Section 40(A) 2: Disallowances of Expenses to Specified Person
If you are running a business or a profession you are allowed to claim its expenses from your income. However, these expenses may not be allowed if you make payments to specified persons who are listed in the Income Tax Act. Where payment made to them is excessive or unreasonable and not according to the fair market value of goods or services provided, you may not be able to claim it. The assessing officer may not allow you to claim expenses for payments made to specified persons ( as per Section 40A(2) of the Income Tax Act ) if :
- Payment is to be made to certain specified persons
AND
- Income Tax Officer believes that such expenditure is excessive or unreasonable with regard to the fair market value of the goods, services or facilities provided.
If both the above conditions are fulfilled, the Income Tax
Officer can disallow the expenditure to the extent he considers it excessive or
unreasonable.
Who is the Specified Person?
There is a list of specified persons mentioned in the Income Tax Act. Specified Person includes the relatives also. But before we discuss the list of specified persons, we should know the meaning of substantial interest.
Substantial Interest
A person will be considered to have a substantial interest in the business or profession on satisfying the conditions below.
- In the case of a company carrying on business or profession, the person owning at least 20% voting power at any time during the year shall be called as someone who has a substantial interest in the company.
For instance
If in ABC Pvt ltd, X1 firm holds 23% equity shares of the ABC ltd, then X1
firm shall have Substantial Interest in the company.
- In any other case such as firm, an association of persons and a sole proprietorship, a person entitled to at least 20% of profits made by the business or profession during the year shall be deemed to have Substantial Interest in such business or profession.
The list of specified persons in case of different categories of taxpayers for imposing the provisions of section 40A(2) are as follows:
Individuals
- Relatives of Individual such as a spouse, brother, sister, lineal ascendant or descendant of the individual like parents, grandparents, son, daughter etc.
- Any person in whose business or profession, individual himself or his relative has a substantial interest.
For instance
Mr Ashok who is running a business has 22 % shares in X ltd. Now any amount
paid/payable by Mr Ashok to X ltd will be subject to the category of
specified person under Section 40 A(2)(b)
Company, Firm or HUF
- Director(s) of the company, partners in a firm, members of HUF or association of persons. Also, the family member or relative of such director, partner or member will be considered as specified persons.
- Any person in whose business or profession, such director or partner or member himself or relative of such person has a substantial interest
For instance
If the relative of the director of X1 ltd is entitled to a 22% share of profits in
ABC firm, then ABC firm ltd will be considered as a specified person to X1 ltd in
case of any business transaction between the two
OR
For instance
If the relative of the director of X1 ltd is entitled to a 22% share of profits in
ABC firm, then ABC firm ltd will be considered as a specified person to X1 ltd in
case of any business transaction between the two
In any other case of a taxpayer
An individual who has a substantial interest in the business or profession run by the taxpayer.
For instance
Mr Puneet is entitled to a 25% share of Abc firm, then he shall deem to be
specified person to ABC firm in case of any business transaction between the
two.
A company, firm, AOP or HUF which has a substantial interest in the business or profession run by the Also the director of the company or partner of the firm or member of HUF and AOP along with their relatives which has a substantial interest in the business or profession run by the taxpayer shall be deemed to be specified persons.
For instance
if director ABC ltd is entitled to 25% of the profits in the business run by Mr
Rahul. Then ABC Ltd shall be deemed to be a specified person to Mr Rahul in case of
any business transaction between the two.
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