What is Section 40A(3) of income tax

  • Author :
  • TATA AIG Team
  • Published on :
  • 21/11/2023

One of the key priorities of the government and taxation system in India is to promote accountability and transparency. All the financial transactions between businesses and individuals require monitoring and responsibility, levied using multiple income tax rules and regulations.

One such provision is Section 40A(3) of the Income Tax Act 1961. As per Section 40A(3) of the Income Tax Act, all individuals and businesses exceeding a certain threshold of cash payments receive disallowance of cash payment claims.

In this detailed blog, we will cover all about 40A(3) and 40A(3A) of the Income Tax Act, the 40A disallowance limits, the details about disallowance of cash payment exceeding ₹10,000 and other compliance requirements under this section.

Understanding Section 40A(3) of the Income Tax Act

The primary purpose of the cash limit as per Income Tax Section 40A(3) and 40A(3A) is to reduce individuals and businesses skipping tax payments while encouraging the use of digital payment options more rigorously.

Under this section, to track all transactions to avoid cases of tax evasion, the Income Tax Department has put a rule of disallowing cash payments exceeding ₹10,000 for any business or individual.

Simply put, now there is a cash expenses limit, which can be claimed as an expense under the Income Tax Act. This cash limit as per Income Tax should not exceed ₹10,000 in a day under any circumstance, or the expenses will be disallowed for expense claim.

However, this limit is changed to ₹35,000 in case the cash payments are made towards third parties offering carrier services to businesses like trucks, lorries, vans, etc.

Example of deductions under Section 40A(3A)

Let us assume a grocery store owner running the shop from his house. His daily payment cycle is approximately ₹8000, ₹7500, and ₹10,000. Here, as the total of cash payments does not exceed the threshold of ₹10,000, he will be eligible to request a deduction on expenses.

However, if the same payment cycle becomes ₹15,000, ₹8500, and ₹7800, his total daily cash payments will exceed ₹10,000, and he will not be able to avail of a deduction on this expense amount.

List of Payment Modes Permitted under Section 40A(3)

To claim any payment as a deduction or expense for income tax purposes, here is a list of payment modes that are permitted for use.

Cheque

Demand drafts

Net banking

Credit or debit card payments

Other digital payment modes like UPI

Exceptions under Section 40A(3A)

All payments made to banking institutions or RBI

All payments made towards Life Insurance Corporation

All payments made to the government, including tax payments like TDS, GST, customs, etc.

All payments made using the digital modes mentioned above are also exempted.

Any payment made to vendors residing outside a city or in a village, like agricultural or dairy products that are paid in cash to the vendor as no banking service is available.

Payments made to employees or their family members as part of resignation settlement, gratuity, death benefit of employee, etc., under ₹50,000.

What are the Implications of Section 40A(3)?

One of the key implications of Section 40A(3) is increased tax liability. This is because, under this section, when the cash expenses or payments made to one person or business exceed ₹10,000, they will be disallowed for deduction.

This means that the list of disallowed expenses is added back to the taxable income of the individual or business entity, increasing the overall tax liability.

This tax liability can be higher in cases where relevant fines, penalties, and interest are added to the taxable amount due to non-compliance.

What are the Compliance Requirements under Section 40A(3)?

All business entities and individuals should refrain from non-compliance with the rules of Section 40A(3) to avoid financial penalties. Some of the key filing requirements include:

Proper maintenance of all cash payment records daily, especially the ones exceeding ₹10,000.

Recipient details of all the cash payments like name, address, PAN details, payment records, etc.

A conscious effort to ensure no disallowed expenses are added to the taxable income at the time of filing ITR

Make a list of unavoidable cash payments and keep all records related to the payment handy to provide them to the tax authorities whenever needed

Assess and understand all the exemptions under Section 40A(3) to ensure you comply with the criteria to avoid unnecessary tax liability

Conclusion

The main purpose of Section 40A(3) is to encourage the use of digital payment modes and reduce black money transactions or cash payments in general. This is important to monitor individual and business transactions and ensure no tax evasion.

Most services offered for the betterment of society allow digital payments. An example is a Tata AIG online health insurance plan. The best part is that with us, you can enjoy cashless health insurance and gain access to our 10,000 network hospitals without having to pay out of your pocket for the covered expenses.

With medical insurance, you can safeguard your finances while reducing the potential tax liability on income. So buy a health insurance policy for yourself and your loved ones and enjoy cashless treatments up to your policy coverage.

FAQS

Is capital expenditure included under section 40A(3)?

No, the cash payment restriction is only inclusive of revenue-related expenditures. Capital expenditure is not included in this section.

If I need to pay a cash vendor ₹40,000 for a job, can I divide the payment in 4 instalments of ₹10,000 on different days to avoid disallowance?

Yes, if you pay only ₹10,000 to a vendor daily, you are within the cash expense limit and can avoid disallowance. However, you need to ensure all the documentation regarding the vendor and payments are ready in case you need to justify to tax authorities.

Disclaimer / TnC

Your policy is subjected to terms and conditions & inclusions and exclusions mentioned in your policy wording. Please go through the documents carefully.

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