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Research and Analysis on reporting of certain transactions in as envisaged

Section 40A(2) of Income Tax Act, 1961 deals with payments to relatives and associated persons….

Research and Analysis on reporting of certain transactions in as envisaged u/s 40A(2)(b) of the Income Tax Act, 1961.

Section 40A(2) of Income Tax Act, 1961 deals with payments to relatives and associated persons. It provides that where the assessee incurs any expenditure in respect of which payment is to be made to a specified person and the Assessing Officer is of the opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods, services or facilities for which the payment is made or legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to him therefrom, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as deduction.

The question under consideration is whether the transaction of loans, advances or similar nature which are not deductible from Income of the assessee   will be reported under Section 40A(2)(b) of the Act, Clause-23 of Tax Audit Report?

Hence to understand it one needs to refer the different provisions of Income Tax Act, 1961 which is stated below in this study.

Query:

Our advice has been sought under Income Tax Act 1961 on the  below query:

  • Whether the Transactions mentioned above will be reported under Section 40A(2)(b), Clause 23 of Tax Audit report?

Analysis and Facts:

In order to further analyze the query, it is imperative to quote the relevant provisions of law under Income Tax Act, 1961 at this juncture-

Particulars of payments made to persons specified under section 40A(2)(b). [Clause 23]

40.1 Section 40(A)(2) provides that expenditure for which payment has been or is to be made to certain specified persons listed in the section may be disallowed if, in the opinion of the Assessing Officer, such expenditure is excessive or unreasonable having regard to:

  1. the fair market value of the goods, services or facilities for which the payment is made; or
  2. for the legitimate needs of business or profession of the assessee; or
  3. the benefit derived by or accruing to the assessee from such expenditure.

40.2 The section enjoins on the Assessing Officer the power to fix the quantum of Under this clause, the particulars of payments coming under this sub-section are to be stated. The following steps may be taken by the tax auditor in this connection:

  1. Obtain full list of specified persons as contemplated in this
  2. Obtain details of expenditure/payments made to the specified persons.
  3. Scrutinize all items of expenditure/payments to the above
  4. It may be difficult to locate all such payments and it may also involve a time consuming effort. It is, however, possible to localize the area of enquiry by ascertaining the following:
  1. Call for all contracts or agreements entered into by the assessee and list out the contracts or agreements entered into with the specified persons and segregate the items of payments made to them under these
  2. In case of payments for purchases and expenses on credit basis, the appropriate ledger accounts can be scrutinized to identify the dealings with the specified persons.
  3. In case of cash purchases and expenses, the purchase or expense account should be scrutinized. It may be difficult to identify such payments in each and every case where the volume of transactions is rather huge and voluminous.
  4. Therefore, it may be necessary to restrict the scrutiny only to such payments in excess of certain monetary limits depending upon the size of the concern and the volume of business of the assessee.

Chart of persons specified in Section 40A(2)(b)- (Refer Paragraph 40.1)

Part-I

 

Individual Firm Association of persons HUF Company
1.His relatives 1.Its partners 2.Their relatives 1.Its members 2.Their relatives 1.Its members 2.Their relatives 1.Its directors 2.Their relatives

 

Part-II

 

Where person having substantial interest in the business or profession of the assessee is
Individual Association of persons HUF Company
1. His relatives 1.Its members 2.Their relatives 1. Its members 2.Their relatives 1.Its Directors 2.Their relatives

3.Any other company carrying on business or profession in which the first mentioned company has substantial interest.

 

Note: Where one or more of the persons falling in any of the above categories (i.e. individual and his relatives, firm, its partners and their relatives, etc.) have substantial interest in the business or profession carried on by any person – that person is also covered under section 40A(2)(b).

Part-III

 

Director Partner Member of AOP Member of HUF
Companies in which he is a Director Firms in which he is a partner AOP of which he is a member
All other Directors of such Companies All other partners of such firms All other members of such AOP All other members of such HUF
Their relatives Their relatives Their relatives Their relatives

Notes:

  1. Relative is defined in section 2(41) as in relation to an individual including husband, wife, brother, sister or any lineal ascendant or descendent of that
  2. “Person having a substantial interest” is explained in section 40A as under:
  1. In the case of company – the person concerned is, at any time, during the previous year the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits) carrying not less than 20% of the voting
  2. In other cases – such person is at any time during the previous year, beneficially entitled to not less than 20% of the profits of such business or

Expenses or payments not deductible in certain circumstances.

40A. (1) The provisions of this section shall have effect notwithstanding anything to the contrary contained in any other provision of this Act relating to the computation of income under the head “Profits and gains of business or profession”.

(2)(a) Where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in clause (b) of this sub-section, and the Assessing Officer is of opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods, services or facilities for which the payment is made or the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to him therefrom, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction :

[Provided that [for an assessment year commencing on or before the 1st day of April, 2016] no disallowance, on account of any expenditure being excessive or unreasonable having regard to the fair market value, shall be made in respect of a specified domestic transaction referred to in section 92BA, if such transaction is at arm’s length price as defined in clause (ii) of section 92F.]

(b) The persons referred to in clause (a) are the following, namely:—

  1. where the assessee is an individual, any relative of the assessee;
  2. where the assessee is 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;
  3. any individual who has a substantial interest in the business or profession of the assessee, or any relative of such individual;
  4. 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 [or any other company carrying on business or profession in which the first mentioned company has substantial interest];
  5. 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 director, partner or member of such company, firm, association or family or any relative of such director, partner or member;
  6. any person who carries on a business or profession,—
  1. where the assessee being an individual, or any relative of such assessee, has a substantial interest in the business or profession of that person; or
  2. where 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 in the business or profession of that

Explanation.—For the purposes of this sub-section, a person shall be deemed to have a substantial interest in a business or profession, if,—

  1. in a case where the business or profession is carried on by a company, such person is, at any time during the previous year, the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits) carrying not less than twenty per cent of the voting power; and
  2. in any other case, such person is, at any time during the previous year, beneficially entitled to not less than twenty per cent of the profits of such business or profession.

3. Where the assessee incurs any expenditure in respect of which a payment or aggregate of payments made to a person in a day, otherwise than by an account payee cheque drawn on a bank or account payee bank draft, [or use of electronic clearing system through a bank account [or through such other electronic mode as may be prescribed], exceeds ten thousand rupees, no deduction shall be allowed in respect of such expenditure.

(3A) Where an allowance has been made in the assessment for any year in respect of any liability incurred by the assessee for any expenditure and subsequently during any previous year (hereinafter referred to as subsequent year) the assessee makes payment in respect thereof, otherwise than by an account payee cheque drawn on a bank or account payee bank draft,[or use of electronic clearing system through a bank account [or through such other electronic mode as may be prescribed]], the payment so made shall be deemed to be the profits and gains of business or profession and accordingly chargeable to income-tax as income of the subsequent year if the payment or aggregate of payments made to a person in a day, exceeds ten thousand rupees:

Provided that no disallowance shall be made and no payment shall be deemed to be the profits and gains of business or profession under sub-section (3) and this sub-section where a payment or aggregate of payments made to a person in a day, otherwise than by an account payee cheque drawn on a bank or account payee bank draft, [or use of electronic clearing system through a bank account [or through such other electronic mode as may be prescribed], exceeds ten thousand rupees,] in such cases and under such circumstances as may be prescribed, having regard to the nature and extent of banking facilities available, considerations of business expediency and other relevant factors :]

[Provided further that in the case of payment made for plying, hiring or leasing goods carriages, the provisions of sub-sections (3) and (3A) shall have effect as if for the words “[ten] thousand rupees”, the words “thirty-five thousand rupees” had been substituted.]

4. Notwithstanding anything contained in any other law for the time being in force or in any contract, where any payment in respect of any expenditure has to be made by [an account payee cheque drawn on a bank or account payee bank draft [or use of electronic clearing system through a bank account [or through such other electronic mode as may be prescribed]] in order that such expenditure may not be disallowed as a deduction under sub-section (3), then the payment may be made by such cheque or draft [or electronic clearing system] [or such other electronic mode as may be prescribed]; and where the payment is so made or tendered, no person shall be allowed to raise, in any suit or other proceeding, a plea based on the ground that the payment was not made or tendered in cash or in any other ]

5. Omitted by the Direct Tax Laws (Amendment) Act, 1987, w. e. 1- 4- 1989. 

6. Omitted by the Direct Tax Laws (Amendment) Act, 1987, w. f. 1- 4- 1989.

7(a) Subject to the provisions of clause (b), no deduction shall be allowed in respect of any provision (whether called as such or by any other name) made by the assessee for the payment of gratuity to his employees on their retirement or on termination of their employment for any

(b) Nothing in clause (a) shall apply in relation to any provision made by the assessee for the purpose of payment of a sum by way of any contribution towards an approved gratuity fund, or for the purpose of payment of any gratuity, that has become payable during the previous year.

Explanation.—For the removal of doubts, it is hereby declared that where any provision made by the assessee for the payment of gratuity to his employees on their retirement or termination of their employment for any reason has been allowed as a deduction in computing the income of the assessee for any assessment year, any sum paid out of such provision by way of contribution towards an approved gratuity fund or by way of gratuity to any employee shall not be allowed as a deduction in computing the income of the assessee of the previous year in which the sum is so paid.]

8. Omitted by the Finance Act, 1985 w. e. f 1- 4-

9.  No deduction shall be allowed in respect of any sum paid by the assessee as an employer towards the setting up or formation of, or as contribution to, any fund, trust, company, association of persons, body of individuals, society registered under the Societies Registration Act, 1860 (21 of 1860), or other institution for any purpose, except where such sum is so paid, for the purposes and to the extent provided by or under clause (iv) [or clause (iva)] or clause (v) of sub-section (1) of section 36, or as required by or under any other law for the time being in force.

10.  Notwithstanding anything contained in sub-section (9), where the Assessing Officer is satisfied that the fund, trust, company, association of persons, body of individuals, society or other institution referred to in that sub-section has, before the 1st day of March, 1984, bona fide laid out or expended any expenditure (not being in the nature of capital expenditure) wholly and exclusively for the welfare of the employees of the assessee referred to in sub-section (9) out of the sum referred to in that sub-section, the amount of such expenditure shall, in case no deduction has been allowed to the assessee in respect of such sum and subject to the other provisions of this Act, be deducted in computing the income referred to in section 28 of the assessee of the previous year in which such expenditure is so laid out or expended, as if such expenditure had been laid out or expended by the

11. Where the assessee has, before the 1st day of March, 1984, paid any sum to any fund, trust, company, association of persons, body of individuals, society or other institution referred to in sub-section (9), then, notwithstanding anything contained in any other law or in any instrument, he shall be entitled—

  1. to claim that so much of the amount paid by him as has not been laid out or expended by such fund, trust, company, association of persons, body of individuals, society or other institution (such amount being hereinafter referred to as the unutilised amount) be repaid to him, and where any claim is so made, the unutilised amount shall be repaid, as soon as may be, to him;
  2. to claim that any asset, being land, building, machinery, plant or furniture acquired or constructed by the fund, trust, company, association of persons, body of individuals, society or other institution out of the sum paid by the assessee, be transferred to him, and where any claim is so made, such asset shall be transferred, as soon as may be, to him.]

No deduction or allowance shall be allowed in respect of any marked to market loss or other expected loss, except as allowable under clause (xviii) of sub-section (1) of section 36.]

Legislative History:

This section was inserted by the Finance Act, 1968 (19 of 1968), with effect from 1 April, 1968, with a view to taking measures for countering tax evasion.

Object of the section:

In the course of business or profession, the assessee has to incur expenditure involving payments made from time to time to different persons under various circumstances. The legislature found from experience that the existing provisions of the Act were inadequate to deal with the evasion of tax under the cloak or guise of permissible deductions.

Section 40A was added by the Finance Act of 1968 and it came into force with effect from 1 April 1968. While introducing the Bill in the Lok sabha for its consideration, the Finance Minister made a speech on 29 April, 1968, in which he pointed out that the provision in question was intended to serve the objective of checking tax evasion.

Applicability of the Section:

The following are broadly the types or classes of payments in respect of the deductibility of which this section imposes restrictions and limitations:

  1. Payments to Relatives, associates and associated concerns [sub-section (2)]
Sub-section (1): General

An overriding provision:

As pointed out in Shree Sajjan Mills v CIT [(1985) 156 ITR 585 (SC)] section 40A, which contains a non- obstante clause in sub-section (1), is an overriding provision which operates in spite of anything to the contrary contained in any other provision of the Act relating to the computation of income under the head ‘Profits and gains of business or profession’. In other words, the legislature has made it clear that the provisions of section 40A will apply in supersession of other contrary provisions of the Act relating to the computation of income under the aforesaid head [Hasanand Pinjomal v CIT (1978) 112 ITR 134 (Guj).

Sub-section (2): Payments to relatives and associates

Legislative History (1968):

This sub-section continues unamended except that a proviso to clause (a), which was there originally was omitted subsequently. The proviso read as under:

“Provided that the provisions of this sub-section shall not apply in the case of an assessee being a company in respect of any expenditure to which sub-clause (i) of clause (c) of section 40 applies.”

The object, scope and effect of the introduction of this sub-section was explained by the Board in a circular (Circular No. 6P, dated 6 July, 1968) in the following terms:

Expenditure incurred in business and profession involving payment to relatives and associate concerns”-

  1. The Finance Act, 1968 has introduced new section 40A with effect from 1 April, 1968. Under sub- section (2) of new section 40A, expenditure incurred in a business or profession for which payment has been or is to be made to the taxpayer’s relatives or associates concerns is liable to be disallowed in computing the profits of the business or profession to the extent the expenditure is considered to be excessive or unreasonable. The unreasonableness of any expenditure is to be judged having regard to the fair market value of the goods, services or facilities for which the payment is made or the legitimate needs of the business or profession or the benefit derived by, or accruing to, the taxpayer from the expenditure. Such portion of the expenditure which in the opinion of the Income-tax Officer (now Assessing Officer), is excessive or reasonable according to these criteria is to be disallowed in computing the profits of the business or profession.
  2. The categories of persons, payments to whom fall within the purview of this provision comprise, inter alia,-
  1. any relative of the taxpayer, or where the taxpayer is 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 and also relatives of such director, partner or member;
  1. persons who have a substantial interest in the business or profession of the taxpayer, and relatives of such persons; where such person is a company, firm, association of persons or Hindu undivided family, the directors, partners and members and their relatives;
  2. persons in whose business or profession the taxpayer has a substantial interest directly or
  3. The term “relative”, as defined in section 2(41) means, in relation to an individual, the husband, wife, brother or sister or any lineal ascendant or descendant of that individual. A person will be deemed to have a substantial interest in a business or profession if, in a case where the business or profession is carried on by a company the person beneficially owns shares in the company (other than preference shares), carrying not less than 20 per cent of the voting power and in any other case, where the person is beneficially entitled to not less than 20 per cent of the profits of business or profession.
  1. It may be noted that the provision is applicable to all categories of expenditure incurred in business and professions, including expenditure on purchase of raw materials, sores or goods, salaries to employees and also any other expenditure on professional services, or by way of brokerage, commission, interest, etc. Where payment for any expenditure is found to have been made to a relative or associate concern falling within the specified categories, it will be necessary for the Income-tax Officer (now Assessing Officer) to scrutinize the reasonableness of the expenditure with reference to the criteria mentioned in the The Income-tax Officer is expected to exercise his judgment in a reasonable and fair manner. It should be borne in mind that the provision is meant to check evasion of tax through excessive or unreasonable payments to relatives and associate concerns and should not be applied in a manner which will cause hardship in bona fide cases.
Curb on payments to connected persons:

One of the serious concerns of the revenue in the matter of computation of the business income was the avoidance or evasion of tax by claiming deduction of liberal payments made or benefits granted by an assese to closely connected persons ostensibly for services rendered by them. To curb the practice, the legislature initially introduced a restriction in the case of companies and gave the department a power to investigate into the reasonableness of the payments made to such persons in the light of the business needs of the company and the benefit obtained by making such payments (Section 10(4A) of the 1922 Act, re- enacted as section 40(c)(i) and (ii). The starting point of this development was Newton Studios v CIT (1955) 28 ITR 378 (Mad). A ceiling was introduced later). This power extended to remuneration, benefit or amenity provided to a director or a person having a substantial interest in the company (The 1961 Act added also the benefits given to a “relative of such director or other person”) either directly or in the form of enjoyment of assets belonging to the company. In 1963, the legislature conceived of the idea of a ceiling on the remuneration allowable to an employee of a company but modified it in 1964 by imposing a ceiling on the perquisites (which is so widely prevalent that it has come to be known, affectionately by the recipients as ‘perks’) allowed to its employees (later restricted to those drawing Rs. 7,500 or more per month as salary). The present section, inserted in 1968, has extended the curb, with modifications, to the case of all assessees

An analysis of this section discloses the following constituent elements in the scheme of disallowance:

  1. The assessee may be an individual, firm, company, association of persons (A ‘body of individuals’ is left out here) or Hindu undivided family [Ved Prakash M Patel v CIT (1988) 169 ITR 591 (MP)].
  2. The expenditure in question is one which involves a payment to a close associate. [The statute does not use this word; it is used here only to facilitate convenient reference] of the
  3. The persons treated as associates of the assessee are elaborately defined in clause (b). The determination includes the concepts of ‘relative’
    and a person having a substantial interest in the business or profession of the assessee or the One important aspect of the application of the provision will be to establish this associateship between the payer and the payee.
  4. The expenditure incurred is considered by the officer to be excessive or unreasonable, having regard to-
    1. The fair market value of the goods, services or facilities for which the payment is made; or
    2. The legitimate business needs of the assessee’s business or profession; or
    3. The benefit derived by or accruing to the assessee from the payment.

If the above conditions are fulfilled, the officer can disallow the expenditure to the extent he considers it excessive or unreasonable by the above objective standards or otherwise [For the three considerations mentioned are not exhaustive. See- Synpro Industries v CIT (1984) 146 ITR 176 (MP); Ganesh Soap Works v CIT (1986) 161 ITR 876 (MP); Anandji Shah v CIT (1990) 181 ITR 171 (Ker)].

Section 40A(2)(b):

The opening words of section 40 indicate that the amounts enumerated therein shall not be deducted in computing the income chargeable under the head “profits and gains of business or profession”, notwithstanding anything to the contrary in sections 30 to 38.

Expenditures must have been made:

Clause (a) contemplates an assessee incurring any expenditure in respect of which a payment has been or is made to any person referred to in clause (b). Where no such expenditure is incurred, obviously, the provisions of this sub-section cannot be invoked. In the case [CIT v Subbaraya Chetty & Sons (AK) (1980) 123 ITR 592 (Mad); CIT v Udhoji Shri Krishnadas (1983) 139 ITR 827 (MP)], the assessee sold goods to another with whom it had a close connection, i.e., it charged a lower sale rate in effect. The bona fide nature of the transaction was not in dispute. It was held that all that had happened was that a certain portion of the normal sale price was given up. As there was nothing which was paid out or away by the assessee from the sale price or the income that had accrued to it, there was no expenditure which could be disallowed by reference to section 40A(2)(a).

Question of fact or law:

In Upper India Publishing House (P) Ltd v CIT [(1979) 117 ITR 569 (SC). Also CIT v Skyline Industries Pvt Ltd (1985) 154 ITR 373 (MP); CIT v Orissa Cement Ltd (1988) 171 ITR 72 (Del); CIT v Kumar Engineers (1989) 178 ITR 630 (P&H); CIT v Northern India Iron & Steel Co Ltd (1989) 179 ITR 599 (Del); Trinity Pharmaceuticals India Ltd v CIT (1994) 206 ITR 431 (Ker)], it has been held by the Supreme Court that whether a particular expenditure is excessive and reasonable or not is essentially a question of fact and does not involve any issue of law. It was pointed out that in order to invoke clause (a), it has first to be held that a particular expenditure is excessive or unreasonable.

COURT RULINGS:

  1. TRADE DISCOUNT : In the case of United Exports v. CIT [2009] 185 374/[2011] 330 ITR 549 (Delhi), it was held that Trade discount provided to a sister concern is not an expenditure and therefore, no disallowance u/s. 40A(2) of the Act can be made.11/26/2020 4/59
  2. LINK WITH PROFITS : Edwise Consultants (P.) v. Addl. CIT [2013] 35 149/143 ITD 307 (Mum.-Trib.) Payment of high incentives to directors was not justifiable, merely because assessee-company had earned high profits in current year.
  3. JUSTIFICATION : In the case of Upper India Publishing House (P.) v. CIT [1979] 117 ITR 569/1 365 (SC), it was held that – Section 40A(2)(a) cannot have any application, unless it is first held that the expenditure was excessive and unreasonable.
  4. LITERAL INTERPRETATION : In case of State of Tamil Nadu Kandaswamy AIR 1975 SC 1871, it was held that Being a provision specifically designed to counter evasion of tax, the principle of strict literal interpretation generally applicable to Taxing Statutes, shall not apply. Where specific provision has been made for stopping the tax evasion than liberty of literal interpretation doesn’t exist.
  5. REASONABLENESS : In the case of CIT Samsung India Electronics Ltd. [2011] 338 ITR 186/11 221/199 325 (Delhi) (Mag.), it was held that when assessee able to proves that prices of raw material purchased from holding company is reasonable, then there cannot be any addition u/s 40A(2)(b).
  6. APPLICABILITY ON PARTNERS :Section 40A(2) applies in the case of firms only to payments made in lieu of goods, services and facilities to partners which are not covered by Section 40(b), and to all payments made for the goods, services and facilities to members of the family of a partner, or any relative of a If has to be held that the overriding effect given to Section 40A(2) is only in respect of matters not covered by Section 40(b). N.M. Anniah & Co. v. CIT [1975] 101 ITR 348 (Kar.).
  7. MOTIVE OF TAX EVASION: In case of CIT Indo Saudi Services (Travel) (P.) Ltd. [2009] 310 ITR 306 (Bom.), Honb’le Bombay High Court held that Section 40A(2)(b) is not applicable when the recipient is subject to higher tax / where tax evasion motive doesn’t exist.
  8. FULFILMENT OF ONLY ONE CONDITION: The Assessing Officer is required to record a finding as to whether expenditure is excessive or unreasonable in relation to any one of three requirements prescribed in section which are independent and alternative to each other; for making disallowance, all three requirements need not exist simultaneously. Coronation Flour Mills v. Asstt. CIT [2009] 314 ITR 1/[2010] 188 257 (Guj.).
  9. BURDEN OF PROOF: In case of Nund & Samont (P.) Ltd. v. CIT [1970] 78 ITR 268 (SC), it was held that burden of proof of reasonableness on the assessee for no disallowance u/s 40A(2)(b).
  10. SAME TAX BRACKETS: In the case of CIT V. S. Dempo & Co. (P.) Ltd. [2011] 196 193/8 159 (Bom.) it was held that where assessee purchased from its subsidiary company, at prices higher than the market rate for assured supply, there was no question of diversion of funds since both the assessee and the subsidiary were subjected to the same rate of tax, hence there was no warrant for addition by invoking section 40A(2).
  11. Where the interest paid by assessee to close relative and associate concern is not more than the rate at which interest was paid to other creditors, the interest so paid cannot be disallowed by invoking the provisions of s. 40A(2). Refer to Amrit Soap Co. CIT 17 DTR 350.

REPORTING REQUIREMENTS

  1. TAX AUDIT REPORT: The Tax Auditor needs to certify in the Clause 23 of the Form 3CD (Tax Audit Report), that the payments made or to be made to the Related parties for the expenditures, which debited to the Profit & Loss Account, is at par or less than fair market value of the Tax Auditor is required to collect all the information related to the transactions with related parties like copies of agreements, invoices, detailed description of services / goods, ledger account of concern parties.

TRANSACTIONS NOT COVERED

  1. Capital Expenditure: In general, capital expenses are not covered because of not charging to Profit & Loss Account. Although Depreciation on such capital expenditure will be claimed in the future but Depreciation is an allowance not However, provisions of Section 40A(2)(b) are applicable to expenditures which are in capital nature but fully claimed as deduction under other provisions (e.g. U/s 35. Sec 35(2AB), 35 or 35AD).
  2. Bad debts
  3. Payment to Partners
  4. Section 40A(2)(b) only covers expenditure not income. There is no need to report any kind of transaction of the nature of income which credited to the Profit and Loss Account.

Allowability of payment made to related parties under the Income-tax Act

Income-tax Law is concerned only with reduction of tax liability by an assessee by diverting business profits to relatives and associate concerns in the form of excessive payments for goods, services, etc. In order to curb such evasion, section 40A(2) was inserted by the Finance Act, 1968, with effect from April 1, 1968 which empowers Income-tax Authorities to disallow an expenditure or payment to the extent it is considered excessive or unreasonable, for the purpose of computing profits and gains of a business or profession.

Conclusion:

The payment should be in the nature of expenditure to qualify for reporting in Section 40(A)(2)(b) of the Act. If there is no expenditure then the provisions of Section 40A(2)(b) of the Act cannot be invoked. The understanding based on facts, provisions of law quoted above is that even if there is expenditure which is capital in nature (not debitable to profit and loss account) shall not necessitate reporting in Clause 23 of Tax Audit report for Section 40(A)(2)(b) of the Act. Further the expenditure to be reported in Clause 23 of Tax Audit report for Section 40(A)(2)(b) of the Act should lead to tax evasion.

The transaction of loans, advances or similar nature which are not deductible from Income of the assessee are outside the purview of Section 40A(2)(b) of the Act. The intention of legislature is clear and unambiguous since separate sections i.e. Section 269SS & 269T read with Section 2(22)(e) of the Act are separately defined in the provisions of the Act along with its reporting requirements in Tax Audit Report.

Disclaimer:

Our conclusions are based on the completeness & accuracy of the facts stated therein & assumptions, which if not entirely complete or accurate, should be communicated to us, as the inaccuracy or incompleteness could have a material impact on our conclusions. The conclusions reached & views expressed in the note are based on our understanding of the law & regulations prevailing as of the date of this note as well as our past experience with the tax and / or regulatory authorities. However, there can be no assurance that the tax authorities or regulators will concur with our views.

Legislation, its judicial interpretation & the policies of the tax and / or regulatory authorities are subject to change from time to time & these may have a bearing on the advice that we have given. Accordingly, any change or amendment in the law or relevant regulations would necessitate a review of our comments & recommendations contained in this note. Unless specifically requested, we have no responsibility to carry out any review of our comments for changes in laws or regulations occurring after the date of this note.

 Without prior permission of DMCGLOBAL SERVICES LLP, the contents of this study / note may not be quoted in whole or in part or otherwise referred to in any documents. This document is for the specific purpose and we accept no responsibility or liability to any party.

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