Tax Audit & Special Audit
1. Tax Audit u/s. 44AB
1.1 Section 44AB of the Income-tax Act, 1961 was introduced by section 11 of the Finance Act, 1984 with effect from 1st April, 1985. Under section 44AB of the Income-tax Act, audit of the accounts of certain assessees is required if the total sales, turnover or gross receipts for the previous year exceeds Rs. 40 lakhs in the case of a business, or Rs. 10 lakhs in the case of a profession. In common parlance, section 44AB audit is popularly known as ‘tax audit’.
The purpose of tax audit as elaborated in the Departmental Circular is to ensure that the books of account and other records are properly maintained, that they faithfully reflect the correct income of the tax-payer and claims for deduction are correctly made, to facilitate administration by proper presentation of accounts before the tax authorities and to save Assessing Officer’s time in carrying out routine verification.
The tax authorities have their specific information requirements which may not be available from the general purpose financial statements. Special statements for the specific use of tax authorities are therefore prepared and the auditors are called upon to report on them.
If a person fails to get his accounts audited as required under section 44AB or to furnish the report of such audit, a sum equal to 0.5% of the total sales, turnover or gross receipts, as the case may be, or a sum of Rs,1,00,000, whichever is less, can be levied as penalty.
For the purpose of section 44AB, an audit report is to be given in Form No. 3CA if the person carrying on business or profession is required to get his accounts audited under any other law, in which case, the tax auditor is not required to give his opinion as to whether the accounts give a true and fair view or not. In all other cases, an audit report is to be given in Form No. 3CB.
The report in Form No. 3CA or 3CB is to be accompanied with Form No. 3CD giving a statement of particulars required to be furnished under section 44AB of the Income-tax Act, 1961 in the case of assessees carrying on business or profession. The statement of particulars required to be furnished in Form No. 3CD underwent major changes with effect from assessment year 1999-2000.
Recently in December 2004 an annexure was added to form 3CD with a note that if the annexure is not filled up the form will be considered as incomplete.
The provisions of tax audit being fairly known, and the Institute of Chartered Accountants of India (ICAI) has issued a guidance note on the same and also has a publication namely “Issues on Tax Audit”. In view thereof only the recent changes and amendments having a bearing on the requirements of Form 3CD are discussed hereunder:
Before proceeding to discuss the form itself, and though discussion on the same is slightly out of context we wish to draw attention of readers on a few areas of documentation, particularly since in a few years all Chartered Accountants will be subject to a peer review. These areas are as under:Documentation required/ conditions to be complied with before acceptance of Tax Audit
Appointment of auditor – Letter evidencing appointment issued by
In case of individual, individual himself
In case of Firm – Partner
In case of Company – Director, preferably with reference to a Board resolution
AOP – by member of AOP
Engagement letter – this is mandatory from 2003-04
In case previous year’s audit conducted by other auditor, NOC from the previous auditor
1.2 Clause 14(d)(ii) – Change in rate of exchange currency:
Particulars of depreciation allowable as per the Income-tax Act in respect of each asset/ block of assets is required to be furnished. The aforesaid clause requires details about (i) actual cost or WDV of the asset/block of assets (ii) additions/deductions during the year including on account of change in rate of exchange of currency (iii) depreciation allowable; and (iv) WDV at the end of the year.
Prior to the revision of Accounting Standard – 11 (AS-11) “The effects of Changes in Foreign Exchange Rates”, exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets were required to be adjusted to the cost of fixed assets which, in the revised AS-11 is dispensed with. However, neither Schedule VI to the Companies Act, 1956 nor Form No. 3CD has been amended in line with the revised AS-11 and accordingly, the adjustment to cost/WDV on account of change in rate of exchange of currency would have to be made.1.3 Clause 15 – Amounts admissible under sections 33AB, 33ABA, 33AC, 35, 35ABB, 35AC, 35CCA, 35CCB, 35D, 35E
Under the said clause, amounts admissible under the abovementioned sections are required to be stated. However, deduction allowable under section 35DD in respect of amortisation of expenditure in case of amalgamation or demerger and under section 35DDA in respect of amortisation of expenditure incurred under voluntary retirement scheme have not been included under the said clause as there has been no amendment in Form No. 3CD after the insertion of the aforesaid sections in the Act. One may take a view and furnish particulars in respect of section 35DD and section 35DDA under the aforesaid clause.
Though the change is not recent one must bear in mind that section 35D also applies to “extension” of an undertaking. Consequently, if the provisions of section 35D cover expenditure the allowability under section 37(1) stands excluded.1.4 Clause 17(f) – Amounts inadmissible under section 40(a)
The scope of section 40(a) has increased substantially as a result of various recent amendments made in the said section. In addition to the non-availability of deduction in respect of any interest, royalty, fees for technical services or other sum chargeable under the Act, which is payable outside India or in India to a non-resident, on which tax has not been deducted or, after deduction, has not been paid before the expiry of the prescribed time, the following items have been included as amounts not deductible:
Section 40(a)(ia) – Any interest, commission, brokerage, fees for professional services, fees for technical service payable to a resident and payments to contractor or sub-contractor being a resident on which tax is deductible at source and such tax has not been deducted or, after deduction, has not been paid to the credit of the Central Government within the prescribed time limit shall not be allowed as a deduction and accordingly would have to be reported under the said clause. However, where in respect of any of the aforesaid payments, tax has been deducted or paid in a subsequent year, such sum will be allowed as a deduction in computing the income of the previous year in which such tax has been paid.
A number of issues will arise in this context and the tax auditor will have to express an opinion on the same – these are
If there is a short deduction of tax at source, will the entire expenditure be disallowable or is a proration possible?
If the tax is deducted during the previous year and paid during the previous year, but after the time prescribed u/s 200(1), what will be the consequence?
If the tax is not deducted, but still paid by the assessee, will the expenditure be allowed?
What is the position qua expenditure that is reimbursed to the assessee by its customer / supplier?
The taxation Laws Amendment Bill 2005 (effective for assessment years 2006-07) has added rent and royalty to the aforesaid list. The said bill also proposes to amend the meaning of “rent” in section 194-I to include payment for use of any machinery, plant, equipment, furniture or fittings either separately or together with land and / or buildings. Accordingly, separate payments for furniture hire or rent for machinery will also be subject to deduction of tax at source under section 194-I and non deduction of tax thereon would attract disallowance under section 40(a)(ia).
The Bill also proposes to amend section 194J(effective for assessment years 2006-07) to include deduction of tax on payments for royalty and for any sum under an agreement for not carrying out any activity in relation to any business or not sharing any know-how, patent, copyright, trade-mark, licence, franchise or any other business or commercial right of similar nature or information or technique likely to assist in the manufacture or processing of goods or provision for services, which is referred in section 28(va). It may be noted that though section 194J is proposed to be amended to cover both royalty and other sums covered under section 28(va) as aforesaid, section 40(a)(ia) refers only to royalty and hence only non deduction of tax on royalty would require to be reported under clause 17(f) in Form No. 3CD.
As stated earlier, in case where in respect of any of the aforesaid payments, tax has been deducted or paid in a subsequent year, such sum will be allowed as a deduction in computing the income of the previous year in which such tax has been paid. Even though Form No. 3CD does not require this information to be reported, it would be advisable and beneficial to the assessees to give by way of a note, deduction allowable in a particular year on the basis of tax deduction and payment thereof being made in that year.
Section 40(a)(ib) – Any sum paid on account of Securities Transaction Tax (STT) is not allowable as a deduction under section 40(a)(ib) and accordingly STT debited to the Profit and Loss Account would be required to be reported.
Section 40(a)(ic) – The Finance Act, 2005 has introduced a new Chapter XII-H to levy a fringe benefit tax (FBT) @ 30% (plus applicable surcharge and education cess) of the value of fringe benefits provided or deemed to have been provided by an employer to his employees. No deduction is available in respect of FBT paid while computing the income under the head ‘Profits and Gains of Business or Profession’ as provided for in section 40(a)(ic). Accordingly, FBT debited to the Profit and Loss Account would be required to be reported.1.5 Clause 21 – Deductions allowable only on payment basis
Sums referred to in section 43B are allowable as deduction only on payment basis and for this purpose, if the said amounts are paid on or before the due date of furnishing the return of income of the previous year, the same can be claimed in the relevant previous year. Section 43B has been amended to include clause (f) in respect of any sum payable by the assessee as an employer in lieu of any leave at the credit of his employee. One may have to include the said item also while reporting under clause 21 though the Form No. 3CD has not been amended to include the said item.
It may be also noted that though Finance Act 2003 amended section 43B w.e.f. from assessment year 2004-05, by virtue of which contribution to a provident fund or superannuation fund, would be allowed if they are paid at any time before the due date for filing income tax return, Form 3CD still contains a reference to the second proviso of section 43B which was deleted by Finance Act, 2003. A suitable note needs to be given in the tax audit report in this regard.
2. Special Audit u/s. 142(2A)
2.1 In terms of Section 142(2A), if during the proceedings before an assessing officer, he is of the opinion that
having regard to the nature and complexity of accounts of the assessee, and
in the interest of the revenue.
it is necessary to get the accounts of the assessee audited by an accountant as defined in the explanation before section 288(2), he may do so after obtaining the approval of the Chief Commissioner or Commissioner in this regard. The audit report should be in the form prescribed and should, apart from the particulars set forth in the form, contain such particulars as the assessing officer may require.
The audit is to be completed within the time frame prescribed by the assessing officer, which period may be extended by him subsequently up to a period of 180 days from the date, the direction is received by the assessee.
The expenses including fees should be paid by the assessee, and in default may be recovered from him in the manner provided for arrears of tax.
The assessee should be given an opportunity to be heard in respect of any matter gathered during the enquiry u/s 142(2A).
The judicial view regarding the power of an assessing officer to order a special audit u/s 142(2A) is that once the assessing officer on an objective assessment considers that an order u/s 142(2A) is necessary and both the ingredients i.e complexity of accounts and the conduct of an audit being in the interest of revenue are satisfied, no interference with the order is called for. The fact that an audit under section 44AB of this Act or an audit under any other statute has already been carried out cannot be a bar to the assessing officer invoking his powers under this section.2.2 Form and particulars prescribed
The audit report is to be submitted in prescribed Form 6B. Most of the particulars contained are similar to those contained in Form 3CD. The only distinct clauses are clause 8, where details of expenditure resulting in any benefit or amenity to
a director
person who has substantial interest in the company
relative of such person are to be given.
Further, expenses in respect of assets, which are used wholly or partly for persons referred to above are required to be given,. The other distinct details are in clauses 12 and 13, which require particulars of loans taken by the assessee from banks, financial institutions, and others and the details of security/ collateral security offered.
3. Annexure
With effect from 1-12-2004, an Annexure to Form 3CD has been prescribed by the Income-tax (Fourteenth Amendment) Rules, 2004 which is to be signed by the person competent to sign Form No. 3CA or Form No. 3CB, as the case may be. This annexure requires details in respect of components of liabilities, gross turnover, gross profit, commission received and paid, interest received and paid, depreciation as per books, net profit/loss before tax and taxes on income paid or provided for in the books.