Section 40A(3) disallowance fails where cash is deposited through a prescribed statutory payment mechanism and the recipient is identifiable.

Cash deposited directly into the wholesale licensee's bank account for purchase of country spirit was treated as a genuine, traceable payment made under the State excise payment mechanism, with the recipient's identity undisputed. On those facts, the object of section 40A(3)-preventing unaccounted cash expenditure and tax evasion-was not frustrated. The transaction was therefore brought within the liberal scope of the Rule 6DD exceptions, including payments made to a Government-linked recipient under a prescribed mode and to an agent. The disallowance under section 40A(3) was held not sustainable.

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Issues: Whether the disallowance under section 40A(3) of the Income-tax Act, 1961 was justified in respect of cash deposits made into the bank account of the wholesale licensee for purchase of country spirit, or whether the payments were covered by the exceptions in Rule 6DD of the Income-tax Rules, 1962.

Analysis: The payments were held to be genuine, the identity of the recipient was not in doubt, and the cash was deposited directly into the bank account of the wholesale licensee in compliance with the State Excise notification requiring such mode of payment. The object of section 40A(3) is to curb unaccounted cash expenditure and tax evasion, and that object was not defeated on these facts because the transaction was traceable and the payee was identifiable. The wholesale licensee functioned under the State excise framework as an intermediary required to receive payment in the prescribed manner, bringing the case within the liberal construction of the Rule 6DD exceptions, particularly those relating to payment to the Government under legally prescribed tender and payment to an agent.

Conclusion: The disallowance under section 40A(3) was not sustainable, and the cash payments were protected by Rule 6DD.

Final Conclusion: The assessee's expenditure could not be disallowed merely because payment was made in cash through bank deposit to the wholesale licensee, since the statutory object of section 40A(3) was not frustrated and the transaction fell within the recognised exceptions.

Ratio Decidendi: Where cash is deposited directly into the identifiable payee's bank account in a genuine transaction made under a statutory payment mechanism, and the payment satisfies the substance of a Rule 6DD exception, section 40A(3) does not apply.

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