Aspects of Income Tax Scrutiny

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Claribel Foster
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1 Objective Aspects of Income Tax Scrutiny The main objective of the IT officer during scrutiny is to make sure that the income shown in the return is real and there is no tax evasion. The expenses incurred are also scrutinised to find out whether they are actually incurred and are not fictitious. For this, the assessing officer calls for the following documents/information: 1. Summary of all the bank accounts and copies of the bank pass book/statement explaining each debit and credit. 2. Details of the family members living with assessee. 3. Investments made in immovable properties, FDRs, shares, debentures, bonds and sources of funds for making such investments by assesee and his family members. 4. Details of all 12 months credit card statements and source of payment thereof. 5. Details of loans accepted and given during the year especially friends and relatives, and also confirmation from borrowers alongwith their respective PANs. 6. Details of gifts given and taken during the year. 7. Details of household expenditure and drawings made to meet it. 8. Details of foreign travel/ packaged tour undertaken and expenditure thereon. 9. Club membership and annual subscription. 10. Details and source of expenditure on children s education. 11. Details and source of expenditure on family weddings, parties and any other festive occasion held during year under scrutiny. 12. Details of motor vehicles held and source of purchase thereof. 13. Details and proofs of rent paid during the year for which HRA has been claimed as exempt. 14. Details and proofs of donations made for which deduction has been claimed u/s 80G. 15. Source of income of minor child and assets held by him. 16. Details of household electricity expenses and the electronic gadgets in home. Help during assessment stage: 1. It should be ensured that all the credits of income appearing in the bank statement/pass book have been shown in the return. A balance sheet should be prepared for each year which keeps a proper track of assets and incomes. 2. Adequate withdrawals (cash or bank) should be made for personal and household expenses. The ITO would be smart enough to make an estimate that how much money a family like yours would be requiring for household needs (based on the size of family and cost of living in the city) and compare it with withdrawals made by the assessee for the given purpose. If there is shortfall then it is presumed that there is supply of black money which is generally spent on day-to-day expenses. 3. Ensure that payment for the expenses charged on the credit cards is done through regular bank account and not secret bank account.

2 4. A proper record should be maintained of the investments made along with their sources and supporting documents. All unexplained investments would be added as income. 5. Income of minor child should be included in the income of parent whose total income is higher, before including the income of minor child. 6. If HRA exemption is claimed, then the proof of rent paid has to be furnished. Also ensure that if rent is paid to one s parents or any relative, then the rent is shown in the return of income of the person receiving the rent. 7. If any asset is purchased by spouse out of the money gifted by assessee then the income from such asset would be included in the income of assessee. 8. One should generally not give interest-free loans when one has already borrowed money and is repaying that with interest. The most common disallowance/addition that is being made nowadays in the scrutiny assessment orders is the addition of notional interest on interest free loans given to someone. It has to be proved that the loans are genuine and reasons for giving interest-free loans are also genuine. 9. Proper record should be maintained of the gifts received including gift deed, PAN and bank statement of donor. With effect from April 1, 2006, gifts received from nonrelatives in excess of Rs.50,000 would be taxable as income of receiver. However, gifts from relatives and those received on occasion of marriage of individual are exempt without any limit. The scrutiny assessment should be completed in 21 months from the end of the relevant assessment year. For instance, The scrutiny for assessment year has to be completed by December 31, No doubt, the scrutiny process causes hardship to the assessee as the main focus of the IT department is to recover as much tax as possible. But taking proper measures from the beginning itself can mitigate the trouble. Computing the income chargeable to tax as per the provisions of the Income-Tax Act, 1961 is the first step in tax compliance. The natural sequence thereafter would be filing the return of income and awaiting approval of the tax authorities in respect of the income returned by means of an assessment order. Section 139 (1) enjoins on all corporate and partnership firms to file return of income whether or not they have income or loss. In the case of other assessees i.e., individuals, HUFs etc., the return of income has to be filed only if the income exceeds the prescribed basic limit. This write-up discusses the scrutiny procedure prescribed by the Central Board of Direct Taxes (CBDT) for the current financial year and the related issues. Legal provisions As per Section 143 (1) if any tax or interest is due, an intimation is required to be issued to the assessee. Similarly, where there is any refund due on the basis of return filed by the assessee, an intimation is required to be issued by the Assessing Officer (AO). The time limit for giving intimation is one year from the end of the financial year in which the return was filed. For example, for the assessment year if the return is filed on June 5, 2007, the time limit for giving intimation under Section 143(1) is available up to March 31, 2009.

3 Where the AO believes that the claim of loss, exemption, deduction, allowance or relief in the return is inadmissible or if he considers it necessary to ensure that the assessee has not understated his income, a notice under Section 143 (2) would be issued for verifying the books of account and other relevant documents and evidences. The culmination of this exercise would be scrutiny assessment envisaged in Section 143(3). Time Limit The time limit for service of scrutiny notice is 12 months from the end of the month in which the return was filed by the taxpayer. The time limit for completing the assessment is 21 months from the end of the assessment year in which the return was first assessable. For the assessment year if the return is filed after June 1, 2007 the time limit for completing scrutiny assessment would expire after December 31, The time limit for issuing intimation under Section 143(1) for non scrutiny cases, however, is available up to March 31, 2010 ( i.e.2 years from the end of the financial year in which the return was filed). Guidelines for Selection The CBDT instruction The CBDT has given norms for current fiscal for selection of cases meant for scrutiny. For corporates: All banks and public Sector undertakings are liable for scrutiny. Also, all NSE-500 companies and BSE-A group companies listed in Bombay Stock Exchange as on March 31, 2007, are covered. Companies in Delhi, Mumbai, Chen nai, Kolkata, Pune, Hyderabad, Bangalore and Ahmedabad paying book profit tax under Section 115 JB on the book profit of Rs 50 lakh and above are liable for scrutiny. In the case of companies in other places the monetary limit for book profit is Rs 25 lakh. All non-banking financial corporations and investment companies having paid up capital of Rs 10 crore are covered. Companies who have amalgamated and seeking set off of loss under Section 72 A are also to be scrutinised. Where the fresh capital introduced is Rs 50 lakh during the year such assessees are liable for scrutiny assessment. For non-corporates: If the fresh capital introduced exceeds Rs 50 lakh in respect of cases in Delhi, Mumbai, Chennai, Kolkata, Pune, Hyderabad, Bangalore and Ahmedabad are liable for scrutiny. In respect of other places the monetary li mit for fresh capital introduction is Rs 10 lakh for scrutiny selection. Where the unsecured loans introduced during the year exceeds Rs 25 lakh, such case is also covered. All market committees and statutory bodies are liable for compulsory scrutiny. Professionals with gross receipts of Rs 20 lakh or more but the income returned is less than 20 per cent are liable for scrutiny of their cases. Common to all taxpayers The following criteria apply for all the taxpayers regardless of their status. All search and seizure cases and surveys conducted under Section 133 A. Cases where deduction under chapter VI-A exceeds Rs 25 lakh. Cases were the CIT or ITAT has confirmed addition or disallowance of Rs 5 lakh or above in an earlier year and the identical issue arising in the current year. All cases in which the appeal is pending before CIT or pending before ITAT in respect of appeal preferred by the Department

4 relating to addition or disallowance of Rs 5 lakh and the identical issue arising in the current year. Charitable trusts claiming exemption under Section 11 with gross receipt exceeding Rs 5 crore in 8 cities viz Delhi, Mumbai, Chennai, Kolkata, Pune, Hyderabad, Bangalore and Ahmedabad. For other places the monetary limit is Rs 1 crore. Educational institutions, hospitals (being non profit organisations) with aggregate receipt exceeding Rs 10 crore (including corpus donations) in 8 cities and Rs 5 crore in other places. However, it will not apply to those which are su bstantially financed by the Government. All cases where the total value of International Transactions for the year exceeds Rs 15 crore. Stock brokers and commodity brokers where the brokerage exceeds Rs 1 crore. Stock brokers and commodity brokers including sub-brokers if the bad debt claim is Rs 5 lakh. For corporates, if the bad debt claim is Rs 10 lakh or more it will be liable for scrutiny. All cases where deduction under Sections 10A/10B/10BA/10AA exceeds Rs 25 lakh. Contracts (other than transporters) whose contract receipt exceeds Rs 1 crore and the income declared is less than 5 per cent of gross contract receipts. Loss from house property if more than Rs 2.50 lakh. Investment in property is more than 5 times the gross income (including agriculture and other exempt incomes). Short-term capital gains covered under Section 111A and long-term capital gains exceeding Rs 25 lakh. Sale of property as per AIR return but no capital gain declared in the return of income. Commission paid during the year if more than Rs 10 lakh. Real estate business with gross turnover of Rs 5 crore. Business of hotels/tour operators with gross turnover exceeding Rs 5 crore but the net profit is less than 0.05 per cent. All cases where depreciation claimed at the rates of 80 per cent and 100 per cent is more than Rs 25 lakh. All cases where the net agricultural income is more than Rs 10 lakh. Deduction under Sections 80-IA (4), 80-IB, 80-IAB, 80-IC, 10(23C), 10A, 10AA, 10B or 10BA is claimed for the first time. All returns filed in response to notice under Section 148 shall be liable for scrutiny. Some issues While above the parameters set for selection of cases for scrutiny is welcome, there is no general exemption or relief from scrutiny for admitting higher income by the taxpayers. For

5 example, if the taxpayer admits 30 per cent more than the previous year income still he can be subjected to scrutiny assessment if any transaction therein is covered by the above-said criteria. Indiscriminate issue of Section 148 notice and thereby subjecting the taxpayer to scrutiny assessment is possible. Monitored cases At present, approval of scrutiny draft orders by the higher authorities delays the completion of assessment and causes hardship to the taxpayers. The AO who is empowered to make assessment in law must be permitted to complete the assessment without procedural bottlenecks. The administrative delay could be reduced by fixing the responsibility on the AOs wholly and solely for completing the scrutiny assessments. Power with the Assessee to Challenge If the AO chooses a case for scrutiny deviating from the norms fixed by the Board then the assessee can challenge the selection of case by means of a writ. There is no provision within the statute book for preventing the AO from proceeding further. However, even after the completion of assessment it could be challenged. Favourable decisions could be found in Nayana P. Dedhia vs Asst. CIT (86 ITD 398); Bombay Cloth Syndicate vs CIT (214 ITR 210) and CIT vs Savoy Enterprises Ltd (211 ITR 192). Contrary decision could be found in Setalvad Brothers vs M.K.Meerani, Addtl. CIT (253 ITR 530). Can Scrutiny can be part of RTI? The Government is not bound under the Right to Information law to divulge details about its Income Tax scrutiny policy, used to identify tax payees before subjecting them to detailed investigation. The Central Information Commission held this while accepting the Finance Ministry's view that revealing information related to the scrutiny guidelines would adversely affect economic interests of the country. "The Finance Ministry at the highest level has analyzed the whole issue and has given its considered opinion about the possible effect of disclosure on economic interest of the State," a CIC bench headed by Chief Information Commissioner Wajahat Habibullah said The order came on an RTI application of Kamal Anand who sought details from Central Board of Direct Taxes about its instructions issued to I-T assessment officers on scrutiny policy for financial year , while also claiming a copy of the policy guidelines for individual tax payers.

6 The matter, that was taken with the Commission following CBDT's refusal to provide the details, was thereafter referred to the Department of Revenue within the Finance Ministry for its views. In its submissions before the CIC, the Finance Ministry had said that divulging details about the scrutiny guidelines would affect India's economic interests by making it easy for unscrupulous tax payers to evade taxes. It was said that the guidelines were meant for use by I-T assessment officers to enforce compliance of tax-payers' liability, and hence there was no public interest attached to such disclosures. Provisions Amended by Finance Act, 2008 Assessing Officer can suo moto or on an application by assessee and for any good and sufficient reasons can extend the period for furnishing the audit report directed u/s 142(2A). Tuglak Reform The old procedure of Processing of Returns under section 143(1)(a) has comeback with wider scope but without the sting of additional tax. From all returns have to be processed wherein arithmetical mistakes and incorrect claims apparent from the information in the return, will be added back and intimation will be issued demanding the additional demand or refunding the excess taxes paid. Such intimation can be issued only within one year from the end of the financial year in which such return was filed. No intimation will be issued if no demand or refund is due. Provision for making Centralised processing of Returns were also made. Incorrect claims is defined as Ø Inconsistency in figures in the entries in return Ø Where evidence is required to be filed as per various provisions of the Act, but nor filed Ø Where deduction exceeds the limits prescribed under various provisions of the Act

7 Like in the past, this reform will only open a Pandora's box for various high pitched additions by the officers, innumerable number of audit objections, host of rectification applications and finally piling the pendency in various appellate forums. Ultimately tax collected in the process will be negligible and except for the revenue, all others in the stream will enjoy. Ultimate losers will be assessee and revenue. Since corresponding amendments were not made to the provisions for rectification and appeals arising out of such adjustments, the starting point of litigation will be the power to agitate against such adjustments. Time limit for issue of notice under section 143(2) is now fixed at 6 months from the end of the financial year in which such return is filed. Now selection for scrutiny can be made financial year-wise. Earlier the time limit was 12 months from the end of the month in which the return was filed and hence there was scope for some returns filed in lean period to escape from scrutiny norms as the computerized selection is done at some irregular intervals. The new provision brings more clarity. A new proviso is added to sec. 147 to avoid income involving issues which are already subject matter in revision / reference / appeal proceedings. Sec. 151 now provides that in cases where JCIT / CIT / CCIT granted approval for re-opening of assessment, such authorities by themselves need not issue notice u/s 148. This provision is with retrospective effect from Sec. 153A is amended to provide for revival of earlier proceedings if any proceedings initiated under sec. 153(1) got annulled in subsequent appellate proceedings. Norms relaxed for scrutiny of company tax returns (Press release dated July, 28th 2008 ) In what could be a major relief to the corporate sector, the Central Board of Direct Taxes (CBDT) has decided not to scrutinize tax returns of more than 1,000 top companies provided no serious disputes are pending against them.

8 The annual returns of tax complying companies would not be scrutinized this year. The decision has been taken by the CBDT to encourage better tax compliance among the corporate, a senior finance ministry official, who did not wish to be identified, said. Last year, CBDT scrutinized tax returns of about 200 A group companies listed on the Bombay Stock Exchange, 500 National Stock Exchange companies and all non-banking finance companies. The tax returns of all the banks and public sector units were also checked. The decision to relax scrutiny norms follows an announcement by finance minister P. Chidambaram after the annual meeting of chief commissioners of income tax. Chidambaram had then said that the government would ensure that tax complying taxpayers are not harassed by the income-tax (I-T) department. When a firm or individual is under scrutiny, the assessing officer issues notice to the taxpayer within a year of filing the return and investigates any tax evasion by verifying claims about tax exemptions, amount in bank accounts, cash reserves, details of loans, gifts and credit cards. Under the new rule, if the I-T department has not raised tax demand of Rs10 lakh or more in addition to the deposited tax, and if it has not won any tax suit against the firm, the I-T officers would not open returns for scrutiny. But the department may consider to open tax returns of companies if they infused fresh capital of Rs50 lakh or more during last fiscal or filed for tax exemptions for the first time under any scheme. In , the department scrutinized about 320,000 tax returns, including about 51,000 filed by corporates. This resulted in an additional tax demand of Rs.73,200 crore. Demand of the Tax Paying Community With buoyant tax collections becoming regular year after year, many tax practitioners that Business Line spoke felt that it would have been fair and justified if the scrutiny norms are made public so that transparency in selection of cases for scrutiny and correct collection of taxes could be guaranteed.

Total turnover/ Gross receipts 30% 30% of FY > Rs 50 Cr No change in rate of Surcharge

Total turnover/ Gross receipts 30% 30% of FY > Rs 50 Cr No change in rate of Surcharge 1. Income Tax Rates: Category of Income New rate of tax Old rate Taxpayer for FY 2017-18 of tax Individuals/ Upto Rs 2.5 L Nil Nil HUF/ BOI/ Rs 2.5 to 5 L 5% 10% AOP/ Rs 5 to 10 L 20% 20% Artificial Above