Section 40A(3) & Section 40A(3A)

On the 8th of November 2016, the Union Government of India declared a ‘historic’ demonetisation of high-value currency notes across the country. The stated objective of this massive exercise was 3-fold:

• To curb the stashing of black money and cut down on illegal or ‘hawala’ transactions.
• To push forward the Government’s stated objective of digitising payments, and
• To make the society-at-large more tax-compliant.

All of these have a single running feature – cutting down on the use of cash. Section 40A3 of Income Tax Act is also an initiative to reduce transactions in cash. Instead, more emphasis is laid on digital payments that leave behind a trail.

Following is a look at the various facets of this Act.

Explaining Section 40A 3: the ‘Disallowance of Expenses’

This Section has 2 primary sub-heads- 40A3 (a) and 40A3 (b). The first provision deals with individuals, while the latter deals with firms and organisations.

According to the latest laws laid down in the 2017 Union Budget, any payments made to an individual above Rs. 10,000 a day in cash cannot be claimed as a deduction while filing tax returns. Before the 2017 announcement, this upper ceiling was set at Rs. 20,000 per day. 

This reduction of threshold is projected by experts as a significant dis-incentivisation of cash transactions. 

Under Section 40A3 (b), all expenditure incurred by any organisation, company, or firm that the establishment pays in cash above Rs. 10,000 per day cannot be claimed as tax exemption either. One significant feature of the 40A3 Income Tax Act in this second scenario is that it limits itself to expenses only. 

If the same organisation is accruing assets by purchasing land or machinery, etc., it does not come under the ambit of expenses and is covered under the Capital Gains Act.

Thus, regardless of whether cash payments are by individuals or companies, the upper ceiling is Rs. 10,000 per day. The Government is encouraging electronic payments including credit and debit cards, account-payee bank cheque or draft, ECS, and other means.

However, suppose an organisation is hiring new employees, plying goods via transporters, or leasing goods carriages. In that case, the Rs. 10,000 cash payment ceiling can be breached, and the maximum sum payable by cash is Rs. 35,000 a day. This is the only exemption possible under Section 40A3 (b).

There are several merits that shifting to digital payments brings with them. They leave a trail that can be followed by tax sleuths, ensuring that minimum ‘Black Money’ enters the economy and provides tools to the SFIO and other Central organisations to combat graft or fraud.

Implementation and Examples

Here are 2 examples of the implementation of Section 40A3.

• Messrs XYZ, a fictitious company, purchases stationary on 3 separate instances and pays Rs. 16,000, Rs. 15,000, and Rs. 9,000 on 3 separate days in cash. The total expense incurred is Rs. 40,000. This sum will not be allowed as a deduction when the total income of the company is being calculated as it is in excess of the Rs. 10,000-a-day limit.
• Now, if the same organisation purchases stationary and pays Rs. 9,000, Rs. 6,000, and Rs. 10,000 on 3 different days in cash, the total sum spent can be tax-exempt. That is because, under the provisions of Section 40A3 (b), all 3 payments are legally valid. 

The same examples and associated exemptions will also apply to an individual if the total payments a day are up to and including Rs. 10,000 in cash. 

Exemptions under Rule 6DD

Section 40A3 has several exemptions since India is still a cash-dependent economy. All of these instances come under Rule 6DD. In all the scenarios given below, there will be no ‘disallowance’ of payments even if it is more than Rs. 10,000 a day and where an AC-payee cheque or bank draft is not used. 

• All payments to:

1. The Life Insurance Corporation of India or LIC.
2. The State Bank of India and any of its subsidiaries, both banking & non-banking.
3. Any of the hundreds of Co-operative Banks in India recognised by the RBI.
4. Any Primary Agricultural Credit Society (or PACS) which works at the grassroots of India’s lakhs of villages and Panchayats.
5. The Reserve Bank of India itself.

• On occasion, certain payments must be made to the Government of India. These can be made in legal tender without attracting the laws of Section 40A3.
• Rule 6DD also applies to the following modes of payment:

1. Letters of Credit, bankers commercial credit, or any LoUs arranged by a scheduled commercial bank.
2. Inter-bank and Intra-bank transfer of funds.
3. Bills of exchange which are payable to banks only.
4. Using the Electronic Clearing System or ECS for transferring money, and
5. Using either credit or debit cards.

• Payments made to procure a wide range of products manufactured by cottage industries that run without electricity can be made in sums more than Rs. 10,000 each day without attracting Section 40A3 provisions.
• Payments made to an individual who resides or runs a business in an area not covered by the formal banking services are also exempt under Rule 6DD.
• Rule 6DD also applies to any assessee (mostly organisations and firms) to its employee/s after all standard tax deductions when the employee is posted temporarily in another area. To override Sec 40A 3A of income tax act, such an employee:

1. Must be posted for at least 15 days in a different location, and
2. Should not hold a bank account in that area.

• Payments in cash of Rs. 10,000 and more per day are allowed on days when banks are closed. This exception is applicable on all scheduled bank holidays and on days when normal operations are disrupted due to strikes.
• Finally, an authorised money changer is allowed to breach the cash-transaction limit when purchasing travellers’ cheques or any foreign currency.

There has been a large spike in digital payments and money transfers after these rules were framed. Besides, the Government has aggressively pursued the idea of a ‘Cashless India’ at all levels of governance.