Shri Mahaviray Namah J. B. NAGAR CPE Study Circle of WIRC TAX AUDIT: Practical issues By Vinod Kumar Jain, FCA Reference Material GUIDANCE NOTE PUBLISHED BY THE ICAI ISSUES ON TAX AUDIT PUBLISHED BY THE ICAI STANDARD ON AUDITS PRESCRIBED BY ICAI ACCOUNTING STANDARDS PRESCRIBED BY ICAI ACCOUNTING STANDARDS NOTIFIED U/S. 145 GUIDANCE NOTE ON TAX AUDIT u/s. 44AB 12.10.07 (www.icai.org.. Resources) What is the Objective of Tax audit? Circular No. 387 dated 6 th July 1984 specifies the objective of tax audit as under: ` A proper audit for tax purposes would ensure that the books of account and other record are properly maintained, that they faithfully reflect the income of the tax payer and claims for deduction are correctly made by him. Such audit would also help in checking fraudulent practices. It can also facilitate the administration of tax laws by a proper presentation of the accounts before the tax authorities and considerably saving the time of assessing officers in carrying out routine verifications, like checking correctness of totals and verifying whether purchases and sales are properly vouched or not. The time of the assessing officers thus saved could be utilized for attending to more important investigational aspects of a case. Who is liable for tax audit u/s. 44AB? The limit has been changed with effect from AY 2011-12 of turnover in case of business from Rs. 40 Lakhs to Rs. 60 Lakhs and in case of gross receipt in profession from Rs. 10 Lakhs to Rs. 15 Lakhs. The earlier limit of Rs. 40 Lakhs was fixed in 1984. If we consider the cost inflation index of 133 in 1985 and 785 at present, this limit should have been Rs. 2.35 Crores. Can a person having less than prescribed turnover be liable for tax audit u/s. 44AB? (Section 44AE and Amended section 44AD (effective from AY 2011-12) Amended S. 44AD is applicable to only eligible assessees viz. a resident individual, HUF or partnership firm. This section does not apply to LLP and Companies. This section also does not apply to assessees claiming deduction u/s. 10A, 10AA, 10B, 10BA or deduction u/s. 80H to 80RRB. Income covered u/s 44AD is not liable to provisions of advance tax payment. This section applies to the eligible assessee carrying on any business except the business covered u/s. 44AE or assessees having turnover or gross receipts not exceeding Rs. 60 Lakhs. Any business covers all kind of business and does not distinguish between traders, manufacturers, money lenders, commission agents, speculative business income etc. Since there is a distinction between Business and Profession, professionals do not come under its preview.
2 It prescribes 8% of turnover or gross receipts as net profit from the business, or at a sum higher than aforesaid as declared in the return as income chargeable to income. In case an eligible assessee chooses to offer income lower than what is prescribed, then, the assessee is required to maintain books of account and get them audited u/s. 44AB. Similarly S. 44AE provides assessee owning less than 10 carriages and earning from business of plying, hiring or leasing goods carriages will have presumptive income from heavy goods vehicles Rs. 5,000 per vehicle per month and from light goods vehicle Rs. 4,500 per vehicle per month. If such assessee chooses to offer income lower than what is prescribed, then, the assessee is required to maintain books of account and get them audited u/s. 44AB of the Act. Who can be appointed as Tax Auditor A Chartered Accountant or a firm of Chartered Accountants in full time practice can be appointed as Tax Auditor. Internal Auditor cannot be a tax auditor. (wef 12.12.08) Communication with previous auditor, whether necessary? Yes. What, if previous auditor objects on outstanding consultancy fees? How many Tax Audits a Chartered Accountant can undertake? A firm of Chartered Accountants cannot accept more than 45 Tax Audits per partner. A member cannot accept more than 45 tax audits. How can a Company remove Tax Auditor? Removal of tax auditor does not require compliance as specified u/s. 224 of Companies Act. There is no specific procedure, however, it is possible for the management to remove a tax auditor when there are valid grounds for such removal. Is it mandatory to submit to tax audit report to AO after efilling return Annexure less return. Under rule 12(2) the report etc. should not be furnished along with return of income. Tax Audit report may be retained by the assessee in his records and produced to AO whenever called for during hearings. However, filling up particulars of tax audit in the ereturn is important and date of of audit mentioned therein is also significant. Consequence of failure to carry out tax audit in time (S. 271B) If an assessee fails to procure tax audit reprot within prescribed time AO can levy penalty of an amount being lower of ½% of Turnover or gross receipts or Rs. 1,50,000/- (wef 1.4.11, earlier Rs. 1,00,000/-). However if failure is for reasonable cause penalty is not to be levied. S.273B Can penalty u/s. 271B be imposed when books of account not maintained? Assessee not maintaining books of account, penalty can be levied only u/s. 271A for violation of Sec. 44 AA and there being no possibility of offence contemplated u/s. 44AB of failure to get the accounts audited, penalty u/s. 271B cannot be imposed. Surajmal Parsuram Todi Vs. CIT [1996] 222 ITR 691 (Gau)
3 Is ICAI Guidance Note binding? Guidance Note is recommendatory in nature and `Issues on Tax audit is a supplement to the Guidance Note is treated as having lesser binding force. Member may take a different view under certain circumstances. Should the tax auditor obtain signature of assessee on Form 3CD? At least on office copy. Can a tax audit report be revised? GN13.10. It may be pointed out that report under section 44AB should not normally be revised. However, sometimes a member may be required to revise his tax audit report on grounds such as : (i) revision of accounts of a company after its adoption in annual general meeting. (ii) change of law e.g., retrospective amendment. (iii) change in interpretation, e.g., CBDT Circular, judgements, etc. In case where a member is called upon to report on the revised accounts, then he must mention in the revised report that the said report is a revised report and a reference should be made to the earlier report also. In the revised report, reasons for revising the report should also be mentioned. Extensive uses of N.A. in tax audit report by Auditors, whether proper? At times assessing officers complain, many tax audit report just contains N.A. or -, Should positive statements like (a) There is no change in the nature of business (b) There has been no deviation in method of accounting (c) There is no such payment.: be used? Should good tax audit reports be published? What is Turnover? Guidance note on Tax Audit issued by ICAI has elaborated at length in Para 5.1 to para 5.16. `Issues on Tax Audit published by the Institute also answer to issues No. 6 to 33 and explains the same in detail. The first test check would be whether it is profession or business. In case of profession only gross receipts need to be considered, whereas in case of business sales, turnover or gross receipt needs to be considered. How to distinguish Profession with Business? Coaching classes run by a Chartered Accountant vis a vis by a non qualified businessman. ISOTA issue 29 Business Income : Income from educational institution run by a person who does not possess any professional qualifications; ISOTA issue 29 Professional Income: Income from coaching classes run by a Chartered Accountant or a person possessing professional qualifications. Since teaching is a vocation and since profession includes vocation, this view is possible;
4 Turnover / Gross Receipt GN 5.11 (a) In case of a day trader / speculator : sum total of differences, whether +ve or ve. GN 5.11 (b) In case of security derivative transactions: sum total of differences, whether +ve or ve. Also premium on sale of options. GN 5.11 (c) In case of commodity derivative transactions : in case of settlement without delivery, sum total of differences, whether +ve or ve. In case of delivery, total values of sales. GN 5.13 (vi) In case of a clearing & forwarding agent: Reimbursement of custom duty & other expenses are not a part of turnover. GN 5.13 (ix) In case of a advertising agent booking space: Advertising charges recovered by way of reimbursement not a part of turnover. Purchases, WIP, Sale proceeds of fixed assets, write back of accounts of creditors, surrender of stock in search etc. would not form part of turnover. Sales tax, excise duty charged on sales ISOTA issue 11: The words `sales, `turnover and `gross receipts are commercial terms and they should be constructed in accordance with the method of accounting regularly employed by the assessee. If the sales tax collected is credited separately to sales tax account and payments thereof are debited in the same account, they would not be included in the turnover. Paragraphs 5.5 and 5.6 clarify this. On other hand Section 145A provides sale of goods includes any tax, duty, cess or fees. It may be noted that this applies to CENVAT and VAT. However, this does not apply to service tax. Use of Form 3CA & 3 CB Form no. 3CA requires the tax auditor to enclose a copy of the audit report conducted by the Statutory Auditor. Where the statutory report is not available for whatever reason, tax auditor should give his report in form no. 3CB. Impact of AAS 28 Auditing & Assurance Standard 28 is operative for all Audits hence even tax audit report in form 3CB needs following type of affirmation: `These financial statements are the responsibility of the entity s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with the auditing standards generally accepted in India. Those standards require reasonable basis for our opinion. Contents of 3CD Part A (clause 1 to 6), Part B (Clause 7 to 32), Annexure I (PartA & PartB) Form will be treated incomplete if Annexure I is not filled up. Clause 4: What would be status in case of a LLP (Limited Liability Partnership)? Firm in case LLP formed in India. Company in case LLP formed outside India. (S. 2 (23) Clause 7: Change in partners profit sharing ratio Whether reporting required, in following situation:
5 Change in partner s remuneration or rate of interest on Capital Minor becoming major & opting to continue & agree to share in losses Clause requires reporting of change in profit sharing ratio only and does not call for other details. However, for effective reporting it is advisable to report even such changes. Clause 8 (a): Nature of business or profession It is important to specify exhaustive list of nature of business. Why? Clause 9: Books of Account Is it necessary to have hard copy of printouts? Section 2[12A) books or books of account includes ledgers, day-books, cash books, accountbooks and other books, 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 : Whether stock records are books of account? Tax auditor s responsibility where proper stock records not maintained. Clause 11: Method of Accounting Change in method of accounting vis a vis change in accounting policy GN 22.7. A change in an accounting policy will not amount to a change in the method of accounting and hence such change in the accounting policy need not be mentioned under subclause (b). This is due to the fact that as per the requirements of As-1 and AS(IT)-1 such changes and the impact of such changes will be disclosed in the financial statements. It may be noted that a change in the method of valuation of stock will amount only to a change in an accounting policy and hence such a change need not be mentioned under sub-clause 11(b) but should be mentioned in the financial statements. What if previous year accounts are not audited? Certificate from Assessee should be obtained that opening balances are correct. Scope of Section 145A. Gross Method vs. Net Method. ICAI s GUIDANCE NOTE ON TAX AUDIT u/s. 44AB dated 12.10.2007 According to the institute there would be no impact on profitability by following exclusive method either in case of VAT or CENVAT vis a vis provisions of Section 145A of the I.T. Act. Reconciliation statement pursuant to section 145A needs to be prepared. The institute Guidance note gives a very elaborate discussion with various examples on this issue. Clause 12: Valuation of closing stock In cash system of accounting, whether closing stock will come? Clause 12A : Capital assets converted in to stock in trade The purpose of this clause is to determine fair market value for capital gains tax purpose.. One may refer definition of Capital Assets u/s. 2 (14) and of transfer u/s. 2 (47)(iv).
6 Clause 13: Amounts not credited to Profit & loss A/c. What if not accounted for in accounts? Example : One of the partners enjoys free foreign tour organized by supplier on firm achieving a target turnover. Scope restricted to books of account. However documents that came across while conducting audit needs also to be considered. Clause 13 (d): Amount not credited to Profit & Loss A/c. : Any other item of income In case of non-corporate assessee amounts credited to capital accounts can be looked in to such as interest on income tax refunds. Clause 13(e): Whether amount of capital gains or capital receipt be mentioned? Should money received on share application be reported in 13(e) The objective of details required against any other item of income & capital receipt, if any is to assess income, as such details should be given accordingly. Hence tax auditor may restrict to taxable receipts. Clause 14: Particulars of Depreciation CENVAT and Vat amount should be deducted from cost to the extent credit thereof is availed. Can depreciation be claimed in following situation? A Company holds an asset in the name of a director. A partnership firm holding fixed asset in the name of a partner. Under cash system of accounting, payment for purchase of fixed assets is not made. If an assessee wants to claim no or lower depreciation on an asset, what is the responsibility of an auditor? Amendment to Explanation 3 to Section 32(1) by Finance (No.2) Act, 2009 wherein the word block of assets is substituted with the word assets. As such particulars of additional depreciation should be given assets wise and not block wise. Clause 16: Bonus, Commission, PF recoveries etc. There is an amendment in S.43B for allow ability of late payment of PF. However In view of no amendment in the provision of section 2(24)(x) and section 36(1)(va) if assessee fails to pay any PF contribution deducted from the salary of employees within specified due date under respective Acts, the deduction will continue to be disallowed. Clause 17: General & also on penalty & fine etc. Penalty : Infraction of law or arising out of contractual obligation compensatory in nature? Interest on arrears of sales-tax is compensatory in nature and, therefore, it is allowable as deduction. LACHMANDAS MATHURDAS Vs. CIT (2002) 254 ITR 799 (SC)
7 Penalty paid to Municipal Corporation for regularization of unauthorized construction (plan not approved) is in nature of penalty for violation of law. Not allowable u/s. 37(1). Radha ballabh Silk Mills v. DCIT 12 SOT 423 (Mum) Payment to Municipal Corporation for condoning deficiency in open space is not a penalty for infraction of law. CIT vs. Lokenath & Co 147 ITR 624 (Del) Amounts inadmissible under Section 40A (3) read with rule 6DD: Aggregate of payments made in a day by Cash or payments otherwise than by A/c. Payee Cheque or bank draft in excess of Rs. 20,000 (Rs. 35,000 in case payment is made for plying, hiring or leasing goods carriages. Where payment is made to sundry creditors for an expense allowed in earlier year in aggregate more than Rs. 20,000 in a day otherwise than through A/c Payee cheque or bank draft, the same would be considered as business income of the year in which such payment is made. Section 40A(3) is not applicable when income is determined by applying net profit rate. CIT vs. Purshottamlal Tamrakar Uchera [2003] 184 CTR (MP) 349. Clause 17 (a) Capital expenditure 3 tests to be applied to determine whether expenditure is capital or revenue test of enduring benefit, ownership test, functional test. In case of software ownership test alone may not be sufficient functional test and enduring benefit may be more important. Clause 17 (f) (amount inadmissible u/s 40(a)) Section 40 a (i) TDS on sum payable outside India or to non resident is to be paid within time prescribed u/s. 200(1), otherwise expense would be deductible in the year of TDS payment. Section 40 a (ia) TDS on sum payable to resident is to be paid before filing of return or due date of filing, whichever is earlier, otherwise expense would be deductible in the year TDS is paid. TDS on salary is still outside preview of section 40 a (ia) Clause 17 (l): Amount of deduction inadmissible in terms of section 14A Rule 8D: Expenditure in relation to exempt income shall be aggregate of i. Amount of expenditure directly relating to exempt income ii. Interest paid if not directly attributable to any particular income or receipt, such interest in ratio of average investments with exempt income to average total assets iii. ½ % of average investment with exempt income Section 14A is highly controversial. If auditor is in agreement with the computation of assessee, he should report the amount along with suitable disclosure of material assumptions. Otherwise, if auditor is not in agreement with the assessee he should either give qualified opinion, adverse or disclaimer of opinion.
Clause 17A: Amount of interest inadmissible u/s. 23 of the MICRO, Small and Medium Enterprises Development Act, 2009 Amount to be reported whether sum debited to Profit and Loss Account or not. Clause 20: Amounts chargeable u/s. 41 Chargeability u/s. 41 is only if amount allowed as deduction in earlier year. Mere time barring of liability without write back not liable u/s. 41(1). Waiver of principal amount of loan by bank, whether liable u/s. 41(1) is controversial. 8 Clause 21: Payments covered u/s. 43B Furnishing of bank guarantee for unpaid liability cannot be equated with actual payment so as to satisfy the requirement of section 43B. CIT vs. Udaipur Distillery 186 CTR (Raj) 1 Excess deposit in account current with excise department to be treated as excise duty actually paid. Thus deductions allowed even if payment is made before liability incurred. However, unutilised MODVAT credit is not sum actually paid till adjusted. (Glaxo Smithkline Consumer Healthcare, ITAT Chandigarh, Special Bench). Clause 24(b): Loan and Deposit Repaid If a partnership firm makes payment on behalf of family members, from whom loans are taken, of their LIC premium, income tax, insurance bill etc. by account payee cheque in favour of concerned authorities, would this be treated as repayment made otherwise than account payee cheque. 269T. No branch of a banking company or a co-operative bank and no other company or cooperative society and no firm or other person shall repay any loan or deposit made with it otherwise than by an account payee cheque or account payee bank draft drawn in the name of the person who has made the loan or deposit - Clause 27:Tax deducted at source As there are lots of debatable issues, appropriate comments shall be made. CBDT Circular No.4 of 2008 in respect of TDS u/s. 194I provides that TDS on service tax on rent need not be deducted as service tax is not income by way of rent. Land lord is collecting agency for the Government. CBDT clarification dated 30.6.2008 to Bombay Chamber of Commerce that TDS is to be deducted also in respect of service tax on professional fees, because it is sum payable as fees. New Section 206AA makes mandatory requirement to furnish PAN. In case deductee does not furnishes PAN to deductor, Deductor to deduct TDS at the rate applicable or 20%, whichever is higher. A view is taken that this is applicable even in case of Non residents or those covered under DTAA.
9 GENERAL ISSUES Assessee vis a vis auditors duty Information to be complied and authenticated by the assessee. Auditors duty to check the details applying the auditing standards and techniques. In case of conflicting views with the assessee, the auditor may state both the views. In case of conflicting judicial precedents, auditor should state the judgment relied upon. Working papers No one will believe you did something on an audit if there is nothing in your working papers file to show for it. They are aid in the planning and performance of audits They are aid in supervision and review of audit work They provide evidence of the audit performed to support the auditor s opinion. Documentation for tax audit Documentation refers to the working papers prepared or obtained by the auditor and retained by him in connection with performance of his audit. SA - 210 : Appointment letter defining scope of audit SA - 580 : Management representation letter SA - 310 : Notes on the nature of business SA - 500 : Sample Purchase and Sales bills, Proof of assets purchased and revenue expenditure capitalised, Trial balance and Financial statements duly signed b the assessee SA - 505 : Bank loan statement, Bank balance confirmation, Major sundry debtors and creditors balance confirmation, SA 520 : analytical ratio analysis SA - 550 : List of related parties and transaction AS -1 Notes on accounts and disclosure of accounting policies AS -2 Valuation of inventories with quantitative inflow and outflow statement AS 5 Extraordinary Items nature & disclosure AS 6 : Depreciation calculation statement AS 29 : Estimation of liabilities including contingent liabilities 3CD check list, documentations, 3CD specific certificates, statutory compliances etc. Abatement? BEWARE A person other than tax payer who willfully makes or causes to tax payer to make any false entry in the books of accounts or any statement to evade any tax liability would be made liable to imprisonment range from 3 months to 3 years with fine. (Abatement u/s. 277A) To sum up, one must keep in mind: Concept of Prudence, Substance over form, Materiality & Matching Concept.