Section 40A of the Income Tax Act specifies certain expenses that are not allowed as deductions when computing taxable income. This includes excessive or unreasonable payments made to relatives, and cash payments exceeding Rs. 10,000 for most expenses or Rs. 35,000 for vehicle leasing expenses. There are some exceptions such as payments made to banks or the government. The section aims to prevent overstating expenses to reduce tax liability by disallowing fabricated payments or excessive related party transactions not at arm's length.

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Important Disallowances under
Income Tax Act (Sec 40A)
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S&A Knowledge Series
Prepared by Harsh Kapoor Article Assistant
Vetted by Aswani Kumar Partner (Direct Taxes)
www.sethspro.com info@sethspro.com New Delhi | Lucknow | Coimbatore

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WHAT IS SEC 40A
Under the Income tax Act,1961 profit or gain from business or profession is considered
income and such income is chargeable to tax. The expenses incurred in relation to
business can be deducted from revenue from business or profession. However, there are
certain restrictions on such deduction of expenses and payments. Certain expenses or
payments cannot be allowed as deduction. Section 40A specifies the expenses or
payments not deductible. Below are the two most important sub sections out of the
section.
EXPENSES DISALLOWED
1. Excessive or unreasonable expenses paid to relatives
Sub Section 2(a) deals with the disallowance of excessive or unreasonable
expenses paid to relatives of assessee. Where payment has been or is to be made to
any person referred to in clause (b) of this sub-section and Assessing officer is of the
view that expenditure incurred is excessive or unreasonable keeping in view the
fair market value of goods and legitimate needs of the business, he can disallow the
unreasonable portion of such expenses. However, the AO would need to establish that
the payments made are excessive and merely on his hunch it cannot be said so.
Relatives for the purpose of this section are defined as
I. where the assessee is an individual, any relative of the assessee.
II. where the assessee is a company, firm, association of persons or HUF, any
director of the company, partner of the firm, member of association or family, or
any relative of such director, partner or member.
III. any individual holding substantial interest in assessee’s business, or any relative
of such individual.
IV. a company, firm, AOP or HUF holding substantial interest in the assessee’s
business or any director, partner or member of such co., firm, AOP or HUF or any
relative of such director, partner or member or any other company in which the
first mentioned co. has a substantial interest.
V. a Co, firm, AOP or HUF of which a director, partner or member has a substantial
interest in the business of the assessee.

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2. Cash Payments
Payments or aggregate of payments in respect of expenditure made to a person in a
single day, otherwise than by an account payee cheque, bank draft or use of any
electronic mode, exceeds Rs. 10,000, the same shall not be allowed as deduction.
Please note that any creditor standing in your books is also paid in excess of the
stipulated amount would be liable for disallowance. In case of payment made for
plying, hiring, or leasing goods carriages, the limit is Rs. 35,000.
Exceptions to the rule are
(i) Payment to any bank/RBI/LIC/Agricultural credit society.
(ii) Payment made to govt in legal tender.
(iii) Payment for agricultural purposes.
(iv) Payment to be made in a village or to a person who resides in such village which
is not served by any of the banks.
(v) Payment to cottage industry which is working without power.
(vi) Payment made during a bank holiday or bank strike.
(vii) Money changer can make payments in cash in exchange of foreign currency.
(viii) Payment to agent when agent has to make payment in cash on behalf of the
person.
(ix) Any salary paid to an employee who is:
(a) temporarily posted in a place other than normal place & (b) does not
maintain any bank account at such place.
(x) Any payment made on retirement/retrenchment/ resignation/death of
employee, if such payment does not exceed Rs. 50,000.
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