Section 40A(3) is an important section of the Income Tax Act that ensures there is proof of payment made which helps to reduce tax evasion and increases accountability. Payment can only be made through demand draft or cheques.
This section of the Income Tax act is an overriding section that prohibits deduction of payment of ₹20,000 and above in a single day. The only modes of payment allowed are cheque or demand drafts. If the payment made is in relation to hiring, plying or leasing goods carriages, the limit on deduction for such payments will be ₹35,000.
The subsection 40A(3)(b) contains provisions for deeming a payment received as profits if the expenditure was incurred in a specific assessment year and payment was received in the subsequent year exceeding ₹20,000. If such a payment has been received in any other modes other than account payee cheque or account payee draft, it cannot be shown as a deduction.
This section of the Income Tax act ensures accountability and reduces the chances of tax evasion since payments are only realized through account payee cheques and therefore, there is a definite record of the payment made. This section only deals with payment received for the expenditure and procurement of capital assets are not covered under this section.
The rule 6DD deals with provisions made to create exceptions to Section 40A(3).
Rule 6DD - The exceptions:
The following category of payments exceeding ₹20,000 are allowed to made in a mode other than account payee cheque or bank draft.
- RBI (Reserve Bank of India) or any other bank
- SBI (State Bank of India) and its subsidiaries
- Land mortgage bank or Co-operative bank
- LIC (Life Insurance Corporation of India)
- Primary credit society or Primary agricultural society
- When payment is made to the government when such a payment is required to made in legal tender under specified rules.
- When the payment is made in certain modes such as letter of credit issued by the bank, telegraphic or mail transfer initiated through a bank, an adjustment made in books of accounts from a bank account, bill of exchange payable to the bank only, electronic clearing system made through a bank account and payments made using debit/credit card.
- Adjustments made in the books of account where the payment is an adjustment made to offset the liability incurred by the assessees to the payee for the goods/services rendered.
- When the payment is made towards procurement of products manufactured by cottage industries without the aid of electrical power.
- When the payment is made to a person residing or carrying our business in a town/village which is not served by a bank. Such payee must be carrying out the business/profession in the place with no access to banking services.
- When the payment made by the assessee is in relation to the salary paid after deducting the income tax. Such as employee should be posted temporarily for 15 days or more, outside his/her normal place of duty. Such an employee should not have an active bank account, serviceable at the place of posting/ship.
- When the payment is made on a day where banks were closed due to bank holiday or strike.
- When the payment is made by the assessee to their agent who is in turn makes payments for procuring goods or services on behalf of the assessee.
- When the payment is made by the assessee to purchase foreign currency or travellers cheques. Such payments should only be made to authorized money changers.