The Hindu Business Line : Payments by a different mode

In the past few years, the lawmakers have slowly but surely removed several of such disallowances to ensure that the gap between book income and tax income is bridged.

There are specific disallowances — Section 43B, for instance — which mandates certain types of expenditure to be allowed only on payment basis.

Similarly, Section 40A(3) of the Act stipulates that any expenditure incurred in excess of Rs 20,000 shall not be allowed as deduction if made otherwise than by crossed cheque or crossed bank draft.

There have been controversies on this provision and several High Courts have examined this provision from several angles.

Recently, the Gujarat High Court, in CIT vs Mrinalini V. Sarabhai (2003 64 ITR 265), had to consider whether initiating a payment through `pay order' would constitute payment made by account-payee cheque.

Facts, issues

The assessee had appointed a firm, M/s. Chidambaram, as an agent, which used to look after the financial affairs of the assessee and the said firm also used to make and receive payments on behalf of the assessee as per instructions given by the assessee.

Very often, when the assessee had to make payment to a particular person and had also to receive money from that particular person, the said firm used to make necessary adjustments in the account of the assessee and the final resultant figure was either paid on behalf of the assessee or was received on behalf of the assessee by the said firm.

The instruction given by the assessee to the firm for making payment on behalf of the assessee was known as `pay order'.

It is pertinent to note that the term `pay order' used by the assessee would not denote or mean a cheque or any such other instrument.

In pursuance of the aforesaid arrangement made by the firm, the firm used to look after the financial affairs of the assessee.

For the assessment year 1981-82, with which we are concerned, the assessee had given certain instructions to the firm for making some payments and in pursuance of the said instructions or `pay orders', the firm had made payments to several persons including Sikhar Investments Pvt. Ltd, Utpal Investments Pvt. Ltd, and Vividh Investments Pvt. Ltd.

The said companies used to render certain services to the assessee.

As per the above arrangement, certain final payments, after making necessary adjustments or hawalas in the nature of expenditure, were made to the abovementioned companies by the firm on behalf of the assessee.

The income-tax officer (ITO) disallowed some of such expenditure under Section 40A(3) of the Act on the ground that the assessee had given `pay orders' to the firm and the firm had not made the entire payment to the companies concerned by crossed cheques or crossed bank drafts as required under the said section.

The assessee's case before the ITO was that the firm used to look after the financial affairs of the assessee and the firm was also maintaining the ledger account of the assessee. The assessee used to pay some amount `on account' to the firm and from that amount, in pursuance of instructions received from the assessee; the firm used to make payments. As stated hereinabove, payments were made by account-payee cheques by the firm to the persons concerned.

The ITO did not accept the explanation of the assessee to the effect that the case of the assessee was covered under rule 6DD(j) of the Income-Tax Rules, 1962 and he disallowed in all a sum of Rs 12,000.

Being aggrieved by the assessment order, the assessee preferred an appeal before the Commissioner of Income-tax (Appeals). The CIT (A) allowed the appeal and deleted the disallowance. Being aggrieved by the order passed by the CIT (A), the Revenue filed an appeal before the Tribunal and the said appeal was dismissed by the Tribunal. The matter thereafter reached the High Court

Court decision

The Gujarat High Court held the payments in question were not hit by Section 40A(3) of the Act. The court reasoned that "it is pertinent to note that the assessee was not making any payment directly to the concerned creditor. She had engaged a firm, which used to look after the financial affairs of the assessee.

The firm used to collect and make payments on behalf of the assessee. If a particular payment was to be made to a particular person, and if from the same person the assessee had to recover some amount, the firm, which used to keep ledger accounts of the assessee as well as of the debtors and creditors of the assessee, used to adjust the amount payable to or recoverable from the concerned persons and used to pay or receive the final resultant amount on behalf of the assessee.

The aforesaid practice was duly revealed before the ITO. Somehow, the ITO believed that the said system can give "chances and opportunities to use or create black money" and, therefore, merely on such an apprehension he disallowed the expenditure of Rs 12,000.

Upon perusal of the entire facts, it is clear that whatever final payments had been made by the firm as an agent of the assessee, they were made by account-payee cheques.

If the ultimate payment in respect of the expenditure was made by a crossed cheque drawn on a bank, in our opinion, the transaction cannot be hit by the provisions of the Section 40A(3) of the Act.

The court took support from the law laid down by the Supreme Court in the Attar Singh Gurmukh Singh (1991 191 ITR 667) case, where it was held that the function of the ITO or the assessing officer (AO) is to see whether a transaction is genuine.

In the instant case, the assessee had adopted a peculiar method of maintaining her books of account and having her business transactions, and according to her method, the entire work with regard to payment and collection of money was entrusted to the firm.

If, in such a set of circumstances, the firm makes payment on behalf of the assessee by account-payee cheques, by no stretch of imagination can it be said that there was any cash transaction or there was any possibility of having "chances and opportunities to use or create black money."

It is also pertinent to note that this court, way back in 1978 in the Hasanand Pinjomal (1978 112 ITR 134) case, had interpreted the second proviso to Section 40A(3) of the Act. It held that for the purpose of business expediency, practicability has to be judged from the angle of the businessman and not the Revenue. Accordingly, the Gujarat High Court decided the matter in favour of the assessee.

In this Internet age, payments are made through the electronic media, credit cards, and so on. Settlement of claims between parties partakes several forms, which need not necessarily involve payments by way of cheque or cash. It is in this background that the continuance of Section 40A(3) needs to be re-examined and maybe modified.

It is not anybody's case that indiscriminate payment by way of cash should automatically entail an assessee to a business deduction.

But then one has to weigh the facts of each case, examine the practical situations that develop and only then decide whether payments by a particular mode are justified or not to decide the allowability of an expenditure.