## Payments to Relatives and Associates — Section 40A(2)

If an assessee incurs expenditure by way of payments to specified persons, and the Assessing Officer (A.O.) considers the payment excessive or unreasonable having regard to fair market value, the A.O. can disallow the excess portion.

### Who are 'specified persons'?

1. For an Individual assessee:

Any relative — spouse, brother or sister, and any lineal ascendant or descendant.
Any entity in which the individual or relatives have a substantial interest.

2. For Company / Firm / HUF / AOP:

Directors, partners, or members, and their relatives.
An individual (and their relatives) having a substantial interest in the company.
Any entity in which the company/firm/director/partner/member or their relatives have a substantial interest.

### Meaning of 'Substantial Interest'

Minimum 20% voting power OR 20% profit-sharing rights.

> Only the excess over fair market value is disallowed — not the entire payment.

Worked example

### Example 1

Example. A company pays its director ₹5,00,000 for consultancy whose fair market value is ₹3,00,000. The A.O. can disallow the excess of ₹2,00,000 under Section 40A(2); ₹3,00,000 remains allowable.

### Example 2

Example — substantial interest test. An individual holds 25% of the profit-sharing rights in a firm. That firm is a 'specified person' (≥20% threshold met), so payments to it are scrutinised under Section 40A(2).

⚠️ Common exam mistakes

Disallowing the entire payment rather than only the excess over fair market value.
Using the wrong substantial-interest threshold — it is 20% voting power / 20% profit share.
Forgetting that for individuals, 'relative' has a narrower meaning (spouse, brother/sister, lineal ascendants/descendants).

Reference: Section 40A(2) — Income-tax Act, 1961

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Disallowance of excessive/unreasonable payments to relatives and associates – Section 40A(2)

Worked example

⚠️ Common exam mistakes