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

### Idea

If a business pays a specified (related) person an amount that is excessive or unreasonable relative to the fair market value of goods/services/facilities, the A.O. may disallow the excess. This is the one place where reasonableness of an expense is tested.

### Specified persons

For an Individual:

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

For a Company, Firm, HUF, or AOP:

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

### Substantial interest

Holding ≥ 20% voting power (in a company) or ≥ 20% profit-sharing rights (in other entities).

### What gets disallowed

Only the excess over fair value — not the whole payment.

Worked example

### Example 1

Excessive payment to a relative.

A proprietor pays his brother ₹5,00,000 for consultancy whose fair market value is ₹3,00,000.

The brother is a 'relative' → specified person.
A.O. may disallow the excess of ₹2,00,000; only ₹3,00,000 (fair value) is allowed.

### Example 2

Substantial interest test.

A company pays rent to an entity in which a director holds 25% voting power. Since 25% ≥ 20%, the entity is a specified person, and any unreasonable portion of the rent can be disallowed under 40A(2).

⚠️ Common exam mistakes

Disallowing the entire payment instead of only the excess over fair market value.
Using a threshold other than 20% for 'substantial interest'.
Forgetting that this is the one disallowance where reasonableness IS examined (unlike Section 37).

Reference: Section 40A(2)

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Payments to Relatives and Associates [Section 40A(2)]

Worked example

⚠️ Common exam mistakes