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Practical Issues in Tax Audit

Practical Issues in Tax Audit. C.A. Divakar Vijayasarathy. Provisions of the Act. Audit u/s 44AB is required in the following circumstances: Turnover of a business exceeds Rs 60 lacs Gross receipts of a profession exceeds Rs 15 lacs

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Practical Issues in Tax Audit

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  1. Practical Issues in Tax Audit C.A. Divakar Vijayasarathy Divakar Vijayasarathy & Associates

  2. Provisions of the Act • Audit u/s 44AB is required in the following circumstances: • Turnover of a business exceeds Rs 60 lacs • Gross receipts of a profession exceeds Rs 15 lacs • Assessee covered u/s 44AD/AE/AF intending to disclose lower incomes levels • Non resident assessee covered u/s 44BB/BBB intending to disclose lower levels Divakar Vijayasarathy & Associates

  3. Provisions of the Act • Where an assessee is required to get the books of accounts audited under any other law/ statute: - Separate audit under Income Tax Act is not required • The assessee must furnish audit report as per such statute • The assessee must also furnish auditor’s report in form 3CA/3CB and 3CD (Rule 6G) • Due date for filing : 30th September Divakar Vijayasarathy & Associates

  4. Profession and Business identified • Profession for the purpose of Income Tax Act “includes vocation” • The following areas of work are notified as professions: • Accountancy • Architecture • Authorised representative • Company secretary • Engineering • Film artists • Interior decoration • Information technology • Legal • Medicine • Technical consultancy Any commercial activity other than the above is considered as business for the purpose of Sec 44AB Divakar Vijayasarathy & Associates

  5. Artificial Entity carrying on a Specified Profession • The assessee is a nursing home constituted as a private limited company. During the previous year the nursing home clocked a turnover of Rs 25 lacs from providing medical services. Is the nursing home subject to tax audit?? Divakar Vijayasarathy & Associates

  6. Artificial Entity carrying on a Specified Profession • Issues for consideration: • For a person to be engaged in profession, personal skill is necessary. • A company being an artificial person cannot be said to possess any personal skills, mind and body- therefore it cannot be engaged in profession. • Hence the assessee is not covered u/s 44AB ITO vs Ashalok Nursing Home Pvt Ltd (2006) 156 Taxman 86 (Mad) Divakar Vijayasarathy & Associates

  7. Determination of Turnover • The terms “turnover” and “gross receipts” are not defined by the Income Tax Act • Relevance of the term turnover can be obtained from the following guiding statutes: • Guidance note on Terms used in Financial Statements • Guide to Company Audit • Statement on the Amendments to Schedule VI • Statement on CARO 2003 • Relevant judicial pronouncements Divakar Vijayasarathy & Associates

  8. Implications of Exempted Income • An assessee has an interest income of Rs 50,000 for previous year. He is also managing a business wherein the turnover is Rs 70 lacs. The assessee is eligible for 100% exemption u/s 10A. The assessee claims that his total taxable income does not exceed the basic exemption limit hence he is not required to file his income tax returns. Is the assessee required to get his books audited u/s 44AB?? Divakar Vijayasarathy & Associates

  9. Implications of Exempted Income • Issues for Consideration: • Sec 44AB is applicable if the business turnover of an assessee exceeds Rs 60 lacs. • Whether he is eligible for exemption on profits or is he otherwise required to file a return of income is of no consequence to the applicability of Sec 44AB • Therefore Sec 44AB shall apply irrespective of whether the assessee is required to file his return of income or otherwise. (As per the Guidance Note of ICAI on Tax Audit) However in Asstt CIT vs India Magnum Fund (2002) 81 ITD 295 (Mumbai) it was held that turnover from exempted sources shall not be considered for the purpose of Sec 44AB Divakar Vijayasarathy & Associates

  10. Inclusion of Excise duty in total turnover • An assessee is engaged in the business of manufacturing Chili Powder. During the previous year the assessee clocked a turnover of Rs 65 lacs including an excise duty of Rs 7 lacs. Is the assessee liable for audit u/s 44AB?? Divakar Vijayasarathy & Associates

  11. Inclusion of Excise duty in total turnover • Issues for consideration: • Inclusion of excise duty depends on the method of accounting employed by the assessee • As per the Guidance Note of ICAI: Excise duty shall not form part of turnover if the assessee adopts exclusive method of accounting sales. • However where the assessee adopts inclusive method for accounting invoices, excise duty shall form part of the total turnover • According to Part A Profit and Loss A/c of Form ITR 5 and 6, Item 1 requires the assessee to disclose the sales/ gross receipts net of duty and tax. Therefore we may conclude that the appropriate method would be the exclusive method of accounting. The same analogy may be extended to VAT, service tax and other indirect taxes. Divakar Vijayasarathy & Associates

  12. Sales Return • An assessee clocked a gross turnover of Rs 70 lacs during the previous year. However there was a sales return of Rs 12 lacs of which Rs 4 lacs pertained to the preceding previous year. Is the assessee subject to audit u/s 44AB Divakar Vijayasarathy & Associates

  13. Sales Return • Issues for Consideration: • Value of goods returned do not form part of total turnover • According to ICAI: Goods returned irrespective of whether they pertain to the previous year or earlier years should be reduced from total turnover. Divakar Vijayasarathy & Associates

  14. Turnover Includes.. • Bad debts • Cash discount other than that allowed in invoice • Commission allowed to third parties • Sale of scrap • Sale of by-product • Sale proceeds of shares, securities debenture etc held as stock in trade. • Advances received and forfeited by the assessee Divakar Vijayasarathy & Associates

  15. Turnover excludes.. • Ancillary charges like packing, freight etc unless they are inseparable • Bills cancelled during the period of audit • Price adjustments • Cash discount allowed in invoice • Sale proceeds of fixed assets / investments • Stocks surrendered during survey • Trade discount allowed in sales invoice • Turnover discount – even if it is periodically allowed by separate credit notes Divakar Vijayasarathy & Associates

  16. Assessee engaged in Business and Profession • An assessee is engaged in a profession where his gross receipts are Rs 25 lacs. He is also carrying on a business where the total turnover is Rs 40 lacs. Is the assessee subject to audit u/s 44AB if yes for which source of income. Divakar Vijayasarathy & Associates

  17. Assessee engaged in Business and Profession • Since the gross receipts of the professional source exceed Rs 15 lacs – the assessee is liable for audit u/s 44AB. • It would also be necessary for the assessee to get his books of account of the business also subject to audit u/s 44AB since audit u/s 44AB is assessee specific and not source specific except for presumptive income sources. Divakar Vijayasarathy & Associates

  18. Gross Receipt includes • Cash incentives for exports • Advances received and forfeited • Charges recovered other than reimbursement • Dividends on shares held as stock in trade • Duty drawback • Interest income of a money lender/ lessor • Insurance claims other than on fixed assets • Out of pocket expenses recovered by a Chartered Accountant/ advocate as part of consolidated fee Divakar Vijayasarathy & Associates

  19. Gross Receipts Exclude.. • Advance forfeited in respect of fixed assets • Advance received for services to be rendered • Out of pocket expenses collected separately from clients by solicitors, advocates, chartered accountants and credited to a separate account • Sale proceeds of fixed assets • Write back of amounts payable to creditors • Write back of provisions no longer required. Divakar Vijayasarathy & Associates

  20. Tax Audit Report Divakar Vijayasarathy & Associates

  21. Relevant Forms Divakar Vijayasarathy & Associates

  22. Different Accounting Periods and Auditors • An assessee is a US subsidiary constituted as a private limited company in India. The company follows the calendar year as its financial year. The company has two auditors for the purpose statutory audit and tax audit respectively. Discuss the forms to be used for the purpose of reporting u/s 44AB. Divakar Vijayasarathy & Associates

  23. Different Accounting Periods and Auditors • In this case the company is audited by the statutory auditor, however for a period different from the previous year. • Circular No 561 dated 22nd May 1990 has clarified that in such a situation, the tax auditor has to conduct the audit for the previous year. • Since the tax auditor is conducting the audit himself, the report for the purpose of Sec 44AB should be given in Form 3CB and not Form 3CA. Divakar Vijayasarathy & Associates

  24. Remuneration to Partners • The partnership deed of an assessee states that working partners shall be provided: • In the manner mutually agreed between the partners at the end of the year or • To the extent allowable u/s 40(b) Whichever is lower. During assessment of the partnership firm the Assessing officer claims that remuneration has not been specified as per the partnership deed hence the same will not be allowed as a deduction. Discuss Divakar Vijayasarathy & Associates

  25. Remuneration to Partners • CBDT has clarified vide circular no 739 dated 25-3-1996, that the deed should clearly state: • The amount of remuneration payable to each working partner and • The manner in which remuneration should be computed for each individual working partner. • In the absence of clarity on the above issues, no remuneration shall be allowed u/s 40(b). • Hence in the present case, the Assessing officer is justified in his claim. Divakar Vijayasarathy & Associates

  26. Issues in Presumptive Incomes • Auditor need not certify the accuracy of the turnover figures reported. • A mere mention on the amount as per Profit and Loss account is adequate compliance. • Where an assessee has multiple businesses both covered under presumptive taxation and otherwise- it is advisable to inform the assessee to maintain separate books of account for each such business. Divakar Vijayasarathy & Associates

  27. Multiple Business Sources - • An assessee has three business sources namely: • Income from retail trade: Rs 25 lacs • Civil construction : Rs 20 lacs • Agency commission : Rs 30 lacs Is this assessee liable for audit u/s 44AB?? Divakar Vijayasarathy & Associates

  28. Multiple Business Sources • According to Sec 44AD- presumptive taxation shall apply if the turnover from Civil Construction does not exceed Rs 60 lacs. Hence income from civil construction business shall fall within the ambit of Sec 44AD. • According to Sec 44AF, presumptive taxation shall apply if the total turnover of the assessee does not exceed Rs 40 lacs. As the overall turnover of the assessee including all businesses exceed Rs 40 lacs, the assessee is outside the purview of Sec 44AF. • Since the turnover of retail business and agency commission exceed Rs 60 lacs, the assessee is required to get his books of accounts audited u/s 44AB. Divakar Vijayasarathy & Associates

  29. Multiple Methods of Accounting • An assessee is engaged in two distinct businesses. For one business the assessee adopts cash basis of accounting while he adopts mercantile system for the other business. Is this appropriate?? Would your answer change if the assessee was a Company?? Divakar Vijayasarathy & Associates

  30. Multiple Methods of Accounting • Method of accounting is specific to a business source and not assessee • Therefore an assessee can have cash and mercantile systems of accounting for various businesses. However these methods are to be regularly adopted by the assessee • Where the assessee is a company- Sec 209(3)(b) of the Companies Act mandates a company to maintain books of account on mercantile. Therefore this situation is not possible for a corporate assessee. Divakar Vijayasarathy & Associates

  31. 40A(3) Transactions • Sec 40A(3) read with Rule 6DD states that any payment exceeding Rs 20,000 in aggregate per day per person which is made by modes other than account payee cheque or demand draft shall be entirely disallowed • Sec 40A(3A) has been introduced by Finance Act 2008 accordingly if payments in contravention to Sec 40A(3) have been made in the subsequent previous year against opening liabilities- such payments shall be deemed to be income of the assessee. Divakar Vijayasarathy & Associates

  32. 40A(3) Reporting Clause • According to ICAI the tax auditor may report on the following lines and the same would be construed as adequate compliance “ It is not possible for me/us to verify whether the payments in excess of Rs 20,000 have been made otherwise than by crossed cheque or bank draft, as the necessary evidence is not in the possession of the assessee” However this does not absolve the auditor from performing his regular audit checks and controls Divakar Vijayasarathy & Associates

  33. Interest due but not paid – Sec 43B • An had borrowed a sum of Rs 20 lacs from ICICI bank and Rs 10 lacs from his father both carrying interest @ 12% p.a. • The assessee has made a provision of Rs 20k as interest payable to ICICI for the month of March and Rs 1.2 lacs as interest to father on loan taken. • Both the sums are outstanding as at the due date of filing return of income - Discuss Divakar Vijayasarathy & Associates

  34. Interest due but no paid- Sec 43B • According to Sec 43B, interest on loans taken from banks, public financial institutions and other specified financials are covered. • Hence interest on loan from ICICI shall be disallowed u/s 43B • However interest on loan from father shall not be disallowed since this transaction is outside the purview of Sec 43B Divakar Vijayasarathy & Associates

  35. Outstanding Service Tax Liability • An assessee is a service provider liable for service tax. In the month of March the assessee raised an invoice for Rs 1 lac plus a service tax of Rs 10,300. The amount was ultimately realized only in the month of October. During assessment the Assessing officer held that the outstanding service tax liability unpaid till the due date must be considered as income of the assessee. Discuss Divakar Vijayasarathy & Associates

  36. Outstanding Service Tax Liability • Service tax liability is payable by a service provider only upon receipt of the consideration – Rule 6 of Service Tax Rules • Mere raising of an invoice would not mean that the assessee is liable to make payment within the due date irrespective of whether the consideration is received or not • Therefore service tax outstanding cannot be considered as a disallowance u/s 43B CIT vs Real Image Media Technologies P Ltd (2008) Chennai 114 ITD 573 Divakar Vijayasarathy & Associates

  37. Impact of Micro, Small and Medium Enterprises Development Act 2006 • Any liability to a small and micro enterprise must be settled within 15 days from the appointed date or within the agreed period • The agreed period cannot be later than 45 days • In case of delay interest at three times the bank rate shall be levied beyond the due date • The buyer cannot claim the interest as a deduction under any law including Income Tax Act • Interest levy is mandatory under the Act even if the contract is silent. Divakar Vijayasarathy & Associates

  38. Impact of Micro, Small and Medium Enterprises Development Act 2006 • Small Manufacturer : Investment between Rs 25 lacs and Rs 5 crores • Micro Manufacturer : Investment up to Rs 25 lacs • Small Service Provider : Investment between Rs 10 lacs and Rs 2 crores • Micro Service Provider : Investment up to Rs 10 lacs • A Chartered Accountant’s firm, if registered u/s 8 of MSMED Act is also eligible for classification as a small/micro service provider. Divakar Vijayasarathy & Associates

  39. Disclosures – MSMEDA : Buyer’s Account • According to Sec 22 of MSMEDA, where any buyer is required to get his books audited under any law, following are the disclosures in brief required under the Act 22: • Outstanding principal and interest to Micro/ small enterprises at the end of the accounting year • Amount of interest paid under MSMEDA • Amount of interest accrued and remaining unpaid at the end of each accounting year Divakar Vijayasarathy & Associates

  40. Loans taken and repaid during the previous year – Sec 269SS & 269T • Any loan taken or repaid during the previous year from a person which in aggregate exceeds Rs 20,000 by modes other than account payee cheque or demand requires disclosure. • Loan / deposit includes: any loan or deposit including time and demand deposits/loans. • However in the case of a company loans/deposit do not include demand loans/deposits ie repayable without notice. Divakar Vijayasarathy & Associates

  41. Loans taken and repaid during the previous year – Sec 269SS & 269T • Provisions shall not apply to loans taken from or repaid by a person having agricultural income and no other income chargeable to tax • Penalty if provisions of Sec 269SS and 269 T are applicable: • 271D / 271E an amount equal to the amount repaid/taken shall be imposed as penalty by the Joint Commissioner. Divakar Vijayasarathy & Associates

  42. Clarifications – Sec 269 SS & 269 T • Transactions in current account are considered as loan/deposit • Advance received against agreement of sale of goods is not a loan • Security deposit is considered as loans • Loans and deposits accepted/repaid by means of transfer entries constitute acceptance/repayment by modes in contravention with Sec 269SS/T • Payment/ acceptance through internet banking channels need not be disclosed. Divakar Vijayasarathy & Associates

  43. Loans to Share holders • An assessee being a private limited has extended a loan of Rs 30,000 by cash to one of its directors who is also a share holder holding 25%. The company has an accumulated profit of Rs 25,000 as at 31st of March. The director has repaid Rs 10,000 of the loan and the closing balance is Rs 20,000. Discuss the responsibility of the tax auditor and the assessee on the transaction. Divakar Vijayasarathy & Associates

  44. Loans to Share holders • The transaction is covered within the ambit of Sec 2(22)(e). • The assessee company is required to consider the loan as Deemed Dividend to the extent of accumulated profit and deduct TDS u/s 194 @ 20%. • Since the assessee has extended a loan to a share holder having substantial interest, disclosure requirements of Sec 40A(2)(b) need to be complied. • Repayment of loan within the previous year will not have any impact on the applicability of Sec 2(22)(e) – Supreme Court in Trulata Shyam vs CIT (1977) 108 ITR 345 Divakar Vijayasarathy & Associates

  45. Deemed Dividend u/s 2(22)(e) Deemed Dividend u/s 2(22)(e): • Any loan or advance paid by closely held company to : • An equity share holder holding not less than 10% • Any concern in which such share holder has substantial interest • Any person on behalf of such shareholder Such loan or advance to the extent of accumulated profits (excluding capitalised profits) shall be considered as Deemed Dividend • The assessee company is required to deduct @ 20%/40% u/s 194 on such loan or advance Divakar Vijayasarathy & Associates

  46. Clarifications on Dividend u/s 2(22)(e) • Advance rent will be deemed as dividends even if the amount is received under the lease agreement (not as a share holder or land lord) or even if it has to be adjusted against future rent – CIT vs P.S. Abubucker Madras High Court – 2004 • Sec 2(22)(e) shall also apply to loans in kind –M.D.Jindalvs CIT (1986) 28 Taxman 509 (Cal) • Loan received by a shareholder where the company is engaged in agricultural activities would still be dividend u/s 2(22)(e) – S. Kumaraswamivs ITO (1961) 43 ITR 423 (Mad) Divakar Vijayasarathy & Associates

  47. Audit Documentation • Engagement Letter • Management Representation Document • Profile of the Auditee (In line with SQC) • Audit Notes with relevant supporting documents • Audit Progress Sheet • Tax Audit Program Divakar Vijayasarathy & Associates

  48. Management Representations • Method of Accounting • Valuation of Inventory • Verification of Fixed Assets • Verification of Cash • Non inclusion of Personal Expenditure • Disclosure u/s 40A(2)(b) • Disclosure u/s 40A(3) • Prior period items • Acceptance and repayment of loans – Sec 269SS/269T • Compliance with TDS/TCS provisions • Quantitative details of inventory • Indemnity Divakar Vijayasarathy & Associates

  49. TAX AUDIT THE WAY FORWARD DIRECT TAX CODE

  50. DIRECT TAX CODE 2009 • Turnover limits changed to Rs 100 lacs for business and Rs 25 lacs for professionals • Presumptive taxation - Rule 1 14th Schedule:

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