half day training workshop on ‘how to conduct a tax audit’ · · 2017-10-17clearing &...

BCAS HALF DAY WORKSHOP ON‘HOW TO CONDUCT TAX AUDIT’

4TH SEPTEMBER 2010

By Anil Sathe, FCA

INTRODUCTION

Audit required vide section 44AB of IT Act Audit of Companies vs. Other entities Limit 40 lacs (10 lacs) since 1985 / Now revised to 60 Lacs ( 15 Lacs) Appointment and NOC Relying on another Statutory Auditor Issues where accounting year followed by entity is different from financial

year. 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

How to Conduct Tax Audit - By CA Anil Sathe

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APPLICABILITY OF ACCOUNTING STANDARDS

Corporate entities Mandatory as per Companies (AS) Rules, 2006 Concessions to SMCs from some AS

Non-corporate entities Compliance not given by any statute (except for AS 1 & AS 2 issued

under section 145 of Income Tax Act) As per ICAI guidelines – mandatory for auditors while reporting –

exemptions for SMEs from some AS In practice, important AS like AS 1, AS 2, AS 7, AS 10, etc need to

be followed as otherwise the accounts may not give “True and Fair” view


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CONCEPT OF TURNOVER

Whether to include excise, sales tax, service tax? For proprietorships: total turnover for each business Whether to include sale of capital assets? When to apply limit of 40 lakhs vs. 10 lakhs

Nursing home Interior decorators Management consultants Coaching classes Gain on sale on investments Insurance agents, Financial Planning Advisors, etc


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SALES, TURNOVER & GROSS RECEIPTS:

Nature of business What is Turnover ICAI Guidance Note [GN] – reference

Day trader/speculator Sum total of differences,whether positive or negative

Para 5.11(a) of ICAI GN

Security derivatives transactions

Sum total of differences, whether positive or negative, also premium on sale of options

Para 5.11(b) of ICAI GN

Commodity derivatives transactions

– in case of settlement without delivery, sum total of differences,whether positive or negative– in case of delivery, total value of sales

Para 5.11(b) & (c) of ICAI GN

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SALES, TURNOVER & GROSS RECEIPTS:

Nature of business What is Turnover ICAI Guidance Note -reference

Clearing & forwarding agent

Reimbursement of customs duty & othercharges collected by an agent not part of turnover

Para 5.13(vi) of ICAI GN

Travel agent, where no commission is payable byairlines

Amount received from clients for payment to airlines is reimbursement

Para 5.13(viii) of ICAI GN

Advertising agency booking space

Advertising charges recovered notturnover, provided by way of reimbursement [ABP(P) Ltd. v/s. ACIT 23 SOT 28(Kol)]

Para 5.13(ix) of ICAI GN

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DOCUMENTATION BEFORE COMMENCEMENT

Appointment letter Engagement Letter NOC from previous auditor wherever applicable Declaration of non-interest of auditor in auditee Documents required & permanent file. Audit Programme Accounts / Trial Balance.


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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 Results in amending Form 3CB Whether justifiable?

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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- 2 not relevant for AY 2010-11 & subsequent years]

Annexure I contains 2 parts A/B

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FORM 3CD


11

3CD

Part A

Clauses 1 to 6

Part B

Clauses 7 to 32

AnnexuresI and II

FORM 3CD

12

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

*not relevant for AY 2010-11 & subsequent years


POINTS TO BE BORNE IN MIND WHILE CERTIFYING PRESCRIBED PARTICULARS IN FORM NO.3CDGeneral Issues Information to be compiled and authenticated by the assessee -

Auditor’s duty to check the details, applying the auditing standards andtechniques.

In the case of conflicting Judicial precedents, Auditor should state theJudgment relied upon.

In the case of conflicting views with the assessee, the Auditor may stateboth the views and leave it to the Tax Department to decide the matter.

The Auditor will be normally be guided by the Income Tax Act whilereporting the particulars in Form 3CD.


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PART A: CLAUSES 1 TO 6 (ALSO IN ANNEXURE 1 – PART A): BASIC DETAILS OF ASSESSEE1. Name of Assessee

In case of proprietor, name of business which is being audited – with name [say., XYZ Exports (Prop. ABC)]

If audit of only branch carried out, then name of Branch

2. Address Normally of the registered office In case of a branch, division, etc addresses thereof

3. Permanent Account Number4. Status5. Previous Year ended 6. Assessment Year


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CLAUSE 7(a), 7(b): IF ASSESSEE IS FIRM OR AOP, …

To indicate names of partners/members and profit sharing ratios (including for sharing losses, if different)

Does not cover ratios for remuneration to partners All changes in profit sharing ratios (since last date of preceding

year) to be mentioned

Audit Process Verify the Partnership Deed and Addenda thereto (retain copy in

permanent file) Whether relevant documents filed with concerned authorities like

Registrar of Firms, etc


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CLAUSE 8(a), 8(b): NATURE OF BUSINESS OR PROFESSION, …

To give broad nature of all business/profession

To give principal line of each business/profession “Manufacturing of aromatic chemicals”, not simply

manufacturing or chemicals manufacturing

Similar to information required in ITR Match this with information required in Annexure 1 part B In practice, activities that constitute > 10 % are given

Mention of any material change like: New business started Some business discontinued – (if only temporary suspension

need not be mentioned)


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CLAUSE 8(a), 8(b): NATURE OF BUSINESS OR PROFESSION, … Audit Process Verify the Partnership Deed / Memorandum / Minutes

Verify actual activities carried out (from the components of Income in P & L a/c)

New activities during the year to be mentioned

For companies – compare with: Quantitative details in Part III Schedule VI and particulars given in Part IV of Schedule VI

If in doubt – better to include


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CLAUSE 9(a), 9(b), 9(c):WHETHER BOOKS PRESCRIBED U/S 44AA, … To give list of books prescribed, maintained and

examined Rule 6F prescribes books for certain professionals

mentioned in sec 44AA(1) – not so prescribed for business and others mentioned in sec 44AA(2)

Books constitute books of original entry and maybe prescribed under some other statute

To give the list for all locations (incl stock registers) If maintained in a computer system – to mention so Books would be for recording financial as well as non-

financial information

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CLAUSE 9(a), 9(b), 9(c):WHETHER BOOKS PRESCRIBED U/S 44AA, …Audit Process To obtain list from the management

All 3 lists may not be same: Some books though prescribed, may not be maintained Some books though maintained may not be examined

(say., Petty Cash Book)

To take care to include list for all branches, depots.

To exercise professional judgement and give reservations if certain books required are not maintained

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CLAUSE 10: WHETHER P & L A/C INCLUDES PROFITS ASSESSABLE ON PRESUMPTIVE BASIS?

Relevant sections for presumptive taxation are:

44AD Civil Construction Business ( all business w.e.f. AY 2011-12)

44AE Transport Business44AF Retail Trade ( will not apply from AY 2011-12)44B Shipping buisness of a non-resident44BB Providing services in prospecting or extraction of

mineral oils44BBA Operation of aircraft by non-resident44BBB Civil construction in turnkey power projects by

non-residents20


CLAUSE 10: WHETHER P & L A/C INCLUDES PROFITS ASSESSABLE ON PRESUMPTIVE BASIS? … Reporting is for amounts included in P & L a/c Amount assessable under the presumptive section need not be

given If 2 or more business exist and presumptive section applicable

for some businesses, allocation of expenses may become necessary if common books are maintained

Audit Process To confirm whether any of the businesses fall under this

category If amount included in P & L a/c does not match the amount

assessable under the presumptive section a note maybe added to that effect

Confirm whether common or separate books maintained for such businesses

Verify allocation if common books maintained21


CLAUSE 11(a), (b), (c), (d): METHOD OF ACCOUNTING

Method of accounting followed Accrual vs. Cash method (mixed method not allowed) If cash basis of accounting – then Specific disclosure in

Audit report Method to be consistently followed Isues regarding different methods of accounting for two

businesses Allowability of remuneration in case of professional firm

following Cash basis Cash basis not possible for companies


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CLAUSE 11(a), (b), (c), (d): METHOD OF ACCOUNTING

Deviation from accounting standards prescribed u/s 145. Sec 145 has notified 2 Accounting Standards: AS 1 (IT) – similar to AS 1 of ICAI AS 2(IT) – similar to AS 5 of ICAI

Exception to Sec 145 – interest on compensation or enhanced compensation taxable in the year of receipt irrespective of method of accounting


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CLAUSE 11(a), (b), (c), (d): METHOD OF ACCOUNTING …

AS 1(IT) requires disclosure of all significant accounting policies

Change in method of accounting Allowed as per para 9 of AS 2(IT) in 2 cases

Adoption required by statuteChange would result in more appropriate presentation of

financial Statements. Materiality to be considered Effect on profit/loss to be stated Changed policy to be followed consistently


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CLAUSE 11(a), (b), (c), (d): METHOD OF ACCOUNTING …Audit Process

To find all accounting policies followed for: Revenue Recognition Inventory valuation, Fixed Assets and depreciation Investments Foreign exchange fluctuations Employee benefits, etc

Confirm whether the same are disclosed at one place

If any change in policy, confirm the same is as per 2 exceptions provided by para 9 of AS 2 (IT)

Change needs to be reported even though there may not be a change in taxable income – e.g. depreciation


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CLAUSE 12(a), (b):METHOD OF VALUATION OF CLOSING STOCK Closing stock consists of RM, WIP, FG, Stores, etc Normal valuation principles to be followed:

At cost or NRV whichever is lower; To follow Absorption Costing; To include all costs incl. excise duty (sec 145A) To mention how cost is determined If cost arrived at as SP less GP margin – whether ok? Allowed at SP in certain cases SC decision of British Paints (188 ITR 44)

To also value stores, packing items Change in method of valuation covered in Clause 11


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CLAUSE 12(a), (b):METHOD OF VALUATION OF CLOSING STOCK … To mention effect of 145A on

Any tax, duty, cess ,etc paid/incurred on inputs to be added to the cost of the inputs, if not already added;

Any tax, duty, cess ,etc paid/incurred on sale of goods to be added in sales, if not already added;

Any tax, duty, cess ,etc paid/incurred on inventory to be added to inventory valuation, if not already added;

Section 145A thus requires “Inclusive method” as against “Exclusive method” mandated by AS 2

ICAI GN on “Tax Audit u/s 44AB” mentions (with an illustration) that in both methods, impact on profit/loss is Nil

For an entity following “Exclusive method” ICAI GN has suggested disclosure in the following table (see next slide)

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CLAUSE 12(a), (b):METHOD OF VALUATION OF CLOSING STOCK …

Particulars Increase in Profit (Rs.)

Decrease in Profit (Rs.)

1 Increase in cost of opening stock on inclusion of excise duty on which Cenvat available/availed Xxx Xxx

2 Increase in purchase cost of RM on inclusion of excise duty on which Cenvat available/availed Xxx Xxx

3 Increase in sales of finished goods on inclusion of ED

Xxx Xxx

4 ED paid on Sale of FG due to inclusion in Sales Xxx Xxx5 Increase in closing stock of RM on inclusion of ED Xxx Xxx6 Increase in closing stock of FG on inclusion of ED xxx Xxx7 Increase in ED on closing stock of FG as a result of

its inclusion in closing stock of FG xxx Xxx8 Accounting of Cenvat credit availed and utilised on

RM consumed in payment of ED on FG accounted on basis of RM consumed

Xxx Xxx


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CLAUSE 12(a), (b):METHOD OF VALUATION OF CLOSING STOCK …Audit Process

Get list of Closing Inventory;

Confirm whether all items like RM, WIP, FG, Stores, Packing materials, consumables, etc are valued

Confirm method of valuation (incl determination of cost, etc)

Tally inventory list with that submitted to the bank – quantity should match – value may differ due to different valuation method applied

Confirm applicability of sec 145A

Disclosure as per ICAI GN, if 145A not followed


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CLAUSE 12A(a), (b), (c):CAPITAL ASSET CONVERTED INTO STOCK-IN-TRADE

Sections 2(47), 45(2), 47(iv),(v) and 47A relevant for reporting under this clause

Following particulars to be given: Description of capital asset; Date of acquisition; Cost of acquisition; Amount at which the asset is converted into stock-in-trade

Reporting is only for assets converted into stock-in-trade in the previous year – Taxability of the gains from such transfer need not be commented.

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CLAUSE 12A(a), (b), (c):CAPITAL ASSET CONVERTED INTO STOCK-IN-TRADE

Audit Process Confirm whether any asset has been converted to

stock-in-trade in the previous year; Verify contemporaneous evidence in this regard. Whether any entry passed for the same If amount at which asset is converted is stated other

than at cost, to ascertain the basis thereof whether disclosure made for the above


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CLAUSE 13(a) TO (e): AMOUNTS NOT CREDITED TO P & L A/CAuditors responsibility is restricted to information contained in thebooks of accounts & records. a. Items falling within scope of section 28 [i.e. ss. (i) to (vi)]b. Proforma credits, refunds, are admitted as due by authoritiesc. Escalation claims accepted during the previous yeard. Any other item of incomee. Capital receipt, if any Reporting for (a), (d) and (e) with reference to entries passed in

the books of account Reporting for (b) and (c) with reference to documents made

available If reporting done for items under (b), (c), (d) same again need

not be reported in (a).


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CLAUSE 13(a) TO (e): AMOUNTS NOT CREDITED TO P & L A/C … Receipts directly taken to reserves or capital/current

accounts of partners Reporting necessary irrespective whether amounts are

taxable or exempt e.g. Income tax refunds, subsidies received, remission of loans, Share of profit from firm Compensation for surrender of tenancy rights, etc Compensation from breach of contracts Capital subsidies.

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CLAUSE 13(a) TO (e): AMOUNTS NOT CREDITED TO P & L A/C …Audit Process Confirm whether any receipt covered u/s 28 has been taken

directly to reserves or capital accounts To examine all relevant correspondence for proforma credits,

refunds, claims, etc If such credits, etc have been admitted, though not received, the

same should be reported Consider implications of above on provision for tax If assessee disputes any item based on legal decisions: to

mention the same General disclaimer maybe given that the auditor has

not gone beyond the books of accounts produced tohim during audit and has not conducted aninvestigation to find out if the assessee has notcredited any amounts in the books.


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CLAUSE 14(a) TO (f): FIXED ASSETS & DEPRECIATION Particulars of Block of Assets and depreciation

a. Descriptionb. Rate of depreciationc. Actual cost or WDVd. Additions/Deductions with dates of acquisition/put to use – whether net

of Cenvat credit, Foreign exchange fluctuations, subsidies e. Depreciation allowablef. WDV at end of the year

Additions normally bifurcated into: Used for more than 180 days and others Cut-off date would be 2nd October (not 30th Sept)

If list of additions very voluminous summarised information can be given


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CLAUSE 14(a) TO (f): FIXED ASSETS & DEPRECIATION …

Date when Asset put to use – can differ with date of start of commercial production

Capital assets claimed as deduction R & D assets (also refer clause 15) Assets less than Rs. 5,000?? (Sch. XIV of Companies Act)

Computer Software: whether asset? (Decision of Amyway) Adjustments for currency fluctuations (as per sec 43A) Adjustments for subsidies received (as per expl 10 to sec 43) In case of disputes (which are under litigation) regarding

depreciation claim in earlier years – to clearly mention the same


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CLAUSE 14 (b): RATE OF DEPRECIATION

Recommended Note in the ICAI Guidance Note vis-à-vis “Disputes with tax authorities”:

NOTE: Certain disputes about (a) the rate of depreciation on ________ (b) determination of WDV of block of assets relating to ___________ and (c) ownership of ____________ have arisen in the assessment years ___________ for which assessments are pending/appeals are pending. The figures of WDV and/or rate of depreciation mentioned in the above statement may require modification when these disputes are resolved. Therefore, the amount of depreciation allowable as stated in the above statement will have to be accordingly modified.

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CLAUSE 14 (b): RATE OF DEPRECIATION

Depreciation allowed @ 60% on computer including computer software.

Scope enlarged by recent decision of the Special Bench in the case Datacraft India Ltd.

Routers and switches should be classified as part of computers and be eligible for 60% depreciation.


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CLAUSE 14 (b): RATE OF DEPRECIATION –DEPRECIATION ON INTANGIBLESItem Citation

License of “toll collection” Ashoka Info. (P) Ltd. - (2009) 22 DTR 60 (Pune) (Trib)

Non-compete fees Medicorp Technologies India Ltd. - (2009) 30 SOT 506 (Mad)

Real Image - (2009) 120 TTJ 983 (Mad)


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CLAUSE 14 (b): RATE OF DEPRECIATION –DEPRECIATION ON INTANGIBLES

Item CitationBrand name KEC International Ltd. v/s. ACIT –

unreported decision in ITA No. 4420/Mum/2009

Commercial rights of exploration of mineral oil

ONGC Videsh Ltd. – (2010) 33 DTR 22 (Trib).

Acquiring skill and know-how of employees of business taken over

Bosch Ltd. v/s. CIT – unreported decision in ITA No. 329/Bang/09


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CLAUSE 14(a) TO (f): FIXED ASSETS & DEPRECIATION …

Audit Process Confirm opening block from last year

Tally Additions/deductions with Fixed Assets Schedule

Confirm dates when asset is put to use – when commercial production has started

Confirm whether adjustment for Cenvat, Foreign exchange gains/losses is as per relevant section

Confirm depreciation rates and whether additional depreciation claimed in appropriate cases

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CLAUSE 15 (A) TO (L): AMOUNTS ADMISSIBLE List of amounts admissible under 33AB, 33ABA, 33AC, 35,

35ABB, 35AC, 35CCA, 35CCB, 35D, 35DD, 35DDA, 35E

To mention whether or not the above is debited to Profit &loss a/c

As 26 does not now permit any expenditure to be classifiedas Deferred Revenue Expenditure

Due to this, in most cases amount will not be debited to P &L a/c, but may be appearing as Deferred Tax Asset (onaccount of ensuing timing difference)


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CLAUSE 15 (a) TO (l): AMOUNTS ADMISSIBLE …

Audit Process

Ascertain whether assessee eligible for claim of any expenses as per the above sections

If amount being treated as DRE (esp. if prior to applicability of AS 26), confirm whether the same has been appropriately amortised

If amount fully written off, to confirm with the statement of calculation of Deferred Tax (unamortised amount is to be considered as DTA)

If claim pertains to a capital asset, confirm that no depreciation on the same is claimed u/s 32 (Clause 14 of Form 3CD)


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CLAUSE 16 (a), (b): SUM PAID TO EMPLOYEE AS BONUS, ETC Relevant sections are:

For 16(a) – sec 36(1)(ii), For 16(b) – sec 2(24)(x) and 36(i)(va) Sec 36(1)(ii) would not be applicable in most cases, unless bonus

or commission is paid, which would be otherwise been payable to him as profits or dividend

Under 2(24)(x) sums received from employees as contributions to any PF, ESI, etc are included as income

Deduction allowed u/s 36(i)(va) if the said amounts are deposited on or before the due date – Due date would also include Days of Grace allowed under the respective legislation

Amount deducted, due date for repayment and actual date are to be mentioned.


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CLAUSE 16 (a), (b): SUM PAID TO EMPLOYEE AS BONUS, ETC …Audit Process

Verify agreements, if any, with employees to ascertain whether any amount payable as profits or dividends, but paid as bonus or commission

Obtain list of contributions of employees to PF, ESIC, etc and dates of their payments (cross reference to bank statements)

Confirm due dates as per the concerned legislation

If data voluminous, test check can be done and so mentioned


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DOCUMENTATION AFTER AUDIT

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

Query listing / sign off


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THANK YOU !!

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