INDIRECT TAX STUDY CIRCLE MEETING TUESDAY, 13 TH OCTOBER, 2015 Service tax Investigation, Audit and Scrutiny CA Srikant S. Shenoy Under Chapter V of the Finance Act, 1994 ( Act ) and the rules made there-under every person liable to pay service tax is required to obtain the registration, assesses the tax liability payable by himself, pay the same and thereafter file the service tax returns. Earlier, assessment of service tax paid was carried out by Central Excise Officer. However, w.e.f. 10.9.2004, this has been done away with and self assessment mechanism has been introduced. Hence in such scenario it is imperative for the service tax department to introduce some mechanism to ensure the self assessment made by the assessee is correct, to detect cases of tax evasion, to verify compliance of procedure by the assessee and to curb revenue leakages. To accomplish these objectives the Service tax Department has devised the following methods viz., 1. Service tax Investigation; 2. Service tax Departmental Audit; 3. Scrutiny of Service tax returns. Each of these methods is explained in the ensuing paragraphs. 1. Service tax Investigation 1.1. Investigation is a method resorted to by the department for detection of cases of tax evasion. It is generally undertaken in cases of those persons who are not registered with the service tax department or where the department has some information about the evasion of tax by such person. Usually investigation of cases of service tax evasion are carried out by the following bodies viz., 1
a. Anti Evasion a specific cell constituted under the service tax department; and b. DGCEI - an apex intelligence organization formed under CBEC to tackle the issue of tax evasion. 1.2. Investigation proceedings are carried out by these bodies mainly in pursuance of receipt of some intelligence about cases of tax evasion. For the purpose of carrying out investigation, the investigating authority may call for certain documents from the persons through any of the following methods viz., a. Issuing letters for submission of certain documents/ information; b. Issuing summons to produce documents and give evidence. Investigation by seeking details through letters 1.3. Under this method the department may ask for certain specific information from the noticee such as the quantum of amounts received by the noticee from a particular source or by carrying out a particular activity, nature of the activities carried out by the noticee, sample copy of contracts entered into by the noticee, reasons as to why service tax has not been paid on such activities etc. The details called for may pertain to a period of 5 years. 1.4. The noticee is expected to submit all the details called for by the investigating authority. The investigating authorities may examine the nature of transaction, its taxability and also determine the amount of service tax payable based on the details / information furnished by the noticee. Investigation by way of issuing Summons 2
1.5. Summons means asking a person to appear before the specified authority to give evidence and produce documents and other things. This method is resorted to by the department only in the event if the noticee fails to furnish all the details called for by the department through the earlier method (i.e. information called for through letters). These summons are issued u/s. 14 of the Central Excise Act, 1944 which has been made applicable to Service Tax vide section 83 of the Act. It is usually a fact finding exercise. 1.6. Some of the significant points that needs to be noted in respect of investigation by way of summons are as follows: a. Any Central Excise Officer not below the rank of Superintendent of Central Excise is empowered to issue summon. Though a Central Excise Officer is empowered to exercise this power within his territorial jurisdiction, in cases where it appears that there has been tax evasion, the Central Excise Officer can exercise this power even outside his jurisdiction also. In other words a Central Excise Officer can issue a summons to any person irrespective of the fact whether the said person falls within the jurisdiction of the said Central Excise Officer. b. The notice period of summons is very short. c. During the course of Summon proceedings a Central Excise Officer may record the statement of the noticee which can be used as evidence against such person. d. A summon as such is not a judicial proceeding since examination of the person summoned is not done on an Oath. However, under Section 14 of CEA, 1944 the summons issued by a Central Excise Officer is 3
deemed to be a judicial proceeding for the limited purpose of applying Section 193 and Section 228 of the Indian Penal Code, 1860 1. e. A person summoned or an authorized person (in case where summons are issued in the name of an organization) is bound to appear in person. Appearance through an authorized representative is not allowed. f. Non attendance would amount to an offence punishable with prosecution [s. 89(i)(c) of the Act] and also attracts penalty of higher of Rs.10,000/- or Rs. 200/- per day during which such failure continues [Section 77 (1)(c) of the Act]. 1.7. Some of the dos and don ts that one needs to remember while attending to a summon proceedings are Dos To appear before the specified authority with the records called for. In case of genuine difficulty in appearance before the authority the same should be communicated vide letter to the authority well in advance Submit only those documents which are relevant and would enable the investigating authority to examine the Don ts Not to avoid / neglect or have a callous approach while handling a Summons Don t submit the documents without verifying the facts and figures 1 Section 193 of the Indian Penal Code prescribes imprisonment for a period upto 7 years for giving false evidence and Section 228 of the said code states that a person shall be punished with an imprisonment for a period of 6 months or fine of Rs. 1,000 for interrupting the judicial proceedings. 4
nature of transaction. Ensure that documents pertain to the period for which investigation is being carried out and the same are submitted under a covering letter. In case the summons is not issued to any specific person but are issued in the name of the company, ensure only those persons who are well aware about the facts of the transactions and its taxability appear before the authority. In case where summons are issued to non-technical person they may be briefed about the facts and taxability before attending the summon Where statements have been recorded may request to be furnished with a copy of the recorded statement Not to make any casual statements. When in doubt may seek time by stating is unaware about the details or particular thing or need to verify the facts before making statement. Not to give in to the usual pressure tactics 1.8. The result of the above investigations is the investigating authority may prepare a case and put it up before the jurisdictional Central Excise Officer who may then issue a show cause notice to the investigated person. 1.9. Some Significant challenges faced during investigation a. A person during the course of recording of his statement under the summon proceedings makes a statement about the nature of services which is in contradiction to the contractual documents which would 5
be more important to determine the exact nature of service, the recorded statement or the contractual documents? b. If the summons has been issued by a non-jurisdictional officer can the assessee request to transfer the investigation proceedings to his jurisdictional service tax Commissionerate? c. Can a person be held liable for non-attendance of summon when in fact the notice of summon were received post the scheduled date? d. Can the investigating officer during the summons proceeding compel the assessee to make a statement about the taxability of service or ask him to make a commitment for discharging of the tax liability? 2. Service tax Departmental audit 2.1. The objective of an audit is to examine the veracity of the information that is furnished by the assessee in his service tax returns by corroborating the same with his audited financial records. It also seeks to identify the level of noncompliances by the assessee and discover the possible revenue leakages either due to deliberate action or ignorance of the taxpayer. 2.2. Service tax departmental audit is conducted u/r. 5A of the service tax rules. Rule 5A(1) empowers a Central Excise Officer to have access to the registered premises of the assessee. Sub-rule (2) thereof casts a responsibility upon every assessee to make available his records for verification by any of the following persons viz., a. An auditor (CA/CWA) specially appointed by the Commissioner of Central Excise (CCE) b. An audit party deputed by the department c. Audit party deputed by the C& AG (CERA) 6
2.3. A doubt had been raised about the constitutional validity of Rule 5A(2) of the Service tax Rules, 1994 on the grounds that the conduct of audit by an audit party of the department was beyond the scope of Section 72A of the Act. Under Section 72A a CCE can direct for audit of accounts of the assessee in cases where a. The assessee has failed to declare or determine the value of services provided by him correctly; b. Cenvat credit has been availed by him in excess of the normal limits or if the same has been availed fraudulently; c. In case of multi-location service provider the CCE is unable to obtain complete picture of the accounts from the records available in the registered premises. The Delhi High Court in the case of Travelite (India) v. UOI (2014) 35 STR 653 (Del.) observed that the Finance Act, 1994, itself does not authorize a general audit of the type envisaged under Rule 5(2) of the Service Tax Rules but only stipulated a special audit that can be undertaken if the circumstances outlined in Section 72A are fulfilled. Accordingly, it held that Rule 5(2) of the Service Tax Rules did not have appropriate statutory backing and hence the same is ultra vires the provisions of Finance Act, 1994. However, after the insertion of sub-rule (k) in rule 94(2) of the Act w.e.f. 6.8.2014, it appears a statutory backing for the said rule has been provided. Accordingly it has been clarified by the Board vide Circular No. 181/7/2014-ST dated 10.12.2014 that the said rule can no longer be said to be unconstitutional. 7
2.4. The frequency of selection of an assessee for such departmental audit alongwith the time frame within which such audit is supposed to be completed is given in table below Amount of tax paid (including cash + cenvat) Frequency of audit Estimated time frame for completion of audit More than 3 cr Every year 10 working days > 1 cr but < 3 cr Once in 2 years 7 working days > 25 lacs but < 1 cr Once in 5 years 5 working days < 25 lacs 2% of the taxpayer selected on certain specified risk parameters 3 working days However, it is to be noted that assessees with turnover of less than 60 lakhs are not subjected to departmental audit. 2.5. Audit party deputed by the department usually comprises of Superintendent, 1 Inspector and 2-3 assistants. The audit is conducted on the lines and in spirit of EA -2000 Audit. A broad overview of the departmental audit is as followsa. Desk Review this is the preliminary stage wherein all the information about the assessee is gathered. The information is gathered by way of examining the assessee s profile in department s record, examining the annual accounts, tax audit reports etc. it also involves asking an assessee to fill up and submit a questionnaire containing about 70-80 questions. 8
b. Evaluating the system of internal control existing in the assesses business by carrying out a walk through, touring the premises, ABC analysis etc. c. After carrying out the above steps an audit plan is prepared and thereafter actual verification of records of the assessee is carried out and findings made during the audit are recorded; d. The audit findings if objectionable in nature (i.e. are in contravention of the provisions of law) are discussed with the assessee and also by way of issuing audit objections requesting them to furnish clarifications, supporting etc. or to voluntarily deposit the amount of service tax involved alongwith interest. e. The audit objections alongwith the assessee s reply is discussed in the Monitoring Committee Meeting (MCM meeting) held by the CCE every month and thereafter a final audit report is prepared which contains the decision taken at the MCM meeting on the course of action to be taken in respect of a particular audit objection viz., whether the audit para is to be closed (if the assessee has discharged the service tax liability to the satisfaction of the audit party) or an SCN need to be issued in respect of a particular para. An Audit will be treated as to be completed only on issuance of Final Audit report. 2.6. Some of the documents that are usually called for examination during course of audit by the departmental officers are listed below: Sl. Type of document Objective of examination 1. VAT audit returns To scrutinize the value of deduction claimed on account of sale of material in case of services like 9
Construction services, Works Contract Services, maintenance services, outdoor catering services etc. 2. Tax audit report Details of cenvat credit availed and utilized in books of accounts, cenvat credit availed on capital goods, prior period revenue items (if the same is liable for service tax) 3. TDS certificates/ 26AS statements Value on which TDS is deducted reconciles with turnover disclosed in ST-3 returns; nature of services provided; amount of TDS claimed in Income Tax return whether the corresponding value has been recognized as income for Income Tax purpose if so whether the value has also been disclosed in the ST-3 return 4. Financial statements a) Notes to accounts Management s perception about contingent tax liability if any b) Director s report Description of activities carried out by the company with the classification of service; amount of revenue earned and expenditure incurred in foreign currency 5. Trial Balance Break up of gross income into taxable service income and non-taxable service income; Ledgers from where value of taxable services are derived; 10
Whether any income is recorded net of expenses; Whether deduction on account of reimbursement as pure agent is correctly claimed. 6. Trend Analysis Trend of Service tax collection 7. Ratio analysis Trend of proportion of exempted service to value of total services Value of Major input services : value of taxable services Cenvat credit availed : total service tax liability Value of non-taxable service : value of taxable service 8. Cenvat documents Whether Cenvat credit has been correctly availed; Credit has been availed on documents addressed to registered premises; Whether service tax has been paid properly by the input service provider (may examine this on sample basis from the jurisdictional service tax authorities of the input service provider); Amount of cenvat credit claimed is same in both ER-1 & ST-3 returns if filed by the assessee; In case of provision of both taxable & exempted services reversal as required under cenvat 11
credit rules has been followed properly. 2.7. Some of the significant points to be kept in mind during the conduct of departmental audits are a. Always insist for issuing of audit objections by the audit party in writing; b. Whenever giving any clarification or submission of documents in reply to audit objection the same needs to be done under a covering letter; c. After completion of audit intimate to the audit party stating the various objections that were raised or pointed out during the course of audit and the amount of service tax payments made, if any, during the course of audit alongwith a request for granting the benefit of nonissuance of SCN u/s. 73(3) of the Act. d. May request the audit party to be furnished with a copy of both Draft Audit Report as well as Final Audit Report. 2.8. In addition to the above departmental audit there is another kind of audit which an assessee may be subjected to, known as CERA Audit [Central Excise Revenue Audit]. It is an audit conducted by the office of the Comptroller and Auditor General of India under its Constitutional powers read with The Comptroller and Auditor General (Duties, Powers and Condition of Service) Act, 1971. Under the said Act a duty has been cast upon the C& AG to conduct a revenue audit (i.e. audit of all receipts that are payable into the consolidated fund of India). In fact it is an audit of the efficiency of the Central Excise Department to check as to whether the taxes are properly being assessed, realized and credited by the Central Excise Department into the Consolidated Fund of the Central Government. The C& AG auditors visit the 12
premises of the assessee, examine the books of accounts of the assessee following more or less the same procedure as mentioned in the table given herein before and find out the cases / modes through which there have been revenue leakages. The findings of this audit are then forwarded by the C & AG auditors to the jurisdictional range office which then carries out inquiries subsequently resulting into issuance of show cause notices. 2.9. Issue: Many a times during the course of audit the assessee, on being pointed out by the audit party, pays the tax liability alongwith interest. In every such case is issuance of show cause notice for imposition of penalty u/s. 78 on the grounds of suppression of facts warranted? 3. Scrutiny of returns 3.1. This method is resorted to by the department for the purpose of verifying the assessment made by the assessee. The Board has recently issued a revised guideline [Circular 185/4/2015-ST dated 30.6.2015] for conduct of the scrutiny of the returns the contents of which are explained below. 3.2. Basically there are two kinds of scrutiny that would be done by the department viz., a. Preliminary online scrutiny; and b. Detailed manual scrutiny Preliminary online scrutiny 3.3. This is an automated scrutiny that would be performed on all the returns. The purpose of this scrutiny is to ensure 13
a. Completeness of the information that is required to be furnished by the assessee in the returns; b. Arithmetic correctness of the tax computation and its timely payment; c. Timely furnishing of returns. The errors in respect of any of the above mentioned areas would be detected automatically and such erroneous returns would be forwarded to the jurisdictional range officers for taking corrective action. Detailed manual scrutiny 3.4. This scrutiny would be done of selected returns that would be identified on the basis of certain specified risk parameters. The purpose of this scrutiny is to ensure correctness of the assessment made by the assessee. The scope of this scrutiny would include a. Reconciliation of information furnished by the assessee in his ST-3 returns with the information furnished by him in his Income tax Returns; b. Examining the taxability, admissibility of abatement, eligibility of exemption, valuation of services and cenvat credit availment and utilization. 3.5. Some of the significant points relating to detailed manual scrutiny that needs to be noted are as given below a. Detailed manual scrutiny is complimentary to audit and hence there might be replication in respect of some of the verifications that are carried out during the scrutiny of returns vis-a-vis the verifications that are carried out during the departmental audit; 14
b. Usually the assessee s whose tax payments are less than 50 lakhs and who have not been selected for audit would be selected for detailed manual scrutiny. However, assesses who have been subjected for audit during the past 3 years would not be selected for scrutiny; c. Details required for scrutiny shall be requisitioned only with prior permission of AC/DC; d. Departmental Officers would not be visiting the assessee s premises for carrying out scrutiny of the returns; e. 15 days intimation prior to commencement of scrutiny shall be given and the estimated time frame for completion of scrutiny of ST-3 returns filed during a financial year is 3 months. Checks performed during the scrutiny of ST-3 returns 3.6. The checks that would be performed by the department during the scrutiny of ST-3 returns are as follows- 1. Revenue reconciliation a. Output tax : Amount of Service tax appearing under the heading Duties, taxes and cess received or receivable in respect of goods or services sold and supplied appearing in credit side of P&L Account in the Income Tax Return ( ITR ) [i.e. amount of service tax billed to the customers] to be matched with total service tax paid as reflected in two half yearly ST-3 returns. Similarly service tax paid as reflected in debit side of ITR should also be matched with the service tax paid as reflected in the ST-3 returns. b. Cenvat Credit : Amount of service tax paid appearing under the heading duties or taxes paid or payable in respect of goods and services purchased appearing in Debit Side of P&L Account [i.e. the amount 15
of service tax charged by the input service providers / vendors] in ITR to be matched with total cenvat credit availed as reflected in ST-3 returns. 2. Examining the taxability of services a. Income claimed as non-taxable: The intention under this check is to examine whether any the income earned by an assessee and reflected in his ITR includes any element of service which would attract service tax liability. For this purpose non-taxable income on which no service tax is paid by the assessee is determined by using the following formula Taxable Income = Gross receipts of business / service income + Rent + Commission minus Abatement +Value of exempt service + Value of exports As disclosed in ITR As disclosed in ST-3 The resultant figure which would arise out of the above formula will be compared with the value of taxable service as disclosed in ST-3 return and the difference between the two would be the income on which no service tax has been paid by the assessee. The components of this non-service tax paid income would be examined with the statutory provisions and in the light of the supporting documents like contracts, invoices etc. so as to determine whether it includes any taxable service component. 16
b. Classification of service: under this the category under which the service tax is paid by the assessee (service tax code mentioned in challan & return) is examined with the Section Code under which TDS has been deducted, if any, and mentioned in the 26AS statement of the assessee. The objective is to verify whether the assessee has classified the services rightly for the purpose of payment of service tax. Further the assessee would also be asked to prepare reconciliation between the amount of Income corresponding to the TDS credit claimed by it in the income tax return and the value of taxable services disclosed by it in its ST-3 returns. c. Exemption claimed: the eligibility to the exemption claimed by the assessee would be examined so as to see whether all the conditions in respect thereof are satisfied by examining the supporting contracts and invoices. d. Exports claimed: the correctness of the export benefit claimed by the assessee would be examined by asking the assessee to substantiate the description of service; application of the place of provision of service rule; and receipt of money in convertible foreign exchange. e. Abatement claimed: whether all the required conditions for availment of abatement benefit have been satisfied and whether in respect of such services the conditions of reversal of cenvat credit under rule 6(3) of the Cenvat Credit Rules have also been complied. f. Deductions, if any: If any deductions have been claimed from the value of taxable services reasons for the same alongwith the supporting documents shall be called for. 17
3. Valuation of services a. Reimbursement of Expenditure: whether all the conditions of pure agent have been satisfied by the assessee. This would be done by examining the bills, invoices etc. Further it would also be examined that no cenvat credit has been claimed on such reimbursed services. b. Whether all the expenditure or costs incurred by the assessee during the course of provision of services have been included in the value of taxable services. This will be verified by calling for sample copies of invoices raised by the assessee and the corresponding invoices for cost / expenditure incurred by the assessee. 4. Cenvat Credit a. Eligibility of cenvat credit availed: whether the cenvat credit availed on input services can be said to have been used in relation to manufacture or for the provision of output services. b. Common cenvat credit for both taxable & exempted services: in this the following areas would be examined viz., i. Whether the procedure prescribed u/s. rule 6(3A) has been followed correctly; ii. Whether the reversal of cenvat credit on monthly basis and final reversal at the year end is being done properly; iii. Whether the statement required to be given at the end of the year has been furnished to the department; iv. correctness of the ratio for reversal of cenvat credit; v. Whether any credit attributable to exempted services has been claimed by the assessee. 5. Miscellaneous issues 18
a. Adjustment made under Rule 6(3) of Service Tax Rules: in respect of adjustment of service tax paid u/s. 6(3) of the service tax rules the credit notes issued by the assessee for renegotiation of the invoices and the original invoices would be called for; b. Adjustment made under Rule 6(4A) of Service Tax Rules: in case of adjustment made for excess payment of service tax u/r. 6(4A) of the service tax rules the calculation on basis of which excess service tax was paid earlier would be called for. c. Payment of service tax on advances: whether the service tax has been paid as per the Point of taxation Rules, 2011 on the amounts that are reflected in the liabilities side of the balance sheet advances ; d. Whether service tax has correctly been paid under reverse charge mechanism in respect of payments made outside India viz., fees for technical services, Commission, Royalty, professional fees etc. which are shown in debit side of Profit & Loss Account in Income Tax Returns; e. Whether service tax has correctly been paid under reverse charge mechanism in respect of domestic payments where service tax liability is attracted such as freight paid to GTA, manpower supply, security, sponsorship, legal expenses etc. which are shown in debit side of Profit & Loss Account in Income Tax Returns as 3.7. Some Significant challenges faced during Scrutiny of returns a. What is the implication if the assessee is unable to reconcile the value of taxable service as disclosed in ST-3 returns with the value on which TDS has been deducted as reflected in 26AS statement can it be said 19
that the assessee has not furnished the correct information in the ST-3 returns? b. What would be the implication if it is noticed that the value as disclosed in the income tax returns or the value of materials as disclosed in VAT returns is incorrect? c. What is the implication if the assessee is able to substantiate with contractual documents that he has acted as a pure agent but has failed to disclose the amount of reimbursement received by him as such in his ST-3 returns? 4. Conclusion 4.1. It is to be appreciated that all the three methods introduced by the department for carrying of verification and checks viz., investigation, departmental audit and Scrutiny of ST-3 returns are an essential pre-requisites for the department to ensure that the self assessment of service tax carried out by the assessees is correct and in accordance with the provisions of law and that there is no leakage of revenue. However, the procedure by which these verification and checks are carried out would definitely be a cumbersome exercise both for the assessee and the consultants, but consultant s USP is handling cumbersome work! 20