2017 (4) TMI 458 - HC - Income Tax

Disallowance under Section 40A(3) - AO opined that banker s cheques were not covered in any of the provisions of Rule 6DD of the Income Tax Rules as they were the account payee demand drafts under Section 40A(3)- cancellation of disallowance by ITAT - Held that - This Court is of the opinion that the literal construction of Section 40A(3) sought to be canvassed by the Revenue is narrow and contrary to the provisions of the Negotiable Instruments Act, 1881, especially Section 5 thereof. See Punjab & Sind Bank Vs. Vinkar Sahakari Bank Ltd. & Ors. 2001 (9) TMI 993 - SUPREME COURT OF INDIA held once the holder, which in this case is the complainant Bank, has elected to treat the instrument as a cheque it cannot but be treated as a cheque thereafter. This is an irretrievable corollary of exercising such an election by the holder himself. A complaint is maintainable under Section 142 in the event a banker s cheque is dishonoured. This Court also notices that the expression used in the Income Tax itself is a bill of exchange , which is a class of instruments, that cannot be ignored or disallowed by virtue of Section 40A(3) read with Rules 6 DD of the Income Tax Rules. No substantial question of law arises.

Summary

Issues:
1. Interpretation of Section 40A(3) of the Income Tax Act, 1960 regarding disallowance of expenses.
2. Validity of payments made through banker's cheques/pay orders.
3. Application of Negotiable Instruments Act, 1881 in determining the nature of banker's cheques.
4. Reference to Section 85-A and Section 131A of the Act in relation to drafts and cheques.
5. Holder's election to treat an instrument as either a promissory note or bill of exchange.
6. Legal status of banker's drafts under the Bills of Exchange Act, 1882.
7. Maintainability of complaint under Section 142 for dishonoured banker's cheques.
8. Classification of "a bill of exchange" under Section 40A(3) of the Income Tax Act.

Analysis:
1. The High Court examined the appeal under Section 260A of the Income Tax Act, 1960, focusing on the cancellation of disallowance under Section 40A(3). The court found the literal construction of Section 40A(3) by the Revenue to be narrow and contrary to the provisions of the Negotiable Instruments Act, especially Section 5.
2. The court considered the expenses claimed by the assessee for Assessment Years 2007-08, specifically payments made to suppliers through banker's cheques. The Assessing Officer contended that banker's cheques did not fall under Rule 6DD of the Income Tax Rules, leading to the disallowance under Section 40A(3).
3. By referencing the Supreme Court's decision in Punjab & Sind Bank Vs. Vinkar Sahakari Bank Ltd. & Ors., the High Court highlighted the importance of the structure and nature of banker's cheques in relation to bills of exchange and promissory notes.
4. The court further analyzed Section 85-A and Section 131A of the Act, emphasizing the negotiable nature of drafts drawn by one branch of a bank on another branch, and the applicability of crossing provisions to drafts.
5. It was noted that under Section 17 of the Act, the holder has the discretion to treat an instrument as either a promissory note or bill of exchange, with the election being irreversible once made.
6. The judgment referred to the House of Lords' decision regarding banker's drafts under the Bills of Exchange Act, clarifying the distinction between bills of exchange and promissory notes.
7. The court affirmed the maintainability of complaints under Section 142 for dishonoured banker's cheques, reinforcing the legal status of such instruments.
8. Ultimately, the court dismissed the appeal, concluding that no substantial question of law arose, and emphasizing the classification of "a bill of exchange" as a class of instruments under Section 40A(3) of the Income Tax Act.