TAX AUDIT U/S 44 AB-

AN OVERVIEW

CA Vijay Joshi

Malad Goregaon CPE Study Circe of WIRC of ICAI

On 18th September 2011

CONTENTS

Legislative History Liability to get Accounts audited Qualification of Auditor Exceptions to Tax Audit Mode of Furnishing Tax Audit Report Penalty for Failure Forms applicable for Tax Audit Report Applicability of Accounting Standards &

Standards on Auditing Conclusion

LEGISLATIVE HISTORY

Recommended by Wanchhoo Committee in 1971 Introduced by Finance Act, 1984 w.e.f. 01.04.1985 Intention was to ‘ensure that the books of

accounts and other records are properly maintained and faithfully reflect the true income of taxpayer’ [Refer FM Budget Speech – 1984]

Expected to effectively curb tax evasion and ensure tax compliance

Precious time of the Assessing Officer is saved from routine and ineffective verification like checking and vouching Purchase/Sales Transactions.

LIABILITY TO GET THE ACCOUNTS AUDITED

Any person carrying on a business whose total sales, turnover or gross receipts exceed Rupees Sixty Lakhs during the previous year.

Any person carrying on a profession whose gross receipts exceed Rs. Fifteen Lakhs during the previous year.

Limits increased by Finance Act, 2010 w.e.f. 01.04.2011.

SECTION 44 AB Every person--

carrying on business shall, if his total sales, turnover or gross receipts, as the case may be, in business exceed or exceeds sixty lakh rupees in any previous year ; or

carrying on profession shall, if his gross receipts in profession exceed fifteen lakh rupees in any previous year; or

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 44AE 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,

……. report by an accountant in the form prescribed under this section.

BUSINESS

S 2(13): Business includes any trade, commerce, or manufacture or any adventure or concern in the nature of trade, commerce or manufacture.

The word business is one of wide import and it means activity carried on continuously and systematically by a person by the application of his labour or skill with a view to earn income. The expression business does not necessarily mean trade or manufacture only- Barendra Prasad Roy v ITO [1981]129 ITR 295 (SC).

PROFESSION Section 2 (36):Profession to include vocation.

Profession is a word of wide import and includes vocation which is only a way of living.-CIT v. Ram Kripal Tripathi [1980]125 ITR 408 (All).

Whether a particular activity can be classified as business or profession will depend on the facts and circumstances of each case. The expression profession involves the idea of an occupation requiring purely intellectual skill or manual skill controlled by the intellectual skill of the operator, as distinguished from an operation which is substantially the production or sale or arrangement for the production or sale of commodities.- CIT vs. Manmohan Das (Deceased) [1966] 59 ITR 699 (SC).

The following have been listed out as profession in section 44AA (rule 6F) and notified there under (Notifications No. SO-17 (E) dated 12.1.77, No. SO 2675 dated 25.9.1992 and No. So 385(E) ,dated 4.5.2001):Accountancy, Architectural, Authorised Representative, Company

Secretary, Engineering, Film Artists/Actors, Camera man, Director, Singer, Story Writer, Etc., Interior Decoration, Legal, Medical, Technical Consultancy, Information Technology

WHETHER BUSINESS OR PROFESSION Advertising Agent. Clearing, Forwarding and Shipping agents –CIT V.

Jeevanlal Lallubhai & Co, [1994] 206 ITR 548 (Bom). Couriers. Insurance agent. Nursing Home. 135 ITR 146, 90 ITD 235 Stock and share broking and dealing in shares and

securities-CIT v. Lallubhai Nagardas & Sons [1993} 204 ITR 93 (Bom).

Travel agent.

PRESUMPTIVE INCOME

S. 44AE – Plying, hiring or leasing of goods carriage

S. 44BB – Business of exploration of mineral oils S. 44BBB – Foreign Company engaged in civil

construction business or in erection of plant and machinery or testing or commissioning thereof

In all above categories, if the income is shown less than that presumed under relevant sections, then such assessees are required to get their accounts audited.

SECTION 44AD – AMENDMENT - 01.04.11

Persons covered by Section 44AD would not be required to get their accounts audited under section 44AB merely because he claims his income from eligible business(es) to be lower than 8% of turnover/gross receipts.

He would be required to get his accounts audited only if additionally his total income exceeds the maximum amount which is not chargeable to income tax (i.e. Rs. 1,60,000/Rs. 1,90,000/Rs. 2,40,000)

S. 44AD - PROVISIONS

Explanation to S. 44AD refers to ‘eligible assessee’ AND ‘eligible business’.

Eligible assessee means individual, HUF, partnership firm but not LLP. Thus, company and LLP are excluded.

Eligible business means any business except the business of plying, hiring or

leasing goods carriages referred to in S. 44AE; AND Whose total turnover or gross receipts in the previous

year does not exceed an amount of sixty lakhs rupees.

QUALIFICATION OF AUDITOR

Section 44AB requires that the accounts The explanation to Section 44AB states that the

word accountant shall have same meaning as the explanation to Section 288 (2).

The said explanation to Section 288(2) refers to Chartered Accountant and a person holding a certificate issued by a Part B state can also be appointed as auditor.

Since such appointments are not being made today, it leaves only ‘CHARTERED ACCOUNTANT’ as eligible to be appointed as Auditor for carrying audit u/s. 44AB.

EXCEPTIONS TO TAX AUDIT

Once a person is covered under any of the 4 categories of S. 44AB, the tax audit becomes mandatory.

However, first proviso to Section 44AB, exempts business covered under Section 44B and 44BBA from the purview of Tax Audit.

Second Proviso states that if the accounts of a person are to be audited under any other law, it would be sufficient if the accounts are audited under that law before 30th September but the report in Form 3CA and 3CD should be obtained from an Accountant.

ASSESSEES FOLLOWING DIFFERENT ACCOUNTING YEAR OTHER THAN FINANCIAL YEAR

Companies Act, 1956 does not provide restriction of following Financial Year as previous year.

In cases of companies following different accounting year, say, calendar year as pervious year, whether the Accountant should issue Form 3CA and 3CD using the second proviso without auditing the accounts?

CBDT has clarified vide Circular No. 561 dated 22.05.1990, that the second proviso is applicable only when the accounting year is same as the financial year.

Hence, an Accountant has to conduct a fresh audit in such case and issue his report only in Form 3CB and not in 3CA.

MODE OF FURNISHING OF TAX AUDIT REPORTS Earlier the assessees were required to get the Tax Audit

Reports in the prescribed form from an Accountant and file the same with their return of income by prescribed date.

With electronic filing of return of income, now an assessee has to only get the Tax Audit Report in the prescribed form from an Accountant before 30th September and using the details given therein, prepare the applicable ITR Form and file it electronically.

The Tax Audit Report is required to be produced only on the notice from the Assessing Officer requiring such report to be furnished.

Those assessees who are covered by the provisions of S. 44Ab are required to file their income tax returns using the DSC w.e.f 01.07.2011. [Amendment by Notification No. S.O.1497(E) dt. 01.07.2011]

FORMS APPLICABLE FOR TAX AUDIT REPORT

Sr. No.

Assessees Forms

1 Who is not required to get his accounts audited under any other law

Form 3CBForm 3CD

2 Who is required to get his accounts audited under any other law and the Financial Year adopted for the purpose of previous year

Form 3CAForm 3CD

3 Who is required to get his accounts audited under any other law and has NOT adopted Financial Year as his previous year.

Form 3CBForm 3CD

PENALTY FOR FAILURE TO GET THE ACCOUNTS AUDITED

Non compliance of Section 44AB attracts huge penalty.

S. 271B prescribes a penalty of – ½% of Turnover/Gross Receipts

OR Rs. 1,50,000/-

Whichever is lower.

However, no penalty may be levied if there is reasonable cause for such failure.

SALES - TURNOVER Computation of Specified Limit of Rs 60 Lacs Excise Duty/ Sales tax

Inclusive method vs Exclusive method Cash Discount

To be deducted from sales/turnover if allowed in cash memo/invoice. Otherwise ‘NO’.

Rebate and Discount Trade Discount should be deducted from sales.

Sale return. To be deducted from sales

Sale of Fixed Assets Does not form part of turnover

Sale of Investment. To be excluded from turnover.

SPECULATION TRANSACTION 43(5)

It means a transaction, in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips.

Aggregate of both positive and negative differences is to be treated as ‘turnover’ as per ICAI Guidance Note.

DERIVATIVES EXEMPTED FROM SPECULATIVE TRANSACTION DEFINITION

o Trading carried electronically on screen based system

o Through stock broker registered with SEBIo by banks or MF on a recongised stock exchangeo Supported by time stamped contract note

indicating Unique Client Identity No and PANo In case of such transactions, the following shall be

included in ‘turnover’ for section 44AB purposeso Total of favourable and unfavourable differenceso Premium received on sale of optionso Difference in respect of reverse trades entered. [Growmore

Exports Ltd vs Asst. CIT 2001 78 ITD 95 (Mum)]

DETERMINATION OF TURNOVER:

SPECULATIVE VS DERIVATIVES

Speculativeo The total of favorable and unfavorable differences

shall be taken as turnover.Derivativeso The total of favorable and unfavorable differences

shall be taken as turnover.

o Premium received on sale of options is also to be included in turnover.

o In respect of any reverse trades entered, the difference thereon, form part of the turnover.

CAPITAL GAINS VS. BUSINESS

Depends on facts and circumstances of each case taking into consideration nature, frequency and volume of transaction.

Landmark Judgments :i. CIT v. P.K.N. and Co. Ltd. (1966) 60 ITR 65 (SC).ii. Saroj Kumar Mazumdar v. CIT (1959) 37 ITR 242 (SC).iii. CIT v. Sutlej Cotton Mills Supply Agency (1975) 100 ITR

706 (SC).iv. Venkataswami Naidu & Co.(G) v. CIT (1959) 35 ITR 594

(SC).However, recently courts and tribunals have been holding that any Dealing in shares results in Capital Gains and NOT BUSINESS INCOME.

BOARD CIRCULAR NO. 4/2007, DATED 15-6-2007

It is possible for tax payer to have two portfolios, i.e., an investment portfolio comprising of securities which are to be treated as capital assets and a trading portfolio comprising of stock in trade which are to be treated as trading assets. Where an assessee has two portfolios, the assessee may have income under both heads i.e., capital gains as well as business income.

GROSS RECEIPTS

Instances of Receipts forming part of Gross Receipts

Duty Draw Back Commission - Brokerage Job Work Sale of License Foreign Exchange surplus/ difference on Export Sales Surplus on reimbursement e.g. packing forwarding, freight

etc. Advance receipt from customer forfeited Interest Income if assessable as business income Income of a partner from a partnership firm such as

remuneration and interest on capital account.

GROSS RECEIPTS

Instances of receipts not forming part of Gross Receipts Rental Income. Reimbursement of expenses and other charges to a clearing /

consignment agent. Amount received by a traveling agent for reimbursement of

expenses. Except a travel agent engaged in Package Tour. Write Back of Provisions – Recoveries from Bad Debts. Principle for ascertaining whether reimbursement is part of

gross receipt or not.

Limits of Business and profession- independent or interdependent

These are independent according to ICAI [Para 5.16 of Guidance Note on Tax Audit]

ASSESSEE HAVING EXEMPT INCOME WHETHER REQUIRED TO GET ITS ACCOUNTS AUDITED U/S 44 AB

Trust / Association Exempt u/s 10(21), 10(23A), 10(23B), 10(23BB), 10(23C) and Section 11

Agriculturist

SECTION 11.

Section 11 (4) For the purposes of this section "property held under trust“ includes a business undertaking so held, and where a claim is made that the income of any such undertaking shall not be included in the total income of the persons in receipt thereof, the Assessing Officer shall have power to determine the income of such undertaking in accordance with the provisions of this Act relating to assessment; and where any income so determined is in excess of the income as shown in the accounts of the undertaking, such excess shall be deemed to be applied to purposes other than charitable or religious purposes.

Section 11 (4A) Sub-section (1) or sub-section (2) or sub-section (3) or sub-section (3A) shall not apply in relation to any income of a trust or an Institution, being profits and gains of business, unless the business is incidental to the attainment of the objectives of the trust or, as the case may be, institution, and separate books of account are maintained by such trust or institution in respect of such business.

TRUST ENGAGED IN BUSINESS

A business whose income is utilised by the trust or the institution for the purposes of achieving the objectives of the trust or the institution is, surely, a business which is incidental to the attainment of the objectives of the trust. (247 ITR 785 THANTI TRUST SC, 107 ITD 403 CIT V. Beer Shiva Educational Social Welfare Society, Haldwani, 105 ITD 29 Samaj Kalyan Parishad, Modinagar v. ITO.)

Section 2(15) defining ‘Charitable Purpose’ amended w.e.f. 1-4-2009

Provided that the advancement of any other object of general public utility shall not be a charitable purpose, if it involves the carrying on of any activity in the nature of trade, commerce or business, or any activity of rendering any service in relation to any trade, commerce or business, for a cess or fee or any other consideration, irrespective of the nature of use or application, or retention, of the income from such activity;

6G.REPORT OF AUDIT OF ACCOUNTS TO BE FURNISHED UNDER SECTION 44AB.

(1) The report of audit of the accounts of a person required to be furnished under section 44AB shall,-

(a) in the case of a person who carries on business or profession and who is required by or under any other

law to get his accounts audited, be in Form No.3CA;

(b) in the case of a person who carries on business or profession, but not being a person referred to in

clause (a), be in Form No.3CB.

(2)The particulars which are required to be furnished under section 44AB shall be in Form No.3CD.

Rule 6G

AUDIT REPORT FORM 3CB

1. We have examined the BS & PL of XXXX. . 2. We certify that the BS & PL are in agreement with books

maintained at the head office …and ….branches.3. We report the following observations/comments/discrepancies/

inconsistencies “We have taken into consideration the audit report and the audited statement of accounts, and particulars received from auditors of the branches not audited by us”

……………Subject to above

A. We have obtained all the information and explanations which to the best of our knowledge and belief were necessary for the purpose of the audit.

B. In our opinion proper books of accounts have been kept by the assessee so far as appears from our examination of the books.

3CB..Contd..

3CB CONTD..

C. In our opinion and to the best of our information and according to the explanations given to us, the said accounts, read with notes thereon, give a true and fair view:

1. in the case of balance sheet, of the state of affairs… 31st March.. And

2. in the case of profit and loss account, of the profit… that date.

4. The statement of particulars required to be furnished under section 44AB is annexed herewith in Form No 3CD.

5. In our opinion and to the best of our information and according to the explanations given to us, the particulars given in Form No. 3CD and the Annexure thereto are true and correct.

TRUE AND FAIR VIEW

Framework for Preparation and Presentation of financial statements issued by ICAI.

Financial Statements are frequently described as showing a true and fair view of the financial position, performance and cash flows of an enterprises. Although this framework does not deal directly with such concepts, the application of the principal qualitative characteristics and of appropriate accounting standards normally result in financial statements that convey what is generally understood as true and fair view of such information.

SA-700 THE AUDITOR’S REPORT ON FINANCIAL STATEMENTS

Modifications not affecting Audit opinion

Modification affecting Audit opinion

Emphasis on Matter

Qualified Opinion

Adverse Opinion

Disclaimer of Opinion

TYPES OF AUDIT REPORTS

CLEAN REPORT MODIFIED REPORT

TRUE AND CORRECT VIEW

As seen earlier, the Audit Report in Form 3CB also requires the Accountant to state that the information in Form 3CD is ‘true and correct’.

The information in Form 3CD is in the form of specific questions and answers are resulting in compilation of various financial information.

The applicable Standards shall be ‘Standard on Related Services’ [SRS 4410].

APPLICABILITY OF ACCOUNTING STANDARDS Issued by the ICAI

It is hereby clarified that the mandatory accounting standards also apply in respect of financial statements audited u/s 44AB of the Income Tax Act, 1961. Accordingly, the members should examine compliance with the mandatory accounting standards when conducting such audit.(Published in The Chartered Accountant Journal, August 1994.)

Audit Procedures – SA/SRE/SAE/SRS - Peer Review - ASI

CONCLUSION

One should not loose the original intention of bringing Tax Audit on statute book i.e. to ensure that the books of accounts and other records are properly maintained and faithfully reflect the true income of taxpayer.

Proper filling of Tax Audit Report, Forms with Proper answers to each Clause and maintenance of appropriate records shall help Accountant, Assessee as well as Income Tax Authorities.

Liabilities under Code of Ethics should not be overlooked since the complaints from Income Tax in this respect are also on rise.