A Comprehensive Guide about the Section 40A(3) of Income Tax Act

Section 40A(3) of the Income Tax Act disallows an individual or an entity to claim cash payments exceeding ₹ 10,000 in a day as a deduction. This Section helps to promote digital payment as failure to claim expenses as deductions will lower the savings on tax payments and encourage individuals and business entities to transact in digital mode.

This section restricts deduction of any expenditure exceeding Rs. 10,000/- if made to any single person on the same day. Thereby if  a person wishes to claim deduction of any expenditure then he has to make payment in digitally prescribed mode only.

However, if a person purchases machinery or land, it is not an expenditure. Instead, it comes under the provisions of the Capital Gains of Income Tax Act.

(Source)

If an individual or business completes a transaction in the following payment modes, then they can claim those payments as a deduction:

• Demand draft
• Account payee cheque
• ECS or other digital payment modes

1. Payments made to –

• Reserve Bank of India or other banking institutions recognised under Section 5 clause c of the Banking Regulation Act, 1949
• State Bank of India or its subsidiaries, belonging to the non-banking and banking sector 
• Land mortgage or any cooperative bank 
• Life Insurance Corporation of India 
• Primary Agricultural Credit Society or other primary credit society as identified under Section 56 of the Banking Regulation Act, 1949

2. Payment transferred to the Government through legal tender

3. An assessee transfers payment through-

• Letter of credit arranged via bank 
• Telegraphic or mail transfer through a banking institution 
• Intra-bank or inter-bank transfer of payment
• Bills of exchange payable to a banking institution

4. Payments by adjusting amounts against liability of a payee before assessee for the supply of services or goods

5. A taxpayer pays cultivators or producers for purchasing their following produces or products -

• Forest or agricultural produce
• Produce of poultry farming, animal husbandry, and dairy
• Fish products or fish
• Horticultural or apicultural products

6. An assessee pays a producer for a product manufactured without the help of power in a cottage industry.

7. Payment is transferred within a town or a village to a resident or professional operating a business or other vocations. Note that no banks are operational on the day when such payment is made.

8. An assessee who makes a payment in the form of gratuity or other terminal benefits to his employee or heir should not exceed ₹ 50,000 when such payments are related to resignation, retirement, death, or discharge of that employee

9. An assessee transfer salary to his employee after removing income tax from salary according to Section 192, and he or she can claim those payments as a deduction when that employee-

• Is posted for 15 consecutive days temporarily in a ship or other than his or normal working place
• Does not hold a bank account at a ship or any such place

10. An individual makes a payment to his or her agent. The agent will transfer the cash payment in exchange for receiving goods or services on his or her behalf.

11. Money changer or authorised dealer makes a payment for purchasing traveller cheques or foreign currency as a normal business course.