Section 40A(3/3A) I Restrictions on Expenditure (Capital & Revenue)

Analysis of Section 40A(3) and 40A(3A)

(a) Analysis of sec 40A(3) of the Act.

Where payment is made in the year the expenditure is incurred: 100% disallowance of payment if in excess of Rs. 10,000 and not by a/c payee cheque/draft/ECS. [Sec 40A(3)] There are following two conditions for the applicability of this section. If both of these two conditions are satisfied, then the provisions of this section will be applicable.

Condition 1. The assessee incurs any expenditure exceeding Rs.10000/- which is allowable for computing income under the head business or profession.

Condition 2. The assessee has made payment or aggregate of payments in a day exceeding Rs.10000/- in cash.

If the above two conditions are satisfied, then whole of the expenditure shall be disallowed under this section. In case where payment is made to the transporters for plying, hiring or leasing goods carriages, then amount of Rs.10000/- shall be increased to Rs.35000/ in the above two conditions.

Example: Where expenditure of shop expenses for Bill raised on 11/11/2019 is made on 03/03/2020 by cash amounting to Rs. 30,000, then the payment of Rs. 30,000 will not be allowed as a deduction for the PY 2019-20

Payments made on a single day: where the payment or the aggregate of payments made to a single person on a single day against one bill exceeds Rs 10,000 then the disallowance of such expenditure will be covered by Sec 40A. Thus for disallowance u/s 40A(3) the amount of the bill raised and the payment or payment(s) made to the person on a single day both exceed Rs 10,000.

Illustrations for Sec 40A(3)

(i) An expenditure of Rs. 40,000 is incurred for purchase of stationary against Bill no 2 from M/s XYZ Ltd on 01/01/20. The assessee makes separate payments of Rs. 15,000, Rs. 16,000 and Rs. 9,000 all by cash, to the person concerned in a single day. Since the aggregate amount of payment made to a person in a day, in this case, is Rs. 40,000. Since, the aggregate payment by cash exceeds Rs. 10,000, Rs. 40,000 will not be allowed as a deduction in computing the total income of the taxpayer in accordance with the provisions of the Act.

(ii) An expenditure of Rs. 30,000 is incurred for purchase of stationary against Bill No 1, 2 & 3from M/s XYZ Ltd on 01/01/20, 28/01/20 & 01/02/20 for Rs 10,000 each. The assessee makes separate payments of Rs. 10,000, Rs. 6,000, Rs 5,000 and Rs. 9,000 all by cash at different times, to the person concerned on a single day. Since the aggregate amount of payment made to a person in a day, in this case, is Rs. 30,000 however since the payment is on account of three bills, none of which is in excess of Rs 10,000, thus the entire payment will be allowed.

(iii) An expenditure of Rs. 37,000 is incurred for purchase of stationary against Bill No 1 & 2 from M/s XYZ Ltd on 01/01/20 and 01/02/20 for Rs 28,000 and Rs 9,000 respectively. The assessee makes separate payments of Rs. 15,000, Rs. 13,000 and Rs. 9,000 all by cash, to the person concerned in a single day. Since the aggregate amount of payment made to a person in a day, in this case, is Rs. 37,000 however since the payment is on account of two bills, one of which exceeds Rs 10,000, thus only Rs 28,000 will be disallowed

Example: An expenditure of Rs. 60,000 is incurred freight against Bill no 2 from M/s NITCO Roadways on 01/05/19.The assessee makes separate payments of Rs. 24,000, Rs. 36,000 on 01/09/19 and 01/10/19 respectively. In this case since the payment made is not in excess of the limit of Rs 35,000 thus it will not be disallowed, however the payment made on 01/10/19 shall be disallowed as it exceeds the limit of 35,000. Thus out of expenditure of Rs 60,000 only Rs 24,000 will be allowed as a deduction

(b) Analysis of sec 40A(3A) of the Act.

Where payment is made in the subsequent years (after deduction has been claimed in an earlier year): where an expenditure has been allowed as a deduction in an earlier year(on due basis) and if in any subsequent year the payment in respect of such expenditure is in excess of Rs 10,000 and not by an account payee cheque, account payee bank draft or ECS – then the payment shall be deemed to be income under the head business & profession for the previous year in which payment is made.

There are following two conditions for the applicability of this section. If both of these two conditions are satisfied ,then the provisions of this section will be applicable.

Condition 1. The assessee had claimed deduction in respect of an expenditure exceeding Rs.10000/- in any of the earlier years.

Condition 2. The assessee has made payment of the liability(condition no.1)in cash in subsequent year and payment is exceeding Rs.10000/-in a day

If both conditions are satisfied, the payment so made shall be deemed to be the business income of the previous year in which payment is made.

Example: Where expenditure of shop expense for Bill raised on 01/05/2018 is made on 3/05/2019 by cash amounting to Rs 30,000, then the expenditure of Rs 30,000 was due in PY 2018-19 and would have been claimed as a deduction in that year assuming that the assessee follows mercantile system of accounting, in this case for the PY 2019-20 we cannot ‗disallow' the payment since it is not allowable in that year, thus it will be treated as income of PY 2019-20

Illustration: A Ltd. purchases goods on credit from a relative of a director on June 20, 2018 for Rs. 50,000(market value: Rs 42,000). The amount is paid by a crossed cheque on June 25, 2018.

Out of the payment of Rs. 50,000 Rs. 8,000 (being the excess payment to a relative) shall be disallowed under section 40A (2). As the payment is made by a crossed cheque and the remaining amount exceeds Rs. 10,000, 100% of the balance (i.e., Rs. 42,000) shall be disallowed under section 40A(3).

1. Purchase of stock-in-trade, whether expenditure to be covered by section 40A(3).

In Attar Singh Gurumukh Singh, etc. v. ITO(1991) 191 ITR 667(SC), Supreme Court held that the word 'expenditure' has got its wide import. The expenditure for purchasing stock- in-trade is one of the outgoings. The value of the stock-in-trade has to be taken into account while determining the gross profit under section 28 as per the principles of commercial accounting. The payment made for purchasing stock-in-trade would also be covered by the word expenditure and such payment can be disallowed if they are made in cash in a sum exceeding the amount specified in section 40A(3). Rule 6DD also contemplates payments made for stock-in-trade and raw material.

2. Disallowance under section 40A(3) not attracted where books of accounts are rejected

In IT O v . Sadhwani Brot h ers (20 12 ) 44 (II) ITC L 371 (Jp 'B' - Trib) : (2011) 142 TTJ (Jp 'B'- Trib) 26, it was held that since the books of accounts were rejected therefore, provisions of section 40A(3) were not applicable.

3. Plan to apply flat rate of profit to avoid disallowance.

As observed in New Narayan Builder v. ITO (1992) 43 TTJ (Ahd-Trib) 508, the restriction contained in section 40A(3) relating to allowability of any expenditure would come into play and when such expenditure is otherwise treated as allowable under section 30 to 37. If the income of the assessee is determined by applying flat profit rate, the question of considering the allowability of different items expenses claimed by the assessee does not arise at all. This also affirmed by Ahmedabad Bench of Tribunal in Hynop Food & Oil Industries (P) Ltd v. CIT (1994) 48 ITD 202(Ahd-Trib). But in ITO v, D.D hazare (1994) 48 ITD 595 (Bom-Trib), it was held that where profit are estimated rejecting books of account, it does not bar disallowance under section 40A(3). According to CIT v. Padam Chand Bhansali (2004) 85 TTJ (Jod-Trib) 215, no addition can be made where income has to be computed by applying net profit rate

4. Advance payment is not out of ambit of expenditure.

According to Vijay Kumar Ajit Kumar v. CIT (1991) 55 Taxman 388 (All), merely because a payment in excess of prescribed limit is made prior to delivery of goods, it cannot be argued that it constitutes an advance and not expenditure so as to invoke provisions of section 40A(3).

Mr. X has given an advance to Mr. Y of Rs. 2,50,000 in cash on 15.03.2020 for supply of goods. The goods are supplied on 29.05.2020 for Rs. 2,50,000, and the advance is adjusted. Section 40A (3) will be attracted and Rs. 2,50,000 will be disallowed is Assessment Year 2021-22. Further, it is to be noted that in A.Y. 2020-21 Mr. Y has received Rs. 2,50,000 in cash in contravention of Sec 269ST. He shall be subject to penalty u/s 271DA of the Act.

5. Plan to avoid purchase of fish or fish product from any middleman.

Circular No. 10/2008, dt 5-12-2008, provides as under:

a. 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..

b. The producers' of 'fish or fish products for the purpose of rule 6DD(e) 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.

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

In Orchid Marine v. ITO 2014 TaxPub(DTI 4022 (Coch-Trib), on facts of the case, since the fish was admittedly purchased from a person other than fisherman or producer, the exact role of that middle man has to be examined in view of Circular No. 10/2008, dt. 5- 12-2008.

Where assessee purchased fish from fishermen or headman of fishermen which fell under exceptional circumstances as prescribed in rule 6DD(e), Tribunal was justified in holding that section 40A(3) was not attracted to facts of the case.- Vide CIT v. Blue Water Foods & Exports (P.) Ltd. 2015 TaxPub(DT) 1630 (Karn-HC).

Thus one should plan to purchase fish or fish product from producer himself instead of any middleman.

During the year ended 31/03/20, Geojit Marine Products Ltd. has made payment in cash to the tune of ` 60,000 on a single day to local fishermen, who regularly supply to them lobsters and crabs. Will such cash payments be hit by the provisions of section 40A(3) of the Income -tax Act, 1961? Will your answer be different, if such cash payments are made to a hawker who supplies lobsters and crabs?

CIRCULAR NO. 10/2008: 'fish or fish products' would include 'other marine products such as shrimp, prawn, cuttlefish, squid, crab, lobster, etc.'.

The ;producers' of 'fish or fish products' would include , besides the fishermen, any headman of fishermen, who sorts the catch of fish brought by fishermen from the sea, and then sells to traders, exporters, etc.

Circular No 6/2006: dt 06/10/2006 –exemption will not be given if (recipient) is not a producer of the goods.

6. Section 40A(3) will not hit if purchase from single person and value of each invoice is less than Rs 10000

If purchase is effected from a single person by way of several bills/invoices and if value of each bill/invoice is less than Rs. 10,000 then payments made to settle each bill/invoice would not be hit by provisions of section 40A(3), as each bill/invoice has to be considered as a separate contract Sec 40A(3) or 40A(3A) is in nature of permanent disallowance and it applies qua each expenditure. Therefore, for each expenditure one has to look at the payment or aggregate payment made in a day. For two different expenditure, if the payment is made to same person and if the payment is made in cash does not exceed the limit as prescribed qua each expenditure though cumulatively it exceeds, then no disallowance can be made. IN THE ITAT COCHIN BENCH Raja & Co. v. Deputy Commissioner of Income-tax, Central Circle, Trichur IT APPEAL NO. 534 (COCH.) OF 2011

Example: Mr. A purchases certain goods from Y Ltd. on credit on June 11, 2018 for Rs. 8,000, on June 29, 2018 for Rs. 7,000 and on July 10 2018 for Rs 9,000. The total payment of Rs. 24,000 is made by a crossed cheque on August 1, 2018.

Though the amount of payment exceeds Rs. 10,000, nothing shall be disallowed. To attract disallowance, the amount of bill as well as the amount of payment should be more than Rs. 10,000.

Disallowance of Depreciation where cash payment exceeding Rs. 10,000 is made for purchase of asset (Amendment to section 43(1))

• Clause (1) of section 43 defines "actual cost" for the purposes of claiming depreciation

• The cost in acquisition of any asset or part thereof 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 an account payee bank draft or use of electronic clearing system through a bank account, exceeds ten thousand rupees, such expenditure shall be ignored for the purposes of determination of actual cost

Certain Consequences because of amendment

1. Asset or part thereof: Part may be in the nature of

2 . Land is Non Depreciable asset hence this amendment will not trigger whatsoever.

3 . What if the depreciable asset which was purchased in cash enters the block of the asset and only this asset remains and others are sold then, will Depreciation still be available on WDV of asset sold as asset bought in Cash still exists in block as per sec 50 of Act ?

4 . What If payment is outstanding at the end of the year ?

For Example: Mr.Joel has bought a Machinery from Mr.Jack worth Rs.30,000 by making cash payment on 20th Nov 2017.

EXAMPLE 1: Assessee purchases plant and machinery of Rs. 3,50,000 on 1.04.2020 and pays the entire amount in cash.

Since payment of Rs. 3,50,000/- is made by cash, it shall not be considered as part of actual cost of plant and machinery. The actual cost of plant and machinery shall be taken to be NIL and NIL shall be added to WDV of Block of assets.

Note: As per section 269ST, the seller of machinery is liable to pay penalty of Rs. 3,50,000 for accepting cash of Rs.2,00,000 or more. The Penalty shall be under section 271DA.

EXAMPLE 2: Suppose in Example 1, assessee makes payments as under:

Therefore Rs. 3,25,000/- shall be considered as actual cost and Rs. 3,25,000/- shall be added to WDV of Block of assets.

Note: S. 43(1) defines original cost to mean actual cost of asset as reduced by portion of cost as met directly or indirectly by any other person or authority. FA, 2017 has inserted a second proviso to exclude expenditure incurred in acquisition of any asset or part thereof from actual cost of asset, if the payment in respect of such expenditure is made to a person in a day, exceeding Rs. 10,000 otherwise than by a specified mode.

Whether payments in respect of past expenditure to be included in cost?

The language of the second proviso is where the assessee incurs any expenditure in respect of which payments or aggregate payments made to a person in a day exceed ten thousand rupees, such expenditure shall be ignored for the purposes of determination of actual cost.

As stated above, the language employed in the amendment is "incurs", signifying present tense and implying that it would apply to any expenditure which is incurred after the amendment is made effective, as per one view. As per the other view, it may also mean that both the event of incurring the expenditure and the payment thereof should be after the date on which the amendment is made effective. As per yet another review, it may mean that the expenditure may be incurred in past, that is, prior to the effective date of amendment, but, if the payment is made after the effective date of amendment, the provision would apply. Having regard to the provision, its language and the desire to be prospective, it appears that the first view or second view is preferable. The other view would require reworking of the actual cost in respect of the past and to what extent it should be done or not may be difficult as well as impractical.

Actual cost of asset in case of withdrawal of deduction in terms of section 35AD(7B) r/w 43(1)

Disallowance of Cash Payments under Section 35AD & Restrictions on Claim of Depreciation of Disallowed Capital Expenditure

As per the provisions of section 35AD investment linked deduction is available in respect of capital expenditure laid out for certain specified businesses. An amendment is has been made to curb the incurring of any expenditure in cash on such expenditure which is eligible for deduction under section 35AD and accordingly an expenditure of above Rs. 10,000/- in aggregate made to a person in a day shall not qualify for deduction under the provisions of the said section. It is to be noted that under the existing provisions of the Act revenue expenditure incurred in cash exceeding Rs. 10,000 is disallowed under section 40(A)(3) except in specific circumstances referred in Rule 6DD of Income Tax Rules, 1962. In order to discourage cash transactions even for capital expenditure ,the Act has been amended to clause (f) of Section 35AD(8) of Act whereby any capital expenditure in respect of which aggregate payment made to a person in a day otherwise then by account payee cheque, draft or ECS through bank account exceeding Rs. 10,000/- , same shall be disallowed. Furthermore, as per the provisions of section 35AD(7B) if any asset, in respect of which deduction has been allowed earlier, is put to use for the purpose other than the specified business, then the expenditure allowed as reduced by depreciation calculated in terms of section 32, shall be added back to the income of the assessee in the year in which the asset is so used for purpose other than specified business. There was no clarity as to what would be the actual cost of such asset for the purpose of section 43. Accordingly, a proviso is being sought to be inserted to Explanation 13 in the section 43 in lines with the provisions of section 35AD(7B)which will provide that the actual cost of such asset shall be the actual cost to the assessee, as reduced by depreciation that would have been allowable if the asset had been used for such purpose (i.e for other than the specified business) since the date of its acquisition.

The above provisions can be summarized in the following manner:

• Capital Expenditure is required to be incurred in respect of which aggregate payment made to a person in a day otherwise then by account payee cheque, draft or ECS through bank account exceeding Rs. 10,000
• It is now provided that the Actual cost where deduction was allowed under section 35AD This proviso will revive the actual cost if section 35AD(7B) is revoked and thereby previous deduction are withdrawn.
• Capital asset in respect of which deduction allowed under 35AD is deemed to be the income of the assessee as per 35AD(7B)
• The actual Cost of the asset to the assessee shall be the actual cost as reduced by an amount equal to the amount of depreciation calculated at the rate in force that would have been allowable had the asset been used for the purpose of business

Applicabilty of disallowance u/s 40A of the Act in case assessee opts for presumptive taxation u/s 44AD.

Sec 40A relates to disallowance related to excess payment of related party, cash payment to a person in excess of Rs. 10,000 in a day, payment to unapproved fund, mark to market losses etc. The comparison of sec 44AD and 40A is very interesting and different from sec 43B and sec 40. Sec 40A overrides all the other provisions of PGBP.

The section begins with ―The provisions of this section shall have effect notwithstanding anything to the contrary contained in any other provisions of this Act relating to the computation of income under the head ―Profits and gains of business or profession‖. The non-obstante clause of this section seems to override provisions of sec 44AD. However, the Panaji Tribunal in case of Good Luck Kinetic v. ITO (2015) 58 relating to disallowance u/s 43B have considered two points:

i) Amplitude of non-obstante clause

ii) Payment to crown i.e statutory dues

The provisions of sec 40A are not related to statutory dues and such other dues. It just imposes restrictions on payments and disallows amount which is not paid as per the provisions of the Act. It is also to be noted that provisions of sec 40A of the Act are with regard to allowability of expenditure which has been actually incurred and claimed by the assessee from sec 30 to 38 of the Act. Therefore, if the assessee declares income as per the provisions of sec 44AD of the Act, no disallowance shall be made u/s 40A of the Act.

Example: If any person opting for sec 44AD has made cash purchases worth Rs. 15,000 no disallowance can be made u/s 40A(3), even if the cash payment to a person exceeds Rs. 10,000 in a day. Cash payment to transporter in excess of Rs. 35,000 in a day shall not be disallowed.

Similarly, disallowance u/s 40A for excess payment to relatives cannot be made. No addition u/s 41 can be made.

Disclosure in Tax Audit Report

S. No. 21(d) - Disallowance / deemed income u/s 40A(3)/ 40A(3A)

Cash expenditure limit per person per day is Rs. 10000/-.

The Tax Auditor should obtain a list of all the cash payments exceeding Rs.10,000/- per person per day (Rs.35,000 in case of plying, hiring or leasing goods carriages) made by the assessee during the relevant year which should include the list of payments exempted in terms of Rule 6DD with reasons. This list should be verified by the tax auditor with the books of account in order to ascertain whether the conditions for specific exemption granted under clauses of Rule 6DD are satisfied. Details of payments which do not satisfy the above conditions should be stated under this clause.

In case expenditure is incurred in earlier previous years, but payment is made in the previous year under tax audit, then also the limits discussed above needs to be verified and payments made in excess of the limits would be deemed to be income of current previous year u/s 40A(3A) and is to be reported in clause 21(d)(B).

PARTICULARS OF AMOUNT INADMISSIBLE U/S 40A(3)

Reporting has to be done on the basis of the certificate of the assessee, the fact shall be reported as an observation in clause (3) of form no.3CA and clause (5) of Form No.3CD as the case may be

Recommended Disclosure: In respect of payments by cheque/draft for the expenses covered under this clause, we have to state that it is not possible for us to verify whether the payments in excess of Rs 10,000/35,000 have been made otherwise than by account payee cheque / bank draft since the necessary evidence is not in the possession of the assessee. However the assessee has certified that all such payments relating to expenditure covered u/s 40A(3) / (3A) of the Act read with Rule 6DD, were made either by account payee cheques drawn on a bank or by account payee bank drafts.

Example: Assessee makes cash payment of Rs.13,000/- to Mr. Arjun for purchase of goods on 01.06.2020. Payment is made for following purchases:

What is the amount of disallowance? Whether reporting required?

Invoices for purchase amount to Rs. 7,000 and Rs. 6,000, both of which are below Rs.10,000. The expenditure of Rs. 7,000 would have been allowed in P.Y. 2019-20. For two different expenditure, if the payment is made to same person and if the payment is made in cash does not exceed the limit as prescribed qua each expenditure though cumulatively it exceeds, then no disallowance can be made as held in ITAT COCHIN BENCH Raja & Co. v. Deputy Commissioner of Income-tax, Central Circle, Trichur IT APPEAL NO. 534 (COCH.) OF 2011.

Therefore, no amount shall be disallowed u/s 40A(3) and no amount shall be deemed as income u/s 40A(3A). There is no requirement to report this in Form 3CD