BCAS Half day Workshop on

‘How to conduct Tax Audit’4th September 2010

ByHimanshu Kishnadwala

INTRODUCTION Audit of Companies vs. Other entities Limit 40 lakhs (10 lakhs) since 1985 Increased to 60 lakhs (15 lakhs) from AY 2011-12 As per DTC increased to 100 lakhs (25 lakhs) from 2012-13

Appointment and NOC Relying on work of another Statutory Auditor Format of the Financial statements

Recommended by ICAI For Firms to also state whether registered

Whether previous years’ figures to be given? Minimum fees to be charged

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FORM 3CA, 3CB

When to use 3CA and 3CB? Giving comments in Para 3(a) of Form 3CB Effect thereof? Whether safeguards the auditor?

Adding responsibility and scope Para in 3CB Whether required?

TO add FRN in Form 3CA / 3CB

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Form 3CA, 3CB … Notes to Accounts to normally specify: Method of accounting followed – accrual or cash Method of inventory valuation Fixed Assets and Depreciation Investments Method for accounting Foreign Exchange fluctuations

Items that may require qualification: Mandatory AS not followed (esp. for Companies) Non provision of Income Tax Employee benefits – especially retirement benefits Confirmations for balances Inventory valuation on estimated basis

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Form 3CD

Form 3CD – revised effective 10th August 2006 For a proprietor having 2-3 different business –

whether same or different Form 3CD? Primary responsibility of management To be certified by management Contains Parts A/B and 2 Annexures Annexure I contains 2 parts A/B

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Form 3CD

3CD

Part A

Clauses

1 to 6

Part B

Clauses

7 to 32

Annexures

I and II

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Form 3CD …

Annexures to 3CD

Annexure I

Part A (similar to Part A

of main 3CD –Clauses 1 to 6)

Part B (Parameters)

Annexure II

Value of Fringe Benefits *

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* Not applicable from AY 2010-11

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Clause 17 (a) to (m): Amounts debited to P & L a/c being …

Clause 17(a): Expenditure of Capital nature Some basic tests:

Whether brings into existence an asset or advantage of enduring benefit Whether referable to fixed capital/assets vs. circulating capital/assets Whether relates to very framework of assessee’s business Whether it is initial expenditure or incurred after business started Whether incurred to acquire a concern or goodwill

Concept as per accounting standards and tax laws may differ. Also refer sections 30/31 and large number of precedents To cross refer capex covered u/s 35 (for R&D) To report capex debited to P&L a/c (e.g. capex < Rs. 5,000) SC decision of Saravana Spg Mills P Ltd (2007) 293 ITR 201

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Clause 17 (a) to (m): Amounts debited to P & L a/c being …

Clause 17(b): Expenditure of Personal nature In case of companies – also applicable as per sec 227(1A)(e) General Note that “payments made as per contractual

obligations not considered for this clause” Payments for club membership, time share, etc – whether

personal in nature? [also refer clause 17(d)] If no appeal filed in earlier years for certain disallowances for

expenses towards personal motor car exps, telephone, etc – to mention the same.

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Clause 17 (a) to (m): Amounts debited to P & L a/c being …

Clause 17(c): Expn on advt in any souvenir, etc of a political party

Factual reportingClause 17(d): Expn incurred at clubs To report entrance fees, subscription, Cost for club

services and facilities used Contributions to “Dahi Handi, Ganesh Utsav”, etc Clubs do not include Social service organisations Credit card payments to be scrutinized All payments to Clubs may not need to be reported here:

• e.g. rent paid to Lions Club for hiring a Hall for a staff meeting10CNK

Clause 17 (a) to (m): Amounts debited to P & L a/c being …

Clause 17(e): Expn on fine, penalty, etc Materiality to be considered while reporting No view to be expressed on allowability Penalty and fine are to be distinguished from contractual

obligations - even if such payments are labeled as “penalty” in a contract.

Compensatory vs. penal payments (SC decisions) Prakash Cotton Mills 201 ITR 684 Ahmedabad Cotton Mfg Co Ltd 205 ITR 163 Malwa Vanaspati & Chemical Co 225 ITR 383

Compounding Charges

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Clause 17 (a) to (m): Amounts debited to P & L a/c being …

Clause 17(f): Amts inadmissible u/s 40(a) Applicable to:

Interest, Royalty, FTS payable outside India or in India to a Non-Resident; [40(a)(i)]

Interest, commission/brokerage, Rent, Fees for professional services, FTS payable to Resident; [40(a)(ia)]

Amounts payable to Resident contractor/sub-contractor; [40(a)(ia)] FBT [40(a)(ic)] Wealth Tax [40(a)(iia)] Salaries payable outside India [40(a)(iii)]

Not applicable to: Salaries payable within India

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Clause 17 (a) to (m): Amounts debited to P & L a/c being …

Clause 17(f): Amts inadmissible u/s 40(a) Tax not deducted: Expenses to be disallowed – to report Tax deducted and paid within time limit u/s 200(1) in same

year: Allowable in the same year – not to report Tax deducted and paid after expiry of time limit u/s 200(1) in

same year: Allowable in same year – not to report (to report in clause 27a)

Tax deducted during last month and paid before due date of filing return: Allowable in the same year – not to report (to report in clause 27a)

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Clause 17 (a) to (m): Amounts debited to P & L a/c being …

Clause 17(f): Amts inadmissible u/s 40(a) … Tax deducted but not paid at all: Not Allowable – to report

(to report in Clause 27b) Tax deducted but paid after due date of return: Not Allowable

– to report (to report in Clause 27b) If any sum disallowed and amounts deducted / paid after

deduction after due date Allowable in previous year in which payment made

Tax deducted and paid but at improper rates due to wrong classification: Follow view of management , judicial decisions (or report in Clause 27b)

Tax deducted but surcharge and/or Education cess not deducted: Reasonable view is to disallow proportionately (also to report in clause 27b)

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Clause 17 (a) to (m): Amounts debited to P & L a/c being …

Clause 17(f): Amts inadmissible u/s 40(a) … Interpretation issues can arise on applicability of TDS:

TDS on reimbursements

TDS on supply of packing materials

194C vs. 194J

To consider and mention management view or reliance on judicial cases in appropriate cases

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Clause 17 (a) to (m): Amounts debited to P & L a/c being …

Clause 17(g): Interest, salary, etc inadmissible u/s 40(b)(ba)

Interest needs to be authorised by a deed; Remuneration to be only to paid to working partners if paid to non working partner or to lady partners? Revised limits apply from AY 2010-11

Amount inadmissible to be clearly mentioned

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Clause 17 (a) to (m): Amounts debited to P & L a/c being …

Clause 17(h): Amount inadmissible u/s 40A(3) Payments over Rs. 20,000 other than by Account payee (not

crossed) cheque or draft Disallowance is 100 % of the entire expenditure Rule 6DD (as revised) lays down exceptions in case payment

made in cash if no banking facilities available or due to business expediency Direct bank transfers Allows payments by credit/debit card, etc

Disclaimer Note normally given if evidence of paid cheques, etc not available

Specific Certificate to be obtained from the assessee 17CNK

Clause 17 (a) to (m): Amounts debited to P & L a/c being …

Clause 17(i): Provision for Gratuity u/s 40A(7) Gratuity provision not allowable unless actually paid Payment can be to an approved Gratuity Fund or to an

approved Scheme of LIC or any other Mutual fund For Companies, likely reporting since AS 15 (revised)

applicable, due to which such provisioning mandatory

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Clause 17 (a) to (m): Amounts debited to P & L a/c being …

Clause 17(k): particulars of liability of a contingent nature Contingent liability defined by AS 29. As per AS 29, to recognise a liability if: available evidence entity has present obligation Outflow of resources is ‘probable’ and entity can measure liability reliably.

Whether the following provisions are Contingent Liabilities? Warranty charges Legal obligations for restoration of mines, etc at the end of the

lease period Reward points for credit card companies, airlines, etc

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Clause 17 (a) to (m): Amounts debited to P & L a/c being …

Clause 17(l): Amount inadmissible u/s 14A Deals with expenditure in relation to incomes which are

exempt from tax Rule 8D notified for the same Rule applies only if allocation of expenditure done by assessee

is not satisfactory in the view of the AO Rule could give rise to difficulties for:

Investment Companies Companies holding temporary Investments in MF schemes, etc

Way out could be to advise companies to liquidate temporary investments just before year end

Judicial decisions on sec 14A / Rule 8D20CNK

Clause 17 (a) to (m): Amounts debited to P & L a/c being …

Clause 17(m): Amount inadmissible under proviso to sec 36(1)(iii)

Amount borrowed for the purpose of business or profession allowed as deduction

Various decisions allowed deduction even on borrowings for extension or new business by an existing unit: Refer: Core Healthcare Ltd 298 ITR 194 (SC) Tata Chemicals Ltd 256 ITR 395 (Bom) Grasim Inds Ltd 237 ITR 253 (Bom)

Proviso states “any interest paid for borrowing for acquisition of an asset for extension of existing business or professionwill not be allowed as deduction till date when asset put to use”

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Clause 17 (a) to (m): Amounts debited to P & L a/c being …

Clause 17(m): Amount inadmissible under proviso to sec 36(1)(iii)

To also refer to Explanation 8 to sec 43 – which prohibits capitalization of interest after it is put to use

Differences from AS 16: “Borrowing Costs” Commencement and cut-off date vary Concept of Qualifying Asset not covered in sec 36(1)(iii)

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Clause 17A: Interest inadmissible u/s 23 of the MSME Development Act, 2006.

In most cases, full information about entities covered under MSME Act is not available

If such information is not available/compiled by the assessee, to give suitable note to that effect.

The note can be as:“The assessee is in the process of obtaining the information regarding entities covered by the MSME Act, 2006. In absence of the details, the required information is therefor not provided”

If information available, to find whether there are delays in settlement of bills beyond 45days – in which case provision for interest payable for the delay is mandatory.

Such provision for interest needs to be reported in this clause.CNK 23

Clause 18: Payments to persons u/s 40A(2)(b)

Payments to be construed as covering all “expenditure” Obtain list of specified persons from assessee No Judgment or rationalisation required – only state facts Nature of Relationships not required to be stated For companies – compare with: Reporting as per AS 18, Sec. 295, 297, 314 Disclosures in the register maintained u/s 301

Give full particulars of transactions In case assessee has claimed exemption/deductions u/s 10A,

10B, 80-IA, 80-IB, effect of transactions with associates to be considered while computing the exemption / deduction.

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Clause 19: Amounts deemed as profits u/s 33AB, 33ABA, 33AC

33AB and 33ABA deal with circumstances under which amounts withdrawn from deposit accounts other than the specified purpose is deemed to be chargeable as profits and gains of business.

33AC dealt with withdrawals out of reserves for Shipping Business. Not applicable since AY 2005-06.

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Clause 20: Amount of profit chargeable u/s 41

Refers to remission or cessation of liability or bad debts for which allowance or deduction has been claimed in an earlier year

Also refers to profit arising on sale of fixed assets (incl assets on which deduction u/s 35 has been claimed)

Various SC decisions have laid down that “mere write back does not result in income” Sugauli Sugar Works Pvt. Ltd. 236 ITR 518, Kasturi & Sons Ltd. 237 ITR 24

To verify if any such amounts are credited to P & L a/c and report on the same

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Clause 21(i)(A)/(B), 21(ii)(A)/(B): Disallowances u/s. 43B

To understand the latest provisions of sec 43B Disallowance for the following if not paid within the year or

before the due date of filing return: Any tax, duty, cess, fee, etc.; Employers’ contribution to Provident Fund or other funds; Bonus of commission payable to employees; Interest on loan from financial institutions or scheduled banks; Leave encashment

Separate disclosure for amounts o/s at the beginning of the year and for arising during the year – Clause 21(i)(A) / (B).

To also state whether amount of Sales Tax, excise, etc passed through the Profit and Loss a/c

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Clause 21(i)(A)/(B), 21(ii)(A)/(B): Disallowances u/s. 43B …

Some typical reporting issues: Borrowings from NBFCs not covered Treatment of funded interest (to refer circular 7/2006) Sales Tax Deferral Loans Provision for Excise Duty on closing stock of finished goods Payments made after signing of Form 3CD, but before filing of

return Assumptions for making provision for taxation

List of items disallowed to be cross tallied with Deferred Tax calculations (as would qualify for DTA)

If certain items disallowed in earlier year and now written back in books (since no longer payable), not to include the same for tax computation

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Clause 22(a), 22(b): Modvat, Inc/Exp of Prior period, …

22(a) requires reporting of Modvat (Cenvat) credits availed, treatment in P & L a/c and Balance o/s

Ensure proper reconciliation of data as derived from excise records

Consider various circulars in regard to service tax for utilisation of cenvat credit

In some industries (say., textiles) claiming cenvat credit is optional – in such cases consider whether balance o/s can be utilised in future

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Clause 22(a), 22(b): Modvat, Inc/Exp of Prior period, …

22(b) requires income or expenditure of prior period included in P & L a/c

As per AS 5 [and also AS (IT) 2], revision of estimates does not result in a Prior Period Item

They arise only due to errors or omissions in earlier periods

Materiality to be considered while reporting the same

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Clause 23: Amounts borrowed on Hundi, etc

Refers to section 69D Not applicable in most cases as Hundi not a preferred

mode of borrowing in recent time

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Clause 24(a), 24(b), 24(c): Loans or Deposits accepted/repaid …

Relevant sections are sec 269SS and sec 269T If total amount of loan/deposit exceeds Rs. 20,000, to report

even if each transaction is less than Rs. 20,000 Construed strictly, applies only to amounts accepted/repaid

during the year Preferable to disclose movement of even existing loans

To include even squared up loans If accounts are utilised as current accounts, to segregate loan

and other transactions Security Deposits, loans from NBFCs also to be reported

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Clause 24(a), 24(b): Loans or Deposits accepted/repaid …

If data voluminous (say company accepting FDs), to test check and mention the fact

Repayments by book/transfer entries to be reported Whether repayments by cheque on behalf of depositor to be

reported? (e.g. direct payments for PPF, tax, LIP, etc) Specific Certificate to be obtained that acceptance or

repayment is by “account payee” cheque or draft Disclaimer Note normally given if evidence of paid cheques,

etc not available

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Clause 25(a),: Brought forward losses, depn …

In remarks, reference may also be made to the appellate orders and pending proceedings where the relevant

Where certain information is taken from outside the books i.e. the basis of returns etc., suitable note may be given.

Sl. No

Asstt Year Nature of Loss/Allowance

Amt returned

(Rs.)

Amt assessed

(Rs.)

Remarks

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Clause 25(b): Brought forward losses, depn …

Requires whether change in shareholding in terms of section 79 has taken place: Does not affect set off of unabsorbed depreciation

Applies only to closely held companies Beneficial interest to be compared on last day of

previous year in which loss was incurred and of previous year when loss is to be set off

Exceptions – gift to relative or succession To only mention factual details

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Clause 26: Details of deductions under Chp VIA

To indicate sections under which deduction is to be claimed

(e.g. u/s 80G – amt eligible, actual deduction, etc)

For proprietary concerns, to report deductions like 80C, 80D only if covered in the financial statements being audited

Reporting for deductions u/s 80IA, 80IB, to be supported by separate Forms (e.g. Form 10CCB) and refer to the same

In case of disputes/disallowances in earlier years – to include by way of a note

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Clause 27: Compliance of TDS provisions

Initial answer is to be given in YES / NO If answer is No, details to be given as under:

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Particulars Amount (Rs.)

Tax deductible and not deducted at all

Shortfall on account of lesser deduction than required to be deducted

Tax deducted late

Tax deducted but not paid to the credit of CG

Clause 27: Compliance of TDS provisions …

For voluminous data, tests checks may be adopted –note to be given to that effect

Reconcile with e-TDS return and P & L a/c Co-relate with disclosures in Clause 17(f) In cases where 2 (or more) views are possible, view

followed by the management should be mentioned Different views are possible esp. for payments to

non-residents where DTAA provisions are to be applied

Interest for delays, etc not to be calculated or provided

Clause 28: Quantitative Details

Information to be given as per books of accounts Details about trading as well as manufacturing

activities for all principal items Materiality can be kept in mind – Items constituting more than 10 % of aggregate value of

purchases/consumption/turnover (as per Schedule VI) To reconcile with stock details given to banks Reporting of Yield, Shortage/Excess, if possible

should be done – to compare the same with earlier years or with industry norms

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Clause 29: Tax on Distributed Profits

Factual information & data to be furnished Dividend under 2(22)(e) is excluded- hence there would not

normally be any interpretation issues. Dividends declared during the previous year (whether

interim or final) needs to be reported

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Clause 30 / 31: Cost Audit / Central Excise Audit

Factual information & data to be furnished If Cost Audit applicable but report not obtained, no

mention necessary If Cost audit under progress, to mention the said fact If cost audit report available, to compare numbers

regarding yield, shortage/excess mentioned therein with those reported in Clause 28

If excise audit (or inspection) conducted, but no report issued, to mention the said fact

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Clause 32: Accounting Ratios

4 Ratios to be given Gross Profit / Turnover Net Profit / Turnover Stock-in-trade / Turnover Materials consumed / Finished Goods produced

Only current years ratios to be given – however comparing reported GP/NP ratios with earlier years is an important audit analytical tool

Ratios to be given in value terms and for the business as a whole

Ratios may not make any sense in case of multiple activities

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Documentation

Register for Tax Audits carried out during the year Documentation for 3CD should be separate Check list for 3CD, if possible For debatable issues, separate management

representations, if required Important for Peer Review since tax audit is also an

attest function.

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Questions …

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…Thank youhimanshu@cnkindia.com

BCAS Half day Workshop �on�‘How to conduct Tax Audit’�4th September 2010INTRODUCTIONFORM 3CA, 3CBForm 3CA, 3CB …Form 3CDForm 3CD Form 3CD … Clause 17 (a) to (m): �Amounts debited to P & L a/c being …Clause 17 (a) to (m): �Amounts debited to P & L a/c being …Clause 17 (a) to (m): �Amounts debited to P & L a/c being …Clause 17 (a) to (m): �Amounts debited to P & L a/c being …Clause 17 (a) to (m): �Amounts debited to P & L a/c being …Clause 17 (a) to (m): �Amounts debited to P & L a/c being …Clause 17 (a) to (m): �Amounts debited to P & L a/c being …Clause 17 (a) to (m): �Amounts debited to P & L a/c being …Clause 17 (a) to (m): �Amounts debited to P & L a/c being …Clause 17 (a) to (m): �Amounts debited to P & L a/c being …Clause 17 (a) to (m): �Amounts debited to P & L a/c being …Clause 17 (a) to (m): �Amounts debited to P & L a/c being …Clause 17 (a) to (m): �Amounts debited to P & L a/c being …Clause 17 (a) to (m): �Amounts debited to P & L a/c being …Clause 17 (a) to (m): �Amounts debited to P & L a/c being …Clause 17A: Interest inadmissible u/s 23 of the MSME Development Act, 2006.Clause 18: �Payments to persons u/s 40A(2)(b)Clause 19: Amounts deemed as profits u/s 33AB, 33ABA, 33ACClause 20: �Amount of profit chargeable u/s 41Clause 21(i)(A)/(B), 21(ii)(A)/(B): �Disallowances u/s. 43BClause 21(i)(A)/(B), 21(ii)(A)/(B): �Disallowances u/s. 43B …Clause 22(a), 22(b): �Modvat, Inc/Exp of Prior period, …Clause 22(a), 22(b): �Modvat, Inc/Exp of Prior period, …Clause 23: �Amounts borrowed on Hundi, etcClause 24(a), 24(b), 24(c): �Loans or Deposits accepted/repaid …Clause 24(a), 24(b): �Loans or Deposits accepted/repaid …Clause 25(a),: �Brought forward losses, depn …Clause 25(b): �Brought forward losses, depn …Clause 26: �Details of deductions under Chp VIAClause 27: �Compliance of TDS provisionsClause 27: �Compliance of TDS provisions …Clause 28: �Quantitative DetailsClause 29: �Tax on Distributed ProfitsClause 30 / 31: �Cost Audit / Central Excise AuditClause 32: �Accounting RatiosDocumentationQuestions …