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Section 40A(3): Disallowance of Expenses made in Cash & Exceptions

Updated on: 23 May, 2024 04:10 PM

Whether businesses or individuals, we incur a lot of expenses every day. Before the demonetization of 2016, most of the transactions were made using cash, which made it harder to track the source of income and led to massive evasion of taxes. Section 40A(3) was introduced to reduce tax evasion and promote digital payments. All transactions exceeding Rs.10,000 in a day are disallowed as an expense under the Income Tax Act. However, there is more to this section. This article explains all that you must know about section 40A(3), disallowances, and exceptions.

What is Section 40A(3) of the Income Tax Act?

Section 40A(3) deals with the disallowance of expenses made in cash and exceptions. This section was introduced to disincentivize cash transactions and reduce tax evasion and increase tax accountability.

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

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

then such expenditure will not be allowed as a deduction under section 40A(3) of the income tax act.

This means it will not be considered a business expense and will be added back to the income. Further, it will result in a higher payment of taxes. However, Rule 6DD prescribes certain cases and circumstances where the above-mentioned expenditures will be allowed as a deduction even if payment is made in Cash.

In the case of a transporter (i.e., if the payments are made for hiring or leasing carriages for goods such as lorries, trucks, etc.), the limit has been fixed to Rs. 35,000 instead of Rs. 10,000/-.

This exemption is limited to only the expenses incurred by organizations, companies, and firms. For any other expenses, any payment made in cash exceeding Rs.10,000 cannot be deducted.

If an organization accrues assets such as land and machinery, then it does not come under the category of expenses and is covered under the capital gains act.


What are the various modes of payment allowed u/s 40A(3)?

Even if the amount of expenditure exceeds Rs 10,000 ( or Rs 35,000), no disallowance will be done if such payment has been made via

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

In a nutshell, payment made in cash or through a bearer cheque can be disallowed only.


Examples of the Implementation of Section 40A(3)

Example:

M/S ABC purchases stationery worth Rs.15,000, Rs.16000, and Rs.19000 on 3 different days in cash. The total expense incurred is Rs.40,000. This sum is not allowed as a deduction while calculating the total income of the company as the expense in cash is more than Rs.10,000 a day limit.

If the same organization purchases stationery worth Rs.8,000, Rs.9,000, and Rs.10,000 on 3 separate days each in cash, then the total expense incurred will be allowed as a deduction as it does not exceed the Rs.10,000 per day limit.


What are the exceptions stated under Rule 6DD?

As per Rule 6DD of the income tax act, if a payment exceeding Rs 10,000 is made in cash or through a bearer cheque, it will be ALLOWED in the following exceptional cases:

  • Payment is made to Banking and other credit institutions: Where payment is made to the Reserve Bank of India, LIC, Banks, Government, primary agriculture credit society or co-operative bank, or land mortgage bank.
  • Payment made to Government(both central & state government): Where the payment is made for payment of taxes -direct tax, GST, customs, or any other payment to the Govt. It also covers payments made other than taxes. For e.g., if the scrap is purchased from the Indian railways in cash.
  • Payment through banking system: Where the payment is made by
    1. Any letter of credit
    2. By Telegraphic Transfer/mail
    3. Bill of exchange payable to bank
    4. Use of ECS
    5. Credit/Debit card
    6. Book adjustment in the same bank or between one bank to another
    7. Credit card and Debit card
  • Payment made by Book Entries: Payment made by the book adjustment in the account of the payee against the money due to the assessee for the supply of goods or services.
    Payment to cultivators, growers, or producers of agriculture products, forest products, animal husbandry products (including livestock, meat, hides, and skin), dairy products, poultry farming, fish or fisheries product, products of horticulture, apiculture, etc.
    Where the payment is made for the purchase of products manufactured without the aid of power in a cottage industry to the producer of such product.
    Where the payment to a person who ordinarily resides in a village or town which on the date of such payment is not served by any bank.
  • Payment of terminal benefits: Where any payment is made to an employee or heir of such employee in connection with the retirement, retrenchment, resignation, or death of such employee, on account of gratuity, provided such payment is up to Rs. 50,000/-.
    Payment made to an employee of his salary (after deducting TDS from salary): when such an employee 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, or he does not maintain any account in any bank at such place or ship.
    Payment required to be made on a day when banks were closed either on account of a holiday or strike.
    Payment made by any person to his agent who is required to make payments in cash for goods or services on behalf of such person.
    Payment made by an authorized dealer or a money changer against the purchase of foreign currency or traveler’s cheque in the normal course of his business.
    section 40A(3A)

Now that you know all about section 40A(3), you can go ahead and file your ITR using Tax2win’s DIY portal within a few minutes. And if you are among those who start sweating just at the thought of filing taxes, we have a solution for you too. You can book an eCA and get expert assistance from our experienced CAs to help smoothen your ITR filing journey.


Frequently Asked Questions

Q- What if an expense is allowed on the due basis and is paid in cash next year?

As per section 40A(3A) when an expense payable is allowed in a year and in any subsequent year the assessee makes payment of such expenditure in cash or through bearer cheque exceeding Rs 10,000, then this payment is deemed to be the profit of business or profession and will be charged to tax in such subsequent year.


Q- Can salary be paid in cash excess of Rs 10000?

As a normal rule, salary cannot be paid in cash u/s 40A(3) unless it falls under the exceptions mentioned above.


Q- Can 40A(3) cash expenses exceed Rs 10,000/-?

The cash expenses exceeding Rs.10,000 in a day under the Income Tax Act, 1961, are not allowable as a deduction from the total income chargeable to tax.


CA Abhishek Soni
CA Abhishek Soni

Abhishek Soni is a Chartered Accountant by profession & entrepreneur by passion. He is the co-founder & CEO of Tax2Win.in. Tax2win is amongst the top 25 emerging startups of Asia and authorized ERI by the Income Tax Department. In the past, he worked in EY and comes with wide industry experience from telecom, retail to manufacturing to entertainment where he has handled various national and international assignments.