Tax Audit Report. Under section 44AB. Form 3CA/3CB Form 3CD Annexure I

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1 TAX AUDIT

2 Tax Audit Report Under section 44AB Form 3CA/3CB Form 3CD Annexure I 2

3 Tax Audit under Section 44AB Said Section provides for the Compulsory Audit of accounts of following persons A Person Carrying on Business If his total Sales, Turnover or Gross Receipts, as the case may be in business exceed or exceeds 40 Lakhs rupees in any Previous Year. Different Tax Payers A Person Carrying on Profession If his Gross Receipts exceed 10 Lakhs Rupees in any Previous Year. A Person covered U/sec. 44AD, 44AE, 44AF, 44BB or 44BBB If such person claims that the profits and gains form the business are lower than the profits and gains computed under above sections irrespective of his Turnover 3

4 Scope and Liability of Tax Audit Where the assessee offers an income on presumptive basis u/s 44AD, 44AE and 44AF, there is no need for tax audit report, if the turnover does not exceed the specified limits. A charitable trust, cooperative society etc., though their income may be exempt, yet if their turnover in business exceeds Rs.40 lakhs, they should get their account audited. Even if income of an assessee is below the taxable limit, yet he will be liable to get his account audited, if his turnover in business exceeds Rs. 40 lakhs. Section 44AB is not applicable to non residents deriving income from shipping business (Sec 44B) and also where special provision are applicable for computing profits and gains of business of operations of aircraft in the case of non residents (Sec 44BBA). 4

5 Rule 6G Rule 6G(1) provides that the report of audit of accounts of a person required to be furnished u/s 44AB shall be in Form No.- 3CA: In 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. 3CB: In case of non corporate entities where audit is not required to be carried out under any other law. As per Rule 6G(2), particulars which are required to be furnished u/s 44AB shall be in Form 3CD. 5

6 Forms of Report Nature of Persons Who is required to get his Book of Account Audited under Any other Law Due Date for Getting books Audited and Submission of Audit Report 30th Sept. of A.Y Who is not required to get his Book of Account Audited under Any other Law Audit Report Form 3CA + + Statement Particulars Form 3CD Audit Report Form 3CB 6

7 Tax Audit Report Special Points Proviso to Sec 44AB: The proviso to Sec 44AB lays down that where the accounts of an assessee are required to be audited by or under any other law, 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 other law before the specified date and furnishes by that date the report by an accountant only. W.e.f , tax audit can be carried only by an accountant only. Accordingly, in case of any assessee like a co-operative society where the accounts under the relevant law have been audited by a person other than a chartered accountant, the tax audit will have to be conducted by the accountant as defined u/s 44AB. This has invalidated the Circular No. 561, dated 22 may, Same was also held in the case T.D. venkata rao v. Union of india [1999] 237 ITR 315 (SC) Joint audit report: There could be no objection to joint report, as long as the audit report is signed by all the chartered accountants who have done the audit. As per Statement of Responsibility of Joint Auditors, there could be an agreed report by joint auditor or in case of disagreement, separate reports on matters of disagreement. 7

8 Cont. In case where an assessee follows an accounting year different from financial year: It is necessary that the financial year should be fully covered, though the accounts for the financial year may fall in two different years in assessee s accounts (Board Circular No. 561, dated ) Incomplete report: An incomplete report may constitute professional negligence and render the Chartered Accountant liable for proceedings under u/s 288 of the I.T. Act, and may result in complaint to the ICAI. Consequences of assessment overlooking Sec 44AB: Though tax audit report u/s 44AB was not filed, where the accounts had been examined by the Assessing officer and assessment was made thereafter, such an assessment cannot be subject to revision u/s 263 merely because the assessment was made without tax audit report. Revision could be justified only, where such assessment is prejudicial to revenue. In such a case 8

9 Cont. only a penalty can be levied on the assessee for not filing tax audit report u/s 271B of the Act, if there is no reasonable cause. In a case of a non-resident, where the assessing officer had accepted the returned loss with draft assessment order approved by Additional commissioner, exercise of revision jurisdiction is not valid [CIT v. Clough engineering ltd. [2008] 300 ITR 435 (Uttarakhand)]. Internal auditor of an assessee, whether working with the organisation or independently practising chartered accountant or a firm of chartered accountants, cannot be appointed as his tax auditor [ICAI guidelines as on ]. A chartered accountant in practice can take up 45 tax audits (earlier limit was 30 per chartered accountant) 9

10 Eligibility, Appointment & Removal Eligibility: As per sec. 288 the Accountant (who is appointed as Tax Auditor) should be a Charted Accountant within the meaning of Charted Accountant Act Appointment: He is appointed by Assessee. The tax auditor should obtained the letter of appointment for conducting the audit as mentioned in sec. 44AB Removal: There is no specific procedure for removal of a tax auditor appointed under sec. 44AB However it is possible for the management to remove a tax auditor where there are any valid grounds for such removal. 10

11 Auditor s Responsibility Forms of Certificate and report: Forms No. 3CA and 3CB require certificate as to the reliability of the books in the sense that proper books have been kept and that the report is made after all the necessary information given by the assessee with the assertion that profit and loss account/income and expenditure account and the balance-sheet give a true and fair view as required under clause 3(c) of Form No. 3CB applicable to cases which have not been statutorily audited. At the same time particulars in Form No. 3CD are required to be certified as true and correct. In respect of audited accounts, the requirement of accounts being true and fair is absent in Form No. 3CA applicable to them obviously because statutory accounts would have been so certified as true and fair. Form No. 3CD has to be true and correct even for this class of accounts. Form No, 3CD requires signature of the auditor with his full name and date. Disqualification of Tax Auditor: Though there is no specific disqualification for a Chartered 11

12 Cont. Accountant being an auditor u/s 44AB, disqualification for purposes of company audit u/s 226 of the Companies Act, 1956 should apply even for tax auditor. The Chartered Accountant is bound by regulations imposed on him by the Chartered Accountant Act, 1949, and is expected to follow the guidelines issued by the institute from time to time. Guidance Notes are of a general nature guiding the auditor in the performance of his duties, while opinions relate to specific matters which may involve interpretation of law and may get superseded by either weightier opinions based upon legal precedents, instructions from the concerned authorities, changes in law, etc. Liability of the auditor: Chartered Accountant may be liable for professional negligence under the Chartered Accountants Act, However that does not spare him from any civil liability as under consumer protection law, where it is applicable, or for damages or criminal 12

13 Cont. liability under the prevalent law on failure on his part, if his actions becomes vulnerable under such other laws. Auditor cannot be responsible, if sufficient time is not given to him to take up and complete the work in time, so that audit report can be filed on or before the due date. However, where the delay had occurred in auditor s office and if there is any unreasonable delay on the part of the auditor, he is answerable to the ICAI, if a complaint is made by the client, making him vulnerable to disciplinary proceedings for tax audit as for any other professional misconduct relating to audit [Para 7 of GN]. Neither the assessing officer nor the assessee are bound by the opinion of the tax auditor in his report. They may have their own views for their own reasons. 13

14 Sales, Turnover and Gross Receipts The terms sales, turnover, and gross receipt have not been defined in the statue. Gross Receipts are the amounts received by the assessee from the clients for the contract and does not include within its purview the value of materials supplied by the clients. As per board circulars and Institute guidelines following items will fall within the scope of gross receipts: (a) All assistance from the government whether by way of duty drawback, cash grant, import licence, including profit therefrom. (b) Exchange difference on export sales. (c) Liquidated damages, insurance claims and sale of scrap, etc. (d) In the case of leasing business, hire charges, lease rent and rental or interest for finance leases, installments received in hire purchases. Gross receipts is confined to professional receipts, hence out-ofpocket expenses would not form part of it. 14

15 Cont. U/s 145(1) Sales, Turnover or Gross Receipts are computed either on cash or mercantile system of accounting. The term Turnover would mean, the total sales after deducting therefrom goods returned, price adjustment, trade discounts and cancellation of bills for the period of audit, if any. Adjustment which do not relate to turnover should not be made e.g. writing off bad debts, royalty etc. Items not regarded as turnover: (a) Discount and rebates. (b) Sales return. (c) Sale of fixed assets/investments. (e) Miscellaneous incomes such as dividend, rent and interest but they will be included in the turnover in case of dealers. If sales tax and excise duty are included in the sales price, no adjustment in respect thereof should be made for considering the quantum of turnover. 15

16 Cont. As per ICAI guidelines, in case of non-residents, it is only indian turnover arising out of indian operations which would be relevant for reckoning the limit of turnover. Where an assessee has both profession and business, each being a separate source of income below the limit, there is no need for tax audit. Since each firm is separate and partner is different from firm, limit has to be reckoned for each separately. Though the assessee may have had turnover exceeding the limit and, therefore, liable for tax audit, it will not be liable for tax audit for the year for which it falls short of the limit. 16

17 Cont. In case of Share brokers Transaction entered on his personal a/c are also included in the sale value for the purpose of Sec 44AB. Sub-broker is not different from a share broker. Turnover for transacting in case of shares, securities & derivatives (a) Speculative Transaction:- The aggregate of both positive or negative differences arising from settlement of contracts is to be considered as Turnover. [Para 5.11 of GN on tax audit]. (b) Derivatives, Future & options:- Difference of total favorable & unfavorable Premium received on sale of option Difference of any reverse trade entered (c) Delivery based Transactions:- Total value of sales is to be considered as turnover. 17

18 Cont. In case of Kaccha arahtiya, the turnover is only the commission and does not include the sales on behalf of the principals. On the other hand in case of pucca arahtiya, the total sales/turnover of the business should be taken into consideration for determining the applicability of the provisions of Sec 44AB of the I.T. Act [Para 5.9 of GN on tax audit (Revised 2005)]. 18

19 E-filing of Return It is compulsory to file the return electronically in case your business income is subject to tax audit i.e. if the turnover exceeds Rs. 40 lakhs or in case of a company both private and public. In case an assessee files the return with his digital signature then he is not required to submit the hard copy of the return otherwise he has to submit the print out copy of the return to bangalore office through normal post within thirty days after the date of transmitting the data electronically. 19

20 Penalty for failure to get accounts Audited If the assessee fails to get his accounts audited u/s 44AB in respect of any previous year or years relevant to an assessment year, a flat penalty u/s 271B shall be attracted which is equal to: ½% of the total Sales, turnover or gross receipts Or Sum of Rs. 100,000 (Whichever is less) Sec 273B provides that no penalty shall be imposed for any failure referred to in Sec 271B if assessee proves that there was reasonable cause for such failure. 20

21 Cont. Reasonable Cause It is a subjective matter. Instances where Tribunals/ Courts have accepted as reasonable cause (a) Resignation of the tax auditor and consequent delay; (b) Bona fide interpretation of the turnover based on expert advice; (c) Death or physical inability of the partner in charge of the accounts; (d) Labour problems such as strike, lock-out for a long period, etc; (e) Loss of accounts because of fire, theft, etc., beyond the control of the assessee; (f) Non-availability of accounts on account of seizure; (g) Natural calamities, commotion, etc. 21

22 Cont. Case Law: CIT v. Capital Electronics 261 ITR 4 (Cal). Sec 271B does not imply that the default must be continuous one and that if the audit is made before the completion of the assessment, then the penalty is not imposable. Tools India Distributors v. ITO (2000) 111 Taxman 216 (Mum) (Mag). Where acting on advice of its Chartered Accountant, who relied on Guidance notes issued by the ICAI, assessee entertained a bona fide belief that its turnover did not exceed prescribed limit u/s 44AB, hence, could be said to be prevented by reasonable cause in not getting its accounts audited. 22

23 Penalty u/s 277 A Falsification of books of accounts or documents etc: The Finance (No.2) Act, 2004 has inserted section 277 A w.e.f Accordingly any person shall be punishable with rigorous imprisonment, which may extend form 3 months to 3 years and shall be liable to fine if the following conditions are satisfied: (i) He willfully and with intent to enable any other person (assessee) to evade any tax or interest or penalty chargeable and imposable under the Income Tax Act. (ii) He makes or causes to be made, any entry or statement in any books or other documents relevant for any proceeding under the Act which is false. (iii) He knows it to be false or dose not believe it to be true. 23

24 FORM 3CD PART A Clause (1 to 6) 1. Name of the assessee 2. Address 3. Permanent Account Number 4. Status 5. Previous year ended 6. Assessment year 24

25 Analysis of Clause (1 to 6) In case of proprietorship firm, it is advisable to furnish the name of proprietorship firm with the name of the proprietor. In case of Branch audit, name of such branch should be mentioned along with the name of the assessee. If there is change in the name of the company, the name of such company as on the date of signing of the audit report has to be mentioned along with the original name of the assessee. The address that is given should be one from where the assessee carries on business. In case of a company, the address of the registered office should be stated. In case of audit of a branch or a unit, the address of the branch or the unit should be given. 25

26 Cont. If the application of PAN allotment is pending, it should be reported as PAN has been applied for and the GIR No. may be given. Status means status as per Sec 2(31) of I.T. Act and not residential status. As per Sec 3 of I.T. Act, previous year should end on 31 st March. In case of a Business or profession newly set up in the said financial year, the previous year will begin with the date of setting up of business but will end on 31 st march only. U/s 2(9) of I.T. Act Assessment year means the period of 12 months commencing on the 1 st day of April every year. The Assessment year relevant to the previous year for which the audit has been done should be mentioned. 26

27 PART B Clause 7 7. (a) If firm or Association of Persons, indicate names of partners/members and their profit sharing ratios. (b) If there is any change in the partners or members or in their profit sharing ratio since the last date of the preceding year, the particulars of such change. 27

28 Analysis of Clause 7 This applies only on Firm and association of persons. If the ratio of loss is different from the ratio of profits, then loss ratio should also be given. All the details of partners or members during the entire previous year must be furnished. In case partner is a partner in representative capacity, such fact should be stated. This clause does not cover remuneration and interest to partners, hence there is no need to mention the same. Change in remuneration is not required to be reported. (Para 18.1 of the GN on tax audit). 28

29 Clause 8 8. (a) Nature of business or profession. (b) If there is any change in the nature of business or profession, the particulars of such change. 29

30 Analysis of Clause 8 As per Sec 2(13) of I.T. Act, Business includes any trade, commerce, manufacture or any adventure or concern in the nature of trade, commerce or manufacture. As per Sec 2(36) of I.T. Act, Profession includes vocation. The word profession implies special knowledge acquired only after patent study and application. Share broker does not come within the definition of profession. Permanent discontinuance of a particular line of business requires reporting under this clause (Para 19.2 of the GN on tax audit). 30

31 Clause 9 9. (a) Whether books of account are prescribed under section 44AA, if yes, list of books so prescribed. (b) Books of account maintained. In case books of account are maintained in a computer system, mention the books of account generated by such computer system. (c) List of books of account examined. 31

32 Analysis of Clause 9 Sec 44AA Specified Profession Non Specified Profession or Business Limit Rs 1,50,000 Receipts Limit Total income Rs 1,20,000 or Total Sale Receipts Rs 10,00,000 Exceeds Does not Exceeds Exceeds Does not Exceeds Prescribes Books Rule 6F Any books Any books No books are mandatory 32

33 Cont. Prescribed Books under rule 6F: - Cash book - Journal (if the accounts are kept on mercantile bases) - Ledger - Serial numbered carbon copies of the bills and receipts issued - Original purchase bill/payment vouchers. In addition to the above, a person carrying on medical profession shall maintain following: (i) A daily cash register in form no. 3C. (ii) An inventory of drugs and medicines on first and last day of previous year. Specified Profession: Legal, medical, engineering, or architectural profession or the profession of accountancy or technical consultancy or interior decoration or any other notified profession. 33

34 Cont. As per Sec 2(12A), Books or Books of account includes:- - Ledgers - Day Books - Cash books - Account book -Others Whether kept in the written form or as print-outs of data stored in a floppy, disc, tape or any other form of electro- magnetic data storage device. Proper print outs of accounts generated by the computer system are mandatory. Where the books of accounts are seized by government authorities and are not available for audit, the fact should be precisely mentioned in 3CA/3CB. 34

35 Clause Whether the profit and loss account includes any profits and gains assessable on presumptive basis, if yes, indicate the amount and the relevant sections (44AD, 44AE, 44AF, 44B, 44BB, 44BBA, 44BBB or any other relevant section). 35

36 Relevant sections of clause 10 S.No. Section Business Covered 1. 44AD Civil construction business AE Plying, hiring or leasing goods carriages AF Retail trade B Shipping business in case of non-residents BB Providing service or facilities in connection with, or supplying plant and machinery on hire used, or to be used, in the prospecting for, or extraction or production of, mineral oils BBA Operation of aircraft in case of non-residents BBB Civil construction etc. in certain turnkey power project of foreign companies. 8. Any other relevant section This refers to the sections not listed above under which income may be assessable on presumption basis like Sec 44D and sec 115A(1)(b) and will include any other section that may be enacted in future for presumptive taxation. 36

37 Analysis of Clause 10 Gross receipt does not include the value of material supplied by the client and value of work in progress would not constitute turnover. If composite books of accounts are maintained for the business, then common expenses may be apportioned between the businesses, and the facts and circumstances in each case will determine the basis of such apportionment. Mostly turnover basis is accepted by I.Tax Dept. If profit is credited to Profit & Loss a/c, appropriate qualification will be required but if it is credited to capital a/c of partners/members, there is no requirement of reporting. Eliminate the turnover covered by the presumptive provisions for purposes of limit u/s 44AB. 37

38 Clause 11 a) Method of accounting employed in the previous year. b) Whether there has been any change in the method of accounting employed vis-a-vis the method employed in the immediately preceding previous year. c) If answer to (b) above is in the affirmative, give details of such change, and the effect thereof on the profit or loss. d) Details of deviation, if any, in the method of accounting employed in the previous year from accounting standards prescribed under section 145 and the effect thereof on the profit or loss. 38

39 Analysis of Clause 11 As per Sec 145 the income of the assessee may be computed in accordance with either cash or mercantile system of accountancy regularly employed by him. The hybrid system of accounting (i.e. mixture of cash and mercantile) is not permitted. A non corporate, having more than one business, may adopt cash system of accounting for some business and mercantile system of accounting for another business. Corporate assessee's have to follow accrual basis of accounting in view of Sec 209 of the companies act. It should be legitimate for an assessee to change the method of accounting as long as the change is not casual and is thereafter regularly adopted by the assessee. 39

40 Cont. It is not necessary to have the opening stock revalued on the same basis, where the assessee bonafide changes its method of valuation. Change in accounting policy need not be reported because such changes in accounting policy could not mean that there is change in method of accounting. U/s 145(2), Accounting Standard I relating to disclosure of accounting policies and Accounting standard II relating to disclosure of prior period and extraordinary items and changes in accounting policies is to be followed by the assessee following mercantile system of accounting. Case law: CIT v. Biharilal investment P. ltd. [2008] 299 ITR 1 (SC) Supremacy of system of accounting consistently adopted in the case of a dispute over accounting for chit system was upheld. Recognition of surplus on the basis of completed contract basis was found acceptable. 40

41 Clause (a) Method of valuation of closing stock employed in the previous year. (b) Details of deviation, if any, from the method of valuation prescribed under section 145A, and the effect thereof on the profit or loss. 41

42 Analysis of Clause 12 The word Closing stock read with Sec 145A and AS-2 will include finished goods, raw material, work-in-progress, maintenance supplies, consumables and loose tools. The revised AS-2 states that the inventory costs should be assigned by using FIFO, or weighted average or specific identification cost formula which should reflect the fairest possible approximation to the cost incurred in bringing the terms of inventory to their present location and condition. Statement showing basis of valuation of inventories to be reported: i. Raw material, stores and spares at historical cost. Rates are determined at FIFO basis. ii. Self generated scrap and non-reusable waste at net realizable value. iii. Work-in-progress valued at actual cost of material, labour and production overheads are adjusted/estimated. 42

43 Cont. iv. Finished goods other than by-product at cost or market value, whichever is lower. Cost is determined on the basis of absorption cost. By-product is valued at net realizable value. Since the Liability for excise duty arises when the manufacture of goods is complete, it is necessary to create a provision for liability of unpaid excise duty on stock lying in the factory or bonded warehouse. [GN on Accounting treatment for Excise duty]. The provisions of Sec145A require grossing up of value of sale, purchase and inventories. As such it should not affect or impact the profit or loss otherwise worked out. Assessee may include sales tax, excise duty, octroi or exclude from the value of sales, purchase and inventories depending on the method generally followed. If assessee follows inclusive method, no adjustments in the computation of income are required. If assessee follows exclusive method of accounting, adjustments are to be made in computation of total income and the same should be reported as a deviation from Sec 145A under this clause. 43

44 It is not necessary to change the amount of purchases, sales and inventory recorded in the books. The adjustment can be made in a Memorandum of account while computing the income for the purpose of preparing return of income (Para of GN on tax audit). Effect of deviation on the Profit or loss will be nil. If an assessee made Advance Payment of Excise duty without liability, no deduction shall be given u/s43b. Case Law: Cont. CIT v. Realest Builders and Services Ltd. [2008] 307 ITR 202 (SC) While upholding the consistent method adopted by the assessing officer did observe, that where the system is defective, the Assessing officer is free to recompute the income on a basis to accord with the accounting principles. CIT v. Amrithalakshmi [2008] 300 ITR 78 (Mad.) When cost or market value whichever is less is followed, the inventories may be valued at cost in one year and at market value in another, when it is lower. This cannot be construed as a change in method of accounting.. 44

45 Clause 12A 12A Give the following particulars of the capital asset converted into stock-in-trade: (a) Description of capital asset (b) Date of acquisition (c) Cost of acquisition (d) Amount at which the asset is converted into stock-in- trade 45

46 Analysis of Clause 12A It has been inserted in the new form to include the contingency of capital gains on conversion of capital asset into Stock-in-trade taxable under Sec 45(2). Such conversion is treated as transfer u/s 2(47). U/s 45(2) notional capital gain arising from such transfer will be chargeable to tax in the year in which such stock-in-trade is sold. Cost of capital asset in case of: Purchase actual cost from invoice, Books etc. Self constructed direct related cost. Exchange FMV or Net Book value of asset given up. Inheritance if no evidence exists, then auditor should rely upon the report of the experts such as valuers. 46

47 Clause Amounts not credited to the profit and loss account, being: (a) the items falling within the scope of section 28; (b) the Proforma credits, drawbacks, refund of duty of customs or excise or service tax, or refunds of sales tax, where such credits, drawbacks or refunds are admitted as due by the authorities concerned; (c) escalation claims accepted during the previous year; (d) any other item of income; (e) capital receipt, if any. 47

48 Analysis of Clause 13 Sec 28 cannot be considered as exhaustive. Where there are specific items which are not credited to P & L a/c, or credited to P & L a/c but not considered as income, such items would require reporting. Auditor can rely on management representation. Sec 28 w.e.f will also include any sum, whether received or receivable, in cash or kind, on account of any capital asset (other than land or goodwill or financial instrument) being demolished, destroyed or transferred, if the whole of expenditure on such capital asset has been allowed as a deduction u/s 35AD. In case of assessee following cash system, it should be clearly brought out that admittance of claims during the previous year without actual receipt has no significance in such cases. In case of import entitlements which an exporter is entitled to receive in view of its exports, the date on which the exporter applies for the same will be the date of accrual for the assessee. Escalation claims which has been made and merely expected but not admitted by the other party are not required to be stated. 48

49 Cont. A certificate is necessary from the assessee especially in the cases of contractors where such claims are normal. Professional expertise and judgment have to be used in judging whether any particular receipt is of capital or revenue nature. Due regard should be given to AS-9 Revenue recognition. The word income has been defined u/s 2(24) of the I.T. Act and clause (x) of Sec 2(40) includes any amount received by the assessee from his employees, as contribution to any provident fund as income. Normally such contributions are not shown as income in the P & L a/c. Such contributions can be reported here. Sub clause (e) would cover a case where the amounts are treated as capital account in the books and agreed by the auditor e.g. premium on issue of new shares, sale of assets which may gave rise to capital gains but are not passed through profit and loss account. For grants and subsidy, AS-12 Accounting for government grants should be followed. 49

50 Cont. Case Law: CIT v. Kisan sahkari chini mills Ltd. [2006] 284 ITR 418 (All) All subsidies aiding production and not for establishing an industry should necessarily be treated as revenue receipts, so that sales tax subsidies or concession in power tariff or water charges cannot be treated as revenue receipts. Subsidy is based upon the size of installed machinery, electricity charges or excise or sales tax liability shall also be regarded as capital receipt. 50

51 Clause Particulars of depreciation allowable as per the Income-tax Act, 1961 in respect of each asset or block of assets, as the case may be, in the following form : (a) Description of asset/block of assets. (b) Rate of depreciation. (c) Actual cost or written down value, as the case may be. (d) Additions/Deductions during the year with dates; in case of any addition of an asset, date of put to use, including adjustment on account of: (i) Modified Value Added Tax credit claimed and allowed under the Central Excise Rules 1944, in respect of assets acquired on or after 1st March, 1994, (ii) Change in rate of exchange of currency and (iii) Subsidy or grant or reimbursement by whatever name called. (e) Depreciation allowable. (f) Written down value at the end of the year. 51

52 Analysis of Clause 14 Registered ownership is not necessary. Exclusive possession right, to exclude others from enjoyment of asset, full control over the asset etc, will entitle the enterprise to claim depreciation. AS-19 on leases, require capitalization of the asset by the lessee in financial lease transaction. This will bear no impact on depreciation allowable. Firm can claim depreciation of vehicle registered in partners name. On the assets used partly for business purposes, the deductions u/s 32(1) shall be restricted to a fair proportionate part thereof [Proviso to Sec 32(2)]. Adjustment as contemplated u/s 43A and AS-11 (revised) Accounting for effects in changes in foreign exchange rates are required to be made. Depreciation claim is mandatory for an assessee in calculating taxable income. [Explanation 5 to Sec 32(1)]. 52

53 Cont. Where a claim or non-claim of depreciation is based on judicial pronouncement or on opinion or other contention, it is advisable to disclose such particulars. The interest relatable to any period after such asset is first put to use shall not form part of actual cost. [Explanation 8 to Sec 43(1)]. Depreciation is not allowed on an amount equivalent to CENVAT credit claimed and allowed. [Explanation 9 to Sec 43(1)] Part cost met directly or indirectly by central or state government or any authority established under any law or by any other person, in the form of a subsidy or reimbursement or grant, then such amount which is relatable to any asset is to be excluded from the cost of assets. [Explanation 10 to Sec 43(1)]. Sub clause (iia) of Sec 32(1) provides for additional depreciation to a manufacturing concern on fulfilling certain conditions. 53

54 Cont. Lessee is not eligible for the depreciation but the hire purchaser is so eligible. [Instruction No. 1079, dated Sep 19, 1977] Vehicles standing in the name of directors, but financed by the company with repayment made by the company and vehicles shown as assets in the balance sheet of the company would entitle depreciation for the company. [CIT v. Fazilka dabwali TPT Co. Pvt. Ltd. (2004) 270 ITR 398 (P & H) Fractional ownership of an asset is recognized. [Sec 31(1) of I.T. Act] Where there is trial production or merely use of standby, right to depreciation is available. Interest paid before commencement of production on the amounts borrowed by the assessee for the acquisition and installation of plant and machinery, buildings, furniture and fixture forms part of the actual cost. [Challapalli sugar mills Ltd. (1975) 98 ITR 167 (SC)] Revaluation of assets does not have any impact under the I.T. Act. 54

55 Cont. No depreciation shall be allowed in respect of any plant or machinery if the actual cost thereof is allowed as deduction in one or more years under an agreement under Sec 42. Expression used to be given a wider meaning. It would include not only cases where the machinery, plant were actively employed but also cases where there was what may be described as passive user of the same in the business. An asset could be said to be used, when it was kept ready for use [CIT v. Geotech construction corporation [2000] 244 ITR 452 (Ker)] Similar view has been accepted in case CIT v. Khanna (O.P.) and sons (1983) 140 ITR 558 (P & H), where steps taken to get building into gear for running business constitutes use of building. This has invalidated the earlier decision taken in case Dineshkumar Gulabchand agarwal (2004) 267 ITR 768 (Bom). Also there was an amendment to Sec 32 of the act using the word used in past sense, so that earlier decision would no more have application. 55

56 Cont. Case law: Skyline caterers P. Ltd. V. ITO [2008] 306 ITR (AT) 369 (Mum). Goodwill could be a commercial asset of similar nature on the fact that it is related to right to carry on catering business, so as to be eligible for depreciation. CIT v. Agra beverages corporation P. Ltd. [2008] 300 ITR 286 (All). Bottles and crates were held to be plant. 56

57 Clause Amounts admissible under sections 33AB, 33ABA, 33AC, 35, 35ABB, 35AC, 35AD*, 35CCA, 35CCB, 35D, 35DD, 35DDA, 35E: (a) debited to the profit and loss account (showing the amount debited and deduction allowable under each section separately); (b) not debited to the profit and loss account. 57

58 Brief summary of Relevant sections of clause 15 S.No Section Details 1 33AB Tea Development 2 33ABA Site Restoration Fund 3 33AC Reserve for Shipping. (N.A. w.e.f ) 4 35 Expenditure on Scientific Research 5 35ABB Expenditure on license to operate telecommunication services. 6 35AC Eligible Projects/Schemes 7 35CCA Rural development programme 8 35CCB Conservation of Natural resources 9 35D Amortization of Preliminary Expenses 10 35DD Amortisation of Expenditure in case of amalgamation or demerger 11 35DDA Amortisation of expenditure incurred under voluntary Retirement Scheme 12 35E Expenditure on prospecting certain minerals. 58

59 Analysis of Clause 15 Where the assessee is eligible for deductions under one or more sections, state the deduction allowable under each section separately. A new sec 35AD has been inserted w.e.f which provide for a deduction in respect of the whole of any expenditure of capital nature incurred, wholly and exclusively, for the purposes of any specified business carried on by the assessee during the previous year in which such expenditure is incurred by him. Case law: Rajhans metals P. Ltd. v. ITO [2008] 306 ITR (AT) 245 (Mum). Expenses on the entire cost of the project for setting up a windmill is eligible for amortisation u/s 35D. 59

60 Clause (a) Any sum paid to an employee as bonus or commission for services rendered, where such sum was otherwise payable to him as profits or dividend. [Section 36(1)(ii)]. (b) Any sum received from employees towards contributions to any provident fund or superannuation fund or any other fund mentioned in section 2(24)(x); and due date for payment and the actual date of payment to the concerned authorities under section 36(1)(va). 60

61 Analysis of Clause 16 There is no restriction on the amount of bonus and it may exceed the bonus payable under the Payment of Bonus Act, Amount of bonus or commission paid to a person, which would have otherwise been payable to him as profits or dividend, is not allowable as a deduction. Only the amount is required to be disclosed and expression of opinion about allowability or inadmissibility is not required. Part (b) of clause 16 clearly brings out the provision in law that the delayed payment of welfare dues by way of contribution to provident fund or superannuation fund would lose the benefit of deduction altogether only to the extent of the employee s contribution and not the employer s contribution. Sec 43B would allow listed expenses in the year of payment or where it pertains to the year, if payment had been made before the due date for filing the return. 61

62 Clause Amounts debited to the profit and loss account, being: (a) expenditure of capital nature; (b) expenditure of personal nature; (c) expenditure on advertisement in any souvenir, brochure, tract, pamphlet or the like, published by a political party; (d) expenditure incurred at clubs: (i) as entrance fees and subscriptions; (ii) as cost for club services and facilities used; (e) (i) expenditure by way of penalty or fine for violation of any law for the time being in force; (ii) any other penalty or fine; (iii) expenditure incurred for any purpose which is an offence or which is prohibited by law; 62

63 Cont. (f) amounts inadmissible under section 40(a): (g) interest, salary, bonus, commission or remuneration inadmissible under section 40(b)/40(ba) and computation thereof; (h) (i) whether a certificate has been obtained from the assessee regarding payments relating to any expenditure covered under section 40A(3) that the payments were made by account payee cheques drawn on a bank or account payee bank draft, as the case may be, [Yes/No]: (ii) amount inadmissible under section 40A(3), read with rule 6DD [with break-up of inadmissible amounts] 63

64 (i) provision for payment of gratuity not allowable under section 40A(7); (j) any sum paid by the assessee as an employer not allowable under section 40A(9); (k) particulars of any liability of a contingent nature. Cont. (l) amount of deduction inadmissible in terms of section 14A in respect of expenditure incurred in relation to income which does not form part of the total income (m) amount inadmissible under the proviso to section 36(1)(iii). 64

65 Analysis of Clause 17 Explanation to Sec 30 & 31 provides that cost of repairs & current repairs to building and current repairs to machinery, plant & furniture shall not be treated as capital expenditure. Auditor should qualify the audit report if capital expense were written off against revenue in the P&L a/c. Personal expenses includes those on personal needs of assessee and those having purposes unrelated to business. Since Sec 37(2B) would disallow any expenditure on advertisement in souvenirs etc. published by a political party, information is required under sub-clause (c) of clause17. Donations given directly to political party is not to be reported under this clause. Sec 37(2B) as well as clause 17(c) use the term Souvenir, brochure, tract, and pamphlet. Or the like. Newspaper is not a publication and such expenses need not be reported. 65

66 Cont. Payments to club would not include service organizations like Lions, Rotaries, Jaycees, Giants etc., but will include Gymkhana. [GN on tax audit] If the payment is partially compensatory and partially punitive, on the basis of appropriate criteria, the amount charged will have to be bifurcated and only the amount relating to penalty should be stated. [Malwa Vanaspati & chemical Co. v. CIT (1997) 225 ITR 383 (SC)] Expenditure incurred due to failure to deduct TDS is not allowable as a business expense. [Indian aluminium co. ltd. v. CIT (1971) 79 ITR 574 (SC)] Interest paid in respect of delayed payment of income-tax is not deductible. [Federal bank ltd. v. CIT (1989) 180 ITR 37 (Ker)] Any interest/penalty paid under Direct tax laws is not deductible. Interest paid by the assessee to sales tax department on arrears of sales tax is an admissible deduction. [CIT v. Western indian state motors (1987) 163 ITR 194 (Raj)] 66

67 Demurrage paid to port authorities in connection with release of confiscated goods is not a fine for infraction of law and thus allowable. [Nanhoomal jyoti prasad v. CIT (1980) 123 ITR 269 (All)] Interest paid under employees Provident fund & Misc. Provisions Act, 1952 is allowable, if it is compensatory and not penal. [CIT v. Hyderabad allwyn metal works ltd. (1988) 172 ITR 113 (AP)] Penalty paid by assessee contractor for non-compliance of contract within stipulated time is allowable. [CIT v. R.D. Sharma & co. (1982) 137 ITR 333 (Bom)] Penalty for failure to supply goods under a contract are allowable. [Central trading agency v. CIT (1965) 56 ITR 561 (All)] Securities transaction tax is now allowed as expenditure. Cont. 67

68 Cont. A retrospective amendment is made u/s 40(a)(ia) by the Finance act, 2008 w.e.f which provides that no disallowance will be made where deduction was delayed but all the same paid before the end of the year and in case where deduction has been made on the last day of the previous year and tax is paid before the due date for filing return. Valuation fees paid for valuation of assets does not represent wealth tax and is allowable as deduction. If TDS is deducted late even by one day, the salary paid outside india or to a non-resident in india shall not be allowed as deduction. If TDS is not deducted but paid by the assessee from his own pocket, then also salary payable outside india or to a non-resident in india shall not be allowed as deduction. [Sec 40(a) (iii)] Any tax actually paid by an employer referred to in Sec 10(10CC) would be disallowed [Sec40(a)(v)]. Income-tax payable under I.T. Act or paid under the tax laws of a foreign country is not allowable as deduction. 68

69 Cont. Sec 40(a)(iv) disallows payment to any recognised provident fund, unless effective arrangement is made for tax deduction at source out of payment therefrom. Deduction of remuneration to working partner will not be admissible unless the partnership deed either specifies the amount of remuneration payable to each individual working partner or lays down the manner of quantifying such remuneration [Circular No. 739, dated 25 th march]. Sec40A(3) amended by Finance act 2008 shall be attracted if assessee incurs any expenditure in respect of which payment or aggregate of payments made to a person in a single day of a sum exceeding Rs. 20,000/- otherwise than by account payee cheque or account payee demand draft. Purchase of stocks or raw materials constitute expenditure referred to in Sec 40A(3). Therefore, if payments are made exceeding Rs. 20,000 otherwise than by account payee cheque or account payee bank draft for purchase of stocks or raw materials, then such expenditure will be disallowed [Attar singh gurmukh singh (1991) 191 ITR 667 (SC)]. 69

70 Cont. Purchase of capital assets on which 100% (or even normal) depreciation is allowable does not constitute expenditure and is not covered by Sec 40A(3). Where a pucca ahartiya purchases goods from the principal and makes the payment exceeding Rs. 20,000 otherwise than by account payee cheque or account payee bank draft, then Sec 40A(3) shall be applicable. Where the exception under Rule 6DD is applicable, there is no need for reporting such specific payments. If the gratuity fund is unapproved, deduction for gratuity shall not be allowed even if the provision for gratuity is made as per actuary [Sec 40A(7)]. If a policy is taken from LIC for providing gratuity to employees, then annual premium is allowed as deduction u/s 37(1). Where the assessee contests the claim but all the same makes a provision in the accounts without intimating acceptance of the claim or even while disputing it, such expenses will have to be indicated as contingent liability and will be disallowed. 70

71 Expenditure relatable to income which does not form part of total income cannot be set off against other taxable income [Sec 14A]. The amount of the interest paid in respect of capital borrowed for acquisition of an asset for extension of existing business or profession for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use, shall not be allowed as deduction [Sec 36(1)(iii)]. Case law: Cont. CIT v. Usha iron and ferro metal corporation ltd. [2008] 296 ITR 140 (Del.) Cost of melting shop unit, which was started as an additional facility for producing the necessary raw materials, was deductible since it is expansion of existing business. 71

72 Cont. J.K. Manufacturers ltd. V. CIT [2008] 300 ITR 297 (All.) Expenditure for advertising a new product is deductible. But where no business is carried on with no prospect of resumption, such expenditure will be in admissible. CIT v. G.E. Capital services ltd. [2008] ITR 420 (Del.) Cost of upgradation of software was held to be revenue expenditure as technological changes and the need to upgrade software on regular basis cannot be treated as an enduring advantage. Dr. T.A. Quereshi v. CIT [2006] 287 ITR 547 (SC). Heroin seized from the doctor on the ground of illegal possession is allowable u/s 28(1) since such heroin formed part of his stockin-trade. It was also held that Explanation to Sec 37 applies only to business expenditure and not to business loss. 72

73 Cont. CIT v. Smt. Santosh jain [2008] 296 ITR 324 (P&H) Where an assessment is made rejecting assessee s books of accounts in computing the income on estimate basis, Sec 40A(3) would have no application. 73

74 Clause 17A 17A. Amount of interest inadmissible under section 23 of the Micro, small and Medium Enterprises Development Act,

75 Analysis of Clause 17A As per Sec 23 of the MSMED Act, 2006, amount of interest paid or payable by buyer in accordance with the provisions shall not be allowable as deductible expenditure under the I.T. A ct. The clients of auditor will have to find out eligible suppliers to whom the provisions of section 23 of the Micro, Small and Medium Enterprises Development Act, 2006.apply and interest payable or paid to them will have to be ascertained. The auditor must verify the same carefully and to ensure that the client has taken all reasonable steps to ascertain the information in this regard. Section 23 shall have an overriding effect on the relevant provision of the I.T. Act. Interest can be claimed under different circumstances under different provisions like sections 24, 36, 37 and 57. Section 23 of the Micro, Small and Medium Enterprises Development Act, 2006 will have over riding effect on all the provisions which enable deduction of interest payable by a buyer. 75

76 Cont. to the supplier of goods or service provider in case of delayed payment Eligible supplier must satisfy requirements of Sec 2(n) of MSMED Act otherwise the provision shall not apply and the tax auditor will not be required to report about any supplier. Unless a supplier has given intimation with evidence as to his eligibility, a buyer cannot be presumed that the supplier is eligible, and therefore, interest payable to such a supplier need not be disallowed. 76

77 Clause Particulars of payments made to persons specified under section 40A(2)(b). 77

78 Analysis of Clause 18 If payments made to specified persons is excessive and unreasonable, it should be indicated. There is no ceiling on the total amount paid to vulnerable persons, if it represents fair market value. If the assessee bona fide sells his goods to a vulnerable person at a rate, which is lower than the market rate, there is no expenditure incurred by him and Sec 40A(2) cannot be invoked. Payments, which are made for commercial considerations and which are real and genuine and incurred wholly and exclusively for the purpose of business, cannot be disallowed, even partly, u/s 40A(2)(b). Any Payment made by AOP to its member for supply of goods should be reported. 78

79 Cont. Case law: Dy Cit v Joshi Formulabs (P) Ltd (2000) 67 TTJ 396 (Rajkot) A fully vouched and genuine expenditure cannot be disallowed u/s 40A(2)(b) even if made to sister concern. Khan Carpets v CIT (2003) ITR 325 (All) When there was disproportionate increase in salary without showing exceptional circumstances for it, in such case increase in salary could be disallowed. 79

80 Clause Amounts deemed to be profits and gains under section 33AB or 33ABA or 33AC. 80

81 Analysis of Clause 19 Sec 33AB - Tea Development Account. Sec 33ABA - Site Restoration Fund Sec 33AC Reserve for Shipping Business. [No deduction is allowed under this section w.e.f. A.Y ] The above three items are also covered under clause 15, where information is required as regards to the extent of admissible deduction but such information deals only with the amount of deduction in the year of payment. Amount withdrawn from such deposit account for other than the specified purposes is to be deemed as income chargeable to tax. 81