Budget 2025: Cash Transaction Penalties Explained Section 21

The source, an excerpt from “01.pdf,” outlines a new budgetary measure set to take effect from July 1, 2025, specifically targeting cash transactions. This measure, detailed under Income Tax Section 21, imposes a significant penalty of up to 50% on filers (sellers) who accept cash payments for invoices exceeding Rs 2 lakh. The core impact is that 50% of the expenses related to such cash-paid sales will become disallowed, thereby increasing the seller’s taxable profit and, consequently, their tax liability. The document emphasizes the onus on filers to educate their customers to utilize banking channels for payments to avoid these penalties, as non-compliance will lead to substantial fines upon audit.

Budget 2025: Cash Transaction Penalties for Tax Filers

Budget 2025 introduces significant changes, particularly concerning cash transactions for businesses and service providers who are tax filers. A key focus of this budget is to discourage large cash payments and bring more transactions into the formal banking system.

One of the most notable changes is the imposition of a penalty on filers who accept cash payments from customers for invoices exceeding Rs 2 lakh. Specifically, if a seller (Mr. A), who is a proper tax filer, issues an invoice for more than Rs 2 lakh to a customer (Mr. B), and Mr. B pays in cash, then Mr. A will face a penalty of approximately 50%. This penalty applies regardless of whether the customer is a filer or non-filer.

The mechanism of this 50% penalty involves the disallowance of expenses related to that cash-paid invoice. For example, if a filer has a sale of Rs 3 lakh with a cost of sales of Rs 2.5 lakh (leading to a gross profit of Rs 50,000), and the Rs 3 lakh was received in cash, only 50% of the cost (Rs 1,25,000) will be allowed as an expense. This reduction in allowed expenses will increase the filer’s taxable profit. In the example given, the profit would increase from Rs 50,000 to Rs 1,75,000, leading to a higher tax liability. The rationale is that if expenses are reduced, profit increases, and consequently, more tax must be paid.

This new law, which amends Income Tax Section 21, was part of the budget draft presented to the assembly on October 10, 2025. It is expected to be applicable from July 1, 2025. The source indicates a high likelihood (99%) that such laws will pass.

The budget seems to tighten regulations on filers, who are already subject to proper tax return filing, monthly and annual compliance, and audits. The new law aims to indirectly make filers agents for the Federal Board of Revenue (FBR). Filers are now expected to educate their customers and compel them to make payments through banking channels (e.g., cheque or bank draft) instead of cash. The implication is that if filers continue to accept large cash payments, the fines or additional tax they will have to pay might exceed the profit they make on that transaction.

Therefore, businesses are advised to implement this rule immediately and inform all their customers that cash payments for invoices of Rs 2 lakh or more will no longer be accepted. Breaking down invoices to below the Rs 2 lakh threshold is also considered risky, as audits can reveal such management tactics. The overall goal is to push transactions into auditable banking channels, thereby increasing transparency and potentially tax collection.

Cash Payment Penalties in Budget 2025

Budget 2025 introduces significant provisions regarding cash payments, particularly for businesses and service providers who are tax filers. The primary aim of these new rules is to discourage large cash transactions and encourage the use of formal banking channels.

New Rules and Penalty for Cash Payments: If a tax filer (referred to as Mr. A in the source) sells goods or provides services to a customer (Mr. B) and issues an invoice exceeding Rs 2 lakh, and the customer pays this amount in cash, the filer (Mr. A) will face a penalty of approximately 50%. This penalty applies irrespective of whether the customer (Mr. B) is a filer or a non-filer.

Mechanism of the 50% Penalty: The 50% penalty is implemented by disallowing a portion of the expenses related to that cash-paid invoice. For instance, if a filer has sales of Rs 3 lakh with a cost of sales of Rs 2.5 lakh, leading to a gross profit of Rs 50,000, and the Rs 3 lakh payment was received in cash, the tax authorities will only allow 50% of the cost (Rs 1,25,000) as an allowable expense. The remaining 50% of the cost will not be allowed.

This reduction in allowed expenses directly increases the filer’s taxable profit. In the given example, if the cost allowed is only Rs 1,25,000 against sales of Rs 3 lakh, the profit increases from Rs 50,000 to Rs 1,75,000. Consequently, the filer will have to pay significantly more tax on the increased profit. The principle is that when expenses are reduced, profit rises, leading to a higher tax liability.

Implementation and Rationale: This new law amends Income Tax Section 21 and was part of the budget draft presented to the assembly on October 10, 2025. It is expected to be applicable from July 1, 2025, with a high probability (99%) of passing.

The rationale behind this move is to indirectly compel filers to act as agents for the Federal Board of Revenue (FBR). Filers, who already comply with proper tax return filing, monthly and annual compliance, and audits, are now expected to educate their customers and insist on payments through banking channels (e.g., cheque or bank draft) instead of cash. The implication for filers is that accepting large cash payments for invoices over Rs 2 lakh could result in fines or additional taxes that might even exceed the profit made on that specific transaction.

Recommendations for Businesses: Businesses are advised to immediately implement this rule and inform all their customers that cash payments for invoices of Rs 2 lakh or more will no longer be accepted. The source also warns against the tactic of breaking down invoices into multiple smaller ones (below Rs 2 lakh) to circumvent the rule, as such practices can be identified during audits. The overall objective is to push transactions into auditable banking channels to enhance transparency and improve tax collection.

Budget 2025: Cash Transaction Limits and Penalties

Income Tax Section 21 has undergone significant changes in Budget 2025, primarily aimed at regulating cash transactions for tax filers.

Key Changes and Applicability:

• Budget 2025 Draft: The draft of Budget 2025, presented to the assembly on October 10, 2025, includes these amendments to Income Tax Section 21.
• Effective Date: The new law within Section 21 is expected to be applicable from July 1, 2025. There is a high probability, estimated at 99%, that such laws will be passed.
• Targeted Filers: These changes primarily impact tax filers who conduct business or provide services.

The Core Rule and Penalty:

• Invoice Threshold: If a filer (Mr. A) issues a single invoice to a customer (Mr. B) for a value exceeding Rs 2 lakh, and the customer pays this amount in cash, the filer will incur a penalty.
• Penalty Amount: The penalty charged on Mr. A, the seller who is a proper filer, will be approximately 50%. This penalty applies regardless of whether the customer (Mr. B) is a filer or a non-filer.

Mechanism of the 50% Penalty: The 50% penalty is enforced by disallowing a portion of the expenses related to the cash-paid invoice.

• Expense Disallowance: When an audit occurs, if an invoice of Rs 3 lakh was paid in cash, the tax authorities will only allow 50% of the cost related to that sale as an expense. For example, if the cost of sales was Rs 2.5 lakh for a Rs 3 lakh sale, only Rs 1,25,000 (50% of Rs 2.5 lakh) would be allowed as an expense.
• Impact on Profit and Tax: By reducing the allowed expenses, the filer’s taxable profit increases significantly. In the given example, if the profit was initially Rs 50,000, reducing the allowed expense from Rs 2.5 lakh to Rs 1,25,000 would increase the profit to Rs 1,75,000. An increased profit directly leads to a higher tax liability. The source emphasizes that the filer might have to pay more in fines or taxes than the profit made on that specific transaction.

Rationale and Implications:

• Discouraging Cash Transactions: The primary purpose of this amendment to Section 21 is to discourage large cash payments and push transactions into auditable banking channels.
• Filers as FBR Agents: The law effectively makes filers agents of the Federal Board of Revenue (FBR). Filers, who are already compliant with tax return filing, monthly and annual obligations, and audits, are now expected to educate their customers and compel them to make payments through banking channels (e.g., cheque or bank draft).
• Risk of Circumvention: The source advises against breaking down invoices into smaller amounts (below Rs 2 lakh) to avoid the rule, as such management tactics can be detected during audits.

Recommendations for Businesses: Businesses are strongly advised to implement this rule immediately and inform all customers that cash payments for invoices of Rs 2 lakh or more will no longer be accepted. It is crucial for filers to understand this law and act accordingly from July 1, 2025, to avoid significant tax penalties during audits.

Budget 2025: Cash Payment Penalties for Tax Filers

Tax filers face significant penalties under the new Budget 2025 provisions, particularly concerning the acceptance of cash payments. The core penalty mechanism and its implications are detailed as follows:

Primary Penalty for Filers If a filer (referred to as Mr. A in the source) sells goods or provides services to a customer (Mr. B) and issues a single invoice exceeding Rs 2 lakh, and the customer makes the payment in cash, then the filer (Mr. A) will incur a penalty of approximately 50%. This penalty applies regardless of whether the customer (Mr. B) is a filer or a non-filer.

Mechanism of the 50% Penalty The 50% penalty is implemented through the disallowance of expenses related to the cash-paid invoice.

• Expense Disallowance: According to the new rule in Income Tax Section 21, during an audit, if a filer has an invoice of Rs 3 lakh that was paid in cash, the tax authorities will only allow 50% of the cost of sales related to that transaction as an expense. For example, if the cost of sales for a Rs 3 lakh sale was Rs 2.5 lakh, only Rs 1,25,000 (50% of Rs 2.5 lakh) will be allowed as an expense, while the other 50% will not be allowed.
• Impact on Profit and Tax: By reducing the allowed expenses, the filer’s taxable profit significantly increases. In the given example, if the initial profit on the Rs 3 lakh sale was Rs 50,000 (after deducting Rs 2.5 lakh cost), reducing the allowed expense to Rs 1,25,000 means the profit would jump to Rs 1,75,000. An increased profit directly leads to a higher tax liability. The source warns that the fine or additional tax a filer might have to pay later could exceed the profit made on that specific supply or invoice.

Rationale and Broader Implications for Filers The new law, which amends Income Tax Section 21, was part of the budget draft presented on October 10, 2025, and is expected to be applicable from July 1, 2025, with a 99% likelihood of passing.

• Discouraging Cash: The primary aim is to discourage large cash transactions and push payments into formal banking channels.
• Filers as FBR Agents: The source highlights that filers, who already comply with proper tax return filing, monthly and annual compliance, and audits, are being disproportionately affected. This new law effectively makes filers indirect agents for the Federal Board of Revenue (FBR), requiring them to educate their customers and compel them to make payments through banking channels (e.g., cheque or bank draft) instead of cash.

Avoiding Penalties Businesses that are filers are strongly advised to implement this rule immediately and inform all their customers that cash payments for invoices of Rs 2 lakh or more will no longer be accepted. The source also cautions against breaking down invoices into smaller amounts (below Rs 2 lakh) to circumvent the rule, as such “managed” transactions can be detected during audits. Filers are urged to understand this law and adjust their transaction methods from July 1, 2025, to avoid substantial tax liabilities during audits. The source suggests that this move places the burden of ensuring banking channel payments on filers, a role that traditionally belonged to the FBR.

Budget 2025: Promoting Banking Channels for Tax Transparency

The new tax provisions introduced in Budget 2025 place significant emphasis on the use of banking channels for transactions, particularly for payments exceeding Rs 2 lakh. The primary goal of these changes is to discourage large cash transactions and promote financial transparency.

Importance and Purpose of Banking Channels:

• Discouraging Cash Payments: The core objective of the new law, which amends Income Tax Section 21, is to push transactions away from cash and into formal banking channels.
• Enhancing Transparency and Auditability: Payments made through banking channels (such as cheques or bank drafts) are auditable, meaning they leave a clear financial trail that tax authorities can verify. This helps the Federal Board of Revenue (FBR) improve tax collection and identify potential non-compliance.
• Preventing Circumvention: The source warns against tactics like breaking down large invoices into smaller ones to avoid the Rs 2 lakh cash payment limit, noting that such “managed” transactions can still be detected during audits, reinforcing the need for transparent banking channel use.

Filers’ Role in Promoting Banking Channels:

• Mandate for Filers: Tax filers, who are already compliant with proper tax return filing, monthly and annual obligations, and audits, are now effectively tasked with ensuring their customers use banking channels for payments.
• Educating Customers: Filers are expected to educate their customers and compel them to make payments through banking channels (e.g., cheque or bank draft) instead of cash. The source notes that the FBR is indirectly making filers its agents to enforce this behavior.
• Avoiding Penalties: To avoid the approximately 50% penalty on expenses, filers must ensure that payments for invoices over Rs 2 lakh are received via banking channels. Failure to do so could result in fines or additional taxes that might exceed the profit made on the transaction.

Recommendations for Businesses: Businesses that are tax filers are advised to immediately implement the new rule and inform all their customers that cash payments for invoices of Rs 2 lakh or more will no longer be accepted. The emphasis is on convincing customers to make payments through banking channels to ensure compliance with the new law, which is expected to be applicable from July 1, 2025.

Income Tax Ordinance 2001: Inadmissible Deductions Under Section 21

Section 21 of the Income Tax Ordinance, 2001, primarily outlines deductions that are not allowed (inadmissible deductions) in the computation of income. While the full text of Section 21 itself is not explicitly provided with a standalone heading in the excerpts, its contents and application are clearly referenced by other sections and appear within the “Income from Business” division where “Deductions Not Allowed” would typically be found.

Here are the details regarding Section 21:

1. General Application of Section 21:

• Income from Business: Section 21’s provisions are directly applied in determining deductions for “Income from Business”.
• Income from Property: The provisions of Section 21 apply in the same manner for determining deductions allowed when computing income chargeable under the head “Income from Property”, specifically for amounts related to deductions in Section 15A and non-adjustable amounts received in relation to buildings under Section 16.
• Capital Gains: No deduction is allowed for any expenditure incurred in deriving a gain chargeable to tax under the head “Capital Gains” if that expenditure is referred to in Section 21.
• Income from Other Sources: The provisions of Section 21 apply in the same manner for determining deductions allowed when computing income chargeable under the head “Income from Other Sources” (Section 40).
• Banking Companies: Section 21, along with sub-section (8) of Section 22 and Part III of Chapter IV, applies mutatis mutandis for the computation of a banking company’s income.
• Approved Funds: Section 21(e) is specifically referenced in relation to conditions for recognition and approval of:
• Recognized Provident Funds (Part I of the Sixth Schedule).
• Approved Superannuation Funds (Part II of the Sixth Schedule).
• Approved Gratuity Funds (Part III of the Sixth Schedule). While the specific details of Section 21(e) are not provided, its inclusion in these contexts indicates it outlines rules or conditions for deductions pertinent to these funds.

2. Specific Inadmissible Deductions (as inferred from context within “Income from Business” where Section 21 typically falls):

• Expenditures requiring tax deduction/collection: Any expenditure from which a person is required to deduct or collect tax under Part V of Chapter X or Chapter XII is not allowed as a deduction, unless the person has already paid or deducted and paid the tax as required by Division IV of Part V of Chapter X.
• For purchases of raw materials and finished goods, the disallowance under this clause shall not exceed twenty percent of such purchases.
• Recovery of any tax amount under sections 161 or 162 is considered as tax paid.
• Fines and Penalties: Any fine or penalty paid or payable by the person for the violation of any law, rule, or regulation.
• Personal Expenditures: Any personal expenditures incurred by the person.
• Amounts Carried to Reserve Fund or Capitalised: Any amount carried to a reserve fund or capitalised in any way.
• Payments by Association of Persons to Members: Any profit on debt, brokerage, commission, salary, or other remuneration paid by an association of persons to a member of the association.
• Non-Digital Transactions (for companies): For a company, any expenditure for a transaction paid or payable under a single account head that, in aggregate, exceeds rupees two hundred and fifty thousand, if the payment is not made by digital means from a business bank account notified to the Commissioner under Section 114A.
• This rule does not apply to expenditures not exceeding Rupees twenty-five thousand.
• It also does not apply to expenditures on account of utility bills, freight charges, travel fare, postage, and payment of taxes, duties, fees, fines, or any other statutory obligation.
• This specific clause is effective from a date to be notified by the Board.
• Salary Payments to Individuals: Any salary paid or payable exceeding thirty-two thousand rupees per month to an individual unless it is paid by a crossed cheque or direct transfer of funds to the employee’s bank account or through digital means.
• Capital Nature Expenditures: Any expenditure of a capital nature, except as specifically provided in Division III of that Part.

By Amjad Izhar
Contact: amjad.izhar@gmail.com
https://amjadizhar.blog

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