ISSUES IN TAX AUDIT U/S. 44AB AND U/S. 44AD AND CLAUSE TO CLAUSE ANALYSIS OF FORM NO 3CD

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1 ISSUES IN TAX AUDIT U/S. 44AB AND U/S. 44AD AND CLAUSE TO CLAUSE ANALYSIS OF FORM NO 3CD CA NAVEEN KHARIWAL G. B.COM,FCA Finance Act, 1984 Hon. Finance Minister: Tax Audit intended to ensure that the books of account and other records are properly maintained and faithfully reflect the true income of the taxpayer 1

2 Circular No. 387 dt A proper audit for tax purposes would ensure: That books of accounts and other records are properly maintained That they faithfully reflect the income of the taxpayer Claims of deductions are correctly made by him Circular No. 387 dt Such audit would also help in checking practices fraudulent Facilitate administration of tax laws by proper presentation of accounts Considerable saving of time of the AO in carrying out routine verifications Checking correctness of totals and verifying purchase and sales are properly vouched whether 2

3 [Audit of accounts of certain persons carrying on business or profession. 44AB. Every person, (a) carrying on business shall, if his total sales, turnover or gross receipts, as the case may be, in business exceed or exceeds 6 [sixty lakh rupees] in any previous year; or (b) carrying on profession shall, if his gross receipts in profession exceed 8 [fifteen lakh rupees] in any [previous year; or (c) carrying on the business shall, if the profits and gains from the business are deemed to be the profits and gains of such person under [section 44AE ] [or section 44BB or section 44BBB], as the case may be, and he has claimed his income to be lower than the profits or gains so deemed to be the profits and gains of his business, as the case may be, in any [previous year; or]] (d) carrying on the business shall, if the profits and gains from the business are deemed to be the profits and gains of such person under section 44AD and he has claimed such income to be lower than the profits and gains so deemed to be the profits and gains of his business and his income exceeds the maximum amount which is not chargeable to income-tax in any previous year,] 3

4 get his accounts of such previous year audited by an accountant before the specified date and [furnish by] that date the report of such audit in the prescribed form duly signed and verified by such accountant and setting forth such particulars as may be prescribed : Provided further that] in a case where such person is required by or under any other law to get his accounts audited, it shall be sufficient compliance with the provisions of this section if such person gets the accounts of such business or profession audited under such law before the specified date and [furnishes by] that date the report of the audit as required under such other law and a further report [by an accountant] in the form prescribed under this section. Explanation. For the purposes of this section, (i) accountant shall have the same meaning as in the Explanation below sub-section (2) of section 288; [(ii) specified date, in relation to the accounts of the assessee of the previous year relevant to an assessment year, means the [30th day of September] of the assessment year.]] 4

5 Liability of Tax Audit A charitable trust, cooperative society etc., though their income may be exempt, even if turnover exceed the threshold limit, they should get their account audited. If income of an assessee is below the taxable limit, he will also liable to get his account audited, if the turnover in business exceed the threshold limit. Section 44AB not applicable to assessee covered us 44B and 44BBA. A non-resident is also required to get his accounts audited and to furnish report under sec 44AB, but only pertaining to Indian operations. An agriculturist is not required to get his accounts audited u/s 44AB even though the total sales of agricultural products may exceed Rs 60 lakhs. 5

6 Total Sales, Turnover or Gross Receipts Not defined in Sec. 44AB or any other provision of the Act. Can be interpreted as volume of business, total is for all three expressions. Sale denotes sale of movable commodity. Turnover is aggregate amount for which sales effected or services rendered (as per guidance note of ICAI). Gross receipt to include all receipts whether in cash or kind from carrying of business. Sales, turnover & gross receipts should be determined as per method of accounting regularly employed. ISSUE NO. 1 whether the sales by commission agent or by person on consignment basis forms part of turnover The position that emerges from ICAI s Guidance Note and CBDT s Circular No. 452, dated is as under: If the property in the goods or all significant risks and rewards of ownership of goods belongs to the commission agent or consignee immediately before the transfer by him to a third party, then the sales price received / receivable by the commission agent or consignee shall form part of his sales / turnover. If the property in the goods or all significant risks and rewards of ownership in the goods continue to remain with the principal (consignor) immediately before the transfer by him, (the commission agent or consignee) to a third party, then the sales price received / receivable by the commission agent or consignee shall not form part of the sales / turnover of the commission agent or consignee. The sales price received / receivable by him shall form part of the sales / turnover of the principal (consignor). 6

7 ISSUE NO. 2 In case of share brokers Share brokers, on purchasing securities on behalf of their customers, do not get them transferred in their names but deliver them to the customers who get them transferred in their names. The same is true in case of sales also. The share broker holds the delivery merely on behalf of his customer. The property in goods does not get transferred to the share brokers. Only brokerage which is being accounted for in the books of account of share brokers should be taken into account for considering the limits for the purpose of section 44AB. However, in case of transactions entered into by share broker on his personal account, the sale value should also be taken into account for considering the limit for the purpose of section 44AB. The case of a sub-broker is same as that of a share broker. Issue No. 3 - Speculation Transaction 43(5) It means a transaction, in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips. Thus, in a speculative transaction, the contract for sale or purchase which is entered into is not completed by giving or receiving delivery so as to result in the sale as per value of contract note. 7

8 The contract is settled otherwise and squared up by paying out the difference which may be positive or negative. As such, in such transaction the difference amount is 'turnover'. In the case of an assessee doing speculative transactions there can be both positive and negative differences arising by settlement of various such contracts during the year. Each transaction resulting into whether a positive or negative difference is an independent transaction. Further, amount paid on account of negative difference paid is not related to the amount received on account of positive difference. In such transactions though the contract notes are issued for full value of the purchased or sold asset the entries in the books of account are made only for the differences. Accordingly, the aggregate of both positive and negative differences is to be considered as the turnover of such transactions for determining the liability to audit vide section 44AB. 8

9 Issue No. 4 - Derivatives, futures and options: Such transactions are completed without the delivery of shares or securities. These are also squared up by payment of differences. The contract notes are issued for the full value of the asset purchased or sold but entries in the books of account are made only for the differences. The transactions may be squared up any time on or before the striking date. The buyer of the option pays the premia. (I) (II) (III) The turnover in such types of transactions is to be determined as follows: The total of favourable and unfavourable differences shall be taken as turnover. Premium received on sale of options is also to be included in turnover. In respect of any reverse trades entered, the difference thereon, should also form part of the turnover. 9

10 Issue No. 5 - Delivery based transactions: Where the transaction for the purchase or sale of any commodity including stocks and shares is delivery based whether intended or by default, the total value of the sales is to be considered as turnover. Issue No. 6 - Capital Gains Vs. Business CBDT s Instruction No dated r.w. Circular No. 4/2007, dated Depends on facts and circumstances of each case taking into consideration nature, frequency and volume of transaction. Landmark Judgments : i. CIT v. P.K.N. and Co. Ltd. (1966) 60 ITR 65 (SC). ii. Saroj Kumar Mazumdar v. CIT (1959) 37 ITR 242 (SC). iii. CIT v. Sutlej Cotton Mills Supply Agency (1975) 100 ITR 706 (SC). iv. CIT (Central), Cal Vs. Associated Industrial Development Co.(P.) Ltd. [1971] 82 ITR 586 (SC). v. Venkataswami Naidu & Co.(G) v. CIT (1959) 35 ITR 594 (SC). 10

11 The Authority for Advance Rulings (AAR) (288 ITR 641), referring to the decisions of the Supreme Court in Several Cases, has culled out the following principles:- (i) (ii) Where a company purchase and sells shares, it must be shown that they were held as stock-in-trade and that existence of the power to purchase and sell shares in the memorandum of association is not decisive of the nature of transaction; The substantial nature of transactions, the manner of maintaining books of account, the magnitude of purchases and sales and the ratio between purchases and sales and the holding would furnish a good guide to determine the nature of transactions; (iii) Ordinarily the purchase and sale of shares with the motive of earning a profit, would result in the transaction being in the nature of trade / adventure in the nature of trade; but where the object of the investment is shares of a company is to derive income by way of dividend etc., then the profits accruing by change in such investment (by sale of shares) will yield capital gain and not revenue receipt. 11

12 Board Circular No. 4/2007, dated It is possible for tax payer to have two portfolios, i.e., an investment portfolio comprising of securities which are to be treated as capital assets and a trading portfolio comprising of stock in trade which are to be treated as trading assets. Where an assessee has two portfolios, the assessee may have income under both heads i.e., capital gains as well as business income. Issue No. 7 - The following items would not form part of "gross receipts in business for purposes of section 44AB In the case of a traveling agent, the amount received from the clients for payment to the airlines, railways etc. where such amounts are received by way of reimbursement of expenses incurred on behalf of the client. If, however, the travel agent is conducting a package tour and charges a consolidated sum for transportation, boarding and lodging and other facilities, then the amount received from the members of group tour should form part of gross receipts and In the case of an advertising agent, the amount of advertising charges recovered by him from his clients provided these are by way of reimbursement. But if the advertising agent books the advertisement space in bulk and recovers the charges from different clients, the amount received by him from the clients will not be the same as the charges paid by him and in such a case the amount recovered by him will form part of his gross receipts. 12

13 The principle to be applied is that if the assessee is merely reimbursed for certain expenses incurred, the same will not form part of his gross receipts. But in the case of charges recovered, which are not by way of reimbursement of the actual expenses incurred, they will form part of his gross receipts. Issue No. 8 - An assessee own 4 proprietorship businesses. The aggregate annual turnover of all the concerns exceeds Rs. 60 lakhs but individually each business s turnover is below Rs. 60 lakhs. Further, separate books of account are maintained for each business and profit and loss account and balance sheet are prepared separately. (a) will tax audit under section 44AB be applicable? (b) If yes, should the particulars of all busineses be reported in a single Form No. 3CD? If so, how? (c) Should the tax auditor give a consolidated Form No. 3CD in respect of all the concerns? 13

14 Ans : (a) The requirement of tax audit in the case of an assessee is to be determined taking into consideration the sales, turnover or gross receipts of all the businesses carried on by him. If the aggregate annual turnover of the four proprietary concerns exceed Rs. 60 lakhs, section 44AB would be clearly applicable. (b) In regard to audit report and furnishing of particulars in Form Nos. 3CA/3CB and 3CD, there are two possibilities, Firstly, separate tax auditors may be appointed in respect of individual businesses in which case Form Nos. 3CB and 3CD have to be submitted separately for each business. Alternatively, one tax auditor may undertake the audit of all the businesses. Here also the tax auditor can prepare Form Nos. 3CA/ 3CB and 3CD separately for each business. The need for separate forms for each business arises particularly where reliefs are claimed in respect of individual businesses. 14

15 (c) However it may be noted that tax audit as such is conducted in respect of an assessee and hence the question of consolidating the separate forms into a single form assumes importance. Further, without consolidating the separate Form Nos. 3CD into a single form particulars like deduction permissible under chapter VIA cannot be given. Hence it is advisable to prepare a consolidated form. The auditor consolidating the report / form can rely on the work of the other auditor (AAS -10) (Revised). Issue No. 9 - (i) The assessee is the proprietor of the following businesses: (a) cloth business at Bangalore Sales Rs. 30 Lakhs. (b) yarn business at Chennai sales Rs. 25 lakhs. (c) hosiery business at Calicut Sales Rs. 22 lakhs. Separate sets of books are maintained at each of the above places. The business are carried on in different names viz., (a) Vinay Cloth Stores (b) Nagaraj Yarn Merchants and (c) Natesh hosiery Mart. Should the assessee get his accounts audited under section 44AB in respect of each of the above proprietary concerns? 15

16 (ii) If, in the above case, the hosiery business is carried on by the assessee s wife from the funds gifted by the assessee and the income of the business is includible in the income of the assessee under section 64, what will be te position of audit under section 44AB? (iii) If the assessee is a partner in (a) M/s. A & Co., (Sales Rs. 45 lakhs) (b) M/s. B & Co., (Sales Rs. 48 lakhs) and (c) M/s. D. & Co., (Sales Rs. 40 lakhs) and he has 60% share in each of the above firms, should each of the above firms get its accounts audited under section 44AB? Should the asseessee who is a partner in the above firms get his personal accounts audited under section 44AB as the aggregate of his share in the turnover of the three firms exceeds Rs. 60 lakhs. 16

17 Ans: (i) Even if the assessee carries on business at different places in different names and deals in different commodities, it will be necessary to get the accounts audited if the aggregate amount of sales of all the businesses exceed Rs. 60 lakhs. In the given case the total sales of the three businesses amount to Rs. 77 lakhs Therefore, it will be necessary to get the accounts of all the three concerns belonging to this assessee audited. It may be noted that the emphasis is on the total sales. Therefore, even if the assessee carries on one or more businesses the sales of all the businesses will be taken into consideration. Ans: (ii) If the business is carried on by the wife of the assessee, it cannot be said that it is carried on by the assessee merely because the income from the business is includible in the income of the assessee under section 64. Therefore, the wife of the assessee carrying on hosiery business with turnover of Rs. 22 lakhs will not be required to get the accounts audited under section 44AB. 17

18 Ans: (iii) Each firm is a separate person / assessee for the purpose of Income-tax Act. Therefore, the figures of sales of each firm will have to be considered. In the given case, it will not be necessary for A & Co., B & Co., or C & Co., to get their accounts audited as the sales of any one of these firms do not exceed Rs. 60 Lakhs. Similarly, any partner of these firms will not be required to get his personal accounts audited if he is not carrying on any personal business having sales / turnover exceeding Rs. 60 lakhs. The sales / turnover of the firms in which he is a partner cannot be taken into consideration for this purpose. Issue No (i) A & Co. (Partnership firm) is appointed as selling agent of a textile mill. The firm canvasses orders for the mill. The goods are despatched by the mill to the customers introduced by A & Co. The sales bills are prepared by the mill. A & Co., recovers the sale proceeds and remits the same to the mill. The total sales organised by A & Co., during the year ended amounted to Rs. 20 crores. The 1% earned by A & co., amounted to Rs. 20 lakhs. Should A & Co., get their accounts audited under section 44AB? 18

19 (ii) In the above case if A & Co., had purchased cloth for Rs. 55 lakhs and sold cloth worth Rs. 50 lakhs will the provisions of section 44AB apply? Ans : (i) In this case, A & Co. is a selling agent of the textile mill. From the facts stated in the above issue, it is evident that the selling agent does not become the owner of the goods. The ownership continues to be that of the mill and it passes from the mill to the customer. The goods are despatched directly by the mill to the customers and sales bills are prepared by the mill. Therefore, the amount of the sales made by the mill cannot be taken into consideration for determining the liability of A & Co., to get its accounts audited under section 44AB. Since the commission income of A & Co. is only Rs. 20 lakhs and if there are any sales or other trading receipts of A & Co., which are less than Rs. 40 lakhs, it will not be required to get its accounts audited under section 44AB. 19

20 (ii) As stated above, because the commission income of A & Co. is Rs. 20 lakhs and the sales of cloth amount to Rs. 50 lakhs the total turnover and gross receipts of A & Co. will exceed Rs. 60 lakhs and it will be necessary for it to get its accounts audited under section 44AB. Issue No Mr. B has received goods worth Rs. 50 lakhs on consignment from P & Co. These goods were sold by Mr. B at Bombay for Rs. 62 lakhs. He has issued his own bills disclosing therein that the goods belong to P & Co. On completion of sales he had rendered accounts sales to P & Co. and remitted the sale proceeds after deducting Rs. 1 lakh being expenses incurred for sales and Rs. 50,000/- being his commission. For sales-tax purposes, he is required to record the above sales in his sales records. Should Mr. B get his accounts audited under section 44 AB? 20

21 Ans : In this case, Mr. B is acting as consignment agent for P & Co. The sales made by Mr. B at Bombay for Rs. 62 lakhs are made on behalf of P & Co. These sales cannot be considered as sales of Mr. B. He is only entitled to his commission of Rs. 50,000/- which will form part of his gross receipts. Therefore, Mr. B. will not be required to get his accounts audited under section 44 AB if his total sales and gross receipts including commission income of Rs. 50,000/- does not exceed Rs. 60 lakhs. Issue No Sankhla industries is engaged in the manufacture of electrical goods. The total sales / turnover exceeds Rs. 60 lakhs. It owns the following industrial units. (i) Enterprise engaged in infrastructure development deduction available under section 80IA. (ii) Industrial Unit in a backward are deduction under section 80IB. If the assessee gets its accounts audited under section 44AB, is it necessary to get separate audit reports under section 80IA(7) and 80IB(13) read with 80IA(7)? In case audit is conducted under section 80IA (7) and / or 80IB (13) read with section 80IA(7) which form should be used, Form No. 3CA or 3CB. 21

22 Ans: Yes. It will be necessary to get a separate audit report under section 80(IA)(7) and 80(IB)(13) for each of the industrial unit. The finance Act, 2002 has amended these provisions making it mandatory for all assessees including companies and cooperative societies to submit a report under these sections. It is to be noted that audit report under section 80(IA)(7) and 80(IB) (13) is in respect of an industrial unit covered by the relevant provision whereas audit under section 44AB is in respect of an assessee covered by any of the clauses (a), (b) or (c). It is to be clarified that audit report in such cases will be in form No. 3CB in case the accounts of the assessee have not been audited under any other law such as Companies Act or Cooperative Societies Act etc. Audit under section 80(IA) or 80(IB) of the Income-tax Act will not be considered as audit under any other law. The requirement of section 44AB is a general one covering the overall position of the accounts of the assessee. 22

23 This applies to the accounts of the assessee for the relevant year covering the results of all the industrial units situated at different places. Therefore, when the sales/turnover of all the units put together exceeds Rs. 60lakhs the assessee will have to get the audit conducted under section 44AB and obtain the audit report in Form No. 3CB. Non Resident-Indian Operations: Issue No. 13- A foreign company has some business income from India. It has no permanent establishment in India. Since the income of the foreign company chargeable under the Income tax Act can not be precisely determined, the same has been assessed on the basis provided in Rule 10 of the Income tax Rules, There are no separate books of account for Indian business. What are the tax audit report requirements? Should Form No. 3CD be submitted in respect of such a foreign company? 23

24 Ans: Paragraph 6.3 clarifies that section 44AB does not make any distinction between a resident and a no-resident. Therefore, a nonresident assessee is also required to get his accounts audited and to furnish such report under section 44AB if his turnover exceeds the prescribed limits. This audit, however, would be confined only to the Indian operations carried out by the non-resident assessee since he is not chargeable to Income- tax in India in respect of income accruing or arising or received outside India. In the given issue, since there are no separate books of account for the Indian business, the tax auditor has to necessarily obtain relevant information from the overseas auditor for the purpose of enabling him to make the audit report and also furnish the necessary particulars. So far as audit report is concerned, Form No. 3CB should be used even if the accounts of the non-resident have been subject to audit by an auditor qualified to audit the accounts under the relevant statute of the country. It is also necessary to segregate the data relating to income chargeable under the Income-tax Act. The tax auditor has to make appropriate disclosures based on AAS- 10(Revised) Using the work of another auditor. 24

25 Issue No Surrender of Stocks: A survey was conducted during the financial year 2010/11 and the assessee surrendered stocks worth of Rs. 22 lakhs. During the financial year 2010/11 the assessee is having a turnover of Rs. 49 lakhs. Should the value of surrendered stock be included in the turnover for determining the applicability of section 44AB? Ans: The surrender of stock worth Rs. 22 lakhs during the survey does not mean that the turnover of the assessee for the relevant year exceeded Rs. 60 lakhs. Therefore, the value of surrendered stock cannot be treated as part of turnover for determining the applicability of section 44AB. It is also significant to note that paragraph 5.18 clarifies that section 44AB applies only if the turnover exceeds the prescribed limit according to the books maintained by the assessee. 25

26 Issue No Additional sales found as a result of search In Brijlal Goyal v. Asstt. CIT [2004] 88 ITD 413 (Delhi), The Tribunal held as under :.. Admittedly, the additional sales found as a result of search, was not recorded in the books of account regularly kept in the course of business by the appellant. Merely because the appellant accepted the additional sales for the purpose of assessment of the relevant year on the basis of entries in the seized documents, the same would not constitute accounts of the appellant maintained in the regular course of business and on that basis alone liability cannot be fastened on the assessee by holding him to have committed the default. Issue No Sale of car: Sale of car is not included in sales for the purpose of tax audit but according to some Supreme Court judgments under Sales tax Act, the sale of a car is to be treated as sales and sales tax has to be charged. Then, why should the same be excluded for tax audit purposes? 26

27 Ans: The sale of car is nothing but a sale of capital asset. The expression total sales, turnover or gross receipts used in clause (a) of section 44AB should be understood in the context of the expression in business appearing immediately thereafter in that very clause. The definition of sales under the Sales-tax Act of any state is not relevant for determining the applicability of section 44AB. Paragraphs 5.8(vi) and 5.13 (i) clarify that the sale proceeds of fixed assets would not from part of turnover gross receipts since these are not held for resale. Issue No Write back: As a result of writing back the account of a creditor, the turnover/gross receipt has exceeded Rs. 60 lakhs. Will the assessee be liable for tax audit? 27

28 Ans: Writing back of the amount payable to a creditor of which a deduction has been claimed is deemed as income for the purpose of section 41(1) of the Incometax Act, The amount so written back would not form part of gross receipt and as such will not be includible while determining the quantum for applicability of section 44AB (para 5.13 (xi) of guidance note on tax audit revised 2005 edition). It is also neither sales not turnover. Issue No Inclusion of Sales-tax: 16. A, an assessee, provides the following figures: Sales Rs. 58 lakhs Vat tax collected Rs. 3 Lakhs Is A liable for tax audit under section 44AB? 28

29 Ans: The words sales, turnover and gross receipts are commercial terms and they should be construed in accordance with the method of accounting regularly employed by the assessee. If the Vat tax collected is credited separately to Vat tax account and payments thereof are debited in the same account, they would not be included in the turnover. (Para 5.5 and 5.6 of ICAI s guidance note on tax audit revised 2005 edition). Issue No Sales through stalls: AK Pvt. Ltd. is running a departmental store. There are several stalls. Each stalls belongs to a different person. According to the arrangement by the stall owners with AK Pvt. Ltd., all sales proceeds are to be collected on the printed bills of AK Pvt. Ltd. The delivery counter is common for all stall owners and the same is managed by AK Pvt. Ltd The premises belongs to AK Pvt. Ltd. who takes out insurance and also makes security arrangements. The proceeds of all sales made by various stall owners are collected by AK Pvt, Ltd. 29

30 At the end of every week AK Pvt. Ltd. makes up the sales account of each stall owner and after deducting charges/commission at the agreed rate remits the balance amount to each stall owners. The total turnover on the above basis works out to about Rs. 3 crores. However, the income of AK Pvt. Ltd. from charges/commission recovered from the stall owners is Rs. 30 lakhs. Is AK Pvt. Ltd. liable to get its accounts audited under section 44AB? Ans: It will not be necessary for AK Pvt Ltd. To get its accounts audited under section 44AB. The sales in this case cannot be considered as the sales of AK Pvt. Ltd. These are sales of the stall owners. AK Pvt Ltd. has only undertaken to render services like providing space, making security arrangements, taking out insurance, collection of sale proceeds on behalf of the stall owners and rendering account to them. The commission earned for these services does not exceed the limit of Rs. 60 Lakhs prescribed in section 44AB. Therefore, the provisions of section 44AB are not attracted in this case. 30

31 Discuss the following issues: Issue No Leasing a) In the case of a company engaged in the business of equipment leasing will the provisions of section 44AB for tax audit apply b) In the case of a company engaged in leasing finance, will the provisions of section 44AB for tax audit apply? c) In the above cases how will the monetary limit of Rs. 60 lakhs for turnover or gross receipts be computed? d) In the case of a company supplying equipment on hire purchase basis how will the monetary limit of Rs. 60 lakhs be computed for the purpose of section 44AB? Ans: (i) In the case of a company engaged in the business of equipment leasing the provisions of section 44AB for tax audit will apply if its gross receipts from lease rent exceed Rs. 60 lakhs. (ii) In the case of a company engaged in the business of leasing finance, the provisions of section 44AB for tax audit will apply if its gross receipts from the leasing finance exceed Rs. 60 Lakhs. 31

32 (iii) The monetary limit of Rs. 60 lakhs will be computed in the above cases with reference to lease rent or interest on financing. The value of the equipment given on lease or the amount advanced under leasing finance cannot be considered for this purpose. (iv) When equipment is supplied on hire-purchase basis, the sale is complete when the person taking the equipment exercises his option to purchase. Therefore, during the years when hire charges (excluding instalments of principal amount) are received by the company, the figure of such charges will from part of its gross receipts. When the purchaser exercises his option to purchase, the price at which the equipment is sold to him will form part of total sales or turnover of that year. Issue No Form No. 3CA/3CB: a) The accounting year of an assessee has been changed from calendar year to April to March. Accordingly, the accounts have been drawn for the period from January, 2010 to March 31,2011 which have already been audited for tax audit. Which form of audit report should be used? Form No. 3CA or Form No. 3CB? Should separate accounts have to be drawn for the period from 1 st April, 2010 to 31 st March, 2011? 32

33 (b) Rule 6G(a) provides that in the case of a person who carries on business or profession and who is required by or under any other law to get his accounts audited the audit report should be in Form No. 3CA. Under the Companies Act, all companies are required get their accounts audited. However the accounting year for the Companies Act can be different from that of the previous year under the Income tax Act e.g. under the Companies Act it may be, say, 30 th September. In such cases how can the company comply with the requirements of Form No. 3CA? Ans: Issues (a) and (b) are answered together. The previous year for tax purposes shall always be the financial year as per section 3 of the Income-tax Act. Therefore the final accounts along with tax audit report have to be of the financial year. Accordingly in case the annual accounts i.e. balance sheet and profit and loss account have not been audited and certified, it cannot fulfill the requirement of Form No. 3CA which requires the tax auditor to enclose the audited profit balance sheet as at 31 st March. 33

34 Hence, in such cases the tax payer is required to prepare a separate profit and loss account and balance sheet as at 31 st March and get the same audited and the tax auditor is to give the report in Form No. 3CB whereby he is required first to certify the true and fair view of the balance sheet and profit and loss account and furnish statement of particulars in Form No. 3CD. Though Rule 6G(1)(a) provides that a person who carries on business or profession and who is required by or under any other law to get his accounts audited the tax audit report should be in Form No. 3CA, the word accounts here has to be interpreted in terms of the requirement of Form No. 3CA. Accounts here will mean the accounts i.e. profit and loss account and the balance sheet and tax audit report. In case the accounts i.e. profit and loss account and balance sheet with tax audit report has not been audited under any other law, the correct form will be Form No. 3CB. [Circular No. 561 dated vide page 167 of guidance note on tax audit revised 2005 edition.] 34

35 Issue No Revision of Tax Audit Report: Can a tax auditor revise his tax audit report and Form No. 3CD? Ans: A tax auditor should exercise extreme care and caution while discharging his responsibilities. He should ensure that correct information has been given in Form No. 3CA/3CB and 3CD. However, if he feels that there is a need for revising the audit report and / or Form No. 3CD, it is advisable to do so in a timely manner and he should clearly indicate the reasons for giving a revised report. Attention is also invited to paragraph and to the guidance note on revision of Audit Report which deals with this aspect elaborately. 35

36 Issue No Relying on the work of statutory auditor (i) A tax auditor does not agree with the treatment given in the audited financial statements in respect of (i) personal expenses, (ii) capital expenditure, (iii) valuation of stock-in-trade (iv) method of accounting or (v) other matters covered in Form No. 3CD. (ii) If the statutory auditor has not qualified his audit report on these matters, can the tax auditor qualify his report in Form No. 3CA and make appropriate comments in Form No. 3CD? Ans: (i) In case where statutory audit under any other law has been conducted by an auditor other than the tax auditor the requirement of section 44AB read with Rule 6G(1)(a) is to enclose a report of such audit and the tax auditor is required to furnish statement of particulars in Form No. 3CD and certify that the particulars given in the said Form No. 3CD are true and correct. The tax auditor is not required to comment upon the audit report given by the statutory auditor. As such there will be no requirement on the part of tax auditor to qualify his report in Form No. 3CA. 36

37 (ii) The tax auditor, however, has the primary responsibility of the verification of the particulars prescribed in Form No. 3CD and he should ensure that the particulars stated are in conformity with the provisions of the Income-tax Act. Normally the tax auditor should accept the treatment given to various items in the financial statements which have been audited by the statutory auditor. If, however, while conducting tax audit he is unable to agree with the treatment given to a particular item in the audited financial statement, he should first ascertain preferably from the statutory auditor, the reasons for his giving such a treatment in his statement. It is possible that statutory auditor while considering the items on (i) personal expenses, (ii) capital expenditure, (iii) valuation of stock and trade, (iv) method of accounting or other matter covered in Form NO.3CD might have dealt with the item from the angle of generally accepted accounting principle or statutory provisions covering the entity. The responsibility of furnishing true and correct particulars in Form NO.3CD is that of the entity. For this purpose, statutory provision and judicial pronouncement under tax laws have to be taken into consideration. 37

38 The tax auditor should verify and ensure that particulars in respect of the above items such as personal expenses, capital expenditure, valuation of stock and trade, method of accounting etc. are given on the basis of explanations above. However, any difference between the figures given in the audited financial statements and figures given in Form No.3CD should be explained by giving appropriate notes. If, however, there is any difference in the opinion of the tax auditor and that of the entity in respect of any information furnished in Form No.3CD, the tax auditor should state both the view points and also the relevant information. Attention is invited to paragraph of revised guidance note on tax audit 2005 edition. Issue No. 24 Advance received for services are rendered. These are liabilities and not part of gross receipts until services are rendered. - For contrary viewpoint- see Dy. CIT v. Gopal Krishan Builders.[2004] 91 ITD 124 (Lucknow)(SMC). The Tribunal held that each and every word used in any statute has its importance and is used by legislature after a lot of deliberations. 38

39 The words used in section 44AB: total sales, turnover or gross receipts have been used specifically and the scope of the words gross receipts is quite wide otherwise legislature would have stopped after using the words sales or turnover, Further, these advances were having an element of profit. The amount was to be adjusted towards the cost of flats booked by each customer and the amounts will have an element of construction cost as well as profit which might be bigger in proportion when whole of the cost is realized. What assessees should do to determine applicability of tax audit u/s 44AB is as under (in the light of Tribunal s decision): a) In cases of business which do not have turnover or total sales and professions Determine gross receipts i.e. total amounts received (including advances) which have profit-making quality about them. If gross receipts exceed Rs. 60 lakhs / Rs. 15 lakhs as the case may be, tax audit is applicable. 39

40 b) In cases of businesses in manufacturing / trading sector-i.e. businesses which have turnover / sales The following steps are necessary: 1. Determine Sales / Turnover as per the method of accounting regularly employed by the assessee (Cash or mercantile system) and excluding sales tax / duty / other taxes. 2. Determine gross receipts- i.e. total amounts received (including advances) which have profit making quality about them (as per Tribunal s decision above). 3. If Sales or Turnover or Gross receipts exceed Rs. 60 Lakhs, tax audit is applicable. c) If there is no sales / turnover / work done or completed during the financial year but only advances have been received (to be adjusted against value to be provided by way of goods / services); then if total advances received exceeds Rs. 60 Lakhs / Rs. 15 Lakhs, as the case may be, tax audit under section 44AB is applicable. 40

41 Special provision for computing profits and gains of business on presumptive basis. (1) Notwithstanding anything to the contrary contained in sections 28 to 43C, in the case of an eligible assessee engaged in an eligible business, a sum equal to eight per cent of the total turnover or gross receipts of the assessee in the previous year on account of such business or, as the case may be, a sum higher than the aforesaid sum claimed to have been earned by the eligible assessee, shall be deemed to be the profits and gains of such business chargeable to tax under the head Profits and gains of business or profession. (2) Any deduction allowable under the provisions of sections 30 to 38 shall, for the purposes of sub-section (1), be deemed to have been already given full effect to and no further deduction under those sections shall be allowed : Provided that where the eligible assessee is a firm, the salary and interest paid to its partners shall be deducted from the income computed under sub-section (1) subject to the conditions and limits specified in clause (b) of section

42 (3) The written down value of any asset of an eligible business shall be deemed to have been calculated as if the eligible assessee had claimed and had been actually allowed the deduction in respect of the depreciation for each of the relevant assessment years. (4) The provisions of Chapter XVII-C shall not apply to an eligible assessee in so far as they relate to the eligible business. (5) Notwithstanding anything contained in the foregoing provisions of this section, an eligible assessee who claims that his profits and gains from the eligible business are lower than the profits and gains specified in sub-section (1) and whose total income exceeds the maximum amount which is not chargeable to income-tax, shall be required to keep and maintain such books of account and other documents as required under sub-section (2) of section 44AA and get them audited and furnish a report of such audit as required under section 44AB. 42

43 Explanation. For the purposes of this section, (a) eligible assessee means, (i) an individual, Hindu undivided family or a partnership firm, who is a resident, but not a limited liability partnership firm as defined under clause (n) of sub-section (1) of section 2 of the Limited Liability Partnership Act, 2008 (6 of 2009) and (ii) who has not claimed deduction under any of the sections 10A, 10AA, 10B, 10BA or deduction under any provisions of Chapter VIA under the heading C. - Deductions in respect of certain incomes in the relevant assessment year; (b) eligible business means, (i) any business except the business of plying, hiring or leasing goods carriages referred to in section 44AE; and (ii) whose total turnover or gross receipts in the previous year does not exceed an amount of [sixty lakh rupees].] Critical analysis of section 44AD 43

44 Till the 31 st March,2010, the Chapter Profit & gains of Small business on Presumptive Basis was having majorly 3 sections for Indian entities. > Section 44AD civil construction > Section 44AE Transporters > Section 44AF Retail Traders From the honorable finance minister Mr. Pranab Mukherjee has amended the first section i.e. 44AD along with 5 sub sections to facilitate the business operations of small taxpayers Earlier this section was extended to civil constructions only but now this section has been extended to all small businesses. 44

45 The new section 44AD is as follows: 44AD (1) Notwithstanding anything to the contrary contained in sections 28 to 43C, in the case of an eligible assessee engaged in an eligible business, a sum equal to eight per cent of the total turnover or gross receipts of the assessee in the previous year on account of such business or, as the case may be, a sum higher than the aforesaid sum claimed to have been earned by the eligible assessee, shall be deemed to be the profits and gains of such business chargeable to tax under the head Profits and gains of business or profession. For better understanding of sub section 1 of newly inserted section 44AD, we must know the meaning of following: > Eligible Assessee > Eligible Business > Total Turnover/Gross receipts > Significance of Word Gross Receipts > Claimed to have been earned 45

46 1. Who is an Eligible Assessee? (explanation to Section 44AD) (a) eligible assessee means:- (1) an individual (2) Hindu undivided family (3) or a partnership firm who is a resident. but not a limited liability partnership firm as defined under clause (n) of sub-section (1) of section 2 of the Limited Liability Partnership Act, 2008 (6 of 2009); and (explanation to Section 44AD) (ii) who has not claimed deduction under any of the sections 10A, 10AA, 10B, 10BA or deduction under any provisions of Chapter VIA under the heading C. - Deductions in respect of certain incomes in the relevant assessment year; 46

47 Who all are the aseessees not covered under Section 44AD? > Individual who is not resident > HUF who is not Resident > Association of Person > Firm having non resident Status. > A local Authority > A co-operative Society > Limited Liability Partnership both Indian as well as Foreign > Companies both Domestic and Foreign company > Every Artificial Juridical Person > Individual/HUF/Firms claiming deduction under chapter III of the Act i.e Section 10A,10AA,10B,10BA relating to units located in FREE Trade Zone, Hardware & Software Technology Park etc. > Individual/HUF/Firms claiming deduction under Chapter VIA Part-C (deductions in respect of certain Incomes) i.e Section 80H to 80TT. 2. What is eligible Business? (explanation to Section 44AD) (b)eligible business means, (i) any business except the business of plying, hiring or leasing goods carriages referred to in section 44AE; and (ii) whose total turnover or gross receipts in the previous year does not exceed an amount of[sixty lakh rupees]. Meaning of the above section: Eligible Business covers any business except Transport Business (Transportation Business has special treatment under section 44AE). 47

48 This provision is straightforward and includes all the business whether it is:. > Manufacturing > Trading > Wholesale > Retail > Job Work > Service business > Speculative/ Non speculative. The only criteria is that, the turnover of eligible Business should not exceed Rs. Sixty lakhs in the previous Year. What is not included in the Business?. The profession is not included in the business because: There is specific reference to the word Business in Section 44AD, which does not include profession, and There is specific Turnover limit of Rs. 15 Lakhs for Profession under section 44AB, which means that profession is totally separate from Business. 48

49 How to calculate limit of 60 lakhs? The Total Turnover and Gross receipts should be less than 60 lacs in the previous Year. It includes all the eligible businesses carried on by a eligible assessee during the previous year and the 60 lakhs will be for all of them cumulatively. Few Examples: 1. Manish, a resident individual, is carrying on three eligible businesses, the turnover of which is as under : > Business A (Manufacturing) Rs. 25 Lac > Business B (Trading) Rs. 15 Lac > Business C (Service) Rs. 25 Lac Whether section 44AD is applicable on him? The Answer is NO because turnover of eligible business exceed Rs. 60 Lakhs. 49

50 2. Manish, a resident individual, is carrying on two businesses, the turnover of which is as under : > Business A (Eligible Business) Rs. 55 Lacs > Profession Rs. 10 Lacs > Business B (Transport u/s 44AE) Rs. 6 Lacs Section 44AD and 44AE both are applicable, as profession is not included under section 44AD and section 44AD and 44AE are independent of each other. Who bears the onus of proof to prove the turnover? The onus of proof is on the assessee. It is his duty to prove the turnover. If the assessee is maintaining the books of accounts, then it will be easy for him to prove the same, but if he is not maintaining the books of accounts, then it will be very difficult for him to prove, because there is no specific provision for the same. What documents you should provide to the AO to prove the turnover? - copies of invoices issued during the PY - copies of cash memo - copies of Purchase bill - Bank statement - Inventory details, if any maintained - Average G.P rate applicable to Particular business - Returns filed under sales tax/vat/excise/service Tax laws. 50

51 What is the meaning of Notwithstanding Anything to contrary contained in section 28 to 43C Section 44AD(1) starts with wording Notwithstanding Anything to contrary contained in section 28 to 43C it means section 28 to 43C of Income Tax Act, 1961 is not applicable on eligible assessee carrying on small business. The some of the benefits & losses of this wording is enumerated as under by way of examples : Manish has paid Rs /- for purchase of goods in cash. No disallowance can be made under section 40A(3) for the same. Ashish has paid Rs /- to transporter for freight in cash. No disallowance can be made under Section 40A (3). Vipin has contributed certain sum to national Laboratory which qualifies for deduction under section 35(2AA), if he chooses section 44AD, he will not eligible for benefit of this section. Vicky has recovered certain bad debts written off in earlier years of Rs /-. It may not be added in specified amount declared What is the meaning of Claimed to have been earned? By the introduction of these words in section 44AD(1), the legislature shows its intention to accept specified income as returned income even if higher sum is earned by eligible assessee unless it is claimed by assessee in his Income Tax Return. Example Manish is carrying on small business. The Turnover is Rs. 50 lakhs. The profit as per his books or calculation is Rs. 8 Lakhs. However, he opts to return the income under section 8% i.e Rs. 4 Lakhs. The proceeds of business are deposited in a bank account. 51

52 Can the AO assess the difference amount as undisclosed income? Section 44AD(2) (2) Any deduction allowable under the provisions of sections 30 to 38 shall, for the purposes of sub-section (1), be deemed to have been already given full effect to and no further deduction under those sections shall be allowed. Provided that where the eligible assessee is a firm, the salary and interest paid to its partners shall be deducted from the income computed under sub-section (1) subject to the conditions and limits specified in clause (b) of section 40 52

53 Computation of Taxable Profit u/s 44AD in case of Partnership Firm Profit from Business Particulars Amount 44 AD ( Say the turnover is Rs. 50 lacs) then the4,00,000 income would be 8% Less: Interest allowable u/s 40(b) 1,20,000 Remuneration to partners allowable 1,80,000 Total Income of the Firm U/s. 44AD 1,00,000 Section 44AD (3) The written down value of any asset of an eligible business shall be deemed to have been calculated as if the eligible assessee had claimed and had been actually allowed the deduction in respect of the depreciation for each of the relevant assessment years. 53