Manufacturer's Disallowances, Cash Payments and the 194Q/206C(1H) Puzzle
M/s Suryodaya Engineering Works, the proprietorship of Mr. Ramesh, manufactures precision components. Turnover for FY 2024-25 was ₹3.20 crore, of which ₹1.40 crore was received in cash and the balance through banking channels. The accountant's draft profit is ₹38,00,000 after debiting the following: (i) ₹12,00,000 paid in cash on 18 December 2024 to one raw-material supplier against a single bill; (ii) ₹8,00,000 due to a micro enterprise (registered under Udyam) from 1 November 2024, unpaid on 31 March 2025 though the agreed credit period was 45 days; (iii) ₹5,00,000 paid to a contractor on which no TDS was deducted because the contractor's PAN was not available; (iv) ₹2,00,000 of employees' provident fund contribution collected in March 2025 and deposited on 25 June 2025; (v) ₹60,000 penalty for breach of GST rules. During the year he purchased goods worth ₹82,00,000 from a registered trader and sold goods worth ₹70,00,000 to a company. He is considering opting for section 44AD to sidestep these issues and asks for your advice.
1. Compute the correct business income after all admissible disallowances, citing the provision for each adjustment.
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| Item debited | Adjustment | Provision |
|---|---|---|
| Cash payment ₹12,00,000 to one supplier in a day | Disallow ₹12,00,000 | Section 40A(3): payment otherwise than by prescribed banking mode exceeding ₹10,000 per person per day; ₹35,000 only for transporters, not applicable |
| ₹8,00,000 due to a micro enterprise beyond the agreed 45 days | Disallow ₹8,00,000 (allowed in the year of actual payment) | Section 43B(h) read with section 15 of the MSMED Act |
| ₹5,00,000 contractor payment, no TDS | Disallow 30% = ₹1,50,000; allowed in the year of deduction | Section 40(a)(ia); non-availability of PAN attracts the higher rate under section 206AA but does not change the 30% disallowance |
| Employees' PF ₹2,00,000 deposited 25 June 2025 | Disallow ₹2,00,000 | Section 36(1)(va) – employee contribution must be deposited by the due date under the PF Act (15th of the following month), not by the return due date |
| GST penalty ₹60,000 | Disallow ₹60,000 | Explanation to section 37 – expenditure for a purpose prohibited by law / penalty for infraction |
| Total add-back | ₹24,10,000 |
Business income = 38,00,000 + 24,10,000 = ₹62,10,000.
Note that the ₹1,50,000 disallowed under section 40(a)(ia) is not lost – it becomes allowable in the year in which the TDS is paid. The ₹8,00,000 under 43B(h) likewise shifts to the year of payment. Only the cash payment, the late PF deposit and the penalty are permanent losses.
2. Advise on the TDS/TCS implications of the ₹82,00,000 purchase and the ₹70,00,000 sale, identifying who must act and on what amount.
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Purchase side – section 194Q (TDS on purchase of goods): Mr. Ramesh is the buyer. TDS at 0.1% applies to purchases exceeding ₹50,00,000 in a year, but only where the seller's turnover in the preceding previous year exceeds ₹10 crore, and only on the excess over ₹50 lakh.
- If the trader's turnover exceeds ₹10 crore, TDS = 0.1% × (82,00,000 – 50,00,000) = ₹3,200, to be deducted at the time of credit or payment, whichever is earlier, and deposited by the 7th of the following month.
- Because 194Q applies (where the conditions are met), the seller cannot collect TCS under section 206C(1H) on the same transaction – 194Q overrides 206C(1H).
Sale side – section 206C(1H) (TCS on sale of goods): Mr. Ramesh is the seller. TCS at 0.1% on receipts exceeding ₹50 lakh applies only if his turnover in the preceding previous year exceeds ₹10 crore. His turnover is ₹3.20 crore, so 206C(1H) does not apply and he must not collect TCS from the buyer.
The buyer's position: The buyer cannot deduct 194Q either, because that provision requires the seller's turnover to exceed ₹10 crore, and Mr. Ramesh's turnover is ₹3.20 crore. So the ₹70,00,000 sale is outside both provisions.
Practical point: The TCS/TDS chain depends on the counterparty's turnover, not on the value of the transaction alone. He should obtain a declaration from the trader about turnover and prior-year 194Q compliance before the next quarter's return, since an incorrect deduction or a wrong collection creates interest under section 201/206C(7) and a 202 demand.
3. Assess whether section 44AD is available to him, and state the consequences of the answer for audit and for his disallowance exposure.
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Eligibility test – the ₹3 crore limit is conditional. Section 44AD has been available up to ₹3 crore only where cash receipts do not exceed 5% of total turnover. Here cash receipts are ₹1.40 crore out of ₹3.20 crore = 43.75%, far above 5%. The limit therefore remains ₹2 crore, and turnover of ₹3.20 crore makes him ineligible for section 44AD. The 6% rate for digital receipts cannot rescue him; eligibility is tested before rates.
Consequence 1 – audit: Section 44AB requires audit where turnover exceeds ₹1 crore, with the ₹10 crore threshold available only if cash receipts and cash payments each do not exceed 5%. Since cash receipts are 43.75%, the ₹1 crore threshold applies and a tax audit is mandatory. He must also file the audit report by 30 September 2025 and the return by 31 October 2025.
Consequence 2 – disallowance exposure: The ₹24,10,000 of disallowances cannot be wished away through the presumptive route. Had he been eligible, deemed profit at 8% would have been ₹25,60,000, which is far below the corrected ₹62,10,000 – so the presumptive scheme would actually have helped, but the cash-heavy receipt pattern has shut the door.
Planning advice for FY 2025-26: Route collections through banking channels so that cash receipts fall below 5% of turnover. That single change would (a) restore the ₹3 crore limit for 44AD and (b) raise the tax-audit threshold to ₹10 crore. He should also fix the three process failures – cash purchases above ₹10,000, MSME payments beyond 45 days, and TDS on contractors – which together account for ₹21,50,000 of the add-back.