S. 40A(3): Financial crises may be exceptional or unavoidable circumstance for cash payment
 
The assessee made payments exceeding Rs. 10,000 in cash and claimed that a disallowance u/s 40A(3) read with Rule 6DD(j) & Circular No.220 dated 31.05.1997 could not be made as a payment by cheque etc was not possible due to exceptional or unavoidable circumstances etc. The Tribunal rejected the assessees claim on the ground that that the assessees explanation that the payees would not accept cheques as they had been dishonoured on earlier occasions was fantastic and fanciful as in such case the assessee could have deposited cash and obtained bank drafts. It was also held that the assessee had not explained how it obtained the cash for making the payments & if the amounts were borrowed, there was a violation of s.269SS. On appeal by the assessee to the High Court, HELD reversing the Tribunal:
 
S. 40A (3) & Rule 6 DD (j) have been incorporated in the Act to check the incurring of bogus and fictitious expenses to non existing parties. In the present case, there is no dispute on the identity of the payee and genuineness of the transaction. The only question is whether the assessee has been able to establish exceptional or unavoidable circumstances why the payment made in cash. The assessee was not doing well in its business and was facing liquidity and financial crunch. The assessees explanation that payments were made in cash as preparation of a bank draft or issue of cheque would have resulted in a missed opportunity or failure of a good business deal with third parties is acceptable because there were earlier cases of bounced cheques and when a party is facing liquidity problem, it can get difficult as third parties are reluctant to accept cheques and insist on cash payments. Arranging funds is also a problem and not easy. Also, the cash was obtained from a known party and the AO had not made any addition on that score. Accordingly, disallowance u/s 40A(3) was not justified.