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