IMPORTANT ISSUES IN TAX AUDIT U/S 44AB

IMPORTANT ISSUES IN TAX AUDIT U/S 44AB CA Shruthi B N Overview Applicability Forms Issues in specific clauses of Form 3CD 2 1

APPLICABILITY -RELEVANT PROVISIONS OF LAW 3 General rules for discussion - sequence Literal interpretation of the provision of the law Act, Rules and Forms CBDT circulars Binding on tax authorities/ not on taxpayers CIT v. Hero Cycles Pvt. Ltd [1997] 228 ITR 463 (SC) Hindustan Aeronautics Ltd. v. CIT [2000] 243 ITR 808 (SC) Reliance on judicial precedents Reliance on ICAI Guidance Note ( ICAI GN ): Scope of ICAI GN: 4 2

Relevant Provisions Relevant section / rule Section 44AB of the Income-tax Act, 1961 ( the Act ) Particulars Audit of accounts of certain persons carrying on business or profession Rule 6G of the Incometax Rules, 1962 ( the Rules ) Report of audit of accounts to be furnished under section 44AB Section 271B of the Act Penalty for failure to get accounts audited 5 Section 44AB of the Act Every person, (a) carrying on business shall, if his total sales, turnover or gross receipts, as the case may be, in business exceed or exceeds forty lakh rupees in any previous year; or (b) carrying on profession shall, if his gross receipts in profession exceed ten lakh rupees in any previous year; or (c) carrying on the business shall, if the profits and gains from the business are deemed to be the profits and gains of such person under section 44AD or section 44AE or section 44AF or section 44BB or section 44BBB, as the case may be, and he has claimed his income to be lower than the profits or gains so deemed to be the profits and gains of his business, as the case may be, in any previous year, get his accounts of such previous year audited by an accountant before the specified date and furnish by that date the report of such audit in the prescribed form duly signed and verified by such accountant and setting forth such particulars as may be prescribed : 6 3

Section 44AB of the Act (contd.) First Proviso Section 44AB not applicable if income is of the nature referred in: Section 44B Profits of shipping business in case of non-residents Section 44BBA Profits of operation of aircraft in case of non-residents Second Proviso If audit is required under any other law, it shall be sufficient compliance if: the accounts are audited before the specified date; such audit report is furnished by that date; and a further report in the prescribed form is attached. 7 Audit Report Rule 6G Report in Form 3CA Where the assessee is required to get his accounts audited under any other law Report in Form 3CB Where the assesee is not required to get his accounts audited under any other law Statement of particulars in Form 3CD along with its annexures for all assessees covered under the provisions of section 44AB 8 4

Form 3CB Other Aspects In case of companies - where accounting period is different from the previous year (under section 3): Second proviso to section 44AB will not apply Audit is required for the previous year, in Form 3CB Circular No. 561 dated 22 May 1990 ICAI GN Para 13.10 Statement in Form 3CD to be attached Where audit report of the statutory auditor is not available Forms 3CB and 3CD ICAI GN Para 9.4 9 Penalty provisions section 271B Penalty for failure to get accounts audited and furnish the report of audit under section 44AB The AO may direct that such person shall pay penalty being lower of: 0.5% of the total sales, turnover or gross receipts Rs. 1 Lakh 10 5

PROVISIONS OF LAW SOME ISSUES 11 Person As per ICAI GN (Para 6), Tax Audit is required irrespective of: Income being exempt: A person carrying on business (trust/ institution/ co-operative society) may have some exempt income; but tax audit is required if turnover exceeds Rs. 40 lakhs A person who does not have any income under the head profit and gains of business, eg. an agriculturist, need not carry out a tax audit even if his sales from agricultural products exceed Rs. 40 lakhs in a year A person claiming deduction under section 80IA/80IB/10A/10AA etc would not be exempt from tax audit even though whole /part of the income is not taxable Income below the minimum taxable limit Non-residents also covered if sales/ turnover/ gross receipts, to the extent relating to those operations confined to India, exceeds Rs. 40 lakhs in a year. 12 6

Business Section 2(31) Business includes any trade, commerce, manufacture, adventure or concern in the nature of trade, commerce or manufacture Barendra Prasad Roy v. ITO [1981] 129 ITR 295(SC) Continuous and systematic activity By application of labour and skill to earn income With a view to earning an income Some activities held to be business : Advertising agents, insurance agents, travel agents Clearing forwarding and shipping agents Couriers Nursing home Stock brokers Insurance agents Travel agents 13 Profession Section 2(36) Section 2(36) defines profession to include vocation Profession - CIT v. Manmohan Das (Deceased) [1966] 59 ITR 699 (SC) Profession is an occupation requiring purely intellectual skill or manual skill controlled by intellectual skill of the operator Some specified professions under section 44AA legal, medical, engineering, architectural, technical consultancy, accountancy, company secretary, film artists and information technology Vocation need not be a systematic and organised activity nor any activity with profit motive [CIT v. Ram Kripal Tripathi [1980] 125 ITR 408 (All)] 14 7

Turnover Speculative The total of favorable and unfavorable differences shall be taken as turnover. Derivatives The total of favorable and unfavorable differences shall be taken as turnover. Premium received on sale of options is also to be included in turnover Chit Fund Companies Subscriptions are not treated as income Stock Brokers Brokerage collection to be taken as turnover 15 Gross Receipts In case of professionals (ICAI GN) Out of pocket expenses taken in advance and credited to a separate client s account - does not form part of gross receipts If a consolidated fee is charged forms part of gross receipts For commission agents (relying on CBDT Circular No. 452 dated 17 March 1986): Pure agents who: do not act as a principal; are indemnified by the principal, in the event of any loss; do not have dominion over the goods of the principal; and do not have any interest in the profits and losses of the principal, should consider only the commission received as turnover and not include the sales made on behalf of the principal. 16 8

Other issues Interest income earned before commencement of operations 44AB not applicable as there is no business income Electronic filing of the Income-tax return New return forms to be filed without annexures (including Audit Reports) Audit Reports to be furnished as and when called for by the tax officer [CBDT Circular No. 6/2008] Can penalty be levied for not furnishing the report within the specified date? 17 Applicability-Monetary limits Business 1 41 lakhs Business 1 40 lakhs Business 1 41 lakhs Business 1 39 Lakhs Business 1 39 lakhs Business 1 39 lakhs Business 1 41 lakhs Sole proprietorship business- 30 lakhs Profession 1 12 lakhs Profession 1 10 lakhs Profession 1 9 lakhs Business 2 5 Lakhs Business 2 1 lakh Business 2(44AD/44AE/44AF) 39 lakhs Business 2 (44AD/44AE/44AF) 10 lakhs Salary and interest received from partnership firm- 12 lakhs Yes No Yes Yes No No Yes Yes 18 9

Applicability- Case Study An assessee company running nursing home. Is such activity a Business or Profession? Ashalok Nursing Home (P) Ltd [2006] 156 Taxman 86 (Delhi) held Business William Esplen, Son and Swaimston, Ld. V. IRC- Held only individuals can render professional services Can a partnership firm or LLP render profession? 19 FORM 3CD: ANALYSIS OF ISSUES IN SPECIFIC CLAUSES 20 10

Clause 12- Text (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. 21 Clause 12-Sec 145A Vs AS2(ICAI) S-145 A: Notwithstanding anything to the contrary contained in section 145, the valuation of purchase and sale of goods and inventory.. shall be (a) (b) further adjusted to include the amount of any tax, duty, cess or fee.. actually paid or incurred. date of valuation. AS-2 ICAI: Valuation of Inventory Cost of Purchase 7. The costs of purchase consist of the purchase price including duties and taxes (other than those subsequently recoverable by the enterprise from the taxing authorities),.. Cost of Inventories 6. The cost of inventories should comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. Guidance Note on VAT- issued by ICAI VAT collectible from customers shall not be included in sales figure 22 11

Clause 12-Sec 145A Service Tax Service Tax charged in bills Not routed through profit and loss account Routed through profit and loss account Received but not paid Not received and hence not paid Received but not paid Not received and hence not paid CIT v Noble & Hewitt(I) (P.) Ltd[2008] 116 Taxman 48 (Delhi HC) ACIT V Real Image Media Tech P Ltd (Chennai) 114 ITD 573 Section 43B would apply No deduction allowed as it is not an expense Clause 12 Extract of section 43B Notwithstanding anything contained in any provision of this Act, a deduction otherwise allowable under this Act in respect of- (a) Any sum payable by the assessee by way of tax, duty, cess, or fee, by whatever name called, under any law for the time being in force, or (b),(c), (d),(e),(f). ACIT V Real Image Media Tech P Ltd (Chennai) 114 ITD 573 CIT v Noble & Hewitt(I) (P.) Ltd[2008] 116 Taxman 48 (Delhi HC) 145A does not apply to service tax. If Service Tax not credited to P & L no expenditure is claimed. If no expenditure is claimed - No disallowance u/s 43B Exclusive method of accounting for exercise duty and VAT? D&H Secheron Electrodes(P)Ltd [2008]173 Taxman 188 (MP) Chowranghee Sales Bureau (P) Ltd 87 ITR 542 (SC) 24 12

Clause 13- Text 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 refund of sales tax or value added 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. 25 Clause 13- Analysis Any other income not credited to P&L account- includes section 2(24) (x) income and 40A(3) income Capital receipts not credited to P&L account- loans and borrowings need not be reported here 26 13

Clause 14- Text 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 the case of any addition of an asset, date put to use; including adjustments 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 27 Clause 14- Conditions for availing depreciation The asset should be owned partly or wholly by the assessee It should be used for the purposes of business or profession It should be used during the relevant previous year 28 14

Clause 14 Issues- Finance Lease 1. Arguments in favour of depreciation to the lessor Lessor has legal title to asset and is engaged in carrying on leasing business hence eligible to depreciation [CIT Vs Shaan Finance (1998) 231 ITR 308 (SC)] Only owner is entitled to depreciation if the asset is used in the business ownership to be determined by the terms of the contract between lessor and lessee and capitalisation according to AS 19 by the lessee will have no implication (CBDT Circular 2/ 2001) 2. Arguments in favour of depreciation to the lessee - Industrial Finance Corporation Limited Vs CIT (2005) 4 SOT 223 Delhi HC and Asea Brown Boveri Ltd. v. IFCI (2004) 56 SCL 21 (SC) Depreciation allowed to the lessee if: Finance leasing mere financing arrangement and lessor only providing funds for acquisition of asset (Circular 9/1943) Asset for all intents and purposes becomes the property of the lessee 29 Clause 16- Text (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). 30 15

Clause 16 (b) -ESI/EPF 36(i)(va) Vs 43B Employee s Contribution Income u/s 2(24)(x) Section 36(i)(va) allows deduction only if credited by assesee in employee account within the due dates under relevant Acts(including grace days) Employer s contribution- where the payment has been made before the due date for filing the return under section- 139(1) CIT vs. AIMIL Limited (Delhi High Court), CIT vs. Dharmendra Sharma 297 ITR 320, CIT vs. Sabari Enterprises 298 ITR 141(Karnataka) Even employees' contribution to PF paid before due date of filing ROI is allowable u/s 36(i)(va) 31 Clause 17- Text 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; (f) amounts inadmissible under section 40(a); (g) interest, salary, bonus, commission or remuneration inadmissible under section 40(b)/40(ba) and computation thereof; 32 16

Clause 17- Text (Contd.) (h) (A) 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 (B) amount inadmissible under section 40A(3), read with rule 6DD [with break-up of inadmissible amounts; (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. (l) amount of deduction inadmissible in terms of section 14A in respect of the 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); 33 Clause 17 (a) (a) expenditure of capital nature Should capital expenditure for which 100% deduction is available in Schedule XIV be reported under this clause? Is ESOP a capital or revenue expenditure? Ranbaxy Laboratories Ltd vs. ACIT, 124 TTJ771(Delhi ITAT) 34 17

Clause 17(c) (c) expenditure on advertisement in any souvenir, brochure, tract, pamphlet or the like, published by a political party; 1. Analysis of the provisions Contribution to registered political parties- Section 80GGB/80GGC Contribution to registered political parties Section 293A of the Companies Act Section 293A(3)(b) of the Companies Act, 1956 provides that the amount of expenditure incurred, directly or indirectly, by a company on the advertisement in any publication (being a publication in the nature of a souvenir, brochure, tract, pamphlet or the like) by or on behalf of a political party or for its advantage shall also be deemed,- Where such publication is by or on behalf of a political party, to be a contribution of such amount to such political party, and Where such publication is not by or on behalf of but for the advantage of a political party, to be a contribution for a political purpose to the person mentioning it. 35 Clause 17(c) (contd..) Position Indian Company 1. Contribution to registered political parties by way of advertisement Sec 37(2B) disallowance Sec 80GGB deduction is available 2. Contribution to unregistered political parties Sec 37(2B) Disallowance Sec 80GGB deduction not available Other assessees Contribution to any political parties by way of advertisement Sec 37(2B) disallowance Sec 80GGC deduction not available Expenditure on advertisement in newspaper? 36 18

Clause 17(I) (l) amount of deduction inadmissible in terms of section 14A in respect of the expenditure incurred in relation to income which does not form part of the total income; Issues Whether dividend income from shares and mutual funds are exempt income? Whether sec 14A would apply even in a case where exempt income is not received by the assessee in a previous year? CIT v. Leena Ramachandran (Kerala HC) Godrej & Boyce Mfg. Co. Ltd. v. DCIT(Bombay HC) 37 Clause 17(l) Amount inadmissible under section 14A Expenditure incurred in relation to income which does not form part of the total income is not allowed as a deduction Primary responsibility of the assessee to furnish details Rule 8D [inserted vide Notification no. 208/2006 dated 24 March 2008] provides method for AO to determine the amount of expenditure in relation to income not included in total income Whether Rule 8D is mandatory for assessees? 38 19

Rule 8D Amount of expenditure inadmissible to be computed by the AO Particulars Total I Expenditure directly related to the Income b II Interest incurred during the year A Average Investments (as on 1 April and 31 March) Average Total Assets (as on 1 April and 31 March) Interest expense disallowable A*(B/C) b III 0.5% of average investments b Total disallowance (I) + (II) + (III) B C b 39 Clause 17(l) Amount inadmissible under section 14A ICAI 280 th Council meeting 7 9 August 2008 considered the appropriate guidance to members on clause 17(l): Rule 8D applicable when AO not satisfied with claim of assessee This is during assessment, i. e., after tax audit is completed Hence, tax auditor to verify inadmissible expenditure as determined by the assessee Rule 8D does not mandate that assessee should compute inadmissible amount under that rule Tax auditor to examine details and verify with reference to established principles of allocation of expenditure 40 20

Clause 21- Text (i) In respect of any sum referred to in clause (a), (b), (c), (d), (e) or (f) of section 43B, the liability for which : (A) pre-existed on the first day of the previous year but was not allowed in the assessment of any preceding previous year and was (a) paid during the previous year; (b) not paid during the previous year. (B) was incurred in the previous year and was (a) paid on or before the due date for furnishing the return of income of the previous year under section 139(1); (b) not paid on or before the aforesaid date. (ii) [***] *State whether sales tax, customs duty, excise duty or any other indirect tax, levy, cess, impost, etc., is passed through the profit and loss account. 41 Clause 21- Issues Interest not covered under section 43B- Held in Orient Beverages Ltd *2001+ 117 Taxman 106 Unutilized MODVAT credit cannot be claimed as a deduction- Held in Maruti Udyog Ltd v. Dy. CIT*2005+ 92 ITD 119 (Delhi) Leave encashment to employees- Reliance on Exide Industries Ltd. v. Union of India *2007+ 164 Taxman 9, Calcutta HC Section 43B has got no application when no deduction was claimed CIT v. India Carbon Ltd 262 ITR 327 Excise duty collected but disputed. Hence not paid. The amount was deposited in FD and bank guarantee furnished.- held it is not equivalent to payment. Hence disallowed u/s 43B- 261 ITR 69, 125 Taxman 819 42 21

Clause 21- Issues Whether payments to be considered on FIFO/ LIFO basis? Outstanding opening leave balance not allowed in any earlier previous year Liability incurred during the year Amount paid during the year Amount paid after the due date of filing the return 1,000 1,700 700 500 Disclosure under clause 21(i)(A) 700 Disclosure under clause 21(i)(B) Nil 43 Clause 24- Text (a) * Particulars of each loan or deposit in an amount exceeding the limit specified in section 269SS taken or accepted during the previous year : (i) name, address and permanent account number (if available with the assessee) of the lender or depositor; (ii) amount of loan or deposit taken or accepted; (iii) whether the loan or deposit was squared up during the previous year; (iv) maximum amount outstanding in the account at any time during the previous year; (v) whether the loan or deposit was taken or accepted otherwise than by an account payee cheque or an account payee bank draft. *(These particulars need not be given in the case of a Government company, a banking company or a corporation established by a Central, State or Provincial Act.) 44 22

Clause 24- Text (Contd..) (b) Particulars of each repayment of loan or deposit in an amount exceeding the limit specified in section 269T made during the previous year : (i) name, address and permanent account number (if available with the assessee) of the payee; (ii) amount of the repayment; (iii) maximum amount outstanding in the account at any time during the previous year; (iv) whether the repayment was made otherwise than by account payee cheque or account payee bank draft. (c) Whether a certificate has been obtained from the assessee regarding taking or accepting loan or deposit, or repayment of the same through an account payee cheque or an account payee bank draft. Yes No The particulars (i) to (iv) at (b) and the Certificate at (c) above need not be given in the case of a repayment of an loan or deposit taken or accepted from Government, Government company, banking company or a corporation established by a Central, State or Provincial Act; 45 Clause 24- Issues Whether section 269SS/269T is rigorously applied for payment or receipt in crossed cheque? CIT v. Makhija Construction Co.[2002] 123 Taxman 1003(MP)- Held no penalty under section 271D Loans given to subsidiaries - Shree Durga Distillery v. Addl.CIT(Inv.) [ITA No. 438/Bang/2004] Where equity shares are issued in satisfaction of loan Renewal of loan Disclosure requirements under this clause Negatively worded- transfer entries and book adjustments liable to be hit but 88 TTI 85 (Delhi) lays that loans through book adjustments are not in money and hence section 269SS not applicable-also 89 TTI 324(Ahemdabad) Loans and deposits taken or accepted through electronic transfers are to be disclosed 46 23

Clause 27- Text (a) Whether the assessee has complied with the provisions of Chapter XVII- B regarding deduction of tax at source and regarding the payment thereof to the credit of the Central Government. Yes No (b) If the provisions of Chapter XVII-B have not been complied with, please give the following details*, namely:- (i) Tax deductible and not deducted at all (ii) shortfall on account of lesser deduction than required to be deducted (iii) tax deducted late (iv) tax deducted but not paid to the credit of the Central Government *Please give the details of cases covered in (i) to (iv) above 47 Clause 27- Disclosure requirements Non-deduction of tax Shortfall of deduction Late deduction Non-deposit of tax with the Central Government No disclosure requirements for late deposit of tax with the Central Government 48 24

Clause 27- issues Section 206AA Whether this section overrides the tax rates given under treaties? 49 THANK YOU CA SHRUTHI B N 25