Section 40A(2) of the Income Tax Act, 1961, basically deals with the empowerment of income tax assessing officers. This section lets them to not permit certain kinds of expenditures to be claimed as deduction made to specific individuals.
This section of the Income Tax Act empowers the assessing income tax officer to not allow certain types of expenses to be claimed as deduction made to specific persons if he/she feels the need to do so in the backdrop of such expenditure being undervalued or unreasonable to the fair market value of the goods or services. The following conditions should be satisfied before disallowing the deduction of the assessee.
- The payment made should be in respect of an expenditure.
- The payment has already been made or is scheduled to be made to a specific person.
- The assessing officer is of the opinion that the expenditure is unreasonable.
The different categories of taxpayers for imposing the provisions of section 40A(2) are as follows.
- Individuals: Relatives of lineal ascendant or descendant such as spouse, brother, sister etc. A relative or the individual himself who has substantial interest in business or profession run by self.
- Company, firm or HUF: Director(s) of the company, partners in a firm, association members or family or relative of people in these positions. A relative or the individual himself who has substantial interest in the business or profession the assessee holds such a position.
- All Assessees: An individual who has substantial interest in the business or profession run by the assessee. A company, firm, AOP or HUF which has substantial interest in the business or profession run by the assessee or directors, partners or association members of such members or relative of the person holding such a position.
Description of “Substantial Interest”:
A person will considered to have substantial interest in the business or profession on satisfying the conditions below.
- If the business or profession carried out by the company in which the person carries not less than 20% voting power in the previous year.
- Otherwise, the person is entitled to not less than 20% of profits made by the business or profession in the previous year.