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Section 40a (3) - Disallowances of Expenses

Section 40A (3): Disallowance of expenses made in Cash and Exceptions.

Section 40A (3) came into existence in order to disincentivise cash transactions. It is an important section of the Income Tax Act, 1961, designed to reduce tax evasion and increase accountability. In short, all payments should be made in demand draft/cheque.

Disallowances of Expenses

Both Section 40A (3) and Section 40A (2) disallow certain expenses if they are not in compliance with the guidelines of the Income Tax Act, 1961.

Section 40A (3)(a) states that any expenditure incurred in respect of which the payment is made (exceeding ₹10,000 in a single day) should be done in demand draft/cheque and shall not be allowed as a deduction.

Section 40A (3)(b) states the provisions for deeming a payment as profits and gains of a business if the expenditure was incurred in a specific assessment year and payment was received in the subsequent year exceeding ₹10,000.

Both of these sections are over riding sections under the Income Tax Act, 1961. By making payments via account payee instrument (Demand Draft/Cheque/Electronic Clearing System), it becomes easier for the Income Tax Department to track transactional records, thereby reducing the chances of tax evasion.

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Rule 6DD

Rule 6DD states the exceptions to provisions of Section 40A (3). The following list of exceptions are:

When the payment is made to:

  • RBI (Reserve Bank of India) or another bank
  • SBI or its subsidiaries
  • Land mortgage bank or Co-operative bank
  • Life Insurance Corporation of India

Where the payment is made by:

  • Letter of Credit Arrangements through a bank
  • Mail or telegraphic transfer
  • Adjustment made in the book from any account in a bank to any other account in that or any other bank.
  • Bill of exchange made only payable to a bank.
  • Credit/Debit card
  • ECS - Electronic Clearing System

Where the payment is made to a cultivator for the purchase of:

  • Agricultural or Forest Produce
  • Produce of Animal Husbandry (livestock, meat, hides, skins)
  • Fish or Fish Products
  • Products of Horticulture/Apiculture

Payment made towards procurement of products manufactured by cottage industries (without electrical power).

Payment made to an individual residing or carrying our business in a town/village (not served by a bank).

When payment is made to the government in legal tender under specified rules.

Payment made by an assesse in relation to the salary paid after deducting the income tax.

In such a situation:

  • The employee should be posted temporarily for 15 days or more, outside his/her normal place of duty.
  • The employee should not have an active bank account, serviceable at the place of posting/ship.

When the payment is made on a day of bank holiday.

When the payment is made by the assesse to purchase foreign currency or travellers cheques.

When the payment is made by the assesse to their agent for procuring goods or services on behalf of the assesse.

FAQs on Sec 40a (3)

What is the limit for cash transfer?

The limit of Rs. 20,000 has been reduced to Rs. 10,000 from Annual Year 2018-19.

Can salary be paid in cash in excess of Rs. 10,000?

The salary paid in cash to employees posted at Oil Rigs for more than 15 days cannot be disallowed.