Income Tax Appellate Tribunal (ITAT) Kolkata in a recent judgment has held disallowance u/s 40A(3) could not be made applicable to payment of wage arrears in cash under hindrance/pressure from labour union where bearer cheques were directly depositing in the bank account of the payee.

Case Details:
ITA No.391/Kol /2014 ; AY: 2010-11
Nirmal Kumar Das (Appellant) vs. ACIT (Respondent)
Date of Order: 11-12-2015

Brief Facts of the Case:
That assessee was an individual engaged in business of civil construction and labour supply under the name & style of Das Development Construction. The assessee entered into a bi-partite settlement with the labour for the arrear payment of wages in the presence of Additional Labour Commissioner, West Bengal. Workers protested and denied to accept payment of arrear of wages by account payee cheques. Most of the labours were poor and had no bank account. The union leader of the labours stated in writing to pay the arrear of wages in cash otherwise creating of hindrances in the work. Faced with a situation beyond the control to handle the business, the assessee finally issued bearer cheques in the name of the respective labour for the payment of Wage arrears. However, Assessing Officer disallowed a sum of ₹29,42,357/- u/s 40A(3) of the Act and added it to the income of assessee.

On appeal (CIT(A) also upheld AO order observing that the exceptions provided under Rule 6DD are exhaustive and not inclusive. CIT(A) relied on the judgment of Calcutta High Court in the case of Bagmari Tea Co Ltd. Vs Commissioner of Income-tax (2002) where after referring to the case of Girdhari Lal Goenka Vs CIT (1989), it held as under:-

“….when the payment is made in contravention of section 40A(3) though the payment is genuine, that cannot be allowed, because the genuineness of payment is required in all cases but payment by account payee cheque or demand draft is additional requirement under section 40A(3)). If we follow the view that the payment is genuine, then that should not be disallowed. In that case the provision of section 40A(3) will become redundant….”

Before ITAT, the assessee contented that the payment was made under unavoidable circumstances and such situation is covered for cash payments in the exceptions provided in rule 6DD of Income Tax Rules 1962. ITAT observed that there was no such exception but it took the note that the genuinety of expenses had not been doubted by the Revenue and therefore the provisions of section 40A(3) could not be made applicable to the facts of the instant case because the assessee had taken enough precautions to ensure that the payee also don’t escape from the ambit of taxation on these receipts by directly depositing the bearer cheque in the bank account of the payee. It also noted that the these provision was inserted by Finance Act 1968 with the object of curbing expenditure in cash and to counter tax evasion and The CBDT Circular No. 6P dated 06.07.1968 reiterates this view as under;

“this provision is designed to counter evasion of a tax through claims for expenditure shown to have been incurred in cash with a view to frustrating proper investigation by the department as to the identity of the payee and reasonableness of the payment .”

ITAT relied on the following judgments:
Attar Singh Gurmukh Singh vs ITO reported in (1991) 191 ITR 667 (SC)
CIT vs CPL Tannery reported in (2009) 318 ITR 179 (Cal)
CIT vs Crescent Export Syndicate in ITA No. 202 of 2008 (Cal)
Anupam Tele Services vs ITO in (2014) 43 taxmann.com 199 (Guj)
Sri Laxmi Satyanarayana Oil Mill vs CIT (Andhra Pradesh High Court)
CIT vs Smt. Shelly Passi (P&H)

Important Excerpts from ITAT Judgment:

It is pertinent to notice that the primary object of enacting section 40A(3) was two folds, firstly, putting a check on trading transactions with a mind to evade the liability to tax on income earned out of such transaction and, secondly, to inculcate the banking habits amongst the business community.

Apparently, this provision was directly related to curb the evasion of tax and inculcating the banking habits. Therefore, the consequence, which were to befall on account of non-observation of section 40A(3) must have nexus to the failure of such object. Therefore, the genuineness of the transactions it being free from vice of any device of evasion of tax is relevant consideration. In the instant case, the labours were paid by the bearer cheque only in their respective name only.

The Hon’ble Apex Court in the case of CTO vs Swastik Roadways reported in (2004) 3 SCC 640 had held that the consequences of noncompliance of Madhyapradesh Sales Tax Act , which were intended to check the evasion and avoidance of sales tax were significantly harsh. The court while upholding the constitutional validity negated the existence of a mens rea as a condition necessary for levy of penalty for non-compliance with such technical provisions required held that “in the consequence to follow there must be nexus between the consequence that befall for non-compliance with such provisions intended for preventing the tax evasion with the object of provision before the consequence can be inflicted upon the defaulter.” The Hon'ble Supreme Court has opined that the existence of nexus between the tax evasion by the owner of the goods and the failure of C& F agent to furnish information required by the Commissioner is implicit in section 57(2) and the assessing authority concerned has to necessarily record a finding to this effect before levying penalty u/s 57(2).

Though in the instant case, the issue involved is not with regard to the levy of penalty, but the requirement of law to be followed by the assessee was of as technical nature as was in the case of Swastik Roadways (3 SCC 640) and the consequence to fall for failure to observe such norms in the present case are much higher than which were prescribed under the Madhya Pradesh Sales Tax Act. Apparently, it is a relevant consideration for the assessing authority under the Income Tax Act that before invoking the provisions of section 40A(3) in the light of Rule 6DD as clarified by the Circular of the CBDT that whether the failure on the part of the assessee in adhering to requirement of provisions of section 40A(3) has any such nexus which defeats the object of provision so as to invite such a consequence. We hold that the purpose of section 40A(3) is only preventive and to check evasion of tax and flow of unaccounted money or to check transactions which are not genuine and may be put as camouflage to evade tax by showing fictitious or false transactions. Admittedly, this is not the case in the facts of the assessee herein. The assessee had issued bearer cheques in the name of respective labours which is evident from the additional details submitted by the assessee and placed on page 2 to 6 of the additional details. It is also pertinent to note that the Hon’ble Rajasthan High Court in the case of Smt.Harshila Chordia vs ITO reported in (2008) 298 ITR 349 (Raj) had held that the exceptions contained in Rule 6DD of Income Tax Rules are not exhaustive and that the said rule must be interpreted liberally.

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