Disallowance from Business/Profession income a Practical Approach

Sections 40, 40A and 43B provide the list of expenses which are specifically disallowed while computing income chargeable to tax under the head “Profits and gains of business or profession”. In this advance learning we will learn about various expenses which are specifically disallowed while computing income chargeable under head “Profits and gains of business or profession”. The detailed provisions in this regard are as follows:

Amount not deductible under section 40(a):

Disallowance due to default in deduction of tax at source (TDS) in respect of certain payments made outside India/ in India to a non-resident [Section 40(a)(i)]

next year]. However, if tax is deposited in next year(s) after the due date of deposit, then such amount is deductible in the subsequent previous year in which the said tax is deposited by the assessee with Government.

Illustration

Mr. Soham has paid fees for technical services of Rs. 84,000 to Mr. Shan, a non-resident,in India during the previous year 2012–13. However, such fees of Rs. 84,000 are not deductible as business expenditure during the previous year 2012–13 if tax has not been deducted at source from such fees or after deducting such tax, it has not been deposited with the Government before the end of the previous year 2012–13 or before the due date of deposit specified under section 200(1) in case due date of deposit falls in the next year (i.e., in the previous year 2013–14).

Disallowance due to default in deduction of tax at source (TDS) in respect of certain other payments made to a resident [Section 40(a)(ia)]

Any interest (liable to TDS under sections 193 and 194A), payment to contractors/subcontractors (liable to TDS under section 194C), commission or brokerage (liable to TDS under section 194H), rent (liable to TDS under section 194‑I) and fees for technical/professional services or royalty (liable to TDS under section 194J), paid/payable to a resident, is not

deductible while computing income chargeable to tax under the head “Profits and gains of business or profession” if:

Tax is deductible at source but is not deducted.
With effect from assessment year 2010-11, if tax is deducted during the previous year, and the same has not been paid on or before the due date of filing of return of income specified section 139(1).

In other words, if tax is deducted during the previous year and the same is paid on or before the due date of filing the return as specified in section 139(1), then the concerned expenditure will be allowed as deduction in the previous year in which such expenditure is incurred.

However, if in respect of any such sum, tax has been deducted in any subsequent year, or has been deducted during the previous year but has been paid after the due date specified in section 139(1), such expenditure shall be allowed as a deduction in computing the income of previous year in which such tax (TDS) has been paid to Government.

Illustration

Mr. Raja is running a garment factory (turnover during the preceding year was Rs. 2,52,00,000).

In December, 2012, he paid commission of Rs. 84,000. The entire commission was liable to TDS. Consider the following situations:

(1) He deducted tax (TDS) on commission in December, 2012 and deposited the TDS with the Government on 31–3‑2013. In this situation, such commission is deductible during the previous year 2012–13.

(2) He deducted tax (TDS) on commission in December, 2012 and deposited the TDS with the Government on 1-10-2013. In this situation, such commission is deductible during the previous year 2013–14 (since TDS is deducted during the previous year 2012–13, but paid after the due date of filing the return of previous year 2012–13).

Disallowance of certain taxes

By virtue of section 40(a)(ib)/(ic)/(ii)/(iia) following are not deductible:

 Fringe benefit tax (however FBT has been abolished from assessment year 2010-11).

 Income-tax (including interest, fine, penalty, etc.) whether payable in India or outside India Wealth tax levied under the Wealth-tax Act, 1957 or similar tax chargeable under any law outside India.

Up to assessment year 2008-09, securities transaction tax (STT) was not allowed as deduction (however, relief under section 88E was available). From assessment year 2009-10, STT is allowed as deduction under section 36(1)(xv) (thus, relief under section 88E is no more available).

Illustration

Mr. Sipahi has paid income-tax of Rs. 84,252 for the previous year 2012–13, on 15–7‑2013. In this situation, he cannot deduct the income-tax paid as business expenditure while computing business income for the previous year 2012–13 or in any subsequent year.

Disallowance due to default in deduction/payment of tax at source (TDS) on salary payable outside India/in India to a non-resident [Section 40(a)(iii)]

Any payment which is chargeable to tax under the head “Salaries” and which is payable outside India to any person or in India to a non-resident is not deductible, if tax on such salary has not been paid to the Government nor has been deducted at source.

Illustration

Mr. Soham has paid salary of Rs. 84,000 to Mr. Shan, a non-resident, in India. However, from such salary neither the tax is deducted at source nor the tax is deposited with the Government by Mr. Soham. Hence, he cannot deduct such salary of Rs. 84,000 paid as business expenditure while computing the business income.

Disallowance due to default in deduction of tax at source (TDS) on payments from provident fund, etc. [Section 40(a)(iv)]

Any payment to a provident fund or other fund established for the benefit of the employees of the assessee is not deductible, if the assessee has not made effective arrangement for securing deduction of tax (TDS) from any payment made from the fund which is chargeable to tax under the head “Salaries”.

Illustration

Essem Ltd. made contribution of Rs. 1,84,252 to the recognized provident fund. However, it cannot deduct such contribution of Rs. 1,84,252 while computing the business income if it has not deducted tax at source from any payment made from such provident fund which is chargeable to tax under the head “Salaries”.

Disallowance of tax on non-monetary perquisites [Section 40(a)(v)]

By virtue of section 40(a)(v), tax on non-monetary perquisites [referred to in section 10(10CC)], paid by the employer is not deductible.

Illustration:

Essem Ltd. pays Rs. 40,000 per month as salary to Mr. Kapoor and also provides him a rent-free unfurnished house (lease rent being Rs. 10,000 per month). The tax on such perquisite of Rs. 5,428 is paid by Essem Ltd. Such tax of Rs. 5,428 is not chargeable to tax in the hands of Mr. Kapoor. Hence, while computing business income of Essem Ltd., the tax of Rs. 5,428 paid by it on such non-monetary perquisite, is not deductible by virtue of section 40(a)(v).

Amount not deductible under section 40A:

Disallowance in case of payment made to relatives [Section 40A(2)]

Payment in respect of any expenditure made to any of the following persons will be disallowed till such payment is in excess (or unreasonable) of the fair market value of such expenditure.

The persons referred to in this section include following:

(i) In case of an individual, any relative of such individual;

(ii) In case of a company, firm, association of persons or Hindu Undivided Family, any director of the company, partner of the firm, or member of the association or family, or any relative of such director, partner or member;

(iii) Any individual who has a substantial interest in the business or profession of the assessee, or any relative of such an individual;

(iv) A company, firm, association of persons or Hindu Undivided Family having a substantial interest in the business or profession of the assessee or any director, partner or member of such company, firm, association or family, or any relative of such director, partner or member;

(v) A company, firm, association of persons or Hindu Undivided Family of which a director, partner or member, as the case may be, has a substantial interest in the business or profession of the assessee, or any relative of such director, partner or member;

(vi) Any person in whose business the assessee, or his relative has a substantial interest; or

(vii) Any person in whose business the assessee, being a company, firm, association of persons or Hindu Undivided Family, or any director of such company, partner of such firm or member of the association or family, or any relative of such director, partner or member, has a substantial interest.

SUBSTANTIAL INTEREST : Substantial interest holder refers to any person beneficially holding 20% or more of the equity capital (in case of a company) and 20% or more of share in profit (in any other case), at any time during the previous year.

Illustration

SM Ltd. purchased goods worth Rs. 2,52,000 from one of its directors; however, the market value of such goods is Rs. 2,00,000. In this situation, Rs. 52,000 (being unreasonable) will be disallowed under section 40A(2).

Disallowance in case of payment made by cash, etc. [Section 40A(3)]

Any expenditure exceeding Rs. 20,000, which is otherwise deductible under any provision of the Act, is disallowed (in full), if the payment of such expenditure is made otherwise than by an account-payee cheque or an account-payee demand draft (i.e., by cash or bearer cheque or crossed cheque or bearer demand draft).

However, with effect from 1-10-2009, the aforesaid limit of Rs. 20,000 has been enhanced to Rs. 35,000 in case of payment made for plying, hiring or leasing of goods carriages.

Rule 6DD provides exception to above provision. In other words, in the circumstances specified in rule 6DD nothing will be disallowed even if the payment exceeds aforesaid limit. These exceptions are:

(a) Payment made to the Reserve Bank of India or any banking company or the State Bank of India or any subsidiary bank or any co-operative bank or land mortgage bank or any primary agricultural credit society or any primary credit society; the Life Insurance Corporation of India or to the Government, under the rules framed by it where such payment is required to be made in legal tender;

(b) Payment made by any letter of credit arrangements through a bank or a mail or telegraphic transfer through a bank or a book adjustment in any account in a bank to any other account in that or any other bank or a bill of exchange made payable only to a bank or the use of electronic clearing system through a bank account, credit card and a debit card.

(d) Payment made for the purchase of agricultural or forest produce or the produce of animal husbandry (including livestock, meat, hides and skins) or dairy or poultry farming or fish or fish products or the products of horticulture or apiculture, to the cultivator, grower or producer of such articles or products;

(e) Payment made for the purchase of the products manufactured or processed, without the aid of power in a cottage industry to the producer of such products;

(f) Payment made in a village or town, which on the date of such payment is not served by any bank, to any person who ordinarily resides, or is carrying on any business, profession or vocation in any such village or town (payment made to aforesaid person at a village having bank is not covered by this exception (for details see Press Note, dated 8–5‑1969);

(g) Payment made to an employee or the heirs of such employee, towards terminal benefit and the aggregate of such payment does not exceed Rs. 50,000;

(h) Payment made to employee after deducting the required income-tax (TDS) from such salary, when such employee is temporarily posted for a continuous period of fifteen days or more in a place other than his normal place of duty or on a ship and does not maintain any account in any bank at such place or ship.

(i) Where the payment was required to be made on a day on which the banks were closed either on account of holiday or strike;

(j) Payment made by any person to his agent who is required to make payment in cash for goods or services on behalf of such person;

(k) Payment made by an authorised dealer or a money changer against purchase of foreign currency or travellers cheques in the normal course of his business (i.e., a person authorised as an authorised dealer or a money changer to deal in foreign currency or in foreign exchange under any law for the time being in force).

Following additional provisions should be kept in mind in this regard:

If any expenditure is covered by section 40A(2) as well as section 40A(3), then disallowance under section 40A(3) will be of the excess amount, i.e., the balance amount of expenditure remaining after giving effect to disallowance under section 40A(2).
With effect from 1–4‑2008, if any expense has been allowed as deduction in any earlier year(s) and payment of such expense is made (in excess of Rs. 20,000) in previous year 2008-09 or any subsequent year, otherwise than by an account-payee cheque or account payee bank draft, then such expenses will be disallowed in full.

Illustration

Essem Ltd. purchased goods on credit from A Ltd. on June 20, 2012 for Rs. 19,000 and on June 25, 2012 for Rs. 12,000. The total payment of Rs. 31,000 was made by crossed cheque on August 12, 2012. In this case, though the total amount of payment exceeds Rs. 20,000, nothing shall be disallowed since the individual amount of bill does not exceed Rs. 20,000. To attract disallowance, the amount of bill as well as the amount of payment should be more than Rs. 20,000.

Disallowance in case of certain unpaid liabilities [Section 43B]

Following expenses claimed by the assessee are deductible, only if they are actually paid by the assessee on or before the due date of furnishing the return of income (irrespective of method of accounting followed by the assessee):

(a) Any tax, duty, cess or fee, by whatever name called, under any law.

(b) Any sum payable by the assessee as an employer by way of contribution to any fund for the welfare of employees.

(d) Any sum payable by the assessee as interest on any loan or borrowing from any public financial institution or a State financial corporation or a State industrial investment corporation.

(e) Any sum payable by the assessee as interest on any loan or advance from a scheduled bank (including a co-operative bank).

(f) Any sum payable by the assessee as an employer in lieu of any leave at the credit of his employee (i.e., leave salary).

Any payment which is disallowed under this section is deductible in the year of payment. In other words, if any of the above sum is paid after the due date of furnishing the return of the previous year, then such expenditure is allowed as deduction for the year in which such sum is paid.

Illustration

Outstanding sales tax liability of the previous year 2012–13 is deductible in previous year 2012- 13, if it is paid on or before the due date of furnishing the return of income of previous year. However, if the said amount is paid after the due date of furnishing the return of income, then such sum will be deducted in the previous year in which it is paid.

Exceptions: If the following conditions are satisfied then the above expenses are deductible on

accrual basis :

Payment in respect of the aforesaid expenses is actually made on or before the due date of submission of return of income.
The evidence of such payment is submitted along with the return of income.

If the above two conditions are satisfied and if the assessee maintains books of account on mercantile basis, then the expenditure is deductible on accrual basis in the year in which the liability is incurred.

FAQs

What are the provisions relating to disallowance under section 40(a)?

Following is the list of disallowances under section 40(a):

Disallowance due to default in deduction of tax at source (TDS) in respect of certain payments made outside India/ in India to a non-resident [Section 40(a)(i)]

Any interest, royalty, fees for technical services or other sum (which is chargeable to tax under the Act) which is payable outside India to any person or in India to a non-resident, is not deductible, if the assessee has not deducted tax at source from such payments, or after deducting tax, he has not deposited such tax with the Government before the end of previous year [or before the due date of deposit specified under section 200(1) in case due date of deposit falls in next year]. However, if tax is deposited in next year(s) after the due date of deposit, then such amount is deductible in the subsequent previous year in which the said tax is deposited by the assessee with Government.

Illustration

Mr. Soham has paid fees for technical services of Rs. 84,000 to Mr. Shan, a non-resident, in India during the previous year 2012–13. However, such fees of Rs. 84,000 are not deductible as business expenditure during the previous year 2012–13 if tax is not deducted at source from such fees or after deducting such tax, it is not deposited with the Government before the end of the previous year 2012–13 or before the due date of deposit specified under section 200(1) in case due date of deposit falls in the next year (i.e., in the previous year 2013–14).

Disallowance due to default in deduction of tax at source (TDS) in respect of certain other payments made to a resident [Section 40(a)(ia)]

Tax is deductible at source but is not deducted;
With effect from the assessment year 2010-11, if tax is deducted during the previous year, and the same is not paid on or before the due date of filing of return of income specified section 139(1).

In other words, if tax is deducted during the previous year and the same is paid on or before the due date of filing the return as specified in section 139(1), then the expenditure will be allowed as deduction in the previous year in which such expenditure is incurred.

However, if in respect of any such sum tax has been deducted in any subsequent year, or has been deducted during the previous year but has been paid after the due date specified in section 139(1), then such expenditure shall be allowed as a deduction in computing the income of previous year in which such tax (TDS) has been paid to Government.

Illustration

Mr. Raja is running a garment factory (turnover during the preceding year was Rs. 2,52,00,000). In December, 2012, he paid commission of Rs. 84,000. The entire commission was liable to TDS. Consider the following situations:

(1) He deducted tax (TDS) on commission in December, 2012 and deposited the TDS with the Government on 31–3‑2013. In this situation such commission is deductible during the previous year 2012–13.

(2) He deducted tax (TDS) on commission in December, 2012 and deposited the TDS with the Government on 1-10-2013. In this situation commission is deductible during the previous year 2013–14 (since TDS has been deducted during the previous year 2012–13, but has been paid after the due date of filing the return of previous year 2012–13).

What taxes are disallowed while computing income chargeable to tax under the head “Profits and gains of business or profession”?

Following taxes are disallowed while computing income chargeable to tax under the head “Profits and gains of business or profession”

By virtue of section 40(a)(ib)/(ic)/(ii)/(iia) following are not deductible:

Fringe benefit tax (however, FBT is abolished from assessment year 2010-11).
Income-tax (including interest, fine, penalty, etc.) whether payable in India or outside India
Wealth tax levied under Wealth-tax Act, 1957 or similar tax chargeable under any law outside India.

Illustration

Mr. Sipahi has paid income-tax of Rs. 84,252 payable for the previous year 2012–13, on 15–7- 2013. In this situation, he cannot deduct the income-tax paid as business expenditure while computing business income for the previous year 2012–13 or in any subsequent year.

What are the provisions relating to disallowance due to default in deduction/payment of tax at source (TDS) on salary payable outside India/in India to a non-resident?

Following are the provisions relating to disallowance due to default in deduction/payment of tax at source (TDS) on salary payable outside India/in India to a non-resident:

Any payment which is chargeable to tax under the head “Salaries” which is payable outside India to any person or in India to a non-resident is not deductible, if tax on such salary has not been paid to the Government nor deducted at source.

Illustration

Mr. Soham has paid salary of Rs. 84,000 to Mr. Shan, a non-resident, in India. However, from such salary neither the tax is deducted at source nor is the tax deposited with the Government by Mr. Soham. Hence, he cannot deduct such salary of Rs. 84,000 paid as business expenditure while computing the business income.

What are the provisions relating to disallowance due to default in deduction of tax at source (TDS) on payments from provident fund?

Following are the provisions relating to disallowance due to default in deduction of tax at source

(TDS) on payments from provident fund :

Illustration

What are the provisions relating to disallowance of tax on non-monetary perquisites?

Following are the provisions relating to disallowance of tax on non-monetary perquisites:

By virtue of section 40(a)(v), tax on non-monetary perquisites [referred to in section 10(10CC)], paid by the employer is not deductible.

Illustration

What are the provisions relating to disallowance under section 40A?

Following are the provisions relating to disallowance under section 40A:

Payment in respect of any expenditure made to any of the following persons will be disallowed till the extent such payment is in excess (or unreasonable) of the fair market value of such expenditure.

The persons referred to in this section include following:

(i) In case of an individual, any relative of such an individual;

(iii) Any individual who has a substantial interest in the business or profession of the assessee, or any relative of such an individual;

(v) A company, firm, association of persons or Hindu Undivided Family of which a director, partner or member, as the case may be, has a substantial interest in the business or profession of the assessee or any relative of such director, partner or member;

(vi) Any person in whose business the assessee or his relative has a substantial interest; or

SUBSTANTIAL INTEREST : Substantial interest holder refers to any person beneficially holding 20% or more of the equity capital (in case of a company) and 20% or more of share in profit (in any other case), at any time during the previous year.

Illustration

SM Ltd. purchased goods worth Rs. 2,52,000 from one of its directors. However, the market value of such goods is Rs. 2,00,000. In this situation, Rs. 52,000 (being unreasonable) will be disallowed under section 40A(2).

What are the provisions relating to disallowance in case of payment made by cash, etc.?

Following are the provisions relating to disallowance in case of payment made by cash, etc.:

Any expenditure exceeding Rs. 20,000, which is otherwise deductible under any provision of the Act, is disallowed (in full), if the payment of such an expenditure is made otherwise than by an account-payee cheque or an account-payee demand draft (i.e., by cash or bearer cheque or crossed cheque or bearer demand draft).

However, with effect from 1-10-2009, the aforesaid limit of Rs. 20,000 has been enhanced to Rs. 35,000 in case of payment made for plying, hiring or leasing of goods carriages.

Rule 6DD provides exception to above provision. In other words, in the circumstances specified in rule 6DD, nothing will be disallowed even if the payment exceeds aforesaid limit. These exceptions are as follows:

(a) Payment made to the Reserve Bank of India or any banking company or the State Bank of India or any subsidiary bank or any co-operative bank or land mortgage bank or any primary agricultural credit society or any primary credit society; the Life Insurance Corporation of India or to the Government under the rules framed by it, where such payment is required to be made in legal tender;

(b) Payment made by any letter of credit arrangements through a bank or a mail or telegraphic transfer through a bank or a book adjustment from any account in a bank to any other account in that or any other bank or a bill of exchange made payable only to a bank or the use of electronic clearing system through a bank account, credit card and a debit card.

(d) Payment made for the purchase of agricultural or forest produce or the produce of animal husbandry (including livestock, meat, hides and skins) or dairy or poultry farming or fish or fish products or the products of horticulture or apiculture to the cultivator, grower or producer of such articles or products;

(e) Payment made for the purchase of the products manufactured or processed, without the aid of power in a cottage industry, to the producer of such products;

(f) Payment made in a village or town, which on the date of such payment is not served by any bank, to any person who ordinarily resides or is carrying on any business, profession or vocation, in any such village or town (payment made to aforesaid person at a village having bank is not covered by this exception (for details see Press Note, dated 8–5‑1969);

(g) Payment made to an employee or the heirs of such employee towards terminal benefit and the aggregate of such payment does not exceed Rs. 50,000;

(h) Payment made to employee after deducting income-tax (TDS) from such salary, when such employee is temporarily posted for a continuous period of fifteen days or more in a place other than his normal place of duty or on a ship and does not maintain any account in any bank at such place or ship.

(i) Where the payment was required to be made on a day on which the banks were closed either on account of holiday or strike;

(j) Payment made by any person to his agent who is required to make payment in cash for goods or services on behalf of such person;

(k) Payment made by an authorised dealer or a money changer against purchase of foreign currency or travellers cheques in the normal course of his business (i.e., a person authorised as an authorised dealer or a money changer to deal in foreign currency or foreign exchange under any law for the time being in force).

Following additional provisions should be kept in mind in this regard:

If any expenditure is covered by section 40A(2) as well as section 40A(3), then disallowance under section 40A(3) will be of the excess amount, i.e., the balance amount of expenditure remaining after giving effect to disallowance under section 40A(2).
With effect from 1–4‑2008, if any expense has been allowed as deduction in any earlier year(s) and payment of such expense is made (in excess of Rs. 20,000) in previous year 2008-09 or any subsequent year, otherwise than by an account-payee cheque or account payee bank draft, then such expenses will be disallowed in full.

Illustration

Essem Ltd. purchased goods on credit from A Ltd. on June 20, 2012 for Rs. 19,000 and on June 25, 2012 for Rs. 12,000. The total payment of Rs. 31,000 is made by crossed cheque on August 12, 2012. In this case, though the total amount of payment exceeds Rs. 20,000, yet nothing shall be disallowed since the individual amount of bill does not exceed Rs. 20,000. To attract disallowance the amount of bill as well as the amount of payment should be more than Rs. 20,000.

What are the provisions relating to disallowance in case of certain unpaid liabilities?

Following are the provisions relating to disallowance in case of certain unpaid liabilities:

(a) Any tax, duty, cess or fee, by whatever name called, under any law.

(b) Any sum payable by the assessee as an employer by way of contribution to any fund for the welfare of employees.

(d) Any sum payable by the assessee as interest on any loan or borrowing from any public financial institution or a State financial corporation or a State industrial investment corporation.

(e) Any sum payable by the assessee as interest on any loan or advances from a scheduled bank (including a co-operative bank).

(f) Any sum payable by the assessee as an employer in lieu of any leave at the credit of his employee (i.e., leave salary).

Any payment which is disallowed under this section is deductible in the year of payment. In other words, if any of the above sums is paid after the due date of furnishing the return of the previous year, then such expenditure is allowed as deduction for the year in which such sum is paid.

Illustration

Outstanding sales tax liability of the previous year 2012–13 is deductible in previous year 2012- 13, if it is paid on or before the due date of furnishing the return of income of previous year.

However, if the said amount is paid after the due date of furnishing the return of income, then such sum will be deducted in the previous year in which it is paid.

Exceptions: If the following conditions are satisfied then the above expenses are deductible on accrual basis:

Payment in respect of the aforesaid expenses is actually made on or before the due date of submission of return of income;
The evidence of such payment is submitted along with the return of income.

If the above two conditions are satisfied and if the assessee maintains books of account on mercantile basis then the expenditure is deductible on accrual basis in the year in which the liability is incurred.

Disallowance from Business/Profession income a Practical Approach

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