Cash deposit in bank account of payee amount to cash payment to the payee and S. 40A (3) is applicable.

[C.A. DEV KUMAR KOTHARI]

Relevant links: Section 40A (3) of the Income-tax Act, 1961

Rule 6DD of the Income-tax Rules, 1962.

K. Abdu & Co. V Income-tax Officer, Ward-3, Cannanore

http://www.taxmanagementindia.com/web/view_discussions.asp Issue in discussion forum of www.taxmanagementindia.com

There is an issue raised vide issue ID no. 1566 in which discussion is going on about cash deposit in bank on behalf of party to whom payment is made. It seems that there are confusions and therefore the author though it proper to place a detailed article on the website.

Section 40A (3):

The old as well as amended section 40A (3) and relevant Rule 6DD are well known and well interpreted provisions and readers are well aware of the same. Therefore, for the sake of brevity they are not reproduced. The readers are requested to refer the same as they stood at particular time while applying the underlying theory and interpretations given by courts. Recent amendments in the section and rule may be kept in mind while dealing with current accounts. In this write-up we are mainly concerned with the question, whether, cash deposited in a bank account of supplier can be considered to have exception of disallowance. A judgment of Kerala High Court is also discussed. The weaknesses in the case made out by the assessee are also discussed to learn from mistakes of others, so that in case of similar situation the case can be prepared on sounder footing. 

Payment by way of cash deposit   in bank account vis a vis  by a/c payee cheque:

An account payee cheque can be deposited in the account of payee by the drawer of cheque on behalf of payee or by the payee himself or his other agents. This will make no difference as the payment is made by a/c payee cheque drawn in favor of payee. In case of depositing an a/c payee cheque in account of payee the payment is made through banking channel. The cheque is cleared through banking channel of clearing or transferring. In case the cheque is drawn on some other bank, then cheque is sent for clearing through clearing channels. In case the cheque is on the same bank and branch, the cheque is honored through transfer of funds from the account of the drawer to the account of payee. In case the cheque is drawn on the same bank but on different branch then the cheque can be cleared by transfer if both branches have anywhere banking facility. In case the drawee branch is not part of anywhere banking, then the cheque is to be sent to the clearing.  

On the other hand, if instead of cheque cash is deposited in the account of payee, the requirement of making payment by account payee cheque / DD will not be fulfilled. This is for the following reasons:

            a. cash can be deposited by any one- the person paying  or the person receiving the money. Thus there is no certainty of source of funds.

            b. The credit of money is not through banking channels.

            c. The person who pays records such payment in his cash book as cash payment- it is not a payment from the bank account.

            d. There is no debit in the bank account of the person who pay the money by way of deposit in the account.   

            e. The bank receiving cash will credit in the account of person in whose account money is deposited. There cannot be any link of bank account of person who made payment.

            f. Deposit is made for and on behalf of the person in whose account cash is deposited, therefore it is just equal to a cash payment made to the person in whose account money is deposited.

In case of deposit in account of payee the identity of payee can be established, however, exceptional circumstances, in which payment was made in cash (otherwise by a/c payee cheque) need to be satisfied to overcome disallowance under section 40A (3).

Exemption of banks and FI's

In Rule 6DD payments made to scheduled banks, and some FI, SFI etc. are exempted from the provision of disallowance. However, the requirement is that payment should be made to the specified banks and institutions and not that payment is made to some other person, who has an account of specified banks or institutions. For example, a deposit of cash in a loan account for loan taken from bank will be a payment to the bank against loan taken. Similarly payment of say bank charges made to bank by deposit of cash is a payment to the bank and therefore, exemption under Rule 6DD will be available. However, deposit made in any account of banks customer is not a payment made to the bank, it is payment made to the person in whose account money is deposited.

Even if bank is a collection agent, it cannot be said that money deposited with the bank , to be credited to the account of its customer and principal is a payment made to bank. For example when a bank acts as banker to public issue of securities, the application or allotment money deposited with the banker is not a payment to the bank but to the security issuer.

Case before Kerala High Court:

In case of K. Abdu & Co. V Income-tax Officer, Ward-3, Cannanore 170 Taxman 297 decided by a single judge (his lordship  C.N. Ramachandran Nair, J in Original Petition No. 7697 of 2001 (N) on November 19, 2007 a matter by way of writ petition came before the court. The petitioner made payments in cash by way of deposit of money in bank accounts of suppliers maintained with State Bank of Mysore and Hassan District Co-op. Central Bank Ltd. Assessee claimed that the payment was made to banks and therefore they were eligible from disallowance under section 40A (3) of the Income-tax Act, 1961 in views of Rule 6DD (a) (ii) of the Income-tax Rules, 1962.

 The court held that only payments made to specified banks or institutions in the Rule will be eligible for exemption and not any payment made to any other party who maintained account with bank. Therefore, deposits made in bank accounts of suppliers were not eligible for exemption from disallowance under section 40A(3).

Facts, analysis and comments:

In this case the assessee, is a grocery merchant. He made certain payments in cash, in excess of rupees twenty thousand by way of deposit of cash in accounts of suppliers. Such payments attracted disallowance of 20 per cent under section 40A(3). The assessee claimed that some of the payments had been made in the bank account of the suppliers. The Assessing Officer initially allowed the assessee's claim but, subsequently, rectified it under section 154 and made addition under section 40A(3). On revision, the Commissioner confirmed the order of the Assessing Officer.

On petition, the assessee contended that payments were made in the account of the suppliers maintained with the State Bank of Mysore and Hassan District Co-op. Central Bank Ltd. which come under sub-clause (ii) of clause (a) of rule 6DD and, therefore, those payments were eligible for exemption from disallowance under section 40A(3).

It appears that the assessee choose to make a revision petition under section 264 before the CIT. The CIT confirmed the order under section 154 passed by the A.O. Thus the assessee filed a writ petition before the high Court. The High Court interalia observed and  held as follows: 

            a. The protection under clause (a) of rule 6DD is available only if the payments are made to any of the institutions referred to there under.

            b. In order to qualify for the benefit of rule 6DD(a), the beneficiary of the payee should be an institution referred to therein.

            c.  Even though the assessee contended that payments to any beneficiary in the account maintained in the banks referred to the rule 6DD(a) is also covered by the exception, the same could not be accepted because, some of the institutions referred to in the rule, namely, the Reserve Bank of India, the State Financial Corporations, the Industrial Development Corporation and other financial institutions are not engaged in banking operations. Therefore, rule 6DD(a) applies only to payments to institutions referred to therein and not to payments made in any party's account maintained by the institutions referred to therein.

            d. Therefore, the order of the Commissioner confirming the assessment revised under section 154 was to be upheld.

Another contention was raised that payments were made to truck drivers who brought goods and cash was entrusted to them. In this regard The High Court held as follows:

            a. the contention raised by the assessee that cash remittances in the account of the suppliers were made by entrusting the cash to the truck drivers and, therefore, the same was covered by clause (i) of rule 6DD, was not pressed before the Commissioner.

            b. In any case, the truck drivers, who brought the goods, could not be treated as the agents of the assessee who was required to make payment in cash for the goods to the suppliers.

            c. Thus, said contention was also to be rejected. Therefore, the petition was to be dismissed as devoid of any merit.

Weaknesses of the case and learning therefrom:

It appears that the assessee was not properly advised in this matter due to the following reasons:

            a. the  reasons for making payments in cash, should have been brought on record to establish urgency, bonafides, and other exceptional circumstances.

            b. The order under section 154 should have been challenged on the ground of jurisdiction and non maintainability because as it was a matter which would require lot of enquiry as to whether there were reasons to make payment otherwise than by a/c payee cheques and  two or more views are possible etc. It is not a mistake apparent from records. Once the learned A.O. allowed such payments, after consideration of facts, it was not within his scope to disallow the same by way of rectifying the order as rectification of a mistake apparent from records. It is expected, that on the ground of non rectifiability itself the order under section 154 could be set aside. However it appears that these contentions were not at all raised at any stage- the A.O., The CIT and the High Court.

            c. Instead of petition for revision under section 264 before the Commissioner (Administrative), proceedings by way of appeal before the Commissioner (Appeals) is always better forum in such cases because- the powers of the CIT (Appeal) are much wider than that of CIT (Admin) for the reason that CIT is to look after the matter from administrative angle, further appeal etc. Suppose a CIT (A) has allowed relief on some issue, the CIT (A) can follow his order and allow relief in other appeals filed before him. However, the CIT (Administrative) in revision proceedings may not be able to allow similar relief for the simple reason that the revenue might have filed appeal against the order of the CIT (Appeals). Furthermore, in case of order of CIT (Appeal), second appeal can be filed before the ITAT. Whereas, in case of order in revision under section 264, if the order is not favorable, the assessee ahs to approach high Court. 

            d. All possible contentions must have been raised. Reliance on one contention that deposit in bank account of suppliers were exempt under Rule 6DD was a weak strategy.

            e. Facts as to nature of payments, circumstances in which payment was made by way of deposit in bank accounts instead of by way of a/c payee cheques or drafts, genuineness of payment, whereabouts and accounting of payments by the suppliers etc. should have been pressed.

Thus we can learn from mistakes made by the assessee or his counsels in the case of K. Abdu and make our case stronger by taking all possible contentions and also be adopting most suitable remedy.