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Disallowance of cash payments
May, 17th 2008

To overcome the splitting of payments to the same person made during a day, Finance Bill 2008 has amended Section 40(A)(3).

Tightening the norms to tackle black money.

Tax law has stringent provisions to tackle black money. As cash transactions are the mostly commonly used device for tax evasion, the income-tax law forbids such transactions in business above a prescribed limit. Chapter XXB of the Income-Tax Act 1961 bars cash transactions in excess of Rs 20,000 whether by way of loan, deposit or repayment.

Splitting of transactions

Failure to comply with this mandate will be visited with penalty of a sum equal to the amount of the loan, deposit or repayment. In respect of business transactions, Section 40(A)(3) of the Act lays down a ceiling of Rs 20,000 for such cash transactions. Any expenditure exceeding Rs 20,000 will suffer disallowance if such payment is made otherwise than by an account-payee cheque or bank draft.

It may happen that the expenditure is incurred in a particular year and gets allowed in the relevant tax assessment on mercantile basis. If in the subsequent year the liability is discharged in cash and not by account-payee cheque, disallowance will be made in that year. This is a harsh provision and is meant to encourage the banking habit. By requiring payments to be made by an account-payee instrument, it is possible to verify the genuineness of the transaction, thereby reducing the risk of evasion.

What happens if the transactions are split into several cash payments, each below Rs 20,000? This question arose in several cases before the High Courts.

High Court rulings

In the Kothari Santation and Tiles (P) Ltd case, for instance, the company had to suffer a disallowance of the claim for certain expenditure under Section 40(A)(3) on the ground that the payments were made in cash and exceeded Rs 20,000.

The matter was taken to the Madras High Court, which pointed out that as per the cash book of the company, cash payments were made in respect of each invoice separately and the payments were not made separately for each item of the same invoice.

Section 40(A)(3) does not say that the aggregate of the amount of payment in cash should not exceed Rs 20,000. The Section covers payment in a sum exceeding Rs 20,000. The expression used is single sum.

Therefore, irrespective of any number of transactions, where the amount does not exceed the prescribed monetary limit, the rigours of Section 40(A)(3) will not apply. The High Court concluded that apart from this technicality, practicability of the payment has also to be judged from the point of view of the businessman (282 ITR 117).

The Madhya Pradesh High Court also held that the statutory limit of Rs 20,000 applied to payments made to a party at one time and not to the aggregate of payments made to a party in the course of the day as recorded in the cash book. The words used are in a sum.

Therefore, irrespective of any number of transactions, where the amount does not exceed the prescribed amount in each transactions Section 40(A)(3) will not apply (CIT vs Triveni Prasad Pannalal 228 ITR 680).

To overcome the splitting of payments to the same person made during a day, Finance Bill 2008 amends Section 40(A)(3). It is now provided that where a payment or a aggregate of payments made to a person in a day, otherwise than by an account-payee cheque etc., exceeded Rs 20,000, then the disallowance of such expenditure shall be made under the new Section 40(A)(3).

The taxpayers may split a single payment of Rs 40,000 into three, like Rs 15,000, Rs 16,000, and Rs 9,000 all by cash to the person concerned in a single date. Since the aggregate payment by cash exceeded Rs 20,000, the sum of Rs 40,000 will not be allowed as a deduction in computing the total income of the taxpayer in accordance with the new scheme of Section 40(A)(3).

This is an anti-evasion measure and courts have upheld the constitutionality of this disallowance. Hardship in individual cases will be taken care of by exceptions provided in Rule 6 DD of the Income-Tax Rules, 1962. The objects of curbing circulation of black money and regulating the business transactions have been strengthened. The Section applies to all outgoing, including purchase of stock-in-trade, and advance payments. It will not apply to cases of estimate of gross profit.

Legislative intent

The newly substituted Section refers to a payment or aggregate of payments made to a person in a day. Before the present amendment, the Section referred to payment in a sum, that is a single sum.

Does this change in phraseology effectively carry out the legislative intent? Probably, the drafting of the amendment leaves much to be desired.

The law permits payments up to Rs 20,000 in cash in a day. The same payment can be repeated day after day without suffering disallowance. How many times can Section 40(A)(3) be amended?

T. C. A. Ramanujam
(The author is a former Chief Commissioner of Income-Tax.)

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