the profits and gains of business or profession under sub-section (3) and this sub-section where a payment or aggregate of payments made to a person in a day, otherwise than by an account payee cheque drawn on a bank or account payee bank draft, [4][or use of electronic clearing system through a bank account or through such other electronic mode as may be prescribed, exceeds ten thousand rupees,] in such cases and under such circumstances as may be prescribed, having regard to the nature and extent of banking facilities available, considerations of business expediency and other relevant factors :

[5][PROVIDED FURTHER that in the case of payment made for plying, hiring or leasing goods carriages, the provisions of sub-sections (3) and (3A) shall have effect as if for the words [6][ten] thousand rupees", the words "thirty-five thousand rupees" had been substituted.]

KEY NOTE

1. Inserted by the Finance Act, 2017, with effect from 01.04.2018

2. Substituted for the words "bank account" wherever they occur, the words "bank account or through such other electronic mode as may be prescribed" by the Finance (No. 2) Act, 2019, with effect from 01.04.2020

3. Substituted for “twenty” by the Finance Act, 2017, with effect from 01.04.2018.

4. Substituted for “exceeds twenty thousand rupees,” by the Finance Act, 2017, with effect from 01.04.2018.

5. Inserted by the Finance (No. 2) Act, 2009, with effect from 01.10.2009

6. Substituted for “twenty” by the Finance Act, 2017, with effect from 01.04.2018.

As per section 40A(3A), the restriction is also applicable

(a) If the tax payer had claimed a deduction in respect of any expenditure relation to any previous year.

(b) Payment to such expenditure is made during the current year. If during the current year payment made in a day otherwise than by an account payee cheque or account payee demand draft/use of electronic clearing system through a bank account exceeds ₹ 10,000.

CBDT Circular No. 10/2008, dated 05.12.2008

Subject : Clarification regarding the meaning of the expression 'fish or fish products' used in sub-clause (iii ) of clause (f) of rule 6DD of the Income-Tax Rules, 1962

Representations have been received from various quarters regarding problems being faced by the seafood exporters mainly on account of provisions of Section 40A (3) of the Income-tax Act, 1961.

2. Disallowance of expenditure under the provisions of sub-section (3) of Section 40A of the I.T. Act, 1961 is made in the computation of income in a case where a payment or aggregate of payments exceeding twenty thousand rupees is made to a person in a day, otherwise than by an account payee cheque drawn on a bank or an account payee bank draft. However, payment otherwise than by an account payee cheque drawn on a bank or by an account payee bank draft exceeding twenty thousand rupees does not attract the aforesaid disallowance in certain circumstances as prescribed under rule 6DD of the Income-tax Rules, 1962. Such exceptions, inter-alia, refer to payment made to the producer for the purchase of ‘fish or fish products' under sub-clause (iii) of clause (e) of rule 6DD. [Clause (f) of rule 6DD prior to coming into effect of the Income Tax (Eighth Amendment) Rules, 2007 w.e.f. Assessment year 2008-09].

3. The following clarifications are, therefore, being issued for proper implementation of rule 6DD of the Income-tax Rules, 1962:—

(i) The expression ‘fish or fish products' used in rule 6DD(e)(iii) would include 'other marine products such as shrimp, prawn, cuttlefish, squid, crab, lobster etc.'.

(ii) The 'producers' of ‘fish or fish products' for the purpose of rule 6DD(e) of Income Tax Rules, 1962 would include, besides the fishermen, any headman of fishermen, who sorts the catch of fish brought by fishermen from the sea, at the sea shore itself and then sells the fish or fish products to traders, exporters etc.

4. It is further clarified that the above exception will not be available on the payment for the purchase of fish or fish products from a person who is not proved to be a 'producer' of these goods and is only a trader, broker or any other middleman, by whatever name called.

CBDT Circular No. 8/2006, Dated 06.10.2006

Subject : Clarification regarding the meaning of the expression ‘the produce of animal husbandry’ used in sub-clause (ii) of clause (f) of rule 6DD of the Income-tax Rules, 1962

1. Reference is invited to the clarification issued vide Circular No. 4/2006, dated 29th March, 2006 on the above subject. Vide this circular, it was clarified that the expression ‘the produce of animal husbandry’ used under rule 6DD(f)( ii) would include ‘livestock and meat’ and in a case where payment exceeding rupees twenty thousand is made to a producer of the products of animal husbandry (including livestock, meat, hides and skins) otherwise than by a crossed cheque drawn on a bank or by a crossed bank draft for the purchase of such produce, no disallowance should be attracted under section 40A(3) read with rule 6DD. It was further clarified that the above exception will not be available in respect of payment for the purchase of livestock, meat, hides and skins from a person who is not proved to be the producer of these goods and is only a trader, broker or any other middleman by whatever name called.

2. Representations have been received from certain quarters seeking further clarification as to who are the producers of livestock and meat and the evidence required to be furnished in this regard by the persons making the payments.

3. The Board after examination of the issue is of the view that any person, by whatever name called, who buys animals from the farmers, slaughters them and then sells the raw meat carcasses to the meat processing factories or to the traders/retail outlets would be considered as producer of livestock and meat.

4. The benefit of rule 6DD of the Income-tax Rules, 1952 shall be available to the person referred to at para 3 above subject to furnishing of the following :—

(i) A declaration from the person receiving the payment that he is a producer of meat;

(ii) A confirmation that the payment, otherwise than by an account payee cheque or account payee bank draft, was made on his insistence; and

(iii) A further confirmation from a veterinary doctor certifying that the person specified in the certificate is a producer of meat and that slaughtering was done under his supervision.

CBDT Circular : No. 522, dated 18.08.1988.

Subject : Monetary ceilings prescribed in section 40A(3)/269SS/269T - Raised to Rs. 10,000, Rs. 20,000 and Rs. 20,000, respectively, by Direct Tax Laws (Amendment) Act, 1987 - Clarification regarding effective date of change in monetary ceilings

1. Provisions of sections 40A(3), 269SS and 269T have been amended by Direct Tax Laws (Amendment) Act, 1987 (4 of 1988) and consequently the monetary ceilings prescribed under the aforesaid sections have been raised from Rs. 2,500 to Rs. 10,000, Rs. 10,000 to Rs. 20,000 and Rs. 10,000 to Rs. 20,000, respectively. As per provisions of section 1(2) of the Direct Tax Laws (Amendment) Act, these changes have been made effective from 01.04.1989.

2. Board has received a number of representations regarding the date of applicability of the abovementioned amended sections of the Income-tax Act. It is hereby clarified that the amended provisions of sections 269SS and 269T will apply to payments or repayments made on or after 01.04.1989. In respect of disallowance of payments made under section 40A(3), the amendment will apply to payments made in the previous year relevant to the assessment year
1989-90 and subsequent years.

When bank is on holiday or on strike [Clause (j)]

This clause was inserted with effect from 01.12.1995, so as to exclude payments required to be made on a day on which the banks were closed either on account of holiday or strike. Prior to 01.12.1995 also, the exclusion was available under executive instructions. [CBDT Circular No. 250, dated 11.01.1979]

CBDT Circular No. 250 [F. No. 206/1/79-IT(A-II)], dated 11.01.1979.

Subject : Payment made during the period when cheque clearing operations by banks suspended - Whether covered under sub-section (3)

CLARIFICATION 1

1. Representations have been received from the members of public, chambers of commerce, etc., pointing out the hardship resulting from the operation of the provisions of section 40A(3) in view of the difficulties in clearance of cheques issued on banks.

2. Sub-section (3) of section 40A provides for the disallowance of expenditure incurred in business or profession for which payment is made in an amount exceeding Rs. 2,500 otherwise than by a crossed cheque drawn on a bank or a crossed bank draft.

3. Under clause (j ) of rule 6DD the provision in section 40A(3) will not be applied by the Income-tax Officer where he is satisfied that the payment could not be made by crossed bank cheque or draft due to "exceptional or unavoidable circumstances" and the assessee furnishes evidence as to the genuineness of the payment and the identity of the payee. The hold-up in cheque clearing operations in the banks or any other similar circumstances which is likely to cause reasonable apprehension in the mind of the payee that the crossed cheque/bank draft will not be cleared expeditiously would constitute "exceptional or unavoidable circumstances" within the meaning of clause ( j) of rule 6DD. Accordingly, any payment for business expenditure made during the period when the cheque clearing operations are suspended or other similar circumstance as aforesaid exists, will not be covered by the provisions of section 40A(3) provided the assessee furnishes evidence to the satisfaction of the Income-tax Officer as to the genuineness of the payment and the identity of the payee.

CLARIFICATION 2

Under clause (j) of rule 6DD, the provisions in section 40A(3) will not be applied by the Income-tax Officer where he is satisfied that the payment could not be made by crossed bank cheque or draft due to exceptional or unavoidable circumstances and the assessee furnishes evidence as to the genuineness of the payment and the identity of the payee. The suspension of cheque clearing and banking operations consequential to the strike of bank employees will constitute "exceptional or unavoidable circumstances." Accordingly, payments for business expenditure made during this period, and until clearance of cheques is resumed, will be excepted from the operation of section 40A(3), subject to the other requirements that the payment is genuine and the identity of the payee is also established to the satisfaction of the Income-tax Officer. You may inform all your members, accordingly.

Letter : F. No. 142 (14)/70-TPL, dated 28.09.1970.

CBDT Circular No 34 [F. No. 13A/92/69-IT(A-II)], dated 05.03.1970.

Subject : Disallowance of expenditure for which payment exceeding Rs. 2,500 is made otherwise than by crossed cheque/ bank draft under sub-section (3), read with rule 6DD of the Income-tax Rules - Scope and operation of the sub-section explained

1. The Board had occasion to deal with several representations from various chambers of commerce, trade associations and businessmen regarding the scope of provisions of section 40A(3) and rule 6DD. Since many of the points raised therein are of an important nature, the clarifications given thereon are summarised below.

2. The provisions of section 40A(3) would apply in computing the income under the heads "Profits and gains of business or profession" and "Income from other sources" as per section 58(2). All payments in excess of Rs. 2,500 at one time whether for goods or services obtained for cash or credit, which are deductible in computing the income, have to be made by crossed cheque or bank draft. Thus, the price of goods purchased for resale or use in manufacturing process or payments for services will be covered by the provisions of section 40A(3). However, the section will not apply to repayment of loans or payment towards the purchase price of capital assets such as plant and machinery not for resale.

3. A large portion of trade in agricultural commodities is channelled through the institution of "arhatias". While the payments made to the cultivators or growers of agricultural produce are specifically excluded from the purview of section 40A(3) by clause (f) of rule 6DD, the payments made to the "arhatiya" for purchases made from him are not so exempted. It is contended that the "arhatiy" is not in a position to pay the cultivators in cash until the cheques are encashed and this procedure involves severe hardship. However, this difficulty can be met by obtaining the advances from the purchasers, which should of course conform to requirements of section 40A(3). The extension of the exemption to the purchases would defeat the objective of the provisions.

4. So far as payments made to the railways on account of freight charges or for booking of wagons, and payment of sales tax, excise duty, are concerned, clause (b) of rule 6DD specifically exempts such payments from the purview of section 40A(3) if, under the rules framed by the Government, these are required to be made in legal tender.

Cash payments exceeding prescribed limits – Purchases were supported by dealers invoice along with valid transit receipt, receipt documents etc – Disallowance is held to be not justified
Allowing the appeal of the assessee the Court held that all the purchases made were supported by valid dealer invoices. The Commissioner (Appeals), having considered the material, recorded a finding that the parties were existent and that their bank accounts were identified. Except one party, all other parties had filed sales tax returns. The bank report would indicate that the demand drafts were admittedly not crossed. However, the payments were credited into the accounts of the payees. The Tribunal was not justified in confirming the disallowance under Section 40A(3) of the Act. (Related Assessment year : 2005-06) – [M. K. Agrotech (P) Ltd. v. ACIT (2019) 412 ITR 351 : 308 CTR 275 : 176 DTR 294 (Karn)]

Cash payments exceeding prescribed limits – Exporter of frozen buffalo meat - Payment made to producer of meat in cash in excess of Rs 20,000/- disallowance cannot be made - Circular No 8 of 2016 dated 06.10.2016 issued by CBDT cannot impose additional condition in the Act or Rules adverse to an assessee

Dismissing the appeal of the revenue the Court held that, Assessee exporter of frozen buffalo meat. Payment made to producer of meat in cash in excess of Rs. 20,000/- disallowance cannot be made. Circular No 8 of 2016 dated 06.10.2016 issued by CBDT cannot impose additional condition in the Act or Rules adverse to an assessee. Relied UCO Bank v. CIT (1999) 237 ITR 889 (SC) (Related Assessment year : 2009-10) – [PCIT v. Gee Square Exports (2019) 411 ITR 661 : (2018) 100 taxmann.com 461 (Bom.)]

KEY NOTE : SLP of revenue is dismissed, PCIT v. Gee Square Exports (2019) 260 Taxman 175 : (2018) 100 taxmann.com 462 (SC)

Cash payments exceeding prescribed limits – Purchase of jewellery – failure to demonstrate a situation which compelled to make payment in cashDisallowance is held to be justified.
Dismissing the appeal of the assessee ,the court held that failure of assessee to demonstrate a situation which compelled to make payment in cash for purchase of jewellery, disallowance is held to be justified. (Related Assessment year : 2013 -14) – [Natesan Krishnamurthy v. ITO (2019) 262 Taxman 127 : 178 DTR 177 (Mad)]

Cash payments exceeding prescribed limits - Payments were made during public holidays - No disallowance could be made – Payments to agents - No disallowance can be made

Allowing the appeal of the assessee the Tribunal held that , payments exceeding Rs. 20,000 for purchase of construction materials on bank holidays, due to business needs to complete the project on time. Disallowance is held to be not justified. Assessee also produced documentary evidences to show that person to whom payments were made in cash in excess of Rs. 20,000 had acted as agent of assessee for purchase of construction material on behalf of assessee, such payments would fall
under exception clause of rule 6DD(k) hence no disallowance can be made. (Related Assessment year : 2006-07 to 2009-10) – [Surya Merchants Ltd. v. DCIT (2019) 174 ITD 393 (ITAT Delhi)]

Expenses or payments not deductible-Cash payments exceeding prescribed limits – Where the income is computed applying the gross profit rate, no disallowances can be made by applying provisions of Section 40A(3)

Dismissing appeal of the revenue the Court held that, where the income is computed applying the gross profit rate, no disallowances can be made by applying provisions of Section 40A(3). – [CIT v. Jadau Jewellers And Manufactures (P) Ltd. (2018) 409 ITR 85 (Raj)]

KEY NOTE : SLP is granted to the revenue, CIT v. Jadau Jewellers And Manufactures (P) Ltd. (2016) 406 ITR 4 (St.)

Genuine and bona fide transactions are not taken out of the sweep of the Section 40A(3)

Amount paid for purchase of agricultural produce - Where the Department filed SLP to appeal against the judgment of Kerala High Court in CIT v. Keerthi Agro Mills (P) Ltd. [IT Appeal Nos. 257 of 2015 and 39 of 2016, dt. 03.10.2017]: (2017) 2017 TaxPub(DT) 4497 (Ker-HC), whereby the High Court held that even if the spending were above Rs. 20,000 in a day, there would be no escaping from another statutory safeguard the assessee enjoys and since section 40A(3) is a deeming provision, rule 6DD clearly exempts the agricultural produce -paddy-from the rigours of section 40A(3) and hence, the assessee's transactions were exempted under rule 6DD, the Supreme Court dismissed the SLP.--Department filed SLP to appeal against the judgment of Kerala High Court in CIT v. Keerthi Agro Mills (P) Ltd. [IT Appeal Nos. 257 of 2015 and 39 of 2016, dated 03.10.2017]: (2017) 2017 TaxPub(DT) 4497 (KerHC), whereby the High Court held that even if the spending were above Rs. 20,000 in a day, there would be no escaping from another statutory safeguard, the assessee enjoys and since section 40A(3) is a deeming provision, rule 6DD clearly exempts the agricultural produce - paddy-from the rigours of section 40A(3) and hence, the assessee's transactions were exempted under rule 6DD.

The Hon’ble Kerala High Court in case of M/s. Keerthi Agro Mills (P) Ltd., Mattoor on 03.10.2017 in appeal number ITA. No. 257 of 2015 has held as under:

“….Similarly, in Attar Singh Gurmukh Singh v. ITO reported in (991) 191 ITR 667 (SC), the Supreme Court has examined both Section 40A(3) and Rule 6DD. It has held that Section 40A(3) must not be read in isolation or to the exclusion of Rule 6DD; the Section must be read along with the Rule. If read together, it will be clear that the provisions are not intended to restrict the business activities. Section 40A(3) only empowers the assessing officer to disallow the deduction claimed as expenditure in respect of which payment is not made by crossed cheque or crossed bank draft. The payment by crossed cheque or crossed bank draft is insisted on to enable the assessing authority to ascertain whether the payment was genuine or whether it was out of the income from disclosed sources. The terms of Section 40A(3) are not absolute. Consideration of business expediency and other relevant factors are not excluded. The genuine and bona fide transactions are not taken out of the sweep of the Section. - [PCIT v. Keerthi Agro Mills (P) Ltd. (2018) 257 TAXMAN 1 (SC)]

Cash payments exceeding prescribed limits Agricultural produce-Paddy from farmers - No disallowance can be made

Dismissing the appeal of the revenue the Court held that; Agricultural produce i.e. Paddy purchased from the famers by making cash payments exceeding prescribed limits, no disallowance can be made. Section 40A(3) is a deeming provision and rule 6DD exempts agricultural produce.( Related Assessment year : 2001-02) – [CIT v. Keerthi Agro Mills (P) Ltd. (2017) 405 ITR 192 : 87 taxmann.com 31 (Ker)]

KEY NOTE : SLP of revenue is dismissed; PCIT v. Keerthi Agro Mills (P) Ltd. (2018) 257 Taxman 1 (SC)

Cash payments exceeding prescribed limits Payment made to notified dealer - District Supply Officer's order did not mandate any mode of payment either in cash or by cheque, and, moreover, there were banking channels available even when supplies had been effected, impugned disallowance was rightly made by authorities

Dismissing the appeal of the assessee the Court held that, District Supply Officer's order did not mandate any mode of payment either in cash or by cheque, and, moreover, there were banking channels available even when supplies had been effected, accordingly order passed by Tribunal confirming disallowance of cash payments did not require any interference. (Related Assessment year : 2009-10) – [Madhav Govind Dhulshete. v. ITO (2018) 259 Taxman 149 (Bom.)]

Cash payments exceeding prescribed limits Factory was situated in backward area and payments to transporters had to be made in cash because such persons were not having banking facility around factory area Freight and cartage payments to drivers-Held to be allowable as deduction

Dismissing the appeal of the revenue the Court held that ; Cash payments exceeding prescribed limits in respect of freight and cartage to drivers is held to be allowable as deduction as the factory is situated in backward area and payments to transporters had to be made in cash because such persons were not having banking facility around factory area. – [PCIT v. Lord Chloro Alkali Ltd. (2018) 258 Taxman 131 : 97 taxmann.com 513 (Raj)]

KEY NOTE : SLP of revenue is dismissed. PCIT v. Lord Chloro Alkali Ltd. (2018) 258 Taxman 130 (SC)

Section 40A(3) disallowance for payment by non-crossed drafts, once payee’s account credited

Karnataka High Court reverses ITAT order, deletes disallowance under section 40A(3) for payments made by assessee (a manufacturing company) to vendors by non-crossed bank drafts during Assessment year 2005-06; Notes that Revenue had disallowed the expenses only on the grounds that the drafts were not crossed as mandated by Section 40A(3) read with Rule 6DD, but had not disbelieved the genuineness of purchases; Further notes that the documents such as registered dealer invoices, transit documents, freight charges paid, vendors’ sales tax returns, letters from bank indicated that the purchases were genuine and payments made to vendors were credited to their respective bank accounts; Cites the main objective of crossing a demand draft is to ensure that the payment is deposited in whose favour the draft is drawn (i.e. the payee receives the payment) and it is routed through banking channels, noting that both the conditions were met in the present case, ITAT holds that the spirit for which Section 40A(3) was promulgated is satisfied; Moreover, acknowledges assessee’s contention that normally suppliers require drafts for quick realization, and hence non-crossed drafts were issued, relies on Supreme Court judgment in Attar Singh Gurmukh Singh. - [TS-728-HC-2018(KAR)]

Tribunal deleted addition made under section 40A(3) of cash payments made by assessee to its group concerns for repayment of debt and not for any expenditure incurred and which had not been debited in P&L, observing that the provision of said section is applicable only when an expenditure has been incurred and claimed by way of debiting to P&L account. - [Saamag Developers (P) Ltd. v. ACIT (2018) 168 ITD 649 (ITAT Delhi)]

Section 40A(3) could be invoked only when assessee claimed payment in cash as business expenditure or treated as stock or capitalized the same in order to claim depreciation in the future

Section 40A(3) could be invoked only when assessee claimed payment in cash as business expenditure or treated as stock or capitalized the same in order to claim depreciation in the future. Assessee had not claimed the payment of Rs. 1.50 crores as expenditure or capitalized the same in the value of the land, therefore, disallowance under section 40A(3) could not be made. [Related Assessment year : 2009-10] - [Kalyan Constructions v. ITO – Date of Judgement : 31.07.2018 (ITAT Hyderabad)]

Provisions of Section 40A(3) not intended to restrict business activities

In the present case, the assessee is engaged in dealings in mobile recharge vouchers on a wholesale basis and retail basis. During the assessment year under consideration, the assessee made purchases of recharge vouchers from M/s. Stock Point, Puri and the Assessing Officer verified the ledger account of the assessee and found that a large number of payments exceeding Rs.20,000/- were made in cash in contravention of the provisions of section 40A(3) of the Income Tax Act, 1961.

The Assessing Officer recorded the statement of Shri Upendra Nayak, Prop. Of M/s. stock Point Puri and who has confirmed sales of recharge vouchers of Rs. 70,50,839/- to the assessee and receipts of cash sales but the Assessing Officer found there is variation in the recording of entries in assessee’s ledger and the assessee has violated the provisions of section 40A(3) of the Act and the CIT(A) confirmed the findings of the Assessing Officer.

We find that provisions of Section 40A(3) of the Act prescribes that no deduction shall be allowed in respect of an expenditure for which payment is made to the other person otherwise than by way of an account payee cheque or draft, in all cases where the amount exceeds Rs.20,000/-.

The Assessing Officer has held that payment of Rs. 53,13,007/- made by the assessee to M/s. Stock Point, Puri are made in cash and confirmed by the Prop. Mr Upendra Nayak of M/s. stock Point in his statement recorded under section 131 of the Act and there is no dispute about the sales figure and transaction and revenue has accepted the same.

Further, Ld A.R. relied on the decision of Cochin Bench of the Tribunal in the case of S. Rahumathulla v. ACIT, 127 ITD 440 (Cochin), wherein, on similar situation, it was held that there was only a relationship of a principal and agent and, therefore, there was no question of any purchase being affected by the latter and, accordingly, the Bench concluded that there was no question of allowance of any expenditure in respect of purchases qua which the provisions of section 40A(3) of the Act could apply, irrespective of the mode of payments.

Ld A.R. also relied on the decision of Hon’ble Gujarat High Court in the case of Anupam Tele Services v. ITO, 366 ITR 122 (Guj), wherein also, the assessee was dealing in recharge vouchers and made cash payments on the ground that on account of cheque payment, it will take 4/5 days to clear the payments and, therefore, there will be an adverse impact on the financial position and business operation.

The provisions of section 40A(3) are not intended to restrict the business activities but to caution that payments exceeding Rs. 20,000/- are made in cheque/draft. The provisions of section 40A(3) of the Act are to be in consonance with business expediency trade practice and other genuine relevant factors.

In this present case, the assessee has intimated the circumstances under which the assessee was compelled to make the cash payments and also the genuineness of payment and the identity of the payee is not doubted. Considering the circumstances, business expediency and judicial decisions dealt above, we are of the substantive view that the provisions of section 40A(3) of the Act shall not be a hindrance in the business operation of the assessee, who has been following such pattern from earlier years and on the principle of going concern which the revenue has not doubted. Accordingly, we set aside the order of the CIT(A) and directed the Assessing Officer to delete the addition and accordingly, the ground of the assessee is allowed. (Related Assessment Year : 2011-12) – [Sabita Panda v. ITO - Date of Judgement : 08.03.2018 (ITAT Cuttack)]

Cash payments exceeding prescribed limits - Where income of assessee is computed by applying gross profitrate, section 40A(3) need not be invoked

Where income of assessee is computed by applying gross profit rate, section 40A(3) need not be invoked. - [CIT v. Gobind Ram (2015) 229 Taxman 491 : (2014) 48 taxmann.com 14 (P&H)]

Cash payments exceeding prescribed limits - There is a difference between “crossed cheque” and “account payee cheque”. Payment by crossed cheque attracts Section 40A(3) disallowance-Disallowance was held to be justified

The expression earlier used in section 40A(3)(a) was a “crossed cheque or a crossed bank draft”. This was amended by the legislature to be replaced by the expression “an account payee cheque or account payee bank draft”. This was done in the background of the experience that even crossed cheques were being endorsed in favour of a person other than the drawee making it difficult to trace the constituent of the money. To plug this possible loophole the requirement of section 40A(3) was made more stringent. If we accept the contention of counsel for the assessee that there was no distinction between a crossed cheque and an account payee cheque, we would be obliterating this amendment brought in the statute with specific purpose in mind. Accordingly, payment by a crossed cheque is subject to disallowance under section 40A(3). (Related Assessment year : 2007-08) – [Rajmoti Industries v. ACIT (2014) 367 ITR 392 : 268 CTR 130 : 223 Taxman 428 :103 DTR 113 (Guj)]

No section 40A(3) disallowance for cash payments even if Rule 6DD(j) exception does not apply if there is no dispute as to genuineness of payment and business compulsion

Cash payments exceeding prescribed limit - Cash deposited in bank account of principal. Where assessee-distributor deposited cash amount in principal's bank account on insistence by latter and neither genuineness of the payment nor the identity of the payee were in any case doubted, the rigors of section 40A(3) must be lifted.

The assessee acted as an agent of Tata Teleservices Ltd for distributing mobile cards and recharge vouchers. Tata Teleservices issued a circular to all distributors stating that where the distributor had a bank account with a cooperative bank, payment should be made in cash. Tata Teleservices also wrote to the assessee asking it to pay in cash. Though there was no dispute regarding the genuineness of the payments made, the Assessing Officer made a disallowance under section 40A(3) on the ground that the exception in Rule 6DD did not apply. The CIT(A) reversed the Assessing Officer. However, the Tribunal reversed the CIT(A). On appeal by the assessee to the High Court HELD reversing the Tribunal:

Section 40A(3) and Rule 6DD are not intended to restrict business activities. The terms of section 40A(3) are not absolute. Considerations of business expediency and other relevant factors are not excluded. Genuine and bona fide transactions are not taken out of the sweep of the section. It is open to the assessee to furnish to the satisfaction of the Assessing Officer the circumstances under which the payment in the manner prescribed in section 40A(3) was not practicable or would have caused genuine difficulty to the payee. It is also open to the assessee to identify the person who has received the cash payment. On facts, though the case of the assessee did not fall within the exclusion clause in Rule 6DD (j), section 40A(3) will not apply because (a) there is no doubt as to the genuineness of the payment nor the identity of the payee, (b) the assessee was compelled to pay cash owing to the insistence of its principal and if it had not abided by the direction, the business would have suffered & (c) the exceptions in Rule 6DD are not exhaustive and the rule must be interpreted liberally (Attar Singh Gurmukh Singh 191 ITR 667 (SC), Hynoup Food & Oil Industries 290 ITR 702 (Guj) & Harshila Chordia 298 ITR 349 (Raj) referred). – [Anupam Tele Services v. ITO (2014) 366 ITR 122 : 268 CTR 121 : 222 TAXMAN 318 : 100 DTR 041 (Guj.)]

Cash payments exceeding prescribed limits – Purchase of land in auction

The assessee had purchased a land for Rs. 3.5 crores in an open auction held by the High Court of Judicature at Bombay. The payment of the amount was made by M/s. Zoom Developers Private Limited on behalf of the Assessee. The Assessing Officer made an addition of Rs. 70,00,000/- being 20% of the total payment of Rs. 3.5 crores by holding that the payment was made in cash as the details of payment were not available in the conveyance deed and no details of payment nor the copies of the relevant bank accounts were furnished. The CIT(A) deleted the disallowance holding that from the record that the entire payment of Rs. 3.5 crores was made through Pay Orders and the Drafts prepared from bank accounts of M/s. Zoom Developers Private Limited on behalf of the assessee and considering the fact that the auction was conducted by the High Court. The Tribunal affirmed the CIT (A) order. The High Court confirmed the Tribunal order. - [CIT v. Magnificent Construction (P) Ltd. (2014) 220 Taxman 107 (Mag.)(MP)]

Limit applies to all items in a bill, and not to individual items –

Section 40A(3) concentrates on the size of the payment and the manner of the payment. If different items are included in a single bill, it would not be right to dissect the bill and find out whether each item of expenditure is above Rs. 10,000; the proper way is to read the entries in a wholesome fashion. - [Addl. CIT v. Shree Shanmuga Gunny Stores (1984) 146 ITR 600 (Mad)]

Limit applies to cash portion of payment

Where the payment was made partly in cash and partly by way of post-dated cheques, Section 40A(3) will apply only if the cash payment exceeded the prescribed limit – [H. A. Nek Mohd. & Sons v. CIT (1982) 135 ITR 501 (All)]

Restrictions contained in section 40A(3) would apply to those expenses which are otherwise allowable

Restrictions and limitations contained in section 40A would apply to those expenses which are otherwise allowable under other provisions of the Act. If the expenses are not allowable under other provisions of the Act no question of examining the provisions of section 40A would arise. - [N. M. Anniah & Co. v. CIT (1975) 101 ITR 348 (Kar). Similar view was taken in CIT v. Motilal Khatri (2008) 218 CTR 602 (Raj)

In CIT v. Maddi Venkataratnam & Co. (P) Ltd., the assessee made an illegal cash payment of Rs. 2.95 lakhs to a party in the course of lawful business of export of tobacco and the High Court held that said expenditure was not allowable as deduction under section 37 or section 28 and that in the alternative said expenditure was disallowable under section 40A(3) and that an illegal payment cannot be brought within the exception under rule 6DD(j). The Supreme Court has affirmed the decision in Maddi Venkataraman & Co. (P) Ltd. v. CIT (1998) 144 CTR 214 (SC).

Rejection of accounts, estimation of profit vis-a-vis section 40A(3)

It was held that where the income is assessed at G. P. rate by rejecting the books of accounts of the assessee under section 145(1), proviso, no disallowances can be made separately under section 40A(3).

[CIT v. Banwari Lal Bansidhar (1998) 148 CTR 533 (All)]

Above view was affirmed in CIT v. Purshottamlal Tamrakar Uchehra (2003) 184 CTR (MP) 349 and CIT v. Santosh Jain (2008) 296 ITR 324 (P&H). The adoption of gross profits rate takes care of expenditure otherwise than by crossed cheque or bank draft.

However, in Sai Metal Works ITA 125/2004 dated 10.03.2011 (P&H), it was held that disallowance under section 40A(3) can be made in block assessment even if profit is estimated by applying GP Rate.

Payment made in advancing loans and returning the principal amount of borrowed money not covered by Section 40A(3)

[Press Note : Dated 02.05.1969, issued by Ministry of Finance]

It was held that From a reading of the definition of bill of exchange under section 5 and cheque under section 6 of the Negotiable Instrument Act, 1881, it is clear the banker’s cheques/pay orders/ call deposit receipts are instruments which fall within the definition of bill of exchange. Hence payment made by the same could not be disallowed under section 40A(3). – [CIT v. Vijay Kumar Goel (2010) 324 ITR 376 (Chattisgarh)]

Where Books of accounts have been rejected and profit has been estimated, it is deemed that all the expenses and disallowances have been considered. Hence no further disallowance under section 40A(3) is permissible. – [CIT v. Smt Santosh Jain (2008) 296 ITR 324 (P&H)]

It was held that payments made on a day on which the banks are closed either on account of holiday or strike, shall not come within the ambit of disallowance under section 40A(3). – [CIT v K.K.S. K Leather Processor (P) Ltd. (2007) 292 ITR 669 (Mad.)]

Provisions of Section 40A(3) will apply to transactions outside the books of accounts

The Assessing Officer disallowed a sum of Rs. 43,35,715/- being the purchase price which was paid in cash in relation to the business which was detected in the course of a search conducted after the return was filed. It was admitted during course of such search proceedings that the assessee was carrying on unaccounted business which was not reflected in the regular books of accounts maintained by the assessee. The explanation of the assessee that such unaccounted transactions are always made in cash and hence, provisions of Section 40A(3) of the Act cannot apply, and alternatively the case would be governed by the exception carved out in Rule 6DD(j) of the Income Tax Rules, 1962 (the Rules) as well as Circular No. 220 dated 31st May, 1977 issued by the Central Board of Direct Taxes, was rejected by the Assessing Officer holding that provisions of Section 40A(3) of the Act were mandatory and were also applicable in case of illegal business as held by Andhra Pradesh High Court in the case of S. Venkata Subba Rao Vs. Commissioner of Income Tax, (1988) 173 ITR 340 (AP). The contention regarding applicability of Rule 6DD(j) of the Rules was also rejected by stating that qua the same parties the assessee had made payment by cheques and hence, no exceptional or unavoidable circumstances were made out.

The assessee carried the matter in appeal before the CIT (Appeals) who, for the reasons stated in his order dated 29th December, 1989, confirmed the assessment order on this count. The assessee carried the matter in appeal before the Tribunal. The Tribunal, for the reasons stated in its order dated 10th February, 1992, came to the conclusion that the case of the assessee was covered by the exceptions provided in Rule 6DD(j). According to the Tribunal, in case of a business outside the books, it may or may not be illegal business and generally speaking business outside the books is an exception. That if the intention of the law makers was to tax the income from that kind of business, then logically speaking, the law makers are to be deemed to have taken into account the difficulty in obtaining proof regarding the expenditure. The Tribunal, therefore, goes on to state "..... Therefore, while complying with the statutory requirements, we must so interpret the law that the reality of the situation is duly taken into account. Finally if the state claims a share in any income, it cannot deny to the citizen the expenditure whereby the income is earned. Therefore, we are of the view that the assessee's case would be covered by the exceptions provided in Rule 6DD(j)."

It was held that the Tribunal has committed an error in reading the provision of Rule 6DD(j) of the Rules when it states that the necessity of the assessee proving genuineness of the payment and the identity of the payee is not connected with sub-clause (1) of Rule 6DD(j) of the Rules and the said requirement is only while invoking sub-clause (2) of Rule 6DD(j) of the Rules. The aforesaid reasoning adopted by the Tribunal is fallacious when one considers the object with which the provision has been brought on statute book. It is necessary to bear in mind that even if an exceptional or unavoidable circumstances is pleaded, the Revenue must have data with it to verify the genuineness of the transaction and identify the recipient of the cash payment. If what the Tribunal states is correct, the entire provision is rendered otiose and that interpretation can never be placed on a provision. Accordingly, the question referred to the Court “Whether, the Appellate Tribunal is right in law and on facts in deleting the disallowance made under section 40A(3) holding that the exceptions to that section in Rule 6DD(j) can be applied for payments which were made in the course of a business outside the books?” is, therefore, answered in the negative i.e. in favour of the Revenue and against the assessee. (Related Assessment Year : 1986-87) – [CIT v. Hynoup Food and Oil Ind. (P) Ltd. (Guj) (2007) 290 ITR 702 : (2005) 199 CTR 350 (Guj.)]

Provision is constitutionally valid –

Section 40A(3) cannot be said to be invalid on the ground that it places a restriction on the right to carry on business and is arbitrary.

The provisions of section 40A(3) and rule 6DD were challenged as unconstitutional on the ground that they acted as restrictions on the right to carry on business and were also arbitrary. However, the Supreme Court upheld the validity of these provisions, in the case of Attar Singh Gurmukh Singh v. ITO (1991) 191 ITR 667. The Supreme Court observed :

"Section 40A(3) must not be read in isolation or to the exclusion of rule 6DD. The section must be read along with the rule. If read together, it will be clear that the provisions are not intended to restrict the business activities. There is no restriction on the assessee in his trading activities. . . . The terms of section 40A(3) are not absolute. Considerations of business expediency and other relevant factors are not excluded. Genuine and bona fide transactions are not taken out of the sweep of the section. It is open to the assessee to furnish to the satisfaction of the Assessing Officer the circumstances under which the payment in the manner prescribed in section 40A(3) was not practicable or would have caused genuine difficulty to the payee. Rule 6DD provides that an assessee can be exempted from the requirement of payment by a crossed cheque or crossed bank draft in the circumstances specified under the rule. It will be clear from the provisions of section 40A(3) and rule 6DD that they are intended to regulate business transactions and to prevent the use of unaccounted money or reduce the chances to use black money for business transactions. . . . In interpreting a taxing statute, the court cannot be oblivious of the proliferation of black money which is under circulation in our country. Any restraint intended to curb the chances and opportunities to use or create black money should not be regarded as curtailing the freedom of trade or business." (p. 673) – [Attar Singh Gurmukh Singh v. ITO (1991) 191 ITR 667 (SC)]

KEY NOTE

The validity of these provisions were earlier upheld by the Andhra Pradesh High Court in the case of Mudiam Oil Co. v. ITO (1973) 92 ITR 519.

In CIT v. Hardware Exchange (1991) 190 ITR 61 (Gauhati), the Court has observed that rule 6DD cannot be used as an aid to construction of section 40A(3).

It was held that the purpose of introducing section 40A(3) was to block the loopholes of making cash payments and claiming deductions with a view to frustrate investigation as to the identity of the recipients and the genuineness of the claim. In the instant case, there was no mala fide intention and the payments were found to be genuine and the identity of the payee was also not disputed and there was no mischief of tax evasion on behalf of the assessee. Section 40A(3) came into force from 01.04.1969 and the period during which the said cash payments were made ranged between 03.04.1969 and 02.06.1969. Some margin should also be given for the time taken in publishing the Gazette and receipt of the Gazette by the public. Every assessee does not subscribe to the Gazette and, therefore, the matters published in the Gazette come to the knowledge of the public after sometime only. Therefore, the assessee was entitled to the benefit of rule 6DD(j) and this should be taken as an exceptional or unavoidable circumstance. Further, the assessee was dealing with agricultural produce and was, therefore, entitled to the exemption under rule 6DD(e)(i) in respect of the payments. Accordingly, the said cash payments were not subject to disallowance under section 40A(3) – [Kanti Lal Purshottam & Co. v. CIT (1985) 155 ITR 519 (Raj.)]

Rule 6DD(e)(ii) provides relief from the operation of section 40A(3), inter alia, where the payment exceeding a sum of Rs. 20,000 is made for the purchase of produce of animal husbandry to the producers of such articles. Where, however, the purchases were of hides and skins and the assessee had failed to establish that the payments were made to the producer, the aforesaid relief would not be available – [Ideal Tannery v. CIT (1979) 117 ITR 34 (All.)]

When payment is made partly in cash and partly by cheque - Limit applies to cash portion of payment

Where the payment was made partly in cash and partly by way of post-dated cheques, Section 40A(3) will apply only if the cash payment exceeded the prescribed limit –

Where payment is made partly in cash, and the balance by way of delivery of post-dated bearer cheques, the payment of the money mentioned in the cheques would be taken to have been made on the date on which the cheques matured and were encashed. They were not payments made on the date on which the cheques were issued or given. Hence, the provisions of section 40A(3) will be attracted only if the cash portion of the payments exceeded the prescribed limit. – [H.A. Nek Mohd. & Sons v. CIT (1982) 135 ITR 501 (All.)]

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Expenses disallowed under Section 40A(3) and Section 40A(3A) of the Income Tax Act, 1961

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