Will purchase of asset come under 40A(3)

The CBDT in Circular : No 34 [F. No. 13A/92/69-IT(A-II)], dated 5-3-1970 has clarified in para 2 as under:

 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.

The Delhi Bench of ITAT in Kanshi Ram Madan Lal Vs. ITO (3 ITD 290 dated 29-09-1982) after referring to the following speech of the Finance Minister while introducing the provision in Finance Bill 1968:

Tax liability is sometimes artificially reduced by diverting profits to relatives and associate concerns in the form of excessive payments for goods and services. Claims are also made for deduction of expenses in large amounts shown to have been paid in cash, often with a view to frustrating investigation as to the identity of the recipients and the genuineness of the claim. To plug these loopholes I propose to provide that payments made in business and professions to relatives or associate concerns will have to pass the test of reasonableness in order to qualify for deduction. Further, I propose to provide that payments made in amounts exceeding Rs. 2,500 after a date to be notified later, will be allowed as a deduction only if these are made by crossed cheques or by crossed bank drafts.

The Tribunal then held as follows:

I think the above passage brings out the drift of Section 40A. The Finance Minister mentioned in the context 'deduction of expenses' as also 'excessive payments for goods and services'. Quite obviously general thrust of the provision is towards preventing artificial reduction by diversion of profits to relatives and associate concerns through payments ostensibly for goods, services or facilities. It is in this context that Section 40A(3) has also been enacted. I find it difficult to tear out Section 40A(3) from its legislative matrix and give a special status to it so as to bring within its ambit (at arm's length) capital expenditure also. I would, therefore, hold that there is no case for the impugned disallowance.

Regards

CA.M.K.Krishnan

Vellore

Tamilnadu