Cash transactions are vital to a business, but excessive handling of cash leads to tax penalties and legal issues under the Income Tax Act of 1961. Principal regulations are

• Section 40A(3) (no deduction of expenses of over ₹10,000 in cash)
• Section 269SS & 269 (cash loan and repayment of over ₹20,000 prohibited
• Section 269ST (no receipt of cash over ₹2,00,000)

Violation of these regulations can involve penalties equivalent to the value of the transaction. Additionally, cash donations above ₹2,000 cannot be received as tax deductions, and large cash transactions can lead to a tax audit under Section 44AB.

Key Provisions under Section 269ST: Restrictions on Cash Receipts

Section 269ST of the Income Tax Act states that no individual shall receive INR 2 lakhs and above cash.

• In total, from a person in a day
• In the case of a single transaction
• When making proposals concerning a single situation or incident of a person.

Exceptions to the rule

The provisions of cash transactions do not cover government institutions, banks, post offices, and cooperative banks. Cash receipts for some transactions are also exempted. These include receipts for the sale of agricultural produce, foreign exchange transactions with authorized dealers, and payments by insurers or the government.

Penalties for non-compliance (Section 271DA)

If an individual violates the provision of Section 269ST by accepting 2 lakh or more in cash, they may be penalized under Section 271DA of the Income Tax Act. The penalty under Section 271DA is 100% of the cash received that contravened the provisions of Section 269ST.

Practical examples for different business scenarios

• If a non-resident receives 3 lakh in cash for an Indian business transaction and does not possess a permanent office in India, Section 269ST provisions don’t come into play. This implies that there is no penalty for cash transactions.
• If a farmer is receiving cash of 3 lakh for selling agricultural produce, it is exempt under Section 269ST since cash transactions for agriculture are not subject to ₹2 lakh limit, and therefore, no penalty can be imposed.

Cash Payment Restrictions Under Section 40A (3)

Section 40A(3) is a 2009 amendment to Section 40A. It limits cash payments or receipts above a threshold. Section 40A(3) disallows tax deductions of cash payments exceeding Rs. 10,000 to an individual on a single day. This applies to any mode of payment except bank drafts, account payee cheques, electronic payment systems, and specific electronic modes. The limit under Section 40A(3) rises to Rs. 35,000 when cash payments are made to transporters for hiring, leasing, or using goods vehicles. These rules do not apply to commission agents for goods received for commission or consignment. This is because commission agents are not permitted to deduct such expenditures.

Exceptions to Section 40A(3) are under Rule 6DD

There are times when a cash payment is not feasible; hence, the government has specified conditions under which this rule will not apply. This rule will not be applicable in cases where a taxpayer pays under certain conditions. These conditions are detailed in Rule 6DD, which has been made effective on 10/10/2008 by Notification No. SO2431(E). The following is the list of exceptions to Section 40A(3) of the Income Tax Act:

• Remittance to the state Disallowances never occurs whenever you pay the state government in cash or real money.
• Bills to banks, RBI, and other institutions: You can deposit cash or bearer cheques above the limit of Rs.10,000 in the Reserve Bank of India, State Bank of India, or any bank. You can deposit cash with any primary credit society, land mortgage bank, primary agricultural credit society, or LIC.

Payment to an Authorised Dealer: Rule 6DD has exceptions for money changers and approved dealers, who are legally allowed to provide forex services. The exception is only for buying foreign currencies and travelers’ cheques from money changers and approved dealers.

Payment to Low-paid Workers: The provisions of subsection (3) of section 40A do not apply to employers providing retrenchment compensation, gratuity, or other terminal benefits to employees or their family members. There are, however, two conditions. One, the limit cannot exceed Rs.50,000. Two, it must be provided at the time of an employee’s retirement, resignation, retrenchment, or death.

Payment of Wages in Distant Places: This rule is for employers who pay workers assigned temporarily to a place other than their normal workplace or aboard a ship for 15 days or more. The worker must not have a bank account in that place where he or she can withdraw money.

Pay with Some Options: Exceptions to disallowances under Section 40A (3) of the Income Tax Act are in respect of payments made in the following manner:

• Mail or telegraphic transfers from one bank to another
• Letter of credit issued by banks
• Bill of exchange because of a bank
• Transfer funds from one bank account to another.

Implications for tax deductions and business expense claims

A serious effect of Section 40A (3) is increased taxation to be incurred. This is because if payments given to a business or individual exceed ₹10,000, then they cannot be claimed as deductions. This means that the taxable income of the company or individual includes the list of non-deductible costs, which adds to the tax they have to pay. This amount you have to pay in tax could be higher if fines, penalties, and interest are imposed on you for disobeying the rules.

Cash Sales and Income Disclosure

1. Accurate Documentation of Cash Sales

It is suggested that invoices or cash memos for all sales be rendered, a cash book should be kept to note all transactions, and big cash sales should be placed in a bank account for transparency.

2. Presumptive Taxation and Cash Sales for Professionals and Small Businesses

• Section 44AD: Companies with turnover of ₹2 crore or below can account for 8% profit (6% if online).
• Section 44ADA: Professionals with receipts of up to ₹50 lakh can account for 50% of income.

It is advised to periodically compare the bank deposits with the cash sales records and utilize daily cash sheets to track unrecorded transactions. Locate and correct any discrepancies between the records and the cash. Check missing entries, discrepancies, or theft in cash handling to verify proper records. Use digital transactions to reduce cash imbalances.

Cash Receipts and Section 68: Unexplained Cash Credits

On some occasions, money is redirected to a single taxpayer by another person for tax evasion purposes. To counter such cases, Section 68 treats any unaccounted and credited figure in the account of a taxpayer as taxable income, as stated below:

• Except in cases where the taxpayer fails to furnish any explanation relating to the origin and nature of the credit.
• Where the assessing officer is not satisfied with the explanation provided by the taxpayer.

By making such provisions, Section 68 prevents tax evasion and brings fairness to the system.

Special Provision in Case of Corporate Taxpayers

Any cause provided by a company, one in which the public is not interested or is not interested in any degree—on any amount credited as share application money, share capital, or share premium, therefore, shall be considered as not satisfactory unless

The person on whose account the amount is debited in the company’s books explains the source and nature of the amount credited, and the officer conducting the assessment opines that the given explanation is adequate. But the said special provision will not be available if the person whose name is registered in the company’s records as having in his hands such an amount is a venture capital fund or venture capital company under Section 10(23FB).

Taxability of Unexplained Cash Credit

Unexplained cash credit is considered as income in the year received. Cash credits are charged at the rate of 60% without permitting any basic exemption limit, irrespective of the slab. There is a surcharge at the rate of 25% and a Health & Education Cess at the rate of 4%. The total tax rate of 78% includes the cess.

Digital Alternatives to Cash Transactions

As India continues to evolve and progress towards a cashless economy, most companies will benefit immensely from utilizing a range of digital payment systems. The introduction of UPI (Unified Payments Interface) and other mobile wallet applications, such as Google Pay, PhonePe, and Paytm, has revolutionized how we pay. Not only is this new system time-saving, but it is also far safer and simpler to utilize. These sites offer instant money transfers without having to handle cash, significantly lessening the risk of theft or misuse. Companies can make secure payments through various banking channels such as NEFT, RTGS, IMPS, and corporate bank accounts and make large payments with ease. Not only are these banking facilities secure, but they also provide detailed accounts of transactions that aid in monitoring expenses and income, and thus, managing money becomes an easy task. Moreover, it should be mentioned that the government also offers various tax benefits to companies that use digital means of payment. These include advantages such as a lesser tax under Section 44AD, an exemption on certain charges for digital payment, and the urge for companies to use new-age payment methods.

Maintenance of Books of Accounts for Cash Transactions

Income Tax Act has directed the books of accounts to be kept for Income Tax. They have been indicated under section 44AA and Rule 6F.

Books of accounts must be kept if income from profession or business is more than Rs. 1,20,000 or gross receipts are more than Rs. 10,00,000 for any of the 3 preceding years in the case of an existing profession. The same must also be done in the case of a newly established business/profession where income from the business/profession is likely to be more than Rs. 1,20,000 in any year or gross receipts are likely to be more than Rs. 10,00,000. Further, in the case of specified professionals, books of accounts will be kept only if income is more than Rs. 1,50,000 in all three 3 preceding years.

Specified Books of Account as per RULE 6F

• Cash book: An account of money entering and exiting the bank every day. It reflects what remains of the money at the end of a given day or, at worst, the end of the month.
• A journal according to the mercantile system of accounting. A journal is a log of all day-to-day transactions. It is a record, in accounting terms, where total credits equal total debits when we follow the double-entry accounting system.
• A ledger has all the journal entries and all accounts’ details. This can be used to prepare the financial statements.
• Duplicate of bills or receipts amounting to more than Rs 25.
• Original bills for expenses that are more than Rs 50.

Audit Requirements

Tax Payer Compulsory Audit is required when

• A person carrying on Business If total sales, turnover, or gross receipts are more than Rs. 1 crore (The limit has been increased to Rs. 10 crore for taxpayers whose cash receipts/cash payments do not exceed 5% of the total receipts/total payments
• A person carrying on a Profession If gross receipts are more than Rs. 50 lakh
• A person covered under the presumptive income scheme section 44AD If a person wants to declare the income of the business as lower than the presumptive income calculated as per Section 44AD and the person’s total income is more than the maximum income, which is exempt from tax.
• A person covered under presumptive income scheme section 44AE If a person wants to declare the business’s income lower than the presumptive income calculated as per Section 44AE.
• A person is covered under the presumptive income scheme section 44ADA if the profession’s income is lower than the presumptive income calculated as per section 44ADA and the person’s total income is more than the maximum income, which is exempt from tax.

TDS Applicability on Cash Transactions

In India, Tax Deducted at Source (TDS) is a method for collecting tax rights at the source of income. This means that TDS applies to various types of payments, including cash transactions. Here are some key points to keep in mind:

Section 194N: This rule requires TDS on cash withdrawals that go over ₹1 crore in a financial year from banks, cooperative societies, or post offices. The TDS rate is 2% on any amount that exceeds ₹1 crore.

Section 194A: TDS applies here on interest payments (excluding interest on securities) that exceed ₹5,000 in a financial year. The deduction rate is 10% if the payee has a Permanent Account Number (PAN); otherwise, it jumps to 20%.

What Happens if You Don’t Comply with TDS on Cash Transactions

If you don’t follow TDS rules, there can be some serious consequences:

Late Filing Fee: If you submit your TDS returns late, you’ll incur a fee of ₹200 per day until you file.

Penalty for Non-Deduction: If you fail to deduct TDS, you could face a penalty equal to the amount of tax you didn’t deduct.

Higher TDS Rates: Under Section 206AB, the TDS rate goes up if you make payments to individuals who didn’t file their income tax returns the previous year.

GST Interface with Cash Transactions

Integrating the Goods and Services Tax (GST) system with income tax reporting in India has improved financial transparency and made tax administration smoother. A key part of this integration is GST reconciliation. This process involves ensuring the data reported in GST returns aligns with a company’s financial records. It covers everything from sales and purchases to input tax credits and other financial details, ensuring they’re all accurately reported. Regular reconciliation helps spot and fix any mismatches, which can prevent disputes with tax authorities in the future. The GST framework also requires detailed audit trails for all transactions. These audit trails are essential during GST audits since they clearly record financial activities and confirm compliance with GST regulations.

Sector-specific Cash Pay Considerations

Every industry has its own specific rules when it comes to cash transactions under the Income Tax Act and GST. For example, real estate deals often involve large amounts, and you can’t deduct cash payments over ₹20,000. Then, there are retail businesses, which often handle cash. They must have the right documentation and follow GST rules to avoid issues. Service providers, like freelancers and consultants, must accurately report their cash income and deduct TDS when required. Manufacturers should keep track of their raw material purchases because if they make too many large cash payments, they might run into problems with tax deductions. In agriculture, while farming income is generally tax-exempt, large cash transactions can still raise eyebrows due to anti-money laundering regulations.

Cash Transaction Reporting Requirements

In India, businesses should follow specific reporting rules to keep financial transactions, especially cash ones, transparent. Here are some key reporting mechanisms:

Annual Information Return (AIR): In the past, certain high-value transactions were reported under the AIR system, but that has now been replaced by the Statement of Financial Transactions (SFT) to make reporting easier.

Statement of Financial Transactions (SFT): The SFT is a report that certain entities must file. It details specific financial transactions that go over certain limits. For example, those must be reported if cash payments exceed ₹10 lakh for buying bank drafts, pay orders, or banker’s cheques within a financial year.

Cash Transaction Reports (CTRs): Financial institutions must monitor and report cash transactions over ₹10 lakh (about $13,000) in a single day.

Business Owner’s Compliance Checklist:

To meet these reporting requirements, business owners should:

• Keep detailed records of all financial transactions, especially important cash ones.
• Know which transactions need to be reported and their respective thresholds.
• Ensure all necessary reports, like the SFT, are submitted on time to avoid penalties.

Recent Judicial Pronouncements

The Indian judiciary has played a critical role in making sense of laws about cash transactions, simplifying various issues; several court decisions have focused on the misuse of cash transactions for tax evasion. Judges have also clarified what counts as exemptions under tax laws.

Developing Judicial Views on Cash Transaction Restrictions:

The court’s views on restrictions on cash transactions have changed, with judges supporting measures to reduce black money and encourage digital transactions. These decisions emphasize the need to follow cash transaction limits and promote using formal banking channels. Dealing with cash transactions in India can be tricky, especially for small and medium-sized enterprises (SMEs). Learn about it in this Section 43B (h) guide.

Common Mistakes and Compliance Challenges

A frequent pitfall for business owners is misinterpreting the exemption rules tied to cash transactions. For example, some cash payments might be wrongly exempt from reporting, which leads to compliance issues. Poor documentation of cash transactions can cause problems during audits, as lacking records makes it hard to verify what’s happened. Another area of confusion is aggregation rules, where several small cash transactions get treated as one big transaction, which might exceed reporting limits and end up with fines.

Strategies to Ensure Compliance

Businesses should focus on cash flow management. This means keeping close tabs on cash coming in and going out to ensure their accurate and transparent financial records. Smart banking practices, like routing bigger transactions through formal banks, not only help with compliance but also ease the audit process. Keeping detailed records is especially critical for SMEs because it helps track transactions and produce accurate financial statements.

Conclusion

To keep up with cash transaction laws, businesses must stick to some important rules, like limits on cash for loans, ensuring all documents are in order, and reporting any money transactions. Some good practices include using bank transfers for larger payments, keeping careful financial records, and regularly checking cash flows to avoid tax trouble. As we see more digital transactions and tax checks, there will be more limits on cash and stricter reporting rules in the future.

Frequently Asked Questions

Can I accept more than ₹2 lakh in cash if it’s spread over multiple days?

A business cannot accept more than ₹2 lakh in cash from a person in a single day, even if split into multiple payments. Non-compliance attracts a penalty equal to the amount received.

How do cash restrictions apply to loan transactions?

If you’re looking for a loan of more than ₹20,000, it is supposed to be done through a bank according to Section 269SS and 269T.

What if my business naturally involves high cash volumes?

It’s important to keep detailed cash books, provide receipts, and regularly check your deposits. If you’re making lots of high-value transactions, you might need to file a Statement of Financial Transactions (SFT).

How do I report cash gifts received in my business?

Cash gifts that are more than ₹50,000 from someone not a relative are considered taxable (Section 56(2). Gifts from relatives or during special occasions aren’t taxed, but just be sure to keep a record of them.

What documentation is acceptable proof for cash transactions?

For tax purposes, make sure to keep invoices, receipts, vouchers, and bank deposit slips that show the date, amount, and payee details.