2006 (10) TMI 454 - HC - Income Tax

Payments to associate concerns - reimbursement of day-to-day expenses - cash payments exceeding 10, 000 - Interpretation of the r. 6DD(j) - whether cash payments made by the assessee to the associate concerns would attract s. 40A(3)? - HELD THAT - In our considered opinion even though s. 40A(3) of the Act is not absolute payments made in cash cannot automatically be allowed merely for the reason that the payments were made to associate concerns and such reason that weighed the CIT(A) is not only illogical but also outside the scope of s. 40A(3) of the Act. If such reason is accepted the transactions which frustrate s. 40A(3) would pave way for evading tax which is contrary to the object of s. 40A(3). The cumulative effect of Circular of CBDT dt. 31st May 1977 r. 6DD(j) and s. 40A(3) is that the assessee should satisfy that there were exceptional and unavoidable circumstances of transactions in which payments were made in cash and that payment by way of crossed cheque or crossed bank draft was not practicable or the same would have caused genuine difficulty to the payee having regard to the nature of the transaction or there was necessity for expeditious settlement. In addition to that the assessee should also furnish evidence to the satisfaction of the AO as to the genuineness of payments as well as the identity of payee. We fail to see that the assessee has satisfactorily explained the exceptional and unavoidable circumstances warranting the payment by cash; the payments by way of crossed cheque or crossed bank draft was not practicable; such payments would have caused genuine difficulties to the payee; and there was necessity for expeditious settlement. Even though it is found that the assessee made cash payments for day-to-day affairs of associate concerns the reason given by the CIT(A) for deleting 20 per cent disallowance that the payments were made to associate concerns and hence they were allowable cannot be a justifiable reason as it is outside the scope of s. 40A(3) of the Act. We are satisfied that the deletion of disallowance of 20 per cent the total amount frustrates s. 40A(3) of the Act. In the result we answer the questions of law referred to above in favour of the Revenue and against the assessee. The appeal stands allowed. No costs.

Summary

Issues Involved:
1. Applicability of Section 40A(3) of the Income Tax Act, 1961 to the reimbursement of day-to-day expenses made to associate concerns.
2. Conditions under Section 40A(3) regarding payments by crossed cheque or demand draft and their applicability to payments made to associate concerns.

Detailed Analysis:

Issue 1: Applicability of Section 40A(3) to Reimbursement of Day-to-Day Expenses
The core issue was whether the amounts paid to associate concerns as reimbursement of day-to-day expenses would be subject to disallowance under Section 40A(3) of the Income Tax Act, 1961. The respondent/assessee, a partnership firm engaged in the export of garments and textiles, made substantial cash payments exceeding Rs. 10,000 to an associate concern, ARJ Textiles (P) Ltd., for machining charges. The Assessing Officer (AO) disallowed 20% of the total cash payments, amounting to Rs. 5,52,220, under Section 40A(3), as these payments were not made by crossed cheque or demand draft. The CIT(A) deleted this disallowance, reasoning that the payments were reimbursements and hence Section 40A(3) was not applicable. The Tribunal upheld the CIT(A)'s decision, which led to the Revenue's appeal.

Issue 2: Conditions Under Section 40A(3) Regarding Payments by Crossed Cheque or Demand Draft
Section 40A(3) stipulates that any expenditure exceeding Rs. 10,000 (later increased to Rs. 20,000) should be paid by crossed cheque or demand draft to be allowed as a deduction. The rule aims to prevent tax evasion by ensuring payments are made from disclosed sources. Rule 6DD(j) provides exceptions where payment by crossed cheque or draft is not practicable due to exceptional or unavoidable circumstances, and the assessee must furnish evidence of the genuineness of the payment and the identity of the payee.

Judgment Analysis:
The High Court examined whether the payments made by the assessee to associate concerns in cash could be exempted under Rule 6DD(j). The court noted that the AO disallowed the payments on the grounds that they were made in cash and did not meet the conditions of Section 40A(3). The CIT(A) and the Tribunal, however, accepted the assessee's argument that the payments were reimbursements and thus outside the scope of Section 40A(3).

The court referred to various judgments to emphasize that the object of Section 40A(3) is to check tax evasion and ensure payments are made from disclosed sources. Genuine and bona fide transactions could be exempted if the assessee proves that payment by crossed cheque or draft was impracticable or would cause genuine difficulty to the payee. The court found that the CIT(A)'s reason for deleting the disallowance was illogical and outside the scope of Section 40A(3), as it would pave the way for tax evasion.

The court concluded that the assessee failed to satisfactorily explain the exceptional and unavoidable circumstances warranting cash payments, and the deletion of the 20% disallowance by the CIT(A) frustrated the object of Section 40A(3). Therefore, the court ruled in favor of the Revenue, allowing the appeal and reinstating the disallowance.

Conclusion:
The High Court held that the payments made by the assessee to associate concerns in cash were subject to disallowance under Section 40A(3), as the assessee did not satisfactorily prove exceptional circumstances or genuine difficulty in making payments by crossed cheque or draft. The appeal was allowed, and the disallowance reinstated.