Whether when assessee makes a payment of Rs 20,000/- and above by crossed cheque but fails to add the word a/c payee only, such expenditure warrants disallowance u/s 40A(3)(a) - YES: HC

THE issues before the Bench are - Whether when the assessee makes a payment of Rs 20,000/- and above by crossed cheque but fails to add the word a/c payee only, such expenditure warrants disallowance u/s 40A(3)(a) and Whether the banks are under directive from the RBI not to deposit the cheque amount in favour of any person other than the drawee of the cheque. And the answers go against the assessee.

Facts of the case

The assessee’s return of income was taken for scrutiny. The assessing officer disallowed 20% of the total payment during the year under consideration otherwise than by account payee cheque in violation of provisions of section 40A(3)(a) of the Income Tax Act, 1961.

The CIT(Appeals) dismissed the assessee’s appeal holding that the cheques were otherwise than Account Payee Cheques. It was held that the evidences in the form of endorsement and acceptance noted down on the overleaf side of the cheques confirmed that cheques were not A/c. Payee cheques. It was held that assessee tried to place a false claim by submitting the documents which he knew were not true. There was enough evidence to point out that there was violation of provisions of section 40A(3)(a) of the Act and the Assessing Officer rightly considered that payments were made otherwise than by Account Payee Cheques, and thereby, there was violation of provision of section 40A(3)(a) of the Act. CIT(Appeals) held that the Assessing Officer rightly disallowed 20% of payment and added the same to the total income of the assessee.

In further appeal, the Tribunal held that Circular issued by the CBDT referred to the Instructions issued by the Reserve Bank of India to the banks in which the difference between a crossed cheque and account payee cheque had been brought out. While account payee cheque was credited by the drawee bank to the bank account of the payee and none else, crossed cheque can be negotiated and thus can be credited by the drawee bank to the bank account of a person other than the payee. The payments made by a crossed cheque cannot be considered as payment by account payee cheque. Law required payments to be made by an account payee cheque and not by a crossed cheque. It was held that once payment exceeding Rs.20,000/- was shown to have been made otherwise than by account payee cheque drawn on a bank or account payee bank draft, the expenditure in respect of which such payment had been made cannot be allowed as deduction. The assessee-firm made impugned payments exceeding Rs.20,000/- in a day and claimed deduction in respect thereof while computing its profits. It was admitted by the assessee that the impugned payments exceeding Rs.20,000/- were made otherwise than by account payee cheque drawn on a bank or account payee bank draft. Thus all the conditions for the applicability of section 40A(3) were fully satisfied. Thus, tribunal dismissed assessee’s appeals.

Assessee submitted that payments were made through cheques which were discounted through shroffs and payments were received by the drawees of the cheques. Thus the fact that all payments were received by the drawees was established. This being the paramount consideration of legislature for enactment of section 40A(3) of the Act, disallowance would not be justified. He further submitted that there was no distinction in law between a crossed cheque and an account payee cheque. Term “an account payee cheque” was not defined either under the Act or under the Negotiable Instruments Act and was, therefore, not capable of a precise meaning.

Having heard the parties, the Court held that,

++ Section 40A(3)(a) of the Act as it stood at the relevant time provided that where the assessee incurs any expenditure in respect of which payment is made in a sum exceeding Rs.20,000/- otherwise than by an account payee cheque drawn on a bank or account payee bank draft to the extent of 20% of such expenditure, shall not be allowed in respect of such expenditure. In subsequent year this disallowance of deduction was increased to 100% of the expenditure;

++ previously the language used in the said provision was “a crossed cheque drawn on a bank or by a crossed bank draft”. Such provision was amended with effect from 13.7.2006 to substitute the expression “an account payee cheque drawn on a bank or account payee bank draft”. Thus there was a conscious change in the phraseology used in the said provision and the expression “a crossed cheque drawn on a bank” was replaced by “an account payee cheque drawn on a bank”. Likewise, expression “a crossed bank draft” was replaced by “an account payee bank draft”. The reasons for such amendments were explained in CBDT Circular No.1 of 2007 dated 27.4.2007 providing inter alia that a crossed cheque or a crossed bank draft is not a nonnegotiable instrument. This, at times, results in crossed cheques being endorsed making it difficult to trace final payee and thus defeating the provisions of section 40A(3). As per RBI instructions to banks, an account payee cheque or account payee bank draft cannot be credited to any account other than the account of the payee. The Act was accordingly amended to substitute the said expressions;

++ it is indisputable that the term “an account payee cheque” is well understood and signifies cheque which carries a mandate to have the amount mentioned in the cheque to be paid to the drawee of the cheque. In common parlance and as per RBI directives, it would, thereafter, not be open to the drawee of the cheque to endorse the cheque in favour of another person;

++ directions thus in no uncertain terms mandate the banks to credit the amount of an account payee cheque only in the account of the payee and no other person and conversely not to accept any cheque from any source other than the person named in the account payee cheque except after requiring the drawer of the cheque to withdraw the mandate in this respect;

++ by virtue of the clear understanding of an account payee cheque in commercial parlance further amplified by RBI guidelines noted above, it cannot be said that there is no distinction between a crossed cheque and an account payee cheque. The concept of an account payee cheque which is even otherwise well known in banking circles and commercial parlance; with specific unambiguous directives by RBI gets further amplified. The banks are duty bound to carry out such directions issued by the RBI in exercise of powers under section 35A of the Banking Regulations Act;

++ previously the expression used in section 40A(3)(a) was a crossed cheque or a crossed bank draft. With specific purpose in mind, the same was amended by the legislature to be replaced by the expression “an account payee cheque or account payee bank draft”. This was done in the background of the experience that even crossed cheques were being endorsed in favour of a person other than the drawee making it difficult to trace the constituent of the money. To plug this possible loophole the requirement of section 40A(3) was made more stringent. If we accept the contention of the counsel for the assessee that there was no distinction between a crossed cheque and an account payee cheque, we would be obliterating this amendment brought in the statute with specific purpose in mind;

++ even an account payee cheque may still retain its negotiability unless it carries a further endorsement “non-negotiable”. To this aspect of the matter we are neither called upon nor intended to give any conclusive opinion. We, however, cannot resist referring to the decision of the Calcutta High Court in the case of Messrs. Tailors Priya, a firm vs. Messrs. Gulabchand Danraj, a firm. In such decision also it was observed that a law on the point should be reconsidered and it is generally believed that by crossing a cheque with the words “a/c. Payee only”, it is made non-negotiable. It is clarified that according to the law as it stands at present a cheque even if it is account payee without the endorsement “not negotiable” would still be negotiable instrument;

++ when RBI directives command the banks not to deposit the cheque amount in favour of any person other than the drawee of the cheque and correspondingly prohibit the banks from accepting any cheque, which is account payee cheque from a source other than the drawee, lack of any distinction between a crossed cheque and an account payee cheque without a further endorsement “not negotiable” would be of no further relevance;

++ for the purpose of section 40A(3) of the Act, thus there is really a clear distinction which exists, must be recognised and implemented as required in the plain language used therein;

++ CIT(Appeals) in fact noted a futile attempt on part of the assessee to show that the cheques were A/c payee. Assessee relied on documents which were not genuine. We may, however, proceed on the basis that the payments were in fact received by respective drawees of the cheques. Admittedly, however, there was no other additional ground, compelling reason or commercial expediency, which would have left no choice, would have compelled the assessee to make payment other than by account payee cheques. It was this overwhelming consideration of impossibility of making the payments through the mode other than by account payee cheque which had convinced us to accept the case of the assessee in the case of Anupam Tele Services vs. Income Tax Officer. It was when the assessee would have got out of the business that if ignored the directions of the principal and continued to make payment by account payee cheques the Court granted relief in the said case;

+ in the result, the Tribunal, in our opinion has correctly interpreted the provisions of section 40A(3) in background of the facts arising in these appeals.