TAX AUDIT

1. TAX AUDIT TAX PERSPECTIVE CLAUSES – 12A to 21, 25 to 27 CA ANIL SATHE

2. Tax audit is a combination of • An audit requiring expression of an opinion on whether accounts show a true & fair view. • Certification that the particulars in Form 3CD are true & correct. • In certain clauses of Form 3CD an expression of opinion as to whether a deduction claimed is allowable or an expenditure is deductible or not deductible. CA ANIL SATHE

3. A professional may often wear two hats : • That of an Auditor • That of an authorized representative. Important to understand the difference between two. CA ANIL SATHE

4. Tools that a professional requires to carry out the Audit • Proper knowledge of Accounting Standards & Standards on Auditing. • Reasonable knowledge of tax law. • Awareness of recent developments by way of Judicial pronouncements / notifications / circulars • Basic knowledge of the Indirect Tax laws, FEMA etc. CA ANIL SATHE

5. Understanding the difference between • Mindset of an Assessee & • Mindset of an Assessing Authority CA ANIL SATHE

6. Points to remember while executing a Tax Audit • Proper communication. • Proper documentation. • Timely documentation / adequate disclosure. • Balanced view in interpreting tax laws. CA ANIL SATHE

7. Clause 12A • Give particulars of the capital asset converted into stock-in-trade:- • Profits or gains arising on conversion of a capital asset into, stock-in-trade are chargeable to tax as capital gains. • Verify the resolution passed by the Directors, in case the assessee it is a company, or any other supporting document and the accounting entry passed in books to reflect the asset into stock, instead of as a fixed asset. • Verify the valuation report/any other supporting document based on which the conversion is recorded in the books of accounts. CA ANIL SATHE

8. Clause 13 • Amounts not credited to the profit and loss account, being – • The items falling within the scope of section 28 • Verify the reserves account, or any other account to identify I any item is directly credited to the same . • 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 • Only the claims lodged and admitted by authorities be reported. If such claims are not admitted, the same need not be reported. CA ANIL SATHE

9. Clause 13 • escalation claims accepted during the previous year • Only those escalation claims which are accepted by the party be reported. Even partial claims admitted be reported. • It assessess disputes any item based on legal decision – to mention the same • General disclaimer may be given that the auditor has not gone beyond the books of accounts produced to him during audit and has not conducted an investigation to find out if the assessee has not credited any amounts in the book. CA ANIL SATHE

10. Clause 13 • any other item of income • all instances of income which come to the notice of the auditor, while examining the accounts but which are not credited to the Profit and Loss account be reported . • Verify credits in capital accounts of the proprietor/partner, credits in the other balance sheet items. • capital receipt, if any • where the amounts are treated as capital receipts in the books and the auditor agrees - Such items be reported. e.g. premium received on issue of shares, profit on sale of assets not passed through profit and loss account. CA ANIL SATHE

11. Clause 14 • Particulars of depreciation allowable as per the Income-tax Act, 1961 in respect of each asset or block of assets : • When an asset is purchased – cost of the asset including the expenses incurred to complete the purchase i.e. customs duty, installation cost, etc is added to the block • In the year of purchase – deprecation for full year/half year based on the date when asset is put to use. Verify relevant documents, i.e. technical experts report, etc to determine the date when asset is put to use. • In the subsequent years, if the asset is used for the purpose of business even for part of the year, depreciation is allowable at full applicable rates • Verify the excise records - modvat credit claimed to be reduced from the value of the asset. • Incase of disputes regarding depreciation claim in earlier years, to clearly mention the same. CA ANIL SATHE

12. Clause 14 • Any interest paid on money borrowed for purchase/construction of asset, upto the date on which asset is put to use, be capitalized to the cost of asset. • Any subsidy received for acquiring the asset –be reduced from the cost of acquisition. • Section 43A – Any asset purchased from outside India – out of borrowing in foreign currency – the foreign exchange fluctuation ( only to the extent of amount actually repaid) be considered as part of the cost of the asset. • New plant and machinery acquired and installed after 1.4.2005 by the assessee engaged in the business of manufacture or production or any article or in the business of generation and distribution of power, additional dep of 20% of the cost of plant and machinery is allowed for the first year. • Lease agreement to be verified to ascertain whether the asset is on a finance lease or operating lease. Operating lease – dep available to lessor, Finance lease – dep available to lessee. CA ANIL SATHE

13. Clause 15 • Amounts admissible under sections 33AB, 33ABA, 33AC , 35, 35ABB, 35AC, 35CCA, 35CCB, 35D, 35DD, 35DDA and 35E. • debited to the profit and loss account (showing the amount debited and deduction allowable under each section separately) • Accounts to be scrutinized to identify the amount which is debited to profit and loss account • not debited to the profit and loss account • Where deduction is available for consecutive years, deduction available in subsequent years, though the amount is not debited to profit and loss account. Deduction claimed in the first year of claim be verified. • Whether considered in DTA/DTL calculation , depreciation not available on exp written off. CA ANIL SATHE

14. Clause 16 • 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)]. • This provision is intended to check private companies from avoiding tax by distributing its profits to the shareholders in the guise of salary or to other remuneration by merely showing them as employees • Bonafide payment to a shareholder for services actually rendered would be allowed • When any shareholder is paid any salary, his employment contract, nature of services actually rendered be verified CA ANIL SATHE

15. Clause 16 • 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). • Amount deducted from employees salary is income u/s 2(24). • Contributed within due date (including grace days) deduction available u/s 36(1)(va) . • Obtain list of contribution to employees to PF/ESIC, etc and dates of their payments • Verify Challansevidening contribution to various fund • If data voluminous, test checks can be done and so mentioned. CA ANIL SATHE

16. Clause 17 • Amounts debited to the profit and loss account, being:- • expenditure of capital nature • Verify bills/vouchers of certain specific accounts e.g. Advertisement expenses, software expenses etc. to ensure that amount of capital nature are not claimed as revenue. • In cases of controversy, auditor should report by way of abundant caution, • expenditure of personal nature • Scrutinize ledger accounts like telephone, motor car, entertainment expenses – whether personal expenses of any director/employee are debited to Profit and Loss a/c • Expenses incurred for directors/employees are perquisites in their hands. Company can not have personal expenses. CA ANIL SATHE

17. Clause 17 • expenditure on advertisement in any souvenir, brochure, tract, pamphlet or the like, published by a political party • expenditure incurred on advertisment in any souvenir, brochure, tract, pamphlet published by a political party not allowed as a deduction. • Any amount paid as a contribution to a political party is not subject to disallowance under this section. Deduction available u/s 80GGB, 80GGC • Trade Union, Labour Union formed by political party, having distinct legal entity – no reporting required. • Verify the receipts to ascertain nature of payment. CA ANIL SATHE

18. Clause 17 • expenditure incurred at clubs,— • as entrance fees and subscriptions • as cost for club services and facilities used • Expenses incurred at social clubs like Lions club, rotary club - no reporting required. • Only expenses at recreational clubs need to mentioned • Incurred for employee – to be treated as a perquisite. • expenditure by way of penalty or fine for violation of any law for the time being in force • any other penalty or fine • expenditure incurred for any purpose which is an offence or which is prohibited by law CA ANIL SATHE

19. Clause 17 • Expenditure incurred for any purpose which is an offence e.ghafta or which is prohibited by law not allowed as a deduction. • Payment made for breach of contractual obligation- no disclosure required. • Payment made for violation of law – examine whether compensatory or penal. • Interest paid which is compensatory in nature- not hit by this disallowance. • amounts inadmissible under section 40(a) • Section 40(a)(i) interest, royalty, fees for technical services or any other sum chargeable to tax, payable outside India or in India to a non-resident not allowed as a deduction - if tax is not deducted at source and deposited into the Government treasury during the previous year or in the subsequent year within the specified time limit. CA ANIL SATHE

20. Clause 17 If the tax is deducted and deposited in any subsequent year, deduction for such expenditure available in the year in which the tax is deducted and paid • Section 40(a)(ia) interest, commission or brokerage, fees for technical services, fees for professional services, payment to contractors/ sub-contractors, rent, payment of royalty payable to a resident not allowed as a deduction if tax not deducted at source or after deduction not deposited into the Government treasury before the due date of filing of the return of income. If the tax deducted and deposited in any subsequent year or deducted during the previous year but deposited after the due date of filing of the return, deduction for such expenditure available in the year in which the tax is deducted and paid. • Verify agreements/invoices to determine nature of payment and liability to deduct tax. • Peruse opinion of expert/certificate in Form 15CB • TDS on reimbursement – is it pure reimbursement? CA ANIL SATHE

21. Clause 17 • Section 40(a)(ii) – Income tax paid not allowed as a deduction • Section 40(a)(iia) – Wealth tax paid is not allowed as a deduction • Section 40(a)(iii) Salary payable outside India or in India to a non-resident not allowed as a deduction if tax has not been deducted and paid. • Section 40(a)(v) - Tax on non-monetary perquisites paid by the employer, not allowed as a deduction, since such tax does not constitute a taxable perquisite in the hands of the employee. • Verify employment contract to understand TDS liability. CA ANIL SATHE

22. Clause 17 • interest, salary, bonus, commission or remuneration inadmissible under section 40(b)/40(ba) and computation thereof • The remuneration payable by a firm to the partner is governed by the partnership deed. Under Income-Tax Act, remuneration and interest payable by the firm to the partner allowable only if certain conditions are fulfilled. • Verify the partnership deed, to ascertain the salary payable to partners as mandated by the deed • In this clause computation of disallowance amount has to be given. CA ANIL SATHE

23. Clause 17 • Payments made othehrwise than by A/c Payee cheque • Aggregate payment in a day - in cash or by bearer cheque -in excess of Rs. 20,000 - entire amount disallowed. • Examine on test check basis- report with appropriate comments if no proper evidence for verification of payment is available. • Obtain a list of payment made in cash from client. • Quantify amount of disallowance - transaction wise • Exceptions provided in rule 6DD – where no disallowance is attracted. CA ANIL SATHE

24. Clause 17 • provision for payment of gratuity not allowable under section 40A(7) • Provision made for gratuity shall be allowed only if contribution is to an approved gratuity fund or it is towards gratuity paid during the year • Approval granted to the fund by the commissioner of income tax should be verified • any sum paid by the assessee as an employer not allowable under section 40A(9) • Verify whether contribution is to recognized PF/approved superannuation fund/prescribed pension fund or approved gratuity fund. CA ANIL SATHE

25. Clause 17 • particulars of any liability of a contingent nature • Liability crystallized, though the valuation thereof depends on a future event or quantification cannot be done with certain degree of accuracy - is not a contingent liability. e.g leave encashment, provision for warranty etc. • Liability not crystallized. Provision made based on the relevant Accounting Standard or the Accounting Policy adopted -it is contingent liability- e.g. provision for diminution in value of investment. • Understand the basis of making provision. • Verify the provision relating to disputed claims • Scrutinize various account heads such as of outstanding liabilities, provisions, etc. CA ANIL SATHE

26. Clause 17 • 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 • Any expenditure incurred for earning income which is exempt from tax shall not allowed as a deduction. • Having regard to the accounts of the assessee, if the auditor can identify the expenses incurred – the same be stated in this clause. • When there is no direct nexus or it is not possible to identify expenditure incurred for earning exempt income by applying any reasonable method – mix bag of funds – then disallowance be computed by applying Rule 8D CA ANIL SATHE

27. Clause 17 • If the assessee’s contention is – no expenses are incurred or a specific amount of expenditure is incurred, which cannot be verified by the auditor, then the put an appropriate note. • Always advisable to attribute a certain amount of expenditure as disallowable u/s 14A on some reasonable basis. • amount inadmissible under the proviso to section 36(1)(iii) • Verify the purpose of borrowing and interest paid • Examine the date when asset is put to use. • This disallowance is irrespective of the treatment given in the books of accounts. CA ANIL SATHE

28. Clause 17A • Amount of interest inadmissible under section 23 of the Micro Small and Medium Enterprises Development Act, 2006 • Section 23 of the Micro Small and Medium Enterprises Development Act, 2006 (MSMEDA) overrides the provisions of the Income Tax Act, 1961 • Section 23 of the MSMEDA provides that if a buyer pays interest to a supplier being, a micro or small enterprise, such interest,, for the purposes of computation of Income – Tax Act, not allowed as a deduction • Obtain a full list of suppliers, who fall within the purview of the definition of MSME Act. • Verify whether the payments made to such suppliers with interest. CA ANIL SATHE

29. Clause 18 • Particulars of payments made to persons specified under section 40A(2)(b) • The list of persons covered by the section is quite wide and identification of such relationship can be difficult for the auditor.-Obtain a certificate to that effect from the management • For cross verification, compare the list with related party disclosure in the audited accounts and entries in register maintained u/s 301 of the Companies Act • The reporting is only for payments made and not for amount received. • The auditor to only report the amounts paid and not required to give his opinion on reasonability thereof. CA ANIL SATHE

30. Clause 19 • Amounts deemed to be profits and gains under section 33AB or 33ABA or 33AC • Amounts withdrawn from the reserves or utilized for non-specified purposes be verified and disclosed. CA ANIL SATHE

31. Clause 20 • Any amount of profit chargeable to tax under section 41 and computation thereof • Earlier years records to be verified to ascertain deduction claimed and allowed in respect of loss, expenditure, trading liability or bad debts written off, which are recovered. CA ANIL SATHE

32. Clause 21 • In respect of any sum referred to in clause (a), (b), (c),(d), (e) or (f) of section 43B, the liability for which :— • Amount pre-existing on the first day of the previous year not allowed in any preceding previous year and paid during the year - this amount will not be debited to current years account but will be allowed as a deduction on payment basis • was incurred in the previous year and not paid before the due date of filing of the return is to be disallowed. • Deduction of certain expenses only on payment basis irrespective of the method of accounting followed CA ANIL SATHE

33. Clause 21 • Arithmetically reconcile the details with previous years tax audit and current years accounts. • Verify the challan, receipts and entries in the books to ascertain the amounts paid and remained unpaid during the year. • 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 - if not routed through the Profit and Loss Account – not paid during the year – whether disallowed u/s 43B ? CA ANIL SATHE

34. Clause 25 • Details of brought forward loss or depreciation allowance • Losses in the nature of business loss, speculation loss, unabsorbed depreciation, capital loss be shown separately. – as per return and as per assessment/appeal order. • To check whether the return of income of each year, where the loss has occurred was filed within the due date. • Carry forward of loss is permissible for specific no. of years. • If any appeal/rectification application is filed, which has bearing on the amount of loss assessed , the same should be mentioned CA ANIL SATHE

35. Clause 25 • whether a change in shareholding of the company has taken place in the previous year due to which the losses incurred prior to the previous year cannot be allowed to be carried forward in terms of section 79. • Applicable only to closely held companies • Brought forward loss can be set off during the year only if 51% of the voting power is beneficially held on the last day of the year by the same set of shareholders who beneficially held 51% of voting power on the last day of the year, in which loss occurred • Exceptions provided in the section • Carry forward and set off Unabsorbed Depreciation is not hit by change in shareholding • Verify shareholders register to ascertain any change in the shareholding. CA ANIL SATHE

36. Clause 26 • Section-wise details of deductions, if any, admissible under Chapter VIA • Chapter VI-A covers section 80A to 80U. • The auditor has to satisfy himself that all the necessary conditions for claiming a deduction are fulfilled before he certifies that a particular deduction is available to the assessee. • To state if the auditor relies on the certificate issued by any other consultant quantifying the deduction. CA ANIL SATHE

37. Clause 27 • 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 • If the provisions of Chapter XVII-B have not been complied with, furnish details of – CA ANIL SATHE

38. Clause 27 • Tax not deducted at all – Disallowed – details same as disclosed in clause 17(f) • Shortfall on account of lesser deduction than required to be deducted – Whether disallowed? • Tax deducted late – during the year - give details of all delays – though not disallowed • Tax deducted but not paid to the govt. – paid before the due date of filing the return – disallowed? • To scrutinize ledger accounts of expenses and TDS challans to verify the date when tax deductible –tax dedcuted – tax paid CA ANIL SATHE

39. THANK YOU CA Anil Sathe