Expenses Not Deductible under Income Tax Act.

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The following expenses given by Sections 40 40A and 43B are expressly disallowed by the Act while computing income chargeable under the head “Profits and Gains of Business or Profession”.

1. Interest, Royalty, Fees for Technical Services Payable Outside India or Payable to a Non-Resident [Section 40(a)(i)] –

Disallowance of expenditure under section 40(a)(i) –

If TDS default is committed in respect of payment/credit given to a foreign company/non-resident, the expenditure is disallowed in the hands of payer under section 40(a)(i). These provisions are given below –

Case-1 : TDS is Deductible but not Deducted :

100 % of such expenditure is disallowed in the current Year-

  • If tax is deducted in any subsequent year, the expenditure (which is disallowed in the current year) will be deducted in the year in which TDS will be deposited by the assessee with the Government

Case-2 : Tax is deductible (and is so deducted) during the current financial year but it is not deposited on or before the due date of submission of return of income under section 139(1) :

100 % of such expenditure is disallowed in the current year

  • If tax is deposited with the Government after the due date of submission of return of income, the expenditure (which is disallowed in the current year) will be deductible in that year in which tax will be deposited
Note : If the following three conditions are satisfied, the assessee (i.e., the payer) is supposed to deduct tax at source (TDS) under section 195—

1. The amount paid is interest, royalty, fees for technical services or any other sum (not being salary).

2. The aforesaid amount is chargeable to tax in India in the hands of the recipient.

3. The aforesaid amount is paid/payable to a non-resident. If the above three conditions are satisfied, the assessee (the payer) is supposed to deduct tax at source and deposit the same with the Government.
Expenses Not Deductible under Income Tax Act
Expenses Not Deductible under Income Tax Act

2. Disallowance of Expenditure in respect of any Payment / Credit to a Resident [Section 40(a)(ia)]

– If TDS default is committed in respect of the below payment/credit given to a resident, 30 % of such expenditure is disallowed in the hands of payer under section 40(a)(ia). These provisions are given below –

TDS DefaultIs such Expenditure Deductible in the Current Previous YearIs such Expenditure Deductible in any Subsequent Previous Year
Case 1 – TDS is deductible but not deducted.30 % of such expenditure is disallowed in the current yearIf tax is deducted in any subsequent year, the expenditure (which is disallowed in the current year) will be deducted in the year in which TDS will be deposited by the assessee with the Government
Case 2- TDS is deductible (and is so deducted) during the current financial ear but it is not deposited on or before the due date of submission of return of income under section 139(1)30% of such expenditure is disallowed in the current yearIf tax is deposited with the Government after the due date of submission of return of income, the expenditure (which is disallowed in the current year) will be deductible in that year in which tax will be deposited
Note : In respect of the following payments/credit to a resident, tax is deductible under Chapter XVII-B of the Income-tax Act (i.e., Sections 192 to 206AA) SalaryPayment in respect of life insurance policyInterestPayment in respect of deposits under NSSDividendsPayment on account of certain unitsWinnings from lottery or crossword puzzlesRentWinnings from horse racesPayment on purchase of immovable propertyPayments to contractorsTechnical/professional fees, royalty, fees to a part time directorCommission or brokerage (including insurancePayment of compensation on acquisition of immovable commission) property

3. Default pertaining to Non-Deduction / Non-Deposit of Equalisation Levy [Section 40(a)(ib)] –

Any consideration paid or payable (to a non-resident for a specified service on which equalisation levy is applicable) will be disallowed from the assessment year 2017-18 in the following cases—

  1. Equalisation levy is deductible and such levy has not been deducted.
  2. Equalisation levy is deductible (and it is so deducted) but it is not deposited [on or before the due date of submission of return of income under section 139(1)].

If, however, equalisation levy is deducted/deposited in a subsequent year, the aforesaid consideration shall be allowed as a deduction in computing the income of the previous year in which such levy has been paid.

4. Disallowance of Royalty, Licence Fees, etc., in case of State Government Undertakings [Section 40(a)(iib)] –

The following shall not be allowed as deduction from the assessment year 2014-15 –

  1. Any amount paid by way of royalty, licence fee, service fee, privilege fee, service charge or any other fee or charge (by whatever name called), which is levied exclusively on a State Government undertaking by the State Government.
  2. Any amount which is appropriated (directly or indirectly) from a State Government Undertaking by the State Government.
Note : What is State Government Undertaking –

For the above purpose, a State Government undertaking includes the following–
(i) a corporation established by (or under) any Act of the State Government;

(ii) a company in which more than 50 per cent of the paid-up equity share capital is held by the State Government;

(iii) a company in which more than 50 per cent of the paid-up equity share capital is held by the above two entities (whether singly or taken together);

(iv) a company or corporation in which the State Government has the right to appoint the majority of the directors or to control the management or policy decisions, directly or indirectly, including by virtue of its shareholding or management rights or shareholders agreements or voting agreements or in any other manner;

(v) an authority, a board or an institution or a body established or constituted by or under any Act of the State Government or owned or controlled by the State Government.

5. Salary Payable outside India without Tax Deduction [Section 40(a)(iii)] –

Section 40(a)(iii) is applicable if salary is paid outside India or paid to a non-resident and tax has not been paid to the Government nor deducted at source under the Income-tax Act.

6. Tax on Non-Monetary Perquisite paid by the Employer [Section 40(a)(v)] –

The provisions of section 40(a)(v) are given below –

  1. The employer provides non-monetary perquisites to employees.
  2. Tax on non-monetary perquisites is paid by the employer.
  3. The tax so paid by the employer is not taxable in the hands of employees by virtue of section 10(10CC).
  4. While calculating income of the employer, the tax paid by the employer on non-monetary perquisites is not deductible under section 40(a)(v).

7. Amounts Not Deductible in respect of Payment to Relatives [Section 40A(2)]

For an amount to be disallowed under this Section, three conditions have to be fulfilled:

  1. the payment is in respect of any expenditure;
  2. the payment has been made or is to be made to a specified person in respect of such expenditure;
  3. the payment for the expenditure is considered excessive or unreasonable having regard to:
    • The fair market value of the goods, services or facilities; or
    • the legitimate business needs of the assessee’s business or profession; or
    • the benefit derived by or accruing to the assessee from the payment.

If the above conditions are fulfilled, the Assessing Officer can disallow the expenditure to the extent he considers it excessive or unreasonable by the above objective standards or otherwise.

Note : Section 40A(2) is applicable in the following cases (list is not complete, only important cases are given) –

1. Payment made by an individual to his or her relative.

2. Payment made by a company to a director of the company or any relative of the director.

3. Payment made by a firm/AOP/HUF to a partner/member or a relative of partner/member.

4. Payment made to an individual who has a substantial interest in the business of the payer or a relative of such individual.

5. Payment made to a company who has a substantial interest in the business of the payer, any director of such company or relative of such director.

6. Payment made to a firm/AOP/HUF who has a substantial interest in the business of the payer or partner/ member of such person or relative of partner/member.

8. Amounts Not Deductible in respect of Expenditure exceeding Rs. 10,000 [Section 40A(3)] –

The provisions of section 40A(3) are given below —

Disallowance is attracted under section 40A(3) if the following conditions are satisfied —

  1. The assessee incurs any expenditure which is otherwise deductible under the other provisions of the Act for computing business/profession income (e.g., expenditure for purchase of raw material, trading goods, expenditure on salary, etc.). The amount of expenditure exceeds Rs. 10,000 (Rs. 35,000 if an assessee makes payment for Plying, Hiring or Leasing Goods Carriages).
  2. A payment (or aggregate of payments made to a person in a day) in respect of the above expenditure exceeds Rs. 10,000 (Rs. 35,000 if an assessee makes payment for Plying, Hiring or Leasing Goods Carriages).
  3. The above payment is made otherwise than by an account payee cheque or an account payee demand draft or use of electronic clearing system through a bank account. If all the above conditions are satisfied, then 100 % of such payment will be Disallowed.

Exceptions – The above rule i.e. Section 40A(3) is not applicable to a few cases given below –

(A) where the payment is made to— 

(i) the Reserve Bank of India or any banking company; 

(ii) the State Bank of India or any subsidiary bank; 

(iii) any co-operative bank or land mortgage bank; 

(iv) any primary agricultural credit society or any primary credit society; 

(v) the Life Insurance Corporation of India; 

(B) where the payment is made to the Government and, under the rules framed by it, such payment is required to be made in legal tender; 

(C) where the payment is made by— 

(i) any letter of credit arrangements through a bank; 

(ii) a mail or telegraphic transfer through a bank; 

(iii) a book adjustment from any account in a bank to any other account in that or any other bank; 

(iv) a bill of exchange made payable only to a bank;

(v) the use of electronic clearing system through a bank account; 

(vi) a credit card; 

(vii) a debit cards. 

(D) where the payment is made by way of adjustment against the amount of any liability incurred by the payee for any goods supplied or services rendered by the assessee to such payee; 

(E) where the payment is made for the purchase of— 

(i) agricultural or forest produce; or

(ii) the produce of animal husbandry (including livestock, meat, hides and skins) or dairy or poultry farming; or 

(iii) fish or fish products; or

(iv) the products of horticulture or apiculture, to the cultivator, grower or producer of such articles, produce or products; 

(F) where the payment is 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; 

(G) where the payment is 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; 

(H) where any payment is made to an employee of the assessee or the heir of any such employee, on or in  connection with the retirement, retrenchment, resignation, discharge or death of such employee, on  account of gratuity, retrenchment compensation or similar terminal benefit and the aggregate of such  sums payable to the employee or his heir does not exceed fifty thousand rupees; 

(I) where the payment is made by an assessee by way of salary to his employee after deducting the income tax from salary in accordance with the provisions of section 192 of the Act, and when such employee— 

(i) 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 

(ii) does not maintain any account in any bank at such place or ship; 

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

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

(L) where the payment is made by an authorised dealer or a money changer against purchase of foreign currency or travellers’ cheques in the normal course of his business. 

IMPORTANT NOTES 

1. The provisions of the Section do not apply to repayment of loans or payment towards the purchase price of capital assets such as plant and machinery not for resale. 

2. The provisions of section 40A (3) are applicable only in computing income under the heads ‘Profits and Gains of Business or Profession’ and ‘income from other sources’.

9. Disallowance in respect of Provision for Unapproved Gratuity Fund [Section 40A(7)]:

Gratuity is a liability which normally arises according to the length of the service of the employees’ of the assessee. The liability would generally accrue year after year. However, due to practical difficulties in computing the deduction allowable on accrual basis, it has been provided under section 40A(7) that deduction on account of provision for gratuity shall be allowed only when:—

  1. the amount of gratuity has actually become payable during the previous year to the employees’ (provided deduction has not been claimed under clause (b) below); or
  2. when a provision has been made for payment of a sum by way of any contribution towards an approved gratuity fund.

Therefore, no deduction shall be allowed in respect of any provision made for the payment of gratuity to the employees, even though the assessee may be following the mercantile system of accounting, unless it is a provision for the purpose of payment of a sum by way of any contribution towards an approved gratuity fund.

In other words, any provision for unapproved gratuity fund (for meeting future liability) is not deductible.

Important points should be noted—

  1. An employee retires during the current year. The employer does not maintain any gratuity fund. Gratuity is paid to him during the current year. It is deductible during the current year.
  2. An employee retires during the current year. Gratuity is payable to him. A part of the amount is paid during the current year and the balance will be paid in the next year. A provision is made towards gratuity in the books of account of the current year for making payment in the next year. The entire amount is deductible during the current year (if no deduction was claimed earlier). In this case, deduction is available during the current year even if provision is made for gratuity fund, which is unapproved.
  3. A company has 50 employees. To meet future liability to pay them gratuity at the time of retirement, a gratuity fund is created and the employer makes contribution every year. Employers’ contribution to this fund is deductible only if the fund is an approved gratuity fund.

Table showing the Amount Deductible in different Cases : –

CasesDeductible Amount
CASE-1 : X retires from the service of Y Ltd. on May 31, 2018. The company pays gratuity of Rs. 1,60,000, according to the provisions of the Payment of Gratuity Act, 1972. Y Ltd. does not maintain any provision for gratuity account.Where gratuity is paid during the previous year or where gratuity has become payable during the previous year, it is deductible if no deduction has been claimed on the basis of provisions earlier. Consequently, Rs. 1,60,000 is allowed as deduction for the assessment year 2019-20.
CASE-2 : Z Ltd. maintains an approved gratuity fund. A sum of Rs. 1,00,000 being the employer’s contribution towards the gratuity fund, is debited to the profit and loss account for the year ending March 31, 2019.Where any provision is made for the purpose of payment of a sum by way of any contribution towards an approved gratuity fund, it is allowed as deduction. It is assumed that provisions of section 43B are satisfied .

10. Amount Not Deductible in respect of contributions to Non-Statutory Funds [Section 40A(9)] –

Any sum paid by the assessee as an employer by way of contribution towards Recognised Provident Fund, or Approved Superannuation Fund or an Approved Gratuity Fund, is Deductible to the extent it is required by any law.

What is not Deductible –

If the following conditions are satisfied, then contribution or payment is not deductible by section 40A(9) —

  1. The contribution/payment is made by an assessee as an employer.
  2. It is paid towards setting up (or formation of) any trust, company, association of persons, body of individuals, society or it is paid by way of contribution to any fund.
  3. The contribution or payment is not required by any law.

11. Certain Deductions to be Allowed only on Actual Payment Basis [Section 43B]

Section 43B is applicable only if the taxpayer maintains books of account on the basis of mercantile system of accounting. The provisions of section 43B are given below—

Certain Expenses are Deductible on Actual Payment Basis –

The following expenses (which are otherwise deductible under the other provisions of the Income-tax Act) are deductible on payment basis—

  1. any sum payable by way of tax, duty, cess or fee (by whatever name called under any law for the time being in force);
  2. any sum payable by an employer by way of contribution to provident fund or superannuation fund or any other fund for the welfare of employees;
  3. any sum payable as bonus or commission to employees for service rendered;
  4. any sum payable as interest on any loan or borrowing from a public financial institution (i.e., ICICI, IFCI, IDBI, LIC and UTI) or a State financial corporation or a State industrial investment corporation;
  5. interest on any loan or advance taken from a scheduled bank or a co-operative bank other than a primary agricultural credit society or a primary co-operative agricultural and rural development bank;
  6. any sum payable by an employer in lieu of leave at the credit of his employee; and
  7. any sum payable to the Indian Railways for the use of railway assets.

The above expenses are deductible in the year in which payment is actually made. There is, however, one exception given below.

Exception – Certain Expenses are Deductible on Accrual Basis –

If the aforesaid payment is actually made on or before the due date of submission of return of income, deduction can be claimed on Accrual Basis.

  • Due date of submission of return of income in the case of a company (or in the case of a taxpayer whose books of account are required to be audited under any law) is September 30 of the assessment year.
  • In the case of any taxpayer (having international or specified domestic transactions) due date of submission of return of income is November 30 of the assessment year.
  • In all other cases, the due date of submission of return of income is July 31 of the assessment year.

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