## Payment to Specified Persons (Relatives) — Sec. 40A(2)

To prevent profit-shifting to related parties at inflated rates, the AO is empowered to disallow the excessive or unreasonable portion of payments to 'specified persons'.

### Mechanism

If a payment for expenditure is made to a specified person (relative), the AO can examine whether the amount is reasonable considering Fair Market Value (FMV) of the goods/services.
Any payment in excess of FMV is disallowed (only the excess, not the entire payment).

### Who are 'Specified Persons' [Relatives]?

Assessee	Specified Person (Relative)
Individual	Spouse, Brother, Sister, or any Lineal Ascendant or Descendant of the Individual
HUF	Member of the HUF & relatives of the member
Firm	Partner of the firm & relatives of the partner
AOP / BOI	Member of AOP/BOI & relatives of the member
Company	Director of the company & relatives of the director
For ALL assessees	Any person having substantial interest in the business of the assessee, and their relatives

### What is 'Substantial Interest'?

> Holding 20% or more of the voting power (for companies) OR profit share (for firms/AOPs).

Worked example

### Example 1

Example 1: Mr. A pays ₹50,000/month as rent to his wife for using her premises as office. Market rent = ₹30,000/month.

→ Excess of ₹20,000/month × 12 = ₹2,40,000 disallowed u/s 40A(2). Only ₹3,60,000 (FMV) is allowed.

Example 2: XYZ Ltd. buys raw material worth ₹20,00,000 from a firm where the company's director holds 25% profit share.

→ The firm is a 'specified person' (substantial interest). If FMV = ₹16,00,000, then ₹4,00,000 is disallowed.

Example 3: A firm pays ₹1,00,000 commission to the brother of one of its partners. FMV = ₹70,000.

→ Excess ₹30,000 disallowed; ₹70,000 allowed.

⚠️ Common exam mistakes

Disallowing the entire payment — only the excess over FMV is disallowed.
Forgetting that 'spouse, brother, sister, lineal ascendants/descendants' is the complete relative list for individuals (e.g., uncle, cousin are NOT relatives for this section).
Missing the 'substantial interest' (≥20%) test that applies across all assessee types.
Applying Sec. 40A(2) to interest/remuneration paid to partners — these are covered by Sec. 40(b), not 40A(2).

Bare-Act text Section 40A(2) · Income-tax Act, 1961 · click to expand

Section 40A(2)(a): Where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in clause (b) of this sub-section, and the Assessing Officer is of opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods, services or facilities for which the payment is made..., so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction.

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Payment to Specified Persons [Section 40A(2)]

Worked example

⚠️ Common exam mistakes