Expenses Disallowed – Personal & Non-business Expenses

Even if an expense is for genuine business, it might be disallowed if you break tax rules! Did you pay cash above ₹10,000? Did you forget to deduct TDS? These mistakes add to your taxable profit.

Why are Expenses Disallowed?

To ensure compliance! The Income Tax Act disallows expenses/deductions to punish non-compliance (like cash usage, late tax payments) or prevent tax base erosion.

Effect: Disallowed expense = Added back to Net Profit = Higher Tax

1. General Disallowances (Section 40)

Section 40(a)(i) & 40(a)(ia): Default in TDS

If you fail to deduct TDS or deposit TDS on time:

• Payment to Non-Resident (Outside India): 100% Disallowed if TDS not deducted/paid.
• Payment to Resident (In India): 30% Disallowed if TDS not deducted/paid.

Cure: If you deduct/pay the TDS in a later year, the disallowed amount is allowed in that later year.

Example:

• Paid ₹1,00,000 to a contractor (Resident) without TDS.
• Disallowance: 30% of ₹1L = ₹30,000 added to profit.
• Remaining ₹70,000 is allowed.

Section 40(a)(ii): Income Tax / Wealth Tax

Any rate or tax levied on profits (like Income Tax) is fully disallowed. You cannot claim income tax paid as a business expense.

Section 40(b): Payment to Partners (Partnership Firms)

• Interest to Partners: Allowed max 12% p.a. (excess is disallowed). Must be authorized by deed.
• Remuneration to Working Partners: Subject to limits based on Look Profit:
  • First ₹3L book profit: ₹1,50,000 or 90% (higher).
  • Balance profit: 60%.

2. Cash Payments > ₹10,000 (Section 40A(3))

Rule: Any expenditure > ₹10,000 in a single day to a single person must be paid by Account Payee Cheque/Draft/ECS.

Violation: If paid in CASH (or bearer cheque) > ₹10,000, 100% amount is Disallowed.

Exceptions (Rule 6DD):

• Payment to banks/govt (taxes).
• Payment to cultivators/farmers for produce.
• Payment in places with no banking facility.
• Payment for terminal benefits < ₹50,000.

Example:

• Purchased goods for ₹15,000 cash.
• Disallowance: ₹15,000 (Full amount added back).

3. Provision for Gratuity (Section 40A(7))

Provision for future gratuity is disallowed. Only contribution to Approved Gratuity Fund or actual gratuity paid is allowed.

4. Statutory Dues Unpaid (Section 43B)

Certain expenses are allowed only on ACTUAL PAYMENT basis, irrespective of accounting method.

List of 43B Items:

1. Tax, Duty, Cess (GST, Customs, Excise).
2. Employer's Contribution to PF/Superannuation/Gratuity fund.
3. Bonus or Commission to employees.
4. Interest on Loan from Banks/Institutions/NBFCs.
5. Leave Encashment.
6. Payment to MSMEs (New! Within 15/45 days).

Timing Rule:

• Paid generally: Allowed in the year of payment.
• Exception: If paid before the due date of filing ITR (July/Sept/Oct), it is deemed paid in the previous year (accrual basis valid).

Example:

• GST Liability for March 2025: ₹50,000.
• Paid on Sept 15, 2025 (Before ITR date).
• Allowed in FY 2024-25? YES, because paid before ITR deadline.
• If paid in December 2025? Disallowed in FY 24-25, allowed in FY 25-26.

5. Expenses for Exempt Income (Section 14A)

Expenses incurred to earn exempt income (like agriculture) are Disallowed.

• You cannot deduct salary of a farm manager if agricultural income is exempt.

6. Personal & Non-Business Expenses

Already covered under Section 37, but worth repeating:

• Personal drawings or household expenses.
• Charities/Donations (claim 80G separately, not business expense).
• Capital Expenditure.

Practical Problem: Adjusting Profit

Profit & Loss A/c showed Net Profit: ₹10,00,000. Adjust for:

1. Paid ₹20,000 cash for office repairs.
2. Paid ₹50,000 salary to resident without TDS.
3. Income Tax provision ₹1,00,000 debited.
4. Outstanding GST ₹40,000 (paid after ITR filing).

Solution:

1. Profit: ₹10,00,000
2. Add Backs:
   • Cash Payment (>10k): +₹20,000 (40A(3))
   • Salary (30% disallowed): +₹15,000 (30% of 50k - 40(ia))
   • Income Tax: +₹1,00,000 (40(a)(ii))
   • Unpaid GST: +₹40,000 (43B - paid late)
3. Taxable Business Income: ₹11,75,000

Summary Table

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