{"id":57897,"date":"2023-06-06T19:01:10","date_gmt":"2023-06-06T13:31:10","guid":{"rendered":"https:\/\/corpbiz.io\/learning\/?p=57897"},"modified":"2023-06-06T19:01:12","modified_gmt":"2023-06-06T13:31:12","slug":"section-40a2-of-income-tax-act","status":"publish","type":"post","link":"https:\/\/corpbiz.io\/learning\/section-40a2-of-income-tax-act\/","title":{"rendered":"Section 40A(2) of Income Tax Act \u2013 A Complete Analysis"},"content":{"rendered":"\n<p>Section 40A(2) talks explicitly about\nthe payment of an expenditure to a related person. This means that if you have\npurchased some goods from a person who is your relative and made payment for\nthose goods and services will come under Section 40A(2) of Income Tax Act. The main aim behind\nincorporating Section 40A(2) is\nto stop tax planning.<\/p>\n\n\n\n<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_82_2 counter-hierarchy ez-toc-counter ez-toc-grey ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title ez-toc-toggle\" style=\"cursor:pointer\">Page Contents<\/p>\n<span class=\"ez-toc-title-toggle\"><a href=\"#\" class=\"ez-toc-pull-right ez-toc-btn ez-toc-btn-xs ez-toc-btn-default ez-toc-toggle\" aria-label=\"Toggle Table of Content\"><span class=\"ez-toc-js-icon-con\"><span class=\"\"><span class=\"eztoc-hide\" style=\"display:none;\">Toggle<\/span><span class=\"ez-toc-icon-toggle-span\"><svg style=\"fill: #999;color:#999\" xmlns=\"http:\/\/www.w3.org\/2000\/svg\" class=\"list-377408\" width=\"20px\" height=\"20px\" viewBox=\"0 0 24 24\" fill=\"none\"><path d=\"M6 6H4v2h2V6zm14 0H8v2h12V6zM4 11h2v2H4v-2zm16 0H8v2h12v-2zM4 16h2v2H4v-2zm16 0H8v2h12v-2z\" fill=\"currentColor\"><\/path><\/svg><svg style=\"fill: #999;color:#999\" class=\"arrow-unsorted-368013\" xmlns=\"http:\/\/www.w3.org\/2000\/svg\" width=\"10px\" height=\"10px\" viewBox=\"0 0 24 24\" version=\"1.2\" baseProfile=\"tiny\"><path d=\"M18.2 9.3l-6.2-6.3-6.2 6.3c-.2.2-.3.4-.3.7s.1.5.3.7c.2.2.4.3.7.3h11c.3 0 .5-.1.7-.3.2-.2.3-.5.3-.7s-.1-.5-.3-.7zM5.8 14.7l6.2 6.3 6.2-6.3c.2-.2.3-.5.3-.7s-.1-.5-.3-.7c-.2-.2-.4-.3-.7-.3h-11c-.3 0-.5.1-.7.3-.2.2-.3.5-.3.7s.1.5.3.7z\"\/><\/svg><\/span><\/span><\/span><\/a><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 eztoc-toggle-hide-by-default' ><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/corpbiz.io\/learning\/section-40a2-of-income-tax-act\/#Tax_Planning_with_Relatives\" >Tax Planning with Relatives<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/corpbiz.io\/learning\/section-40a2-of-income-tax-act\/#What_is_Section_40A2_of_the_Income_Tax_Act\" >What is Section 40A(2) of the Income Tax Act?<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/corpbiz.io\/learning\/section-40a2-of-income-tax-act\/#Payment_for_Needs_of_Business\" >Payment for Needs of Business<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-4\" href=\"https:\/\/corpbiz.io\/learning\/section-40a2-of-income-tax-act\/#Who_are_Related_Persons\" >Who are Related Persons?<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-5\" href=\"https:\/\/corpbiz.io\/learning\/section-40a2-of-income-tax-act\/#Understanding_Substantial_Interest\" >Understanding Substantial Interest<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-6\" href=\"https:\/\/corpbiz.io\/learning\/section-40a2-of-income-tax-act\/#Conclusion\" >Conclusion<\/a><\/li><\/ul><\/nav><\/div>\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Tax_Planning_with_Relatives\"><\/span>Tax Planning with Relatives<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>In order to pay less tax, people usually use certain methods and show less income. For showing less income, they opt for <strong><a href=\"https:\/\/corpbiz.io\/income-tax-basics-for-beginners\">tax planning<\/a><\/strong> in a way that they pay a certain amount to their relatives in the form of salary, wages, etc. This way, they will have to pay less taxes.<\/p>\n\n\n\n<p>For example, Mr A earns a total income\nof 75 lakhs to 100 lakhs, on which various tax slabs, surcharge, and cess is\napplicable. Now, he has six family members who have no income. To avoid higher\ntaxes, he used to divide his income among his family members to give less tax\nas lower slab rates would be applicable on a lower income.<\/p>\n\n\n\n<ul><li><strong>Tax Planning while Purchasing Raw Materials<\/strong><\/li><\/ul>\n\n\n\n<p>This is done in a way as, for example,\nMr A, who is involved in the manufacturing business, has to buy raw materials. Now,\none of his relatives purchases raw material from the market for Rs 100 and\nsells them to A for Rs 150. The Rs 50 profit will be the income of the\nrelative, and the profit of A will be reduced by that amount. In this way, the\ntax planning is done in a way to show a huge amount of income in the hands of\nrelatives, thereby reducing the profit of Mr A.<\/p>\n\n\n\n<p>To eradicate this issue, Section 40A(2)\nof the Income Tax Act was introduced, where \u2018A\u2019 will be known as \u2018assessee\u2019.\nNow, if an assessee purchases a raw material and, in return, makes payment to a\nrelative. If the payment made is above the fair market value, then the Assessing\nofficer, at his discretion, has the power to disallow the excessive amount.<\/p>\n\n\n\n<ul><li><strong>Tax Planning While Selling Goods<\/strong><\/li><\/ul>\n\n\n\n<p>Now, there can be another possibility\nof shifting profit to the relatives. For example, instead of selling goods in\nthe market, the manufacturer can sell his goods to a relative, who can act as a\ndealer at a lower price, and he will then further sell the goods in the market.\nNow, the difference amount will be termed as the dealer&#8217;s profit, and the\nmanufacturer&#8217;s income will be represented less.<\/p>\n\n\n\n<p>Until today, there is no law governing\nsuch activity of tax planning which distributes the profit to a relative when\nselling goods. There have been case laws governing this issue, where the court\nhas determined that the Assessing Officer cannot tell the selling price of the\ngoods. Even in the market, goods are being sold on sale, and AO cannot\ndetermine the selling price of all goods and services.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"What_is_Section_40A2_of_the_Income_Tax_Act\"><\/span>What is Section 40A(2) of the Income Tax Act?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Section 40A(2) of the Income Tax Act\nspecifically says that the amount paid to the relatives is not deductible. The\npayment made to the relative as a part of the expenditure is excessive or\nunreasonable or not will be decided by the Assessing Officer at his discretion.\nIf the AO determines the amount paid is excessive, he can disallow it. This\nsection is not mandatory, and it is discretionary at the discretion of the AO.\nThe amount can be termed excessive with regard to:<\/p>\n\n\n\n<ul><li>Payment\nmade is excessive to the <strong>Fair Market Value<\/strong><sup><a href=\"https:\/\/en.wikipedia.org\/wiki\/Fair_market_value\"><strong>[1]<\/strong><\/a><\/sup> of the goods and services.<\/li><li>Payment\nfor Legitimate needs of the business and profession made to the relative.<\/li><li>The\nbenefits derived by or accruing to him therefrom.<\/li><\/ul>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Payment_for_Needs_of_Business\"><\/span>Payment for Needs of Business<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Any expenditure made for the legitimate\nneed or requirement for the promotion or expansion of the business. Now, if\nmade to an unrelated person, this payment for the need of the business cannot\nbe disallowed by the AO. At the same time, if the same payment is made to a\nrelated person, the AO has the power to decide whether there is a need to incur\nthis expenditure. Even if the payment made to the relative is as per the fair\nmarket value but, the AO will allow this payment only if it is the need of the\nbusiness. Otherwise, the AO will disallow the payment made to the relative for\nthe business&#8217;s needs.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Who_are_Related_Persons\"><\/span>Who are Related Persons?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p><strong>If The Assessee Is an Individual<\/strong><\/p>\n\n\n\n<ul><li>If\nthe assessee is an individual, all the relatives of the assessee will be his\nrelatives, such as mother, father, son, daughter, etc. <\/li><li>If\nthe individual assessee has a considerable interest in the business of any\nperson engaged in commerce or profession, or if any relative of the individual\nassessee has a substantial interest in the business of such person, then such\nperson is the designated person of the individual assessee.<\/li><\/ul>\n\n\n\n<p><strong>If The Assessee Is a Company<\/strong><\/p>\n\n\n\n<ul><li>The\nspecified person of the assessee-company is a director of the assessee-company\nor a family of such a director. <\/li><li>The\ndesignated person of the assessee-company is any individual having a\nsignificant stake in the enterprise or line of work of the assessee-company,\nwhether that individual or a related of that individual.<\/li><li>Suppose\nthe assessee company, a director of the assessee company, or a family of such\ndirector has a substantial stake in that person&#8217;s business. In that case, that\nperson qualifies as the designated person of the assessee company.<\/li><\/ul>\n\n\n\n<p><strong>If The Assessee Is a Firm <\/strong><\/p>\n\n\n\n<ul><li>The\ndesignated person of the assessee-firm is a partner of the company or a close\nfamily member of such a partner. <\/li><li>Any\nindividual who is engaged in business or practice is the firm&#8217;s specified\nperson if the firm, a partner of the firm, or a relative of such partner has a\nsignificant stake in that person&#8217;s enterprise.<\/li><\/ul>\n\n\n\n<p><strong>If The Assessee Is A HUF<\/strong><\/p>\n\n\n\n<ul><li>The\ndesignated individual of the assessee HUF is a member of their family or a\nclose relative of such a member. <\/li><li>Any\nperson engaged in business or practises is the HUF&#8217;s designated person if that\nHUF member, a member of their family, or a related member has a significant\nfinancial stake in that person&#8217;s enterprise.<\/li><\/ul>\n\n\n\n<p><strong>If The Assessee Is an AOP<\/strong><\/p>\n\n\n\n<ul><li>The\ndesignated individual of the assessee AOP is a member of AOP or a family of\nsuch a member.<\/li><li>Any\nperson who is engaged in business or practice is the designated person of the\nAOP if the AOP, a member of the AOP, or a relative of one of those members has\na significant financial stake in that person&#8217;s enterprise.<\/li><\/ul>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Understanding_Substantial_Interest\"><\/span>Understanding Substantial Interest<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Suppose a &#8220;specified person&#8221;\nowned shares in the prior year and had at least 20% of the voting power in that\nparticular prior year. In that case, that person is deemed to have a\nconsiderable interest in the company or profession. These shares shouldn&#8217;t have\nbeen eligible for a fixed dividend rate or the chance to partake in earnings.\nIn other situations, the taxpayer is considered to be specified if entitled to\nat least 20% of the business or profession&#8217;s profits in a prior year. Only if\nthe requirement of considerable interest is met will the applicable deductions\nfor costs under the Act be approved.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Conclusion\"><\/span>Conclusion<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Section 40A(2) Of the <strong><a href=\"https:\/\/corpbiz.io\/income-tax-return-filing\">Income Tax<\/a><\/strong> Act was introduced to reduce the tax planning with relatives to show less income. Still, this is not a mandatory section. It depends upon the discretion of the AO to either allow or disallow the unreasonable and excessive amount.<\/p>\n\n\n\n<p class=\"text-left\"><b>Read Our Article<\/b>: <mark style=\"background: #fffd03 !important;\"><a href=\"https:\/\/corpbiz.io\/learning\/tds-provisions-restrictions-disallowance-of-section-40a-ia-and-40a-3\/\">\nTDS Provisions &amp; Restrictions: Disallowance Of Section 40(A) (Ia) And 40a (3)<\/a><\/mark><\/p>\n","protected":false},"excerpt":{"rendered":"<p>Section 40A(2) talks explicitly about the payment of an expenditure to a related person. This means that if you have purchased some goods from a person who is your relative and made payment for those goods and services will come under Section 40A(2) of Income Tax Act. The main aim behind incorporating Section 40A(2) is [&hellip;]<\/p>\n","protected":false},"author":59,"featured_media":57898,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":[],"categories":[10],"tags":[3750],"acf":{"service_id":"403"},"authorName":"Anushka Saxena","authorImageUrl":"https:\/\/corpbiz.io\/learning\/wp-content\/uploads\/2023\/02\/MicrosoftTeams-image-109.jpg","authorDescription":"Anushka Saxena is a final year law student from Indore Institute of Law. She is an hardworking, dedicated and fun-loving person. Her area of interest lies in corporate laws and IPR.","postViews":3444,"readingTime":5,"_links":{"self":[{"href":"https:\/\/corpbiz.io\/learning\/wp-json\/wp\/v2\/posts\/57897"}],"collection":[{"href":"https:\/\/corpbiz.io\/learning\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/corpbiz.io\/learning\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/corpbiz.io\/learning\/wp-json\/wp\/v2\/users\/59"}],"replies":[{"embeddable":true,"href":"https:\/\/corpbiz.io\/learning\/wp-json\/wp\/v2\/comments?post=57897"}],"version-history":[{"count":2,"href":"https:\/\/corpbiz.io\/learning\/wp-json\/wp\/v2\/posts\/57897\/revisions"}],"predecessor-version":[{"id":57900,"href":"https:\/\/corpbiz.io\/learning\/wp-json\/wp\/v2\/posts\/57897\/revisions\/57900"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/corpbiz.io\/learning\/wp-json\/wp\/v2\/media\/57898"}],"wp:attachment":[{"href":"https:\/\/corpbiz.io\/learning\/wp-json\/wp\/v2\/media?parent=57897"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/corpbiz.io\/learning\/wp-json\/wp\/v2\/categories?post=57897"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/corpbiz.io\/learning\/wp-json\/wp\/v2\/tags?post=57897"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}