379. Disallowance of expenditure for which payment exceeding Rs. 2,500 1is made otherwise than by crossed cheque/bank draft under sub-section (3), read with rule 6DD of the Income-tax Rules - Scope and operation of the sub-section explained

CLARIFICATION 1

1. The Ministry of Finance have received enquiries from various trade associations and members of the public about the operation of the new provision in section 40A(3) for the disallowance of expenditure in business and professions for which a payment exceeding Rs. 2,500 1is made otherwise than by a crossed cheque or bank draft.

2. The above provision applies to payments made on or after April 1, 1969. Certain categories of payments have been excluded from its operation. These exclusions have already been notified by the Central Board of Direct Taxes in the Gazette of India, Extraordinary, dated 14-2-1969 2and the Gazette of India, Extraordinary, dated 25-3-1969. Broadly, the following categories of payments have been excluded from the operation of the above provisions :

u Payments which under contracts entered into before April 1, 1969, have to be made in cash

u Payments by book adjustment by the taxpayer in the account of the payee against money due to the taxpayer for any goods supplied or services rendered by him to the payee

u Payments made in villages and towns having no banking facilities, to persons ordinarily residing or carrying on business or profession in any such village or town

u Payments made to cultivators, growers or producers for purchase of agricultural or forest produce, animal husbandry products including hides and skins, products of dairy or poultry farming, products of horticulture or epiculture3, [fish or fish products] and products of any cottage industry run without the aid of power

u Payments made to the Reserve Bank of India, State Bank of India, other banking institutions, including co-operative banks and land mortgage banks, primary credit societies, including agricultural credit societies, Life Insurance Corporation, Unit Trust of India and specified financial institution

u Certain categories of payments made through the banking system, e.g., letters of credit, mail or telegraphic transfers, book adjustments and bills of exchange made payable only to a bank

u Payments of terminal benefits, e.g., gratuity, retrenchment compensation, etc., to low-paid employees or to members of their families

u A residuary exception is also provided in respect of payments which could not be made by crossed bank cheque or draft due to exceptional and unavoidable circumstances, provided the taxpayer furnishes evidence as to the genuineness of the payment and the identity of the payee.

3. The points on which enquiries have been made, and clarifications in the matter are given below :

Question 1 : Does the requirement of making payments over Rs. 2,500 by cheque or draft apply also to payments made for purchase of goods for the business?

Answer : Yes, the provisions apply to all categories of expenditure involving payments for goods or services, which is deductible in computing the taxable income.

Question 2 : Does the requirement apply also to loan transactions?

Answer : No, because advancing of loans or repayment the principal amount of the loan do not constitute expenditure deductible in computing the taxable income. However, interest payments in amounts exceeding Rs. 2,500 at a time are required to be made by crossed bank cheques or drafts, as interest is a deductible expenditure.

Question 3 : Does the requirement apply to payments made by commission agents (arhatias) for goods received by them for sale on commission or on consignment basis ?

Answer : No, this is because such a payment is not an expenditure deductible in computing the taxable income of the commission agent (arhatiya). For the same reason, the requirement does not also apply to advance payments made by the commission agent to the party concerned against supply of goods. However, where a commission agent (arhatiya) purchases goods on his own account, and not on commission basis, the requirement will apply in that case.

Question 4: Does the requirement apply to payments made for goods purchased on credit?

Answer : Yes, if the payment is made in an amount exceeding Rs. 2,500 at a time.

Question 5: What categories of hundi payments are excluded from the operation of the requirement in section 40A(3)?

Answer : Hundi transactions entered into in connection with the advancing of loans or the repaying of loans are outside the scope of the provisions because such transactions do not constitute expenditure deductible in computing the taxable incomevide answer 2 above.

Payments for goods or services made by a bill of exchange (hundi) where the hundi is made payable only to a bank, have been specifically excluded from the operation of section 40A(3) under the Notification in the Gazette of India, Extraordinary, dated 14-2-1969.

Question 6 : Are payments made to the grower or producer of agricultural products excluded from the operation of section 40A(3) even where these have been subjected to some processing by him?

Answer : Yes, payments made to the grower or producer of agricultural or forest produce, produce of animal husbandry, dairy or poultry farming, etc., have been specifically excluded from the requirement in section 40A(3) by the Gazette Notification, dated 14-2-1969, read with the corrigenda published in the Gazette of March 25,1969.

Thus, payments made to a grower or producer of kapas ginned by him or to a grower of paddy which has been converted by him into rice, are excluded from this provision.

Question 7 : Are payments, made in towns having banking facilities, for purchase of goods from villager whose village does not have banking facilities, excluded from the requirement in section 40A(3)?

Answer : No, because in such a case, the payment is made in a town having banking facilities. If the payment is made to the villager in the village in which he is residing and where there are no banking facilities, the requirement in section 40A(3) will not apply.

Press Note : Dated 2-5-1969, issued by Ministry of Finance.

CLARIFICATION 2

A further relaxation has been made in the provision in the Income-tax Rules requiring payments for business expenses exceeding Rs. 2,500 1to be made by crossed cheques or drafts.

The relaxation cover payments in cash in excess of Rs. 2,500¹ made with a view to avoid difficulty to the payee or where it was not practicable to pay in cheque or draft [rule 6DD(j2)]. The availability of this benefit depends upon the nature of transaction as well as the need for its expeditious settlement. The assessee making such payments is, however, required to satisfy the Income-tax Officer about the genuineness of the payment and the identity of the payee.

Background -The Income-tax Act contains a provision in section 40A(3)which requires that payments for business expenditure in amounts exceeding

Rs. 2,500 1should be made by crossed bank cheque or draft in order to qualify for deduction in computing the taxable profits. With a view to avoiding genuine hardship to taxpayers, particularly in the rural areas, certain exceptions were notified under rule 6DD by virtue of which payment in a sum exceeding Rs. 2,500¹ may be made otherwise than by a crossed cheque drawn on a bank or a crossed bank draft in certain circumstances.

These exceptions cover, inter alia, payments made for purchases of agricultural or forest produce, cottage industry products, etc., from the producers of such products; payments made in villages or towns having no banking facility to any person carrying on business or profession in any such village or town; payments made through the banking system, that is, in the form of letter of credit arrangements, telegraphic transfers, adjustments in accounts, or bills of exchange made payable only to a bank; and payments by way of gratuity, retrenchment compensation or other terminal benefits to low-paid employees of the business or profession.

There is also a residuary exception under clause (j) of rule 6DD which provides that the provision for the disallowance of the expenditure might not be applied if the assessee (i) establishes that the payment could not be made by crossed bank cheque or draft due to exceptional or unavoidable circumstances, and (ii) also furnishes evidence to the satisfaction of the Income-tax Officer as to the genuineness of the payment and the identity of the payee.

After considering representations from various quarters that the existing exceptions were not helpful in preventing disallowance of substantial payments for purchases of commodities on the ground that these were made in cash in amounts exceeding Rs. 2,500, the Central Board of Direct Taxes have now liberalised this residuary clause (j) of rule 6DD so as to avoid disallowance of such payments in genuine cases.

Press Note : Dated 19-11-1970, issued by Ministry of Finance.

CLARIFICATION 3

1. The Board had occasion to deal with several representations from various chambers of commerce, trade associations and businessmen regarding the scope of provisions of section 40A(3) and rule 6DD.Since many of the points raised therein are of an important nature, the clarifications given thereon are summarised below.

2. The provisions of section 40A(3) would apply in computing the income under the heads Profits and gains of business or profession and Income from other sources as per section 58(2). All payments in excess of Rs. 2,500 at one time whether for goods or services obtained for cash or credit, which are deductible in computing the income, have to be made by crossed cheque or bank draft. Thus, the price of goods purchased for resale or use in manufacturing process or payments for services will be covered by the provisions of section 40A(3). However, the section will not apply to repayment of loans or payment towards the purchase price of capital assets such as plant and machinery not for resale.

3. A large portion of trade in agricultural commodities is channelled through the institution of arhatias. While the payments made to the cultivators or growers of agricultural produce are specifically excluded from the purview of section 40A(3) by clause (f) of rule 6DD, the payments made to the arhatiya for purchases made from him are not so exempted. It is contended that the arhatiy is not in a position to pay the cultivators in cash until the cheques are encashed and this procedure involves severe hardship. However, this difficulty can be met by obtaining the advances from the purchasers, which should of course conform to requirements of section 40A(3). The extension of the exemption to the purchases would defeat the objective of the provisions.

4. So far as payments made to the railways on account of freight charges or for booking of wagons, and payment of sales tax, excise duty, are concerned, clause (b) of rule 6DD specifically exempts such payments from the purview of section 40A(3) if, under the rules framed by the Government, these are required to be made in legal tender.

Circular : No 34 [F. No. 13A/92/69-IT(A-II)], dated 5-3-1970.

CLARIFICATION 4

Section 40A(3) requires that if any payment in a sum exceeding Rs. 2,500 1in respect of an expenditure incurred after March 31, 1969 is made otherwise than by a crossed cheque drawn on a bank or by a crossed bank draft, such expenditure shall not be allowed as a deduction. It has now been represented to the Board that the entries in bank pass book do not specifically indicate whether the payment made is by a bearer or crossed cheque. The cheques after their encashment are retained by the bank and cannot be produced before the assessing authorities to prove that the payments have been made by crossed cheques.

2. The difficulty pointed out has been considered by the Board in consultation with the Department of Banking and it has been decided that the banks may now return the paid cheques to their constituents after obtaining a formal undertaking from them to the effect that they shall retain the returned paid cheques for a period of eight years and produce them before the Income-tax Officer whenever called upon to do so.

Circular : No 33 [F. No. 9/50/69-IT (A-II) ], dated 29-12-1969.