MIS-CONCEPTION OF CHECK ON TAX EVASIONS BY Section 40A (3) Catch the recipients and tax them -some suggestions for the Finance Minister which need to be implemented on urgent basis.

[DEV KUMAR KOTHARI]

Summary:

Disallowance of a payment duly recorded and disclosed does not serve the purpose of checking tax evasion. To achieve the purpose it is necessary to examine the recipient of payments made by an assessee in any manner- cash, cheque, ECS, or direct credit in account or by adjustments.  To promote payments through banking channels, a 5% disallowance of payments in excess of Rs. 50000 otherwise than through banking channels can be prescribed. Information about payment made in excess of certain limit made to any person and received from any person can be obtained for cross verification and assessment at hands of recipients or payer. Certain administrative changes about separate issue of A/c Payee Cheque books  and bearer cheque books, not allowing alterations in name and cancellation or variation of crossing on a/c payee crossed cheques, proper entries in bank statement or pass books can also help check on tax avoidance if proper cross verifications are made.

The misconception of checking tax evasion through disallowance under S. 40A (3):

Disallowance of cash payments, which are duly recorded in the books of account, does not in any way check tax evasion. When the payment is recorded in the books of account of a taxpayer, it is clear that such payment is out of white/accounted/ disclosed money and not black money. Therefore, provision of Section 40A (3) is not in tune with the avowed purpose of tax evasion.

Tax evasion is possible even if A/c payee cheque is issued

Tax evasion may take place even when a un recorded / un disclosed payment is made by a/c payee cheque drawn on an undisclosed bank account. Or when the recipient of an a/c payee cheque does not record in his books of account. However, such case will not come in light during prepration of return, tax audit, filing of return and assessment of income. This can come to light only when an undisclosed account or expenditure is unearthed during course of cross checking of information, search or survey etc.

Bogus payments or non business payment:

It appears that in context of S. 40A (3)  in the mind the thinking is that payment in cash, of higher amount are bogus payments or payment not for the purpose of business and therefore they should be disallowed. A bogus payment, or a non business expenditure, even if paid by A/c payee cheque, can be disallowed. Therefore, S. 40A (3) hardly serves any purpose of tax evasion by merely disallowing a recorded payment.

Purpose can be achieved only by check at recipient of cash and not payer so s. 40A (3) must be deleted:

The real purpose of checking tax evasion will be served only if the I.T. Department enquires about income of the recipient and if the recipient has not shown cash received as income or revenue he can be assessed for the same.   Therefore, it is suggested that S. 40A (3) must be deleted.

Information about major payments may be gathered and used for cross examination in hands of recipients

Information not only about cash payments but also about cheque payments can be gathered from assesses with the return of income either by way of tax audit report or in some other manner and the same can be used to cross check whether the recipient has disclosed the same as his income and to crack tax evasion at the hands of recipient in case he does not disclose the payment made by payer in his books of account or return of income properly.

Un fortunately it is experienced that an honest tax payer who has recorded payments in his books of account is put to harassment and disallowance and the payee who may not have disclosed the corresponding receipt is rarely enquired and assessed for the same.

The author hopes that honorable Finance Minister will consider this aspect seriously and avoid un-necessary provision like section 40A(3), which has just created litigation and did not serve and cannot serve desired purpose.

A 5% disallowance of cash payments can promote payment through banking channel and transparency:

By making a disallowance of cash payments or payments otherwise than by a/c payee cheque or bank draft or through other banking channels like ECS, direct credit etc. the purpose of payments through banking and transparent channels can be achieved. In case of payments through banking channels the probability is higher that the payee shall disclose receipts and therefore chances of tax evasion at hands of recipients shall reduce.

Provisions to check tax evasion:

There are several provisions in the Act made with a view to check tax evasion. In this write-up the scope is limited towards check by way of prescription that certain transactions of payment or receipts exceeding prescribed limit should be only by be cheque or draft which should be crossed A/C Payees. That means that cheques can be deposited only in a bank account in the name of the person in whose favour cheques has been drawn. The idea behind these provisions is that once cheques are deposited through regular banking channel of clearing or transfer (same bank case), there is chances of better incorporation of the same in accounts and reporting of income by the payer and payee both.

Section 40A (3) - the past, present and future:

Earlier section 40A (3) provided for disallowance of payments of expenses made other wise than by crossed cheques or crossed bank draft if the payment exceeded prescribed amount.  The section was amended w.e.f.  01.04.1996 to provide for disallowance of 20% of such payments. In case of past liabilities paid in any subsequent year, provision exists for rectification of past assessments, if payment is made otherwise than by a/c payee cheque or draft (or crossed cheque or draft earlier at relevant times).

However exceptions were provided in Rules for cash payments made in certain circumstances and for commercial expediency etc. Courts also held that if payment is genuine, no disallowance could be made.

By the FA 2008 amendment has been made to provide that payment or aggregate of payments in a day will be considered. 

The earlier provision, existing provision and proposed provision all provides for non applicability of disallowance in certain prescribed circumstances of difficulties in payment by a/c payee cheque / draft and commercial expediency etc.

Earlier the requirement was to make payment by crossed cheque or draft, which was amended to provide for "a/c payee cheque" or a/c "payee bank draft" by the Finance (Second) amendment Act, 2006.

Cosmetic changes:

As discussed later it is found that the new provision is on the same line as it was prior to 01.04.1996 that is disallowance of entire sum. The change made is about treating the sum paid in respect of old allowed liabilities for expenses as income of the previous year in which cash payment is made otherwise than by "a/c payee cheque/ bank draft" and in a sum exceeding Rs.20000/-. The change by the FA 2008 is to overcome some judicial pronouncements and to consider even more than one  payments made during the year for disallowance.e

Monetary limits - FM seems to have no concern for inflation when it comes to tax laws:

The monetary limit was Rs.2500 up to 01.04.1988, was raised to Rs.10000/- w.e.f. 01.04.1989 and again revised to Rs.20000/- w.e.f.01.04.1997.  Even after amendments during hyper inflation periods the limit is kept at Rs.20,000/-. This shows that the honorable Finance Minister is concerned with inflation only for the public shows and vote bank, and has no concern regarding practical aspects of business and tax administration. This is also clear from the fact that most of other monetary limits for tax audit under section 44AB, receipt or repayment of loans or deposit permissible in cash ( section 269SS and 269T), most of matters relating to tax deduction at source (TDS) under various provisions are not enhanced . Keeping in view inflation over last fifteen -twenty years they should have been increased at least three times. In view of changes in financial situation the limit under section 40A(3)  can reasonably be fixed at Rs.50000/-

Memorandum explaining the proposals:

In the memorandum explaining the proposals in the FB 2007  no reason was  given. It only said  what is present provision and what is proposed? There is no answer to question why a change is required or desirable? Therefore, an amendment without a reason may be considered invalid.

However, in notes to for proposals it is stated that the provisions of section 40A (3) is as an anti-evasion measure substitution of the disallowance of 100 per cent. by 20 per cent. has diluted the deterrence potential of the provisions. Therefore, to re-strengthen the deterrence potential, it is proposed to amend the said provision and to reintroduce   100 per cent disallowance of payments, which are made in violation of its provisions.

As discussed earlier a disallowance in hands of payer who has disclosed the cash payments in books of account does not serve any purpose of checking of tax evasion. The purpose can be served only if the recipient is taxed on such sums received by him.

Therefore, it appears that the changes in the section 40A (3) have been made just for making a change without proper review of result and experience related with section 40A (3).

Circumstances in which section 40A(3) will not apply:

As per past experience now many circumstances in which such disallowance should not be made are settled by old rules and judicial pronouncements. New Rule 6DD is on line of old Rule 6DD  except that provision of old clause (j) is not found which prescribed other circumstances of exceptional nature. However, Assessing officers having habit of routinely applying disallowances in a scrutiny assessment are  likely to lead to unnecessary litigation and harassment.

Provisions to check tax evasion- are they effective?:

Relevant provisions intended to check tax evasion interalia are as follows:

A. S.40A (3) - disallowance of cash payment for certain expenses in specified circumstances.

B. S. 269SS -taking loan or deposit by A/c payee cheques.

C. S.269T -Repayment of loan or deposit by A/c payee's cheques.     

D. S.269TT Repayment for Special Bearer Bonds, 1991 by A/c payee cheques.

E.  S. 44AB- Tax Audit report- Form 3CD clauses 17 (h) read with S.40A (3) and Rule 6DD of the Income-tax Rules, 1962. 

The provisions being very popular they are just refereed to.

On correct review it can be said that only section 269SS serve real purpose because one is warned of consequences if he introduce his black money as cash loan in names of other persons in excess of limit. Though this provision is also not necessary for checking evasion because the A.O. can make addition in the income of assessee under section 68 if he does not find a reasonable explanation , from the assessee ( and in practice from the person who made loan) about the nature of credit, its source and the capacity of the person who made such loan etc. in respect of  any sum credited in the books of account of assessee. In practice we find that even receipts of loans by a/c payee cheques and drafts are many times considered as income of recipient under section 68.

However, repayment of loan or special bearer bonds and other cash payments of expenses, which are duly recorded in books of account of the payer, do not serve the purpose of check on tax evasion at the hands of the payer. The tax evasion can be achieved only if the payee of such payments is examined and assessed to tax as may be applicable in his case.

Request to the Finance Minister:

a. The provision of section 40A (3) may be dropped altogether. Or

b. a 5 % disallowance of current expenses or addition of old accrued liabilities, as the case may be, be provide in case payment-exceeding Rs.50000 is made at a time otherwise than through banking channels.

 c. In tax audit report, information about payment made in excess of rupees one lakh to any person as well as payment received from any party on any account in excess of rupees one lakh, during the previous year in any manner (cash, cheque, accounting adjustment, payment in kind) on any account be obtained and such recipients or payers  can be  examined to check whether he has disclosed such receipts or payments in his books of account properly. In case where tax audit is not required, such information can be obtained as an annexure to the return of income.

Suggestions for the concerned Authorities:

It is suggested that the concerned authorities of GOI namely MOF, RBI, and CBDT may co-ordinate in this matter. The most appropriate authority is RBI. Even CBDT can also issue directions to banks or can make Rules in this regard as the purpose is to check tax evasion. However, to avoid confusion about authority and therefore validity of such instructions it would be better if the instructions are given jointly by the CBDT and the RBI on the following lines:

a. A/c Payee chequebooks shall be issued separately giving details of cheque numbers and the fact that cheques have been crossed A/c Payee only.

b. In such A/c payee Cheques no alteration in the name or by way of cancellation of A/c Payee shall be allowed.

c. Cheques without A/c payee crossing shall be issued separately.

d. The bank statement or pass book as the case may be shall give details of deposits as well as cheques drawn /withdrawals giving name of party concerned in transaction - payer or payee and type of transactions - cash, clearing, ECS, transfer cheque or payment under instructions etc.

It is hoped that Shri P Chidambaram FM may consider this write-up and take a proactive initiative to amend the law to make it useful and purpose serving. Who knows who will present next budget Therefore, an interim amendment is desired to drop un-necessary provision to check tax evasion, although there is no tax evasion and the payment is already recorded in the books of payer.