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If you are running a business or a profession you are allowed to claim its expenses from your income. However, these expenses may not be allowed if you make payment to specified persons who are listed in the Income Tax Act. Where payment made to them is excessive or unreasonable and not according to fair market value of goods or services provided, you may not be able to claim it.

The assessing officer may not allow you to claim expenses for payments made to specified persons ( as per Section 40A(2) of the Income Tax Act ) if :

  • Payment is to made to certain specified persons

AND

  • Income Tax Officer believes that such expenditure is excessive or unreasonable with regard to the fair market value of the goods,services or facilities provided.

If both the above conditions are fulfilled,the Income Tax Officer can disallow the expenditure to the extent he considers it excessive or unreasonable.

 Who are the Specified Person ?

There is a list of specified persons mentioned in the Income Tax Act. Specified Person includes the relatives also.

But before we discuss the list of specified persons, we should know the meaning of substantial interest.

Substantial Interest  : A  person will considered to have substantial interest in the business or profession on satisfying the conditions below.

  • In case of a company carrying on business or profession , person owning atleast 20% voting power at any time during the year shall be called as someone who has substantial interest in the company.
For instance If in ABC pvt ltd, X1 firm holds 23% equity shares of the ABC ltd , then X1 firm shall have Substantial Interest in the company.

 

  • In any other case such as firm, association of persons and sole proprietorship, person entitled to atleast 20% of profits made by the business or profession during the year shall deemed to have Substantial Interest in such business or profession.

The list of specified persons in case of different categories of taxpayers for imposing the provisions of section 40A(2) are as follows:

  1. Individuals
  • Relatives of Individual such as spouse, brother, sister ,lineal ascendant or descendant of the individual like parents,grandparents,son,daughter etc.
  • Any person in whose business or profession, individual himself or his relative has substantial interest .
For instance Mr Ashok who is running a business has 22 % shares in X ltd.Now any amount paid/payable by Mr Ashok to X ltd for will be subject to the category of specified person under Section 40 A(2)(b)

2. Company ,Firm or HUF

  1. Director(s) of the company, partners in a firm, members of HUF or association of persons. Also the family member or relative of such director, partner or member will be considered as specified persons.
  2. Any person in whose business or profession, such director or partner or member himself or  relative of such person has substantial interest .
    For instance if the director of Sunshine pvt ltd holds 30% shares in bluestar pvt ltd, then bluestar pvt ltd will be considered as specified person to the sunshine pvt ltd in case of business transactions between the two.

    OR

For instance if the relative of director of X1 ltd is entitled to 22% share of profits in ABC firm, then ABC firm ltd will be considered as specified person to X1 ltd in case of any business transaction between the two

3. In any other case of taxpayer:

  • An individual who has substantial interest in the business or profession run by the taxpayer.
For Instance Mr Puneet is entitled to 25% share of Abc firm , then he shall deemed to be specified person to ABC firm in case of any business transaction between the two.
  • A company, firm, AOP or HUF which has substantial interest in the business or profession run by the Also the director of the company or partner of the firm or member of HUF and AOP along with their relatives which has substantial interest in  the business or profession run by the  taxpayer shall deemed to be specified persons.
For instance if director ABC ltd is entitled to 25% of the profits in the business run by Mr Rahul.Then ABC ltd shall deemed to be specified person to Mr Rahul in case of any business transaction between the two .

 

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