Important Disallowances under Income Tax Act (Sec 40A)
WHAT IS SEC 40A
Under the Income tax Act,1961 profit or gain from business or profession is considered income and such income is chargeable to tax. The expenses incurred in relation to business can be deducted from revenue from business or profession. However, there are certain restrictions on such deduction of expenses and payments. Certain expenses or payments cannot be allowed as deduction. Section 40A specifies the expenses or payments not deductible. Below are the two most important sub sections out of the
1. Excessive or unreasonable expenses paid to relatives Sub Section 2(a) deals with the disallowance of excessive or unreasonable expenses paid to relatives of assessee. Where payment has been or is to be made to any person referred to in clause (b) of this sub-section and Assessing officer is of the view that expenditure incurred is excessive or unreasonable keeping in view the fair market value of goods and legitimate needs of the business, he can disallow the unreasonable portion of such expenses. However, the AO would need to establish that the payments made are excessive and merely on his hunch it cannot be said so. Relatives for the purpose of this section are defined as I. where the assessee is an individual, any relative of the assessee. II. where the assessee is a company, firm, association of persons or HUF, any director of the company, partner of the firm, member of association or family, or any relative of such director, partner or member. III. any individual holding substantial interest in assessee’s business, or any relative of such individual. IV. a company, firm, AOP or HUF holding substantial interest in the assessee’s business or any director, partner or member of such co., firm, AOP or HUF or any relative of such director, partner or member or any other company in which the first mentioned co. has a substantial interest. V. a Co, firm, AOP or HUF of which a director, partner or member has a substantial interest in the business of the assessee.
2. Cash Payments
Payments or aggregate of payments in respect of expenditure made to a person in a single day, otherwise than by an account payee cheque, bank draft or use of any electronic mode, exceeds Rs. 10,000, the same shall not be allowed as deduction. Please note that any creditor standing in your books is also paid in excess of the stipulated amount would be liable for dis-allowance. In case of payment made for plying, hiring, or leasing goods carriages, the limit is Rs. 35,000.
Exceptions to the rule are (i) Payment to any bank/RBI/LIC/Agricultural credit society. (ii) Payment made to govt in legal tender. (iii) Payment for agricultural purposes. (iv) Payment to be made in a village or to a person who resides in such village which is not served by any of the banks. (v) Payment to cottage industry which is working without power. (vi) Payment made during a bank holiday or bank strike. (vii) Money changer can make payments in cash in exchange of foreign currency. (viii) Payment to agent when agent has to make payment in cash on behalf of the person. (ix) Any salary paid to an employee who is: (a) temporarily posted in a place other than normal place & (b) does not maintain any bank account at such place. (x) Any payment made on retirement/retrenchment/ resignation/death of employee, if such payment does not exceed Rs. 50,000.