Cash payments under excise payment rules were protected from section 40A(3) disallowance where the licensee acted as Government agent.

Cash payments made under a statutory excise payment mechanism to the wholesale licensee appointed for country spirit were held to fall outside disallowance under section 40A(3) because the payee was identifiable, the transactions were genuine, and the licensee acted as an agent of the State Government for the relevant purpose. The object of section 40A(3) was not frustrated, as the payments were traceable and made pursuant to the regulatory framework. The tribunal treated the payments as covered by the exceptions in Rule 6DD(b) and Rule 6DD(k) and recognised the commercial expediency of the payment mode, so the disallowance was not sustainable.

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Issues: Whether the disallowance under section 40A(3) of the Income-tax Act, 1961 was sustainable where the assessee made cash payments into the bank account of the wholesale licensee appointed under the State excise regime for purchase of country spirit.

Analysis: The payment mechanism was governed by the State excise framework, under which retail vendors were required to pay the cost price, duty and bottling charges to the credit of the wholesale licensee. The transactions were genuine, the payee was identified, and the wholesale licensee functioned as an arm and agent of the State Government for the relevant purpose. In that setting, the object of section 40A(3), namely prevention of untraceable cash payments and tax evasion, was not defeated. The payment fell within the protective scope of the cash payment exceptions under Rule 6DD(b) and Rule 6DD(k) of the Income-tax Rules, 1962, and the commercial expediency of the mode of payment was also recognized.

Conclusion: The disallowance under section 40A(3) was not sustainable and the issue was decided in favour of the assessee.

Ratio Decidendi: Where cash payments are made pursuant to a statutory payment mechanism to a licensee acting as an agent of the Government, and the source and destination of funds are identifiable, section 40A(3) does not apply in view of the exceptions for payments to Government or its agent.

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