I paid cash for stock purchases. Can the AO disallow it under 40A(3), and is that section even valid?
The section is valid and it does reach cash payments for purchases of stock-in-trade — the constitutional challenge was dismissed. But it cannot be read in isolation from Rule 6DD: considerations of business expediency and other relevant factors are not excluded, and you may show the circumstances in which payment by crossed cheque or crossed bank draft was not practicable.
Decided by the Supreme Court (K. Jagannatha Shetty and Yogeshwar Dayal, JJ. (judgment delivered by Shetty, J.)) on 1991-08-07, reported as (1991) 191 ITR 667 (SC); 97 CTR 251 (SC); 59 Taxman 11 (SC); [1991] 3 SCR 406. It bears on section 40A(3), section Rule 6DD of the Income Tax Act 1961, in Deductions & Disallowances and Cash Transaction Limits matters.
This is the case the department cites, so read it as the other side's authority first: it forecloses the arguments that s.40A(3) is unconstitutional, that it restricts business activity, or that stock purchases fall outside it. What it leaves you is the escape route the Court itself described — the section regulates rather than prohibits, its object is to check circulation of black money and let the authorities verify payments, and genuine and bona fide transactions are not taken out of its sweep by the mere fact of cash. Practically, every cash-purchase disallowance turns on Rule 6DD and expediency, not on the validity of the section.
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A batch of appeals and a special leave petition, led by Civil Appeal No. 11 of 1991. The assessees had made cash payments exceeding Rs.2,500 for some of their purchases of stock-in-trade, and those payments were disallowed in computing income under the head profits and gains of business or profession as being in contravention of s.40A(3) read with rule 6DD. Two questions were argued: the validity of s.40A(3), and whether it applies at all to payments made for acquiring stock-in-trade. The judgment records that s.40A(3) originally required payments above Rs.2,500 to be made by crossed cheque or crossed bank draft, and that the Amending Act, 1987 raised that ceiling to Rs.10,000 in order to remove hardship to smaller assessees, so that the provision and rule are set out in the judgment at the Rs.10,000 figure. The lead appeal came from the Punjab and Haryana High Court, whose judgment is reported at [1982] 136 ITR 589.
All the appeals and the special leave petition were dismissed with costs (para 9). On validity, the contention that disallowing the purchase price produces a levy on assumed income and so restricts the right to carry on business was held to have little merit: s.40A(3) read with rule 6DD is not intended to restrict business activities, there is no restriction on the assessee's trading, and the section only empowers the Assessing Officer to disallow a deduction where payment is not made by crossed cheque or crossed bank draft (para 7). The terms of the section are not absolute; considerations of business expediency and other relevant factors are not excluded, and genuine and bona fide transactions are not taken out of its sweep (para 7). On the second question, 'expenditure' is undefined and is a word of wide import, taking in all outgoings, so payments for stock-in-trade are covered and may be disallowed; rule 6DD itself contemplates payments for stock-in-trade and raw materials (para 8). The contrary view of the Gauhati High Court in CIT v. Hardware Exchange, that a payment for stock-in-trade is not 'expenditure incurred' because the money does not go out irretrievably, was expressly rejected (para 8).
Payment by crossed cheque or crossed bank draft is insisted on so that the assessing authority can ascertain whether a payment was genuine and whether it came out of income from disclosed sources. The assessee remains free to satisfy the Assessing Officer of the circumstances in which payment in the prescribed manner was not practicable or would have caused genuine difficulty to the payee, and to identify the person who received the cash; rule 6DD then exempts him. Read together, section and rule are intended to regulate business transactions and to prevent or reduce the use of unaccounted money, and in interpreting a taxing statute the Court cannot be oblivious of the proliferation of black money in circulation in the country - so any restraint intended to curb the chances and opportunities to use or create black money should not be regarded as curtailing the freedom of trade or business (para 7). On 'expenditure', the value of stock-in-trade has to be taken into account in determining gross profits under s.28 on principles of commercial accounting, so payments for purchases fall within the word; and rule 6DD's own exemptions for purchases of certain agricultural and horticultural commodities, and for payments in a village with no banking facility, confirm that the section was meant to reach such purchases (para 8).
The terms of section 40A(3) are not absolute. Consideration of business expediency and other relevant factors are not excluded.
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Handle my notice → Ask a CA on WhatsAppThe section is valid and it does reach cash payments for purchases of stock-in-trade — the constitutional challenge was dismissed. But it cannot be read in isolation from Rule 6DD: considerations of business expediency and other relevant factors are not excluded, and you may show the circumstances in which payment by crossed cheque or crossed bank draft was not practicable. This was decided by the Supreme Court (K. Jagannatha Shetty and Yogeshwar Dayal, JJ. (judgment delivered by Shetty, J.)) and bears on section 40A(3), section Rule 6DD of the Income Tax Act 1961. It is reported as (1991) 191 ITR 667 (SC); 97 CTR 251 (SC); 59 Taxman 11 (SC); [1991] 3 SCR 406. This is the case the department cites, so read it as the other side's authority first: it forecloses the arguments that s.40A(3) is unconstitutional, that it restricts business activity, or that stock purchases fall outside it. What it leaves you is the escape route the Court itself described — the section regulates rather than prohibits, its object is to check circulation of black money and let the authorities verify payments, and genuine and bona fide transactions are not taken out of its sweep by the mere fact of cash. Practically, every cash-purchase disallowance turns on Rule 6DD and expediency, not on the validity of the section. If it applies to you, the first step is this: Frame the reply around Rule 6DD and the circumstances that made payment in the prescribed mode impracticable, with dates, place, banking hours and the payee's insistence, rather than on the genuineness of the purchase alone.
A batch of appeals and a special leave petition, led by Civil Appeal No. 11 of 1991. The assessees had made cash payments exceeding Rs.2,500 for some of their purchases of stock-in-trade, and those payments were disallowed in computing income under the head profits and gains of business or profession as being in contravention of s.40A(3) read with rule 6DD. Two questions were argued: the validity of s.40A(3), and whether it applies at all to payments made for acquiring stock-in-trade. The judgment records that s.40A(3) originally required payments above Rs.2,500 to be made by crossed cheque or crossed bank draft, and that the Amending Act, 1987 raised that ceiling to Rs.10,000 in order to remove hardship to smaller assessees, so that the provision and rule are set out in the judgment at the Rs.10,000 figure. The lead appeal came from the Punjab and Haryana High Court, whose judgment is reported at [1982] 136 ITR 589. The matter was decided on 1991-08-07 by the Supreme Court (K. Jagannatha Shetty and Yogeshwar Dayal, JJ. (judgment delivered by Shetty, J.)). On those facts the Supreme Court held as follows. All the appeals and the special leave petition were dismissed with costs (para 9). On validity, the contention that disallowing the purchase price produces a levy on assumed income and so restricts the right to carry on business was held to have little merit: s.40A(3) read with rule 6DD is not intended to restrict business activities, there is no restriction on the assessee's trading, and the section only empowers the Assessing Officer to disallow a deduction where payment is not made by crossed cheque or crossed bank draft (para 7). The terms of the section are not absolute; considerations of business expediency and other relevant factors are not excluded, and genuine and bona fide transactions are not taken out of its sweep (para 7). On the second question, 'expenditure' is undefined and is a word of wide import, taking in all outgoings, so payments for stock-in-trade are covered and may be disallowed; rule 6DD itself contemplates payments for stock-in-trade and raw materials (para 8). The contrary view of the Gauhati High Court in CIT v. Hardware Exchange, that a payment for stock-in-trade is not 'expenditure incurred' because the money does not go out irretrievably, was expressly rejected (para 8).
Payment by crossed cheque or crossed bank draft is insisted on so that the assessing authority can ascertain whether a payment was genuine and whether it came out of income from disclosed sources. The assessee remains free to satisfy the Assessing Officer of the circumstances in which payment in the prescribed manner was not practicable or would have caused genuine difficulty to the payee, and to identify the person who received the cash; rule 6DD then exempts him. Read together, section and rule are intended to regulate business transactions and to prevent or reduce the use of unaccounted money, and in interpreting a taxing statute the Court cannot be oblivious of the proliferation of black money in circulation in the country - so any restraint intended to curb the chances and opportunities to use or create black money should not be regarded as curtailing the freedom of trade or business (para 7). On 'expenditure', the value of stock-in-trade has to be taken into account in determining gross profits under s.28 on principles of commercial accounting, so payments for purchases fall within the word; and rule 6DD's own exemptions for purchases of certain agricultural and horticultural commodities, and for payments in a village with no banking facility, confirm that the section was meant to reach such purchases (para 8). In the words reproduced by the source cited on this page: "The terms of section 40A(3) are not absolute. Consideration of business expediency and other relevant factors are not excluded." The decision followed or applied Mudiam Oil Co. v. ITO [1973] 92 ITR 519 (AP) (approved); Ratan Udyog v. ITO [1977] 109 ITR 1 (All.) (approved); P.R. Textiles v. CIT [1980] 121 ITR 237 (Ker.) (approved); CIT v. New Light Tin Mfg. Co. [1980] 121 ITR 229 (P&H) (approved); Fakri Automobiles v. CIT [1986] 160 ITR 504 (Raj.) (approved); Akash Films v. CIT [1991] 190 ITR 32 (Kar.) (approved); Attar Singh Gurmukh Singh v. ITO [1982] 136 ITR 589 (P&H) (affirmed); Sajowanlal Jaiswal v. CIT [1976] 103 ITR 706 (Ori.) (affirmed); U.P. Hardware Store v. CIT [1976] 104 ITR 664 (All.) (affirmed); CIT v. Hardware Exchange [1991] 190 ITR 61 (Gauhati) (reversed).
It was decided by the Supreme Court on 1991-08-07 and is reported as (1991) 191 ITR 667 (SC); 97 CTR 251 (SC); 59 Taxman 11 (SC); [1991] 3 SCR 406. Binding on every court and authority in India. A Supreme Court decision binds every assessing officer, every Commissioner (Appeals), every bench of the Income Tax Appellate Tribunal and every High Court in India. An officer who declines to follow it is acting contrary to law, and that refusal is itself a ground of appeal. On section 40A(3), section Rule 6DD, the practical question is whether the facts of your own notice match the facts of this case closely enough for the same rule to apply.
It helps the department, and it appears in this library for that reason — you need to know what the Assessing Officer will cite against you. All the appeals and the special leave petition were dismissed with costs (para 9). On validity, the contention that disallowing the purchase price produces a levy on assumed income and so restricts the right to carry on business was held to have little merit: s.40A(3) read with rule 6DD is not intended to restrict business activities, there is no restriction on the assessee's trading, and the section only empowers the Assessing Officer to disallow a deduction where payment is not made by crossed cheque or crossed bank draft (para 7). The terms of the section are not absolute; considerations of business expediency and other relevant factors are not excluded, and genuine and bona fide transactions are not taken out of its sweep (para 7). On the second question, 'expenditure' is undefined and is a word of wide import, taking in all outgoings, so payments for stock-in-trade are covered and may be disallowed; rule 6DD itself contemplates payments for stock-in-trade and raw materials (para 8). The contrary view of the Gauhati High Court in CIT v. Hardware Exchange, that a payment for stock-in-trade is not 'expenditure incurred' because the money does not go out irretrievably, was expressly rejected (para 8). It arises in Deductions & Disallowances and Cash Transaction Limits matters, on section 40A(3), section Rule 6DD of the Income Tax Act 1961, and was decided by K. Jagannatha Shetty and Yogeshwar Dayal, JJ. (judgment delivered by Shetty, J.). Before relying on it, read the source linked on this page and check whether it has since been distinguished, overruled or overtaken by an amendment to the Income Tax Act. In practice the steps that follow from it are these. Do not rest the reply on genuineness alone, because the Court said in terms that genuine and bona fide transactions are not taken out of the sweep of the section. Drop any challenge to the validity of s.40A(3) or any argument that it does not apply to stock-in-trade; both were rejected here. Check the monetary limit and the mode of payment permitted for the year you are dealing with before you compute the disallowance.
Still good law. Applied by the Madras High Court in Arasappan Madhivanan v. ITO [2025] 173 taxmann.com 876 / [2025] 476 ITR 169 (Mad.), decided 7 November 2024, which relied on it in holding that the operation of s.40A(3) is absolute and that rule 6DD carves out exceptions only in the situations the rule itself identifies (para 20), and which quotes the same court in Mrs. R. Thiruvengadam v. ACIT [2019] 108 taxmann.com 487 (Mad.) applying this decision to hold that s.40A(3) covers payments made for acquiring stock-in-trade (para 22). This decision affirmed the Punjab and Haryana High Court judgment in the same matter, [1982] 136 ITR 589. No source could be cited for that finding. Checking whether an authority still stands matters as much as knowing what it held: a decision may be overruled on one point and survive on another, or the provision it interprets may have been amended since. Read the source and the editor's note on this page before relying on it in a reply to an Assessing Officer or in an appeal.
Read the figures and the mechanics carefully before applying this case. The payments in issue exceeded Rs.2,500, and the judgment itself records that the Amending Act, 1987 raised that ceiling to Rs.10,000 to relieve smaller assessees (para 4). As the Madras High Court sets out the current text in Arasappan Madhivanan v. ITO [2025] 476 ITR 169 (Mad.), the limit today is Rs.10,000 for a payment or aggregate of payments to a person in a day, and the permitted modes are an account payee cheque, an account payee bank draft, the electronic clearing system through a bank account, or another electronic mode prescribed by rule 6ABBA - so the crossed cheque and crossed bank draft language of this judgment no longer states the requirement. Note also the balance of the decision: it is an unqualified win for the revenue, and the observation at para 7 that business expediency and other relevant factors are not excluded operates through rule 6DD, not as a general escape from the section. The second holding, at para 8, that payments for stock-in-trade are 'expenditure' within the section, reversed the Gauhati High Court in CIT v. Hardware Exchange [1991] 190 ITR 61. The present-day threshold and the permitted modes of payment are taken from the text of s.40A(3) and rule 6DD as set out in Arasappan Madhivanan v. ITO [2025] 476 ITR 169 (Mad.), not from a statutory source fetched directly. This library shows the verification state of every entry openly. This entry has not yet been read in full by a chartered accountant. The summary reflects the sources listed on this page. Read the source before you rely on it in a reply to an Assessing Officer or in an appeal before the Commissioner (Appeals) or the Income Tax Appellate Tribunal.
All the appeals and the special leave petition were dismissed with costs (para 9). On validity, the contention that disallowing the purchase price produces a levy on assumed income and so restricts the right to carry on business was held to have little merit: s.40A(3) read with rule 6DD is not intended to restrict business activities, there is no restriction on the assessee's trading, and the section only empowers the Assessing Officer to disallow a deduction where payment is not made by crossed cheque or crossed bank draft (para 7). The terms of the section are not absolute; considerations of business expediency and other relevant factors are not excluded, and genuine and bona fide transactions are not taken out of its sweep (para 7). On the second question, 'expenditure' is undefined and is a word of wide import, taking in all outgoings, so payments for stock-in-trade are covered and may be disallowed; rule 6DD itself contemplates payments for stock-in-trade and raw materials (para 8). The contrary view of the Gauhati High Court in CIT v. Hardware Exchange, that a payment for stock-in-trade is not 'expenditure incurred' because the money does not go out irretrievably, was expressly rejected (para 8).
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