Understanding the Section 40A(3) & Section 40A(3A) in the Income Tax Act 1961 for Taxation and Transparency

Last Updated : Sept. 13, 2023, 2:06 p.m.

The Indian government has been trying to digitalise payments in recent years for various reasons, including curbing black money and ensuring accurate taxation. Section 40A(3) and 40A(3A) of the Income Tax Act 1961 contribute to the same cause. Taxpayers need to understand these parts since they significantly impact the reductions they can claim. The nuances of Section 40A(3) and 40A(3A) will be thoroughly examined in this essay, along with their ramifications and effects on taxpayers and companies. The many aspects of this Act are discussed in the section below.

A Description of Section 40A(3): “Disallowance of Expenses”

Two main subheads, section 40A(3)(a) and 40A3(b), make up this section. While the second applies to businesses and organisations, the first focuses on individuals. Amounts paid to an individual in cash that exceeds Rs. 10,000 per day are not allowed to be deducted from income when filing tax returns, according to the most recent legislation outlined in the 2017 Union Budget.

This daily cap was initially set at Rs. 20,000 before the announcement in 2017. Any expenses spent by a business, organisation, or firm that the organisation pays in cash and exceeds Rs. 10,000 per day are also ineligible for tax exemption under Section 40A(3)(b). The 40A3 Income Tax Act’s restriction on expenses is a critical aspect in the second circumstance. The same organisation is exempt from the definition of expenditures and is covered by the Capital Gains Act if it is acquiring assets by buying land, machinery, etc. But let’s say a company is adding personnel, using transporters to move goods, or renting goods waggons. In that situation, the ceiling for cash payments of Rs. 10,000 can be exceeded, and the daily maximum for cash payments is Rs. 35,000. According to Section 40A(3) (b), only this exemption is permissible. Making the switch to digital payments has several benefits. They ensure that a minimum amount of “Black Money” enters the economy, provide a trail tax investigators can follow, and give the SFIO and other government bodies the tools they need to fight corruption or fraud.

Implementation and Examples

Here are two instances of how Section 40A(3) has been implemented.

• A firm called XYZ buys stationary three times and pays cash on three different days for each purchase: Rs. 16,000, Rs. 15,000, and Rs. 9,000. Rs. 40,000 is the entire cost incurred. Due to the amount being more than the daily cap of Rs. 10,000, it will not be permitted to be deducted when determining the company’s overall revenue.
• The entire amount spent on stationary by the same organisation might be tax-exempt if payments of Rs. 9,000, Rs. 6,000, and Rs. 10,000 are made in cash on three separate days. This is due to the fact that all three payments are legitimate, according to Section 40A3(b).

If a person receives up to and exceeding Rs. 10,000 in cash in daily payments, the same instances and related exemptions also apply to them.

Exemptions under Rule 6DD

Given that India’s economy still relies heavily on cash, Section 40A3 provides a number of exemptions. Rules 6DD apply to each of these situations. There won’t be any “disallowance” of repayments in the below circumstances, even if the total daily payment exceeds Rs. 10,000 and an AC-payee cheque or banking draught isn’t utilised.

• All payments to:
  • The Indian Life Insurance Corporation, or LIC.
  • The State Bank of India and each of its affiliated companies, whether they are financial institutions or not.
  • The RBI has recognised the thousands of cooperative banks in India.
  • Any of India’s tens of thousands of villages and Panchayats’ Primary Agricultural Credit Societies (PACSs).
  • Itself, the Reserve Bank of India.
• There are times when specific payments are required to be made to the Indian government. These may be made using legal currency without being subject to Section 40A(3)’s regulations.
• The following payment methods are also covered by Rule 6DD:
  • Any LoUs provided by a scheduled commercial bank, including Letters of Credit, Bankers’ Commercial Credit, and LoUs.
  • Transferring money between banks and within banks.
  • Bills of exchange that can only be paid to banks.
  • Using credit or debit cards, as well as the Electronic Clearing System, or ECS, for money transfers.
• Payments in excess of Rs. 10,000 per day can be made to purchase a variety of goods produced by small-scale businesses that operate without electricity without coming under the purview of section 40A(3).
• According to Rule 6DD, payments made to a person whose residence or place of business is beyond the purview of traditional financial services are also exempt.

After all ordinary tax deductions have been made, Rule 6DD is additionally applicable to any assessee (usually organisations and corporations) and its employee(s) when the employee is temporarily transferred to another location. In order to circumvent Section 40A 3A of the Income Tax Act, such an employee:

●  Must have a posting that must be made for at least 15 days in a different place

●  Has no business maintaining a bank account there.

Conclusion

It should be noted that Sections 40A(3) and 40A(3A) are crucial for encouraging transparency and preventing tax evasion. To avoid adverse outcomes, taxpayers and businesses must be aware of these requirements and strictly abide by them. Companies can effectively negotiate these parts and guarantee their financial dealings remain above board by adopting digital transactions, maintaining correct paperwork, and getting professional help when necessary.

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