Disallowance u/s 40A(3) to be made only when there is expenditure claimed in return of income. Mere entries in books will not change the character of transaction.

The assessee was engaged in the business of financing second
hand motor vehicles on hire purchase basis. The assessee financed the vehicles
identified by the purchaser and entered into hire purchase agreement. The
assessee in its profit and loss account had shown purchase price of these second hand motor vehicles as Rs.
79,14,700 and on the credit side, there was a contra entry of Rs.79,14,700
showing it as sale on hire purchase. The AO found that payments in excess of Rs.
20,000 aggregating to Rs. 23,37,000 were made to 32 parties. The AO required the
assessee to explain as to why 20% of the sum of Rs. 79,14,000 should not be
disallowed. The assessee submitted that transactions were not in the nature of
expenditure. They were simply loan transactions.

The AO observed that the real test, whether a particular
transaction was in the nature of expenditure was to be decided taking into
account how the transactions were entered in the books of account and treatment
thereof. The alleged advances formed part of trading activity. The AO further
observed that in the balance sheet stock on hire under hire purchase basis was
shown, which was nothing but stock in trade. Therefore, such transactions could
not be treated as advances. On this basis, the AO made a disallowance under
section 40A(3) of the Act.

Held:

On appeal, the Hon’ble tribunal held that assessee was not a
dealer in second hand motor cars. He let out the same. Only part of the amount
was financed by the assessee. The invoices were made in the name of the
purchaser. The past behaviour of the assessee also showed that it did not intend
to deal in cars. The assessee did not earn any profit on purchase or sale of
vehicles. It earned income on hire purchase transactions. For invoking the
provisions of section 40A(3), the amount must be claimed as expenditure. When
amounts paid have not been claimed as deductible expenditure while computing
business income, provisions of section 40A(3) cannot be applied. Mere entries in
the books of account will not change the character of financial transactions.
The addition so made was thus deleted.