Expenses Disallowed and Amounts Not Deductible (CA Final DT)

Understand Expenses Disallowed and Amounts Not Deductible

Key rules to remember

Cash payment disallowance

Expenditure (including a purchase of goods) for which payment to one person in one day > ₹10,000 is made otherwise than by account payee cheque/draft, bank electronic mode or other prescribed mode → whole expenditure disallowed

The rule applies to the expenditure incurred for which the payment is made, so it covers purchases and expenses alike, as long as the cost was debited to profit. Check how the purchase was debited. If it was routed through the trading account or stock, the disallowance still applies to that expenditure, so make the adjustment in the profit or stock figure. The limit is ₹35,000 per day for payment to a transporter for hiring goods carriage. The test is per person per day, not per year. Prescribed exceptions exist, such as payments to banks and the Government.

TDS default on payment to a resident

Disallowance = 30% × specified resident payment (such as interest, commission or brokerage, fees for professional or technical services, rent, contract payments), where tax was deductible but not deducted, or deducted but not deposited by the due date for filing the return

The 30% rule applies only to the specified payments to residents, not to every expense. The 30% disallowed is allowed in the year of deposit of the tax. This holds in both cases: the tax is deducted in a later year, or it was deducted in the year of expense and deposited after the return due date. No disallowance applies if the payee has paid the tax and furnished the required certificate.

TDS default on payment to a non-resident

Disallowance = 100% × expense, where the sum is paid to a non-resident (or outside India), is chargeable to tax in India, and tax was deductible but not deducted, or deducted but not deposited by the due date for filing the return

Applies to interest, royalty, fees for technical services and other sums chargeable to tax in India. The trigger is that the sum is chargeable in India and tax was deductible on it. The expense is allowed in the year of deposit of the tax, both where the tax is deducted in a later year and where it was deducted in the year of expense and deposited after the return due date.

Payment-basis items with return-due-date relief

Allowed in the year of provision only if actually paid on or before the due date for filing the return; otherwise allowed in the year of actual payment

Covers statutory dues like tax, duty, cess and fee (the liability itself must actually be paid by the return due date; a mere provision is not enough); employer's own contribution to PF/ESI and similar funds; bonus or commission to employees; and interest on loans from specified banks and institutions. For this interest, actual payment by the return due date is needed. Converting unpaid interest into a loan or borrowing is not treated as payment, so it stays disallowed until actually paid. The conditions differ for each item, so check each one. Employee's contribution is not in this group; see the next rows.

Payment-basis items with no return-due-date relief

Leave encashment: allowed only in the year of actual payment. Sums owed to micro and small enterprises beyond the permitted period (15 or 45 days, as applicable): disallowed in the year of expense and allowed only in the year of actual payment

Paying these after the year-end but before the return due date does not bring the deduction back into the year of provision. Do not group them with bonus or statutory dues.

Employee's contribution

Allowed only if deposited within the due date under the relevant Act, which is stricter than the return due date

Employer's own contribution is different: it is allowed if deposited by the due date for filing the return. Do not apply one date to both.

Related person payments

Disallowed = Amount paid − Amount that would be reasonable as per fair market value or the business need

Only the excess or unreasonable part is disallowed. Apply it to an expense paid to a related person, as defined, for goods, services or facilities.

Other amounts not deductible

Income-tax and its surcharge or cess, and fines or penalties for breach of law: not deductible

Do not confuse these with allowable business levies such as GST on inputs, which follow their own treatment.

How to solve Expenses Disallowed and Amounts Not Deductible questions

1. 1Note the starting figure. Check whether the listed expenses were already debited to the profit and loss account. Add back only what was debited.
2. 2Go through each expense in order. Ask which category it falls in: cash payment, TDS default, related person, payment-basis item, or an ordinary allowable expense.
3. 3For cash payments, apply the rule to the expenditure (including a purchase of goods) for which the payment was made. Check the per-person, per-day total, the mode of payment and the limit (₹10,000, or ₹35,000 for transporters). If it fails, add back the whole expenditure that was paid for.
4. 4For TDS, check whether tax was deductible, whether it was deducted, when it was deposited, and whether the payee is a resident (30%) or non-resident (100%).
5. 5For payment-basis items, find the payment date. Compare it with the required date (the return due date or the due date under the specific law). Add back what was unpaid. For leave encashment and overdue micro and small enterprise dues, only actual payment counts. For interest on loans from specified banks and institutions, converting unpaid interest into a loan is not payment.
6. 6For related persons, compare the amount with a reasonable or fair market amount. Add back only the excess.
7. 7Total the add-backs and state which are permanent and which are allowed in a later year, naming that year.
8. 8Present the final computation clearly and note any assumption, such as the return due date.

Quickest way: Three-question screen per expense

Common mistakes in Expenses Disallowed and Amounts Not Deductible

• Applying 30% to a payment to a non-resident where TDS was not deducted.

  Students remember '30%' as the TDS-default rule and apply it to every payee.

  Fix: Look at the residential status of the payee first. The 30% rate is for residents. For non-residents the whole amount is disallowed.

• Testing the cash limit on the annual total or on each bill instead of per person per day.

  The question gives several payments, and students either add them all up or treat each separately.

  Fix: Group payments by person and by date. Add up the same-day payments to that one person and compare with the limit. Payments to different persons or on different days are not added.

• Disallowing a timing item permanently.

  Students stop after adding back the amount and forget that it is deductible when paid.

  Fix: For payment-basis items and TDS defaults, state the year in which the deduction will be available once the payment or deposit is made.

• Disallowing only the amount of TDS that was not deducted, rather than the expense.

  The words 'non-deduction of tax' make students think of the tax amount.

  Fix: The disallowance is a percentage of the expense on which tax was deductible, not the tax itself.

• Disallowing the whole payment to a related person.

  Students treat any related-party payment as suspect.

  Fix: Disallow only the part that is excessive or unreasonable compared with the fair market value or business need. If it is reasonable, nothing is disallowed.

• Adding back an expense that was never debited to the profit and loss account.

  Students apply the rule mechanically without checking how the books treated the item.

  Fix: Start every add-back with the question: was this charged to profit? If not, there is nothing to add back.

Worked examples