Background:

In order to deter cash transactions, section 40A(3) was incorporated in the Income Tax Act, 1961 (IT Act). As per this section, a taxpayer who incurs cash expenditure in excess of INR 10,000 (reduced from INR 20,000 by Finance Act, 2017) shall not be deductible for the purpose of computing taxable business income. However, considering that there could be genuine hardship faced by the taxpayer, Rule 6DD of the Income Tax Rules, 1962 (IT Rules) lists down circumstances where section 40A(3) of the IT Act shall not apply. With globalisation, setting-up an overseas office or movement of employees across the globe for overseas business is now a common phenomenon. Duringoverseas operations, often these offices or employees are required to incur cash expenses to meet their daily requirements. Hence, generally, a question arises as to whether disallowance under section 40A(3) of the IT Act is attracted when cash expenses (exceeding the threshold limit) are incurred overseas.

Recently, the Mumbai Tax Tribunal¹ had an occasion to examine whether disallowance under section 40A(3) of the IT Act is attracted when the cash expenses are incurred in foreign currency abroad. We, at BDO in India, have summarised the ruling of Mumbai Tribunal and provided our comments on the impact of this decision.

Facts of the case:

Taxpayer, an Indian Partnership Firm, is engaged in the business of manufacturing and export of garments. During the fiscal year 2013-14, the taxpayer had claimed deduction for foreign travel expenses of INR 6mn in its tax return. The tax officer observed that out of this amount, INR 3.15mn was incurred towards exhibition charges. This amount was paid in cash in foreign currency abroad. Further, the tax officer also observed that the taxpayer could not furnish any details or evidence in support of actual expenditure except for cash memos obtained from the commission agents to whom the taxpayer had also paid commission. Referring to section 40A(3) of the IT Act, the Tax Officer disallowed INR 3.15mn by observing that the taxpayer has incurred expenses in cash exceeding the amount of INR 20,000 in a day. On appeal, the First Appellate Authority confirmed the disallowance made by the tax officer.

Tribunal ruling:

Before the Tax Tribunal, the taxpayer submitted that section 40A(3) of the IT Act should not be attracted when the expenditure incurred in cash in foreign currency since the word used in the section is ‘rupee’ and it does not refer to foreign currency. Further, the taxpayer also contended that the provisions of the IT Act cannot be applied outside the territory of India. It also contended that if section 40A(3) of the IT Act is attracted, the exceptions laid down in Rule 6DD of the Rules should be available as the taxpayer did not have a bank account in the foreign country.

Revenue Authorities submitted that merely because section 40A(3) of the IT Act uses the term ‘rupee’, it cannot be construed that the said provisions are not applicable to expenditure incurred in foreign currency. If the taxpayer’s contention is accepted, then it would be impossible to mention the currencies of all the countries in the provisions of the IT Act. Therefore, the provisions of section 40A(3) of the IT Act cannot be interpreted in literal sense.

The Tax Tribunal considered the submissions made by the taxpayer as well as the Revenue Authorities. The Tax Tribunal held that section 40A(3) of the IT Act is attracted on the expenses incurred in cash in foreign currency abroad by making following observations:

• The word ‘rupee’ in section 40A(3) of the IT Act cannot be interpreted in limited or narrow sense to mean only cash expenditure incurred in rupee. The expression means expenditure incurred exceeding the particular amount in rupee terms. Therefore, merely because the expression ‘rupee’ has been mentioned in section 40A(3) of the IT Act, it would not debar the applicability of the provision to expenditure incurred in cash in foreign currency.
• The provision of section 40A(3) of the IT Act makes the intention of the legislature quite clear to disallow any expenditure incurred in cash whether in Indian currency or in foreign currency, if it exceeds the amount of INR 20,000 in rupee term. Considering the fact that cash expenditure may be incurred in various countries having different currencies, it would not have been possible for the legislature to mention the currency of all the countries in the world in section 40A(3) of the IT Act. Therefore, the provision has to be interpreted in a manner to mean cash expenditure equivalent to more than INR 20,000 in a day.
• The Taxpayer has debited expenditure in the Profit and Loss Account in rupee terms. Therefore, for avoiding applicability of section 40(A)(3) of the IT Act, the Taxpayer cannot claim that expenditure having been incurred in foreign currency is outside the purview of section 40A(3) of the IT Act. If this contention is accepted, it will create an anomalous situation, as a taxpayer who incurs cash expenditure in India exceeding INR 20,000 will face the rigors of section 40A(3) of the IT Act whereas another person who incurs unlimited cash expenditure abroad in foreign currency would go scot free. This cannot be the intention of the legislature while enacting section 40A(3) of the IT Act.
• With respect to territorial application of the IT Act to expenditure incurred overseas, the Tax Officer has all the powers to examine the allowability of such expenditure under the provisions of the IT Act while making assessment of the taxpayer. That being the case, it cannot be said that the provisions of section 40A(3) of the IT Act would not be applicable.
• With respect to applicability of Rule 6DD of the IT Rules, there is no specific clause therein which can come to the aid of the taxpayer. Even accepting that the taxpayer could not have issued cheque, there are many other ways open for making the payment through proper banking channels.

BDO comments:

This is an important Ruling as it touches upon the deductibility of cash expenses incurred in foreign currency outside India. Foreign travelling for work purpose is a usual aspect of business. Many Indian taxpayers may not have foreign bank accounts and hence there could be genuine difficulty in meeting various routine / general expenses overseas. More often than not, these expenses were incurred in cash. Now, in light of this Ruling, such expenses (if they cross the threshold) would not be deductible for the purpose of computing taxable business income. With the threshold limit reduced to INR 10,000 it is imperative that the taxpayer has a system in place so that foreign currency expenditure in cash does not exceed equivalent of INR 10,000. However, the Ruling is silent on the exchange rate that should be considered for determining the Rupee equivalent cash expenditure incurred in foreign currency.

Source : https://www.bdo.in/en-gb/insights/alerts-updates/direct-tax-alert-cash-expenses-in-foreign-currency-incurred-abroad-attracts-disallowance-under-sect