Audit report under section 12A(1)(b)

CA Tushar Doctor Audit report under section 12A(1)(b) 1. Income of a charitable trust is exempt as per section 11, 12. One of the conditions for availing exemption is that accounts of the trust should be audited if its income (without giving effect to provisions of sections 11 & 12) exceeds exemption for registration, provides that accounts of the trust should be audited. Where total income before the exemptions u/ss. 11 and 12 of the trust exceeds the maximum amount not chargeable to tax; i.e., ` 1,80,000 (A.Y. 2012-13), in order to get exemption u/ss. 11 and 12, the accounts have to be audited by section 2 of Section 288, who will give his report in Form 10B. If the income of the trust/institution referred to in clause (iv), (v), (vi) or (via) of Sec.10(23C) without giving effect to the provisions of these clauses exceeds the maximum amount not chargeable to tax, such trusts will have to get their Explanation below sub-section (2) of Section 288. (As provided in the Taxation (Amendment) Act, 2006) in form 10BB. 2. The audit report is to be given in Form no. 10B. Report is to be furnished along with the return of income. The auditor should comply with the requirements of the AAS 28 The Auditor s Report on Financial Statements. AAS 28 The Auditor s Report on Financial Statements states that the auditor s report should be appropriately addressed as required by the circumstances of the engagement and applicable laws and regulations. The audit report consists of 4 paragraphs. and loss account The auditor should ensure agreement between the have to exhibit a true and fair view. 2.2 Information and explanations The audit report has to state that all information and explanations which, to the best of the auditor s knowledge and belief, were necessary for the purpose of audit have been obtained. The auditor should maintain proper working papers to show that the information and explanations obtained by him from the institution are adequate. The form requires the auditor to report that proper books of account have been maintained and proper returns have been received from branches not visited by the auditor. Books of Act. Therefore, the books of account have to be so written that they can lead to the preparation 96 SS-V-86

Special Story of the financial statements showing a true and fair view. The books of account should conform to the requirements of section 44AA wherever applicable. Likewise for branch returns, the auditor should check the branch returns as may be deemed necessary by him to enable him to express such an opinion. The expression "subject to the comments given below:" used in the sentence dealing with the auditor s report on the maintenance of proper books of account and proper branch returns indicates the qualifications which the auditor should specify immediately below the paragraph. A plain reading of the above requirement indicates that the comments of the auditor are required to be given just above the paragraph commencing with In my/our opinion.. However, a reference to foot-note 3 in the prescribed form would indicate that the auditor s negative report or qualifying report can relate to any part of the report. In other words, while the form of audit report is prescribed, it is not possible to adhere to it absolutely in the same form in which it is given. Under appropriate circumstances the auditor has to indicate the 2.3 Opinion about the true and fair view The prescribed form requires the auditor to report on the truth and fairness of the financial statements. As most trusts are not well organized, the auditor must apply his usual checks & also obtain management representations as to the completeness and value of the entries in the books of account in respect of assets, liabilities, income and expenditure. As this report is an expression of opinion about the truth and fairness of general purpose financial statement, the auditor should follow all the AASs in conducting the audit. The auditor has to give his report in Form 10B. There is no specific requirement for the auditor to certify the correctness of the particulars in the annexure to Form 10B. But he must affix his signature at the end of the particulars, implying thereby that the auditor is taking the responsibility for verifying the correctness of the particulars given by him in the annexure. (A reference to the annexure is made at serial no (ii) of Form No. 10B). 3. Annexure to the audit report The annexure to the audit report contains a statement of particulars to be given under three parts. The various particulars in the annexure should be based on the audited financial statements. The auditor may also verify minutes book of the governing body, past income-tax records, copy of the trust deed/bye-laws/memorandum of articles, as the case may be in order to give the details asked for. 4.1 Amount of income applied during the previous year Here the term income means income in commercial sense and not total income as per income tax assessment (i.e., sec 2(45) of Income Tax Act). In other words, from the total receipts the expenses necessary for earning that income have to be deducted. The net amount that remains would be available for distribution or application for charitable purposes. Capital expenditure is also application of income. The word applied need not necessarily imply that the amount should be actually spent. Even if an amount is irretrievably earmarked and allocated for the charitable or religious purpose(s), it would amount to application. [CIT vs. Radhaswami Satsang Sabha (1954) 25ITR 472, 522-3 (All); CIT vs. H.E.H. The Nizam's Charitable Trust (1981) 131 ITR 497, 501-02 (AP)]. For the purpose of determining the income available for application for charitable purposes, should the gross income be taken or the net income after deducting all expenses incurred to earn the income. Refer the judgement of the Supreme Court in CIT vs. Programme for Community Organisation [2001] 248 ITR 1. A charitable trust can accumulate 15% of its income. Here it is 15% of gross income & not net income. Agricultural Income: However, the agricultural income will not form part of total income for purpose of computing accumulation of income in SS-V-87 97

excess of 15% of total income as laid down under section 11, CIT vs. Nabhinandan Digambar Jain (2002) 257 ITR 91 (MP). Even when the whole of the capital expenditure may be treated as an application of income towards charitable or religious purposes for the purposes of section 11, the trust may also claim depreciation in respect of the assets used by it for its purposes on the basis of normal commercial principles following the Circular No. 5-P (LXX-6) of 1968 dated 19th June, 1968 issued by the CBDT. The CBDT by its Circular No.100 dated 24th January, 1973 (F.No.195/1/72-IT (A.1.) also observed that repayment of loan originally taken to an application of income for charitable and religious purposes within the meaning of the Act. It also observed in that circular that where the object of the trust is advancement of education and it grants scholarship loans to students for higher granting of such loans, even if interest-bearing, will amount to application of income for charitable purposes. It was held in CIT vs. Janambhumi Press Trust (2000) 242 ITR 457(Kar) that where the assessee trust constructed a building out of its accumulated income as well as from borrowed funds, and later earned rental income from the said building, a part of which was utilized for the repayment of the borrowed funds, such repayment of debt was treated to be as application of income for purpose of section 11. Expenditure by way of payment of tax out of current year s income has to be considered as application for charitable purposes because the payment has been made to preserve the corpus, the existence whereof is essential for the trust itself. [CIT vs. Janaki Ammal Ayya Nadar Trust (1985) 153 ITR 159 (Mad)]. Amount of excess application of the last year can year. [CIT vs. Matriseva Trust (2000) 242 ITR 20 Mad.] In respect of voluntary contributions made with a corpus of the trust or institution, the conditions regarding application of income to such receipts will not apply. The auditor has to report at serial no. 1 of part I (of Annexure) details of income applied. He must verify here whether income is correctly computed & verify the amount actually applied during that year. Also verify the anonymous donations. Hence, it would be advisable for the auditor to get appropriate management representation. In the case of CIT vs. Institute of Banking Personnel Selection 264 ITR 110 (Bom), the Bombay High Court held that income derived from the trust property is to be computed on commercial principles. Accordingly, adjustment of expenses incurred by the trust for charitable purpose in the earlier years against the income earned by the trust in the subsequent year will have to be regarded as application of income of the trust in the subsequent year. The High Court has also held that the depreciation debited in the books should be treated as expenditure for this purpose. The concept of commercial income necessarily envisages deduction of depreciation on assets of the Trust. Section 11 provides that the income of the trust is to be computed on commercial basis i.e. as per normal accounting principles. Normal Accounting principles clearly provide for deducting depreciation to arrive at income. In the case of CIT vs. Maharana of Mewar Charitable Foundation (1987) 164 ITR 439, the Rajasthan High Court has considered the Circular dated 24th Jan, 1973 of CBDT where CBDT has considered the question to whether "where a trust incurs a debt for the purpose of the trust, the repayment of the debt would amount to an application of income for the purpose of trust." According to said circular, if the trust wants to spend more money on charitable and religious purpose, then, in a particular year, it can take a loan and the said loan can be repaid out of the income of the subsequent year & the repayment of the said loan amount out of the income of the subsequent year would amount to 98 SS-V-88

Special Story application of income for charitable & religious purpose under section 11(1)(a) of the Act. Also in recent decision of 2009 in the case of DDIT (E) vs. Govindu Naicker Estate (Mad) 227 CTR 283 it was held that repayment of loan is to be treated as application under Section 11. Where a capital asset is transferred and entire net consideration is utilized to acquire a new capital asset, the whole of capital gains is deemed to have been applied for charitable/religious purposes. If part of the net consideration is used to acquire a new capital asset, then the capital gains equal to the amount, if any, by which the amount so utilized exceeds the cost of the transferred asset, will be deemed to have been applied for charitable/religious purposes [Section 11(1A)]. Also refer Instruction 883 dt. 24-9-1975. No. 5-P (LXX, 6) dt. 19-6-1968 The income of the trust is to be computed in the commercial sense; i.e., "book income". Even when the trust derives income from property, or dividends, such income will be computed on actual commercial basis and not under provisions relating to income from house property or income from other sources. 4.2 Income deemed to have been applied & its investment in the prescribed manner. In order to avail exemption 85 per cent of the income derived during the year has to be applied to charitable or religious purposes. But sometimes it may not be possible. This may be due to the fact that the income has not been received during the previous year or for any other reason. In case of shortfall, the institution can still get the exemption provided it exercises the option for accumulation given in clause (2) of Explanation under section 11(1). To avail the benefit of deemed application of income the person in receipt of the income should exercise an option in writing before the expiry of the time allowed under section 139(1) for furnishing the return of income. The auditor should check from the income-tax computation statement whether there is any short fall in the application of income & whether the conditions stated in clause (2) of the explanation to section 11(1) are satisfied. He must verify the resolution passed by the governing body for exercising the option. Also he must ensure that & keep a copy for his record. He must ensure that investments are made as per sec 11(5) within prescribed time. If the option is exercised, the same must be reported by the accountant at serial no. 2 of Part I of Annexure. He has to also report the amount for which the option has been exercised at serial no. 2 of Part I of Annexure. 4.3 Income set apart for application 1. As stated earlier 85% of the income is to be applied to charitable/religious purposes. Balance 15% can be accumulated. No permission needs to be obtained for the same. At serial no. 3 of Part I of Annexure, the amount of income accumulated is to be mentioned if the amount does not exceed 15%. If it exceeds 15% the excess amount 2. The auditor can ask the management of the assessee to certify the amount so set apart for general (permitted) accumulation. 4.4 Exemption under section 11(1)(c) 1. Under section 11(1)(c), income derived from property held under trust would be exempt if there is a Board s order and (ii) day of April, 1952, the income may be applied for charitable or religious purposes, outside India. in case of the trust created on or after the day of April 1952, income should be applied outside India for such purpose which tends to promote international welfare in which India is interested. The amount so spent 99

should be reported at serial no. 4 of Part I of Annexure. 2. The auditor should verify here the copy of Board s order exempting the relevant income; the date of creation of the trust & the purpose for which the amount has been applied. 4.5 Income accumulated in excess of the per cent of the income referred to in clause (a) or clause (b) of sub-section (1) read with Explanation to that sub-section is not applied, or is not deemed to have been applied, to charitable or religious purposes in India during the previous year but is accumulated or set apart, either in whole or in part, for application to such purposes in India, such income so accumulated or set apart shall not be included in the total income of the previous year of the person in receipt of the income provided the following conditions are complied with namely:- (a) (b) such person specifies, by notice in writing given to the Assessing Officer in the prescribed manner, the purpose for which the income is being accumulated or set apart and the period for which the income is to be accumulated or set apart, which shall in no the money so accumulated or set apart is invested or deposited in the forms or modes 4.5.2 Thus even out of the mandatory ceiling limit institution can accumulate or set apart a portion for 10 is the same time limit as for filing the return of income under section 139(1). It has been held in Mermanjeet Trust vs. CIT 148 ITR 214 ( P& H) and Trustees of Tulsidas Gopalji Charitable Trust vs. CIT 207 ITR 368 (Bom) after time limit prescribed by section 139(1) but before completion of assessment, the assessee will be entitled for exemption. Similar inference may also be drawn from the judgement of Apex Court in CIT vs. Nagpur Hotel Owners Association 247ITR 201 (SC). A Charitable trust is entitled to accumulate its unspent balance for multiple purposes. It is not necessary to intimate the details and the plan of attaining the future projects to assessing officer. In Director of Income tax (Exemption) vs. Daulat Ram Education Society (2005) 278 ITR 260 (Del) it was held that merely because more then one plans which the assessee has for spending on such deny the claim of exemption u/s. 11(2). If the amount applied by the trust is less than 85%, the shortfall in application is not taxable in the following cases 4.5.3 Income is accumulated up to 5 years and the Form No. 10. If accumulated amount could not be applied due to order/ injunction of the court, such Form No. 10 is the same as time limit for filing return u/s 139(1) (Rule 17). However in the case of CIT vs. Nagpur Hotel Owners Association [247 ITR 201 SC] the Hon ble Supreme Court has held that in the absence of reference to time limit in the section itself, such form can be submitted any time before the completion of assessment. 4.5.3.1 The income accumulated must be applied for the specified purpose within the period of accumulation as per application in Form 10. Till the accumulated amount is applied, it must be invested as specified in Section 11(5). This requirement of Section 11(5) is applicable also to those trusts who are claiming exemption under clauses (iv), (v), (vi) and (via) of Section 10(23C). From A.Y. 2003-04, if the accumulated income is credited/ paid to any trust registered u/s 12AA or referred to in sub-clause (iv), (v), (vi) or (via) of 10(23C), it shall not be treated as application of income. 100

Special Story 4.5.3.2 In the case of dissolution of the trust, the AO may allow the application of income in the year in which it is dissolved by way of transfer of the accumulation to other trust registered u/s. 12 AA or institution referred to in Section 10(23C). [2nd proviso to Section 11(3A)]. 4.5.3.3 If there is violation of any of the conditions relating to accumulation of income, such income will be deemed to be income of the previous year in which the conditions are violated or the previous year immediately following the expiry of the period of accumulation. However, with the permission of the AO, u/s. 11(3A) accumulated amount, if could not be applied for the purpose during the specified period, can be applied on other objects of the trust as permitted by AO. 4.6 Investment or deposit in the prescribed manner Income so accumulated or set apart shall not be included in the total income of the assessee in the previous year in which the income is received provided the following conditions are complied with namely: - a) the period for which the income is to be accumulated or set apart, shall in no case b) the money so accumulated or set apart is invested or deposited as per section 11(5). At serial no. 5 of part I of Annexure the auditor has to mention the total deemed accumulation & general accumulation (upto 15%). As per Form 10 investments to be made before the expiry of 6 months from the end of the previous year. But note that in CIT vs. Trustees of Shri Tekchand Chandiram Trust 184 ITR 537, 540 (Bom.) it was held that a form cannot impose a timelimit which statute does not provide. All investments may not be made at the time of signing form 10. The auditor may state here that information given at serial no. 5 of Part I of Annexure and does not include any investments/ which the assessee may make subsequently before the due date of The auditor has to state at serial 6 whether the amount of income mentioned at serial 5 has been invested or deposited as per section 11(5). Those investments/ deposits which do not comply with the statutory requirements should be segregated and shown separately. All investments of the trust must be in modes provided in s. 11(5). If not, they must be brought in conformity within 1 year from the end of the previous year in which such investments are acquired, Contravention results in income and wealth of the trust being taxed at maximum marginal rate. This restriction does not apply to: 1-6-1973; the corpus as on 1-6-1973, by way of bonus shares; If debentures acquired after 28-2-1983 and before 25-7-1991, exemption is denied only in respect of income from such debentures, provided debentures are disinvested by 31-3-1992. 1. Investment in Government savings certificates/other securities/ certificates issued by Central Government under Small Savings Schemes; Savings Bank; 3. Deposit in any account with a scheduled/ co-operative bank; 4. Investment in units of the Unit Trust of India; 5. Investment in any security of the Central/ State Government; 6. Investment in debentures whose principal and interest are fully and unconditionally guaranteed by Central/State Government; 101

7. Investment or deposit in any public sector company (PSC); Shares of PSC may be retained for three years and other investments or deposits till its maturity once PSC ceases to be a PSC; 8. Deposits with or investment in any bonds industrial development in India; 9. Deposits with or investment in any bonds issued by an approved public company with main object of carrying on business of providing long-term finance for construction/purchase of houses in India for residential purposes or for urban infrastructure; 10. Investment in immovable property; 11. Deposits with the Industrial Development Bank of India; 12. Any other prescribed form or mode of investment or deposit. (for example, Units of mutual funds referred to in s. 10(23D), investment by way of acquiring equity shares of a depository prescribed). 13. Investment in "Indira Vikas Patra" and "Kisan Vikas Patra" are in accordance with Circular No. 566, dt. 17-7-1990. 4.7 Deemed income under section 11(1B) 1. Section 11(1B) provides that where any income in respect of which an option is exercised under clause (2) of the Explanation to sub-section (i) is not applied to charitable or religious purposes in India during the period referred to sub-clause (a) or, as the case may be, sub-clause (b), of the said clause then such income shall be deemed to be the income of the person as provided therein. 2. The auditor should checks accounts & audit reports of earlier years & also obtain management representation to this effect. If the income could not be spent due to non-receipt of income, check the year of receipt. The auditor should check that income is spent during the previous year in which it is received or during the previous year immediately following such year. If the income could not be applied for any other reason, then the auditor should ensure the same has been applied during the previous year immediately following the previous year in which the income was derived 4.8 Application for non-charitable purposes 1 Where any part of the income accumulated 11(2) in any earlier year has not been applied for charitable purposes or has ceased to remain invested in specified securities or has not been utilized for purposes for which it was accumulated, then it will be treated as income in the year in which such noncompliance occurs. statements and audit reports of earlier years for ascertaining accumulations made by the trust or institution in earlier years, application of income in the current year out of the accumulations of earlier year(s). 3 Many a time the auditor may not be in a position to get all the particulars required by the above clause. Hence, he can obtain a management representation and thereafter verify the particulars as given by the management and give the same under this clause. 4 The auditor may (a) (b) check the amount spent out of accumulated income of the relevant earlier year and whether it was spent for the same object for which it was accumulated or not. If not, he should mention whether the application/ permission for change of object clause was made/obtained or not; if the amount accumulated has ceased to be so accumulated or was not spent for the 102

Special Story (c) (d) (e) (f) (g) object for which it was accumulated, verify the necessary resolution and should account for such income accordingly; check whether the accumulated amount has ceased to remain invested as per section 11(5) and if any deviation is noted, report the same; verify the investments at the end of every year; examine the accounting treatment and taxability of the accumulated surplus if the same has not been spent or period of accumulation has expired; ascertain the present position of each such accumulation and investment to verify the following: (i) (ii) (iii) (iv) whether the accumulated amount has been utilized for purposes other than charitable or religious purposes; whether it has ceased to be accumulated or set apart for accumulation thereto; whether the corresponding investment is in tact or has ceased to remain invested in any approved form; whether the period for which it was accumulated has expired or not. If it has expired whether the accumulated portion has been used for the purpose for which it was accumulated within that period or in the year immediately following the expiry thereof and prepare a detailed chart as given in Schedule I of revised return Form No.3A in order to have effective control over such accumulations and investments. 5. Application or use of income or referred to in section 13(3) Exemption is not available under section 11 or 12 in respect of any part of income or any property of the institution used or applied referred to in sub-section (3) of section 13. As per proviso to section 13(2)(g) any application of income or property upto ` 1000/- in favour of the specified persons would not disentitle the institution from exemption. They are as follows: (a) (b) (c) (d) (e) (f) the author of the trust or the founder of the institution; any person who has made a substantial contribution to the trust or institution, that is to say, any person whose total contribution at the end of the relevant previous year where such author, founder or person is a Hindu undivided family, a member of the family; any trustee of the trust or manager (by whatever name called) of the institution; any relative of any author, founder, person, member, trustee or manager as aforesaid; any concern in which any of the persons referred to in clauses (a), (b), (c) (d) and (e) has a substantial interest. The auditor has to report at serial no. 1 to 8 of Part II of the Annexure details of transactions amounting to utilization of the income or properties of the institution for the benefit of a specified category of persons. The auditor must obtain management representation in respect of persons referred to in section 13(3) on which he can rely and also obtain a management representation on the following transactions undertaken with the persons other property of the trust persons. 103

& compensation received e. Purchase of shares, security or other f. Sale of share, security or other property to g. Diversion of any income or property in h. Application of income or property in any other manner for the benefit of specified persons i. Medical or educational services made 6. Investments held at any time during the previous year(s) in concerns in which persons referred to in section 13(3) have a substantial interest The aforesaid reporting has to be done at part III of the Annexure. Also report here nominal value of investments & income therefrom. The auditor should obtain a list of concerns in which the persons referred to in section 13(3) have got substantial interest & verify if any investments have been made in those concerns. The auditor the concern and calculate the percentage of the institution s investment in that concern. 7. Furnishing of audit report that the audit report should accompany the return itself. A charitable trust is entitled to claim exemption from income-tax, even if the audit report is submitted before completion of assessment or in course of appellate proceedings. Refer CIT vs. Hardeodas Agarwala Trust (1992) 198 ITR 511 (Cal). CIT vs. Shahzedanand Charity Trust (1997) 228 ITR 292 (PH), CIT vs. Devradhan Madhavallal Genda Trust (1998) 230 ITR 714(MP). The Supreme Court in the case of CIT vs. Nagpur Hotel Owners Association 247 ITR 201, inferred that the audit report cannot be filed after the assessment is completed. 8. Debatable issues The law relating to taxation of charitable trusts has several debatable issues. As a result different views may be possible. The assessee & auditor may have different views. In such a case auditor should state both the view points and also the relevant information in order to enable the tax authority to take a decision in the matter. 9. Regarding charging appropriate audit fees please consider them as your corporate clients, give them best of services advice your time and accordingly charge them at fair rate. Generally a tendency is seen to neglect them, since they are charitable organization and because of the other commitment with your clients and to oblige the client, this work is accepted unwillingly (without mentioning such feelings in so many words). That is not the right attitude. As on today practically all laws (like service tax, MVAT, profession tax, labour laws, wealth tax, TDS, etc) are applicable to a trust. Hence, they require proper attention and thorough consultation on a regular & frequent basis. For client it could be one of the activities and that also of his area of charity but for a true professional this is his bread-butter and Jam. For charging one can refer to institutes scale of fees prescribed for metro as well as for non-metro and also one can refer the 142 (2A), which provisions and form prescribed there in (i.e. Form No. 6B) is nothing but mini version of tax audit. The time prescribed there also is six months like tax audit date of six months after the year end. There the minimum rate is ` 3,750/- per hour and maximum is ` 7500/- per hour and it (i.e. articled clerks) also. 104