What expenditures or payments are disallowed under Income Tax Act?

1. Relevant Legal Provisions:

• Section 40 – General disallowance of certain expenses

• Section 40A – Disallowance of certain cash payments

• Section 40A(2) – Disallowance of excessive payments to related parties

• Section 40(a) – Disallowance related to non-deduction of TDS

• Section 43B – Certain expenses only allowed on actual payment basis

2. General Expenditures Disallowed Under the Income Tax Act:

2.1. Non-deduction of TDS (Section 40(a))

If TDS is not deducted on certain payments (e.g., rent, professional fees, salary), then such payments will be disallowed.

• Section 40(a)(ia) – If TDS is not deducted or deposited before the due date of filing of ITR, the expenditure will be disallowed.

• deduction will be disallowed in computing the income.

2.2. Payments Exceeding ₹10,000 in Cash (Section 40A(3))

Any expenditure made in cash exceeding ₹10,000 in a day to a single person is disallowed unless it falls under the exceptions.

2.3. Excessive Payments to Relatives or Related Parties (Section 40A(2))

Expenditure or payments made to relatives or related parties which are deemed to be excessive or unreasonable in the opinion of the Assessing Officer will be disallowed.

2.4. Payments to Non-Residents Without TDS (Section 40(a)(i))

Payments made to non-residents without deducting tax at source (TDS), or not depositing the deducted TDS, are disallowed.

2.5. Unpaid Liabilities (Section 43B)

Certain expenditures like taxes, duties, and contributions to employee welfare schemes are allowed only if paid on time. If not paid within the relevant period, they will be disallowed.

2.6. Capital Expenditure Without Actual Usage

Capital expenditure on assets not put to use for business purposes is disallowed.

2.7. Illegal Payments (Section 37)

Any illegal payments or expenses made, including bribes or kickbacks, will be disallowed under Section 37, which disallows expenses not wholly and exclusively incurred for the business.

2.8. Personal Expenses

Personal expenditures that are not related to business are disallowed.

2.9. Depreciation on Ineligible Assets

Depreciation is allowed only on assets used for business purposes. If an asset is not used for business, depreciation on it will be disallowed.

3. Summary Table: Disallowed Expenses Under Income Tax Act

✅ Conclusion:

Expenditures or payments are disallowed under the Income Tax Act if they do not meet the prescribed conditions of deduction, such as failing to comply with TDS provisions, being paid in cash exceeding specified limits, being excessive or unreasonable when paid to related parties, or being of a personal or illegal nature. Always ensure that payments are backed by proper documentation and are in compliance with the legal provisions to avoid disallowance.

Whether payment made to relatives is disallowed under Income Tax Act?

1. Relevant Provisions in the Income Tax Act:

• Section 40A(2)(a) – Disallowance of excessive or unreasonable payments to related parties (including relatives)

• Explanation (b) to Section 40A(2) – Defines “related persons”

• Section 64 – Clubbing of income if remuneration is paid to spouse without substantial contribution

2. Can Payment to Relatives Be Allowed as Deduction?

Yes, payment to relatives is not automatically disallowed, but subject to scrutiny under Section 40A(2) of the Act.

The law only disallows the portion of payment which is “excessive or unreasonable” having regard to:

• Fair Market Value (FMV) of the goods/services

• Legitimate needs of the business

• Benefit derived by the business

So, if the payment is at arm’s length and justifiable, it is allowed.

3. Bare Act Text: Section 40A(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 the opinion that such expenditure is excessive or unreasonable… so much of the expenditure as is so considered by him shall not be allowed as a deduction.”

4. Who Are Treated as “Relatives” for This Purpose?

As per Explanation (b) to Section 40A(2):

The term includes (but is not limited to):

• Spouse of the individual

• Brother or sister of the individual

• Brother or sister of the spouse

• Any lineal ascendant or descendant of the individual or spouse

• Any individual having substantial interest in the business or profession of the assessee

Also includes entities in which such relatives have substantial interest.

5. Example Case:

Let’s say a sole proprietor pays ₹40,000/month salary to his brother for doing clerical work.

• If the market salary for such work is ₹20,000/month, then ₹20,000 may be considered excessive.

• The Assessing Officer (AO) can disallow ₹20,000/month as unreasonable expenditure under Section 40A(2).

6. What to Keep in Mind:

✅ Maintain proper documentation (appointment letter, qualification proof, work scope)
✅ Justify payment amount based on industry rates or FMV
✅ Avoid cash payments – use banking channels
✅ Make sure the relative actually works for the business

7. Clubbing of Income (Section 64): A Separate Concern

Even if salary paid to a spouse is reasonable, under Section 64(1)(ii):

If no technical or professional qualification is held by the spouse and she/he does not contribute substantially, the income is clubbed with the assessee’s income.

This is not a disallowance of expense, but clubbing of income for taxation.

✅ Conclusion:

💡 Payments to relatives are not outright disallowed, but only the unreasonable or excessive portion is disallowed under Section 40A(2).

Proper business justification, recordkeeping, and arm’s length payment are essential to ensure deduction is allowed.

As per Section 2(12A):

“Books or books of account” includes ledgers, day-books, cash books, account-books, and other books, whether kept in written form or as printouts of data stored in electronic media.”

Further Rule 6F prescribes specified Books to be Maintained by Professionals as below

1. Cash Book – Daily cash receipts and payments

2. Journal – Chronological record of transactions (if mercantile system)

3. Ledger – Summary of all accounts

4. Carbon copies of bills issued (if over ₹25)

5. Original bills for expenses above ₹50

Additional for Medical Professionals (Rule 6F(3)):

• Daily case register in Form No. 3C

• Inventory of medicines and consumables at year-end