Section 40A(3) of Income Tax Act: Definition and Exceptions

Over the past few decades, India has been focused on pushing out cash payments and replacing them with digital payments. One of the many measures that were implemented to reduce dependence on cash payments was section 40A(3) of the Income Tax Act of 1961.

This particular section of the act imposes certain restrictions on individuals and businesses making cash payments exceeding a certain threshold as a deduction to reduce tax liability. Here is everything you need to know about sec. 40A(3) of the Income Tax Act, including exceptional cases where the provisions of this section do not apply.

WHAT IS SECTION 40A(3) OF THE INCOME TAX ACT, 1961?

According to the provisions of section 40A(3) of the Income Tax Act, cash payments exceeding Rs. 10,000 made to a person or entity on a particular day cannot be claimed as a business expense to lower tax liability.

In the case of cash payments made to transport service providers for hiring, leasing or plying goods vehicles, the maximum limit is increased to Rs. 35,000. Section 40A(3) of the Income Tax Act applies to both individuals with business income as well as full-fledged business entities.

The objective of this particular section of the Income Tax Act is to discourage individuals and businesses from making payments in cash. By promoting digital payments, the provisions aim to create a verifiable paper trail and prevent taxpayers from artificially inflating their business expenses without any proof to reduce their tax liability.

UNDERSTANDING SECTION 40A(3) OF THE INCOME TAX ACT WITH AN EXAMPLE

Here is a hypothetical example to help you understand the provisions of section 40A(3) of the Income Tax Act of 1961 .

Assume you are a business owner providing automobile restoration and repair services. The expenses that you incur during a particular day are as follows:

Now, since the amount of Rs. 60,000 you spent to purchase spare parts was paid for in cash, you cannot claim it as a business expense and reduce your income tax liability. However, since the other two amounts can be deducted from your business income as an expense since they were paid through non-cash methods.

Let us consider the following scenario: Suppose you paid Rs. 60,000 for the purchase of spare parts over the course of 6 days, paying no more than Rs. 10,000 every day. In this case, you can claim the entire Rs. 60,000 as a business expense even though you made the payment in cash since you did not exceed the cash payment limit of Rs. 10,000 per day.

Payment Modes Permitted by Section 40A(3) of the Income Tax Act, 1961 As per section 40A(3) of the Income Tax Act, expenses paid through the following modes can be claimed as business expenses to reduce income tax liability.

•   Account payee cheque

•   Demand draft

•   Electronic Clearing Service (ECS)

•   Internet banking

•   Credit and debit cards

•   Unified Payments Interface (UPI)

•   Immediate Payment Service (IMPS)

•   National Electronic Fund Transfer (NEFT)

•   Real-Time Gross Settlement (RTGS)

•   Bharat Interface for Money (BHIM) Aadhaar Pay

WHAT ARE THE EXCEPTIONS TO SECTION 40A(3) OF THE INCOME TAX ACT, 1961?

Rule 6DD of the Income Tax Act, 1961, lists certain exceptions to the provisions of section 40A(3). According to the rule, the following cash payments, even if they are over Rs. 10,000 in a day, can be claimed as a deduction. Let us examine the various exceptions.

•   Cash payments to the union or state governments through legal tender. This includes tax payments, customs duty, excise duty, railway booking charges, and freight charges, among others

•  Cash payments to the Reserve Bank of India (RBI), State Bank of India, or any other registered banking institution. Cash payments made to cooperative banks, Life Insurance Corporation (LIC), agricultural credit society, and land mortgage banks can also be claimed as a business expense.

•  Cash payments to authorised money exchangers and dealers of foreign currency, provided they are made to purchase traveller`s cheques or foreign currencies.

•  Cash payments to employees in the form of retrenchment compensation, gratuity, or other terminal benefits, provided they do not exceed Rs. 50,000 in a day.

•   Cash payments to employees temporarily residing in remote locations without access to banking services.

•   Payments made through the following modes are also exceptions to the restrictions imposed by section 40A(3) of the Income Tax Act.

•   Letter of credit (LC)

•   Bill of exchange

•   Book adjustment from one bank to another

•   Mail or telegraphic transfers from one bank to another

•   Credit and debit card payments

•   Payments are made by adjusting a purchaser`s liability against the goods and services rendered by the seller.

•   Payments towards the purchase of produce from animal husbandry, poultry farming, dairy farming, horticulture, apiculture, or fisheries. The payments must be made directly to the grower, cultivator, or producer and not to third parties selling the produce.

•  Butchers and meat producers involved in the slaughtering and selling of raw meat and animal carcasses can claim cash payments (exceeding Rs. 10,000) made to purchase animals as a business expense, provided they declare their profession and obtain a certificate from a veterinary doctor

•  Cash payments to cottage industry producers who do not use power for manufacturing or processing products.

CONCLUSION

Section 40A(3) of the Income Tax Act was specially inserted to encourage individuals and businesses to use digital payment methods. By disallowing cash payments above Rs. 10,000, it aims to discourage the use of cash altogether.

However, it is important to keep in mind that payments exceeding Rs. 10,000 made through a bearer cheque are also disallowed. This is because bearer cheques can be encashed at a bank branch and are considered to be on par with cash.