�����������������

A. GENERAL PRINCIPLES OF TAX AUDIT

Tax audit report: earlier format/revised format

1. Can the tax auditor use the revised tax audit forms for reporting in respect of assessment years 1994-95, 1995-96 etc. since such audit reports are being signed after 4th June, 1999? If so, should the reporting/certification be in accordance with the law applicable for the relevant assessment year? Alternatively can the tax auditor restrict himself only to such of those requirements which were mentioned in the earlier tax audit forms?

Ans. All tax audit reports signed on or after 4th June, 1999, whether in respect of the assessment year 1994-95 or 1995-96 or any other year whatsoever should be in the revised format. The tax auditor cannot use the old format merely because the tax audit is in respect of accounts for the financial years corresponding to the assessment years 1998-1999 and/or any of the earlier years. What is relevant is the date of signing of the tax audit report and not the financial year in respect of which such audit report is being given. However, the tax auditor, while giving his tax audit report in the revised format on or after 4th June, 1999, should indicate only those particulars as per the requirement of earlier forms based upon the relevant law applicable to the assessment year in relation to the financial year for which the report is being submitted now. Further, the tax auditor need not give information which are not relevant for the concerned earlier assessment year.

Note: In this publication, unless otherwise stated -

(i) reference to paragraph/s indicates the relevant paragraph/s in the Guidance Note on tax audit (fourth edition) September, 1999.

(ii) reference to a section without reference to the relevant Act means that the section has reference to the Income-tax Act, 1961.

2

This is necessary having regard to the fact that the tax audit report is to be used by the Assessing Officer for the purpose of completing the assessment of the concerned assessee for the relevant year in accordance with the law applicable to that year.

Form No. 3CA/3CB

2.. (a) The accounting year of an assessee has been changed from calendar year to April through March. Accordingly, the accounts have been drawn for the period from January, 1998 to March 31, 1999 which have already been audited for tax audit. Which form of audit report should be used? Form No. 3CA or Form No. 3CB? Should separate accounts have to be drawn for the period from 1st April, 1998 to 31st March, 1999?

(b) Rule 6G(a) provides that 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, the audit report should be in Form No.3CA. Under the Companies Act, all companies are required get their accounts audited. However the accounting year for Companies Act can be different from that of the previous year under Income-tax Act e.g. under the Companies Act it may be, say, 30th September. In such cases how can the company comply with the requirements of Form No.3CA?

Ans. Issues (a) and (b) are answered together. The previous year for tax purposes shall always be the financial year as per section 3 of the Income-tax Act. As such the final accounts required to be enclosed with the return of income along with tax audit report have to be of the financial year. Accordingly in case the annual accounts i.e. balance sheet and profit and loss account to be enclosed with the return of income have not been audited and certified, it cannot fulfill the requirement of Form No.3CA which requires the tax auditor to enclose the ‘audited’ profit and loss account for the year ended on 31st March and ‘audited’ balance sheet as at 31st March.

Hence, in such cases the tax payer is required to prepare a separate profit and loss account and balance sheet as at 31st March and get the same audited and the tax auditor is to give the report in Form No.3CB whereby he is required first to certify the

3

true and fair view of the balance sheet and profit and loss account and furnish statement of particulars in Form No.3CD.

Though Rule 6G(1)(a) provides that a person who carries on business or profession and who is required by or under any other law to get his accounts audited the tax audit report should be in Form No.3CA, the word “accounts” here has to be interpreted in terms of the requirement of Form No.3CA.

“Accounts” here will mean the accounts i.e. profit and loss account and the balance sheet which is required to be enclosed with the return of income and tax audit report. In case the accounts i.e. profit and loss account and balance sheet required to be enclosed with tax audit report has not been audited under any other law, the correct form will be Form No.3CB. Attention is also invited to Circular No.561 dated 22.5.1990 vide page 182 of the Guidance Note on Tax Audit.

3. An assessee is having some branches which maintain proper books of account and some other branches which maintain only imprest account. What will be the implications on the reporting of number of branch offices in Form No.3CB?

Ans. Paragraph 2 of Form No. 3CB requires the tax auditor to certify that the balance sheet and the profit and loss account/income and expenditure account are in agreement with the books of account maintained at the head office at - - - - - and - - - - branches. It is clear, therefore, that while mentioning the total number of branches, only those branches have to be included which maintain books of account. A branch maintaining only an imprest cannot constitute a branch for the purpose of reporting requirements in Form No.3CB and hence such branches need not be included.

Extension of due date

4. Whenever the due date for filing the income-tax return is extended, please clarify whether that would result in the automatic extension of the specified date for furnishing the tax audit report also.

4

Ans. The due dates for furnishing the return of income by different types of assessees is given by Explanation I under section 139(1). The expression ‘specified date’ before which the tax audit report has to be furnished has been separately defined in the Explanation (ii) to section 44AB. Therefore, any extension of ‘due date ’ for furnishing of tax returns under section 139 does not automatically result in the extension of the specified date before which the tax audit report has to be furnished. However, it may be noted that under both the Notification Nos. NIL [F.No. 220/1/99/IT(A-II)], dated 1.10.199 and the Order dated 17th November, 1999 [F.No. 220/1/99-ITA. II] the due dates for filing of the returns under section 139 as well as the specified date under section 44AB were extended appropriately.

Non-resident: Indian operations

5. A foreign company has some business income from India. It has no permanent establishment in India. Since the income of the foreign company chargeable under the Income-tax Act cannot be precisely determined, the same has been assessed on the basis provided in Rule 10 of the Income-tax Rules, 1962.. There are no separate books of account for Indian business. What are the tax audit report requirements? Should Form No.3CD be submitted in respect of such a foreign company?

Ans. Paragraph 6.2 clarifies that section 44AB does not make any distinction between a resident and a non-resident. Therefore, a non-resident assessee is also required to get his accounts audited and to furnish such report under section 44AB if his turnover exceeds the prescribed limits. This audit, however, would be confined only to the Indian operations carried out by the non-resident assessee since he is not chargeable to income-tax in India in respect of income accruing or arising or received outside India. In the given issue, since there are no separate books of account for the Indian business, the tax auditor has to necessarily obtain relevant information from the overseas auditor for the purpose of enabling him to make the audit report and also furnish the necessary particulars. So far as audit report is concerned, Form No. 3CB should be used even if the accounts of the non-resident have been subject to audit by an auditor qualified

5

to audit the accounts under the relevant statute of the country. It is also necessary to segregate the data relating to income chargeable under the Income-tax Act. The tax auditor has to make appropriate disclosures based on SAP-10 “Using the work of another auditor”.

Determination of sales, turnover, gross receipts: applicability of section 44AB.

(a) Combined books for exports and retail trade

6. (a) An assessee is maintaining combined books for export business and retail trade and the combined turnover is less than Rs.40.00 lakhs. Should the tax audit of the whole business be conducted where the assessee claims that the taxable profits of retail business is less than 5% as provided under sub-section (5) of section 44AF? Suppose a person is exporter and retailer, how do we link 44AF and 80HHC?

(b) What is the position when a trader maintains combined books of account in respect of wholesale and retail trade?

Ans.(a) Yes. The tax audit of the whole business is required to be conducted in such cases. As per section 44AB every person who fulfils any of the conditions stated in clause (a), (b) or (c) is required to get his accounts audited of the previous year. Since in this case the assessee is not opting for presumptive taxation in respect of its retail trade business he is covered by clause (c) of section 44AB and as such will be required to get the accounts audited of the whole business. Computation of deduction under section 80HHC shall be in terms of sub-section (3) of section 80HHC.

(b) In such a case, recourse to section 44AF may not be possible and tax audit would be warranted in case the combined turnover crosses Rs.40 lakhs.

(b) Surrendered stocks

7. A survey was conducted during the financial year 1998-99 and the assessee surrendered stocks worth Rs.12 lakhs. During the financial year 1998-99 the assessee is having a turnover of Rs.39

6

lakhs. Should the value of surrendered stock be included in the turnover for determining the applicability of section 44AB?

Ans. The surrender of stock worth Rs.12 lakhs during the survey does not mean that the turnover of the assessee for the relevant year exceeded Rs.40 lakhs. Therefore, the value of surrendered stock cannot be treated as part of turnover for determining the applicability of section 44AB. It is also significant to note that paragraph 5.16 clarifies that section 44AB applies only if the turnover exceeds the prescribed limit according to the books maintained by the assessee.

(c) Sale of car

8. Sale of car is not included in sales for the purpose of tax audit but according to some Supreme Court judgements under Sales-tax Act, the sale of a car is to be treated as sales and sales tax has to be charged. Then, why should the same be excluded for tax audit purposes?

Ans. The sale of car is nothing but a sale of capital asset. The expression ‘total sales’, ‘turnover’ or ‘gross receipts’ used in clause (a) of section 44AB should be understood in the context of the expression ‘in business’ appearing immediately thereafter in that very clause. The definition of ‘sales’ under the Sales-tax Act of any State is not relevant for determining the applicability of section 44AB. Paragraphs 5.7 (vi) and 5.11 (i) clarify that the sale proceeds of fixed assets would not form part of turnover since these are not held for resale and that the sale proceeds of fixed assets would also not form part of “gross receipts in business”.

(d) Trust running a hospital

9. A trust registered as a society is engaged in running a hospital, having gross receipts exceeding Rs.40 lakhs. Is it required to have its accounts audited under section 44AB?

Ans. Running of hospital by a trust is a business activity. Therefore, if the gross receipts from running the hospital exceed Rs.40 lakhs, the trust must get its accounts audited under section 44AB.

7

(e) Write back

10. As a result of writing back the account of a creditor, the turnover has exceeded Rs.40 lakhs. Will the assessee be liable for tax audit?

Ans. Writing back of the amount payable to a creditor of which a deduction has been claimed is deemed as income for the purpose of section 41(1) of the Income-tax Act, 1961. The amount so written back is neither the sale nor turnover/gross receipt and as such will not be includible while determining the quantum for applicability of section 44AB.

(f) Inclusion of sales-tax

11. A, an assessee, provides the following figures:

Sales Rs.38 lakhs

Sales tax collected Rs.3 lakhs

Is A liable for tax audit under section 44AB?

Ans. The words ‘sales’, ‘turnover’ and ‘gross receipts’ are commercial terms and they should be construed in accordance with the method of accounting regularly employed by the assessee. If the sales tax collected is credited separately to sales tax account and payments thereof are debited in the same account, they would not be included in the turnover. Paragraphs 5.5 and 5.6 clarify this.

12.. As per the provisions of Bombay Sales-tax Act excise duty collected from the consumers forms part of sales. By applying the same logic should we not include sales-tax collection as part of “turnover/sales” for determining the applicability of section 44AB?

Ans. The definition in Bombay Sales-tax Act is not relevant for determining the applicability of section 44AB. The words ‘sales’, ‘turnover’ and ‘gross receipts’ are commercial terms and they should be construed in accordance with the method of accounting regularly employed by the assessee. If the sales tax collected is credited separately to sales tax account and payments thereof are debited in the same account, they would not be included in the turnover. Please refer to paragraphs 5.5 and 5.6.

8

(g) Individual businesses - separate or consolidated report/form

13. An assessee owns 4 proprietorship businesses. The aggregate annual turnover of all the concerns exceeds Rs.40 lakhs but individually each business’s turnover is below Rs.40 lakhs. Further, separate books of account are maintained for each business and profit and loss account and balance sheet are prepared separately.

(a) Will tax audit under section 44AB be applicable?

(b) If yes, should the particulars of all businesses be reported in a single Form No. 3CD? If so, how?

(c) Should the tax auditor give a consolidated Form No. 3CD in respect of all the concerns?

Ans.(a) The requirement of tax audit in the case of an assessee is to be determined taking into consideration the ‘sales’, ‘turnover’ or ‘gross receipts’ of all the businesses carried on by him. If the aggregate annual turnover of the four proprietary concerns exceed Rs.40 lakhs, section 44AB would be clearly applicable.

(b) In regard to audit report and furnishing of particulars in Form Nos.3CA/3CB and 3CD, there are two possibilities. Firstly, separate tax auditors may be appointed in respect of individual businesses in which case Form Nos. 3CB and 3CD have to be submitted separately for each business. Alternatively, one tax auditor may undertake the audit of all the businesses. Here also the tax auditor can prepare Form Nos. 3CA/3CB and 3CD separately for each business. The need for separate forms for each business arises particularly where reliefs are claimed in respect of individual businesses.

(c) However it may be noted that tax audit as such is conducted in respect of an assessee and hence the question of consolidating the separate forms into a single form assumes importance. Further, without consolidating the separate Form Nos. 3CD into a single form particulars like deduction permissible under chapter VIA cannot be given. Hence it is advisable to prepare a

9

consolidated form. The auditor consolidating the report/form can rely on the work of the other auditor. (SAP - 10)

14. (i) The assessee is the proprietor of the following businesses:

(a) cloth business at Mumbai—sales Rs. 20 lakhs.

(b) yarn business at Ahmedabad—sales Rs. 15 lakhs.

(c) hosiery business at Baroda—sales Rs. 12 lakhs.

Separate sets of books are maintained at each of the above places. The businesses are carried on in different names viz., (a) Prakash Cloth Stores (b) Pradeep Yarn Merchants and (c) Pratibha Hosiery Mart. Should the assessee get his accounts audited under section 44AB in respect of each of the above proprietary concerns?

(ii) If, in the above case, the hosiery business is carried on by the assessee’s wife from the funds gifted by the assessee and the income of the business is includible in the income of the assessee under section 64, what will be the position of audit under section 44AB?

(iii) If the assessee is a partner in (a) M/s A & Co., (sales Rs. 35 lakhs) (b) M/s B & Co. (sales Rs. 38 lakhs) and (c) M/s D. & Co. (sales Rs. 20 lakhs) and he has 60% share in each of the above firms, should each of the above firms get its accounts audited under section 44AB? Should the asseesee who is a partner in the above firms get his personal accounts audited under section 44AB as the aggregate of his share in the turnover of the three firms exceeds Rs.40 lakhs?

Ans.(i) Even if the assessee carries on business at different places in different names and deals in different commodities, it will be necessary to get the accounts audited if the aggregate amount of sales of all the businesses exceed Rs.40 lakhs. In the given case the total sales of the three businesses amount to Rs.47 lakhs. Therefore, it will be necessary to get the accounts of all the three concerns belonging to this assessee audited. It may be noted that the emphasis is on the total sales. Therefore, even if the assessee carries on one or more businesses the sales of all the businesses will be taken into consideration.

10

(ii) If the business is carried on by the wife of the assessee, it cannot be said that it is carried on by the assessee merely because the income from the business is includible in the income of the assessee under section 64. Therefore, the wife of the assessee carrying on hosiery business with turnover of Rs.12 lakhs will not be required to get the accounts audited under section 44AB.

(iii) Each firm is a separate person/assessee for the purpose of Income-tax Act. Therefore, the figures of sales of each firm will have to be considered. In the given case, it will not be necessary for A & Co., B & Co., or C & Co., to get their accounts audited as the sales of any one of these firms do not exceed Rs.40 lakhs.

Similarly, any partner of these firms will not be required to get his personal accounts audited if he is not carrying on any personal business having sales/turnover exceeding Rs.40 lakhs. The sales/ turnover of the firms in which he is a partner cannot be taken into consideration for this purpose.

Concept of agency

(a) Jobber

15. In case of share broker (jobber) what will be the method of arriving at the turnover for determining the applicability of section 44AB, if the jobber makes the daily purchase and sale of shares on his own account?

Ans. If a share broker enters into transactions on his personal account, the sale value also should be taken into account for considering the limit for the purpose of section 44AB. Paragraph 5.9 provides that share brokers, on purchasing securities on behalf of their customers, do not get them transferred in their names but deliver them to the customers who get them transferred in their names. The same is also true in case of sales. The share broker holds the delivery merely on behalf of his customer. The property in goods does not get transferred to the share brokers. Only brokerage which is being accounted for in the books of account of share brokers should be taken into account for considering the limits for the purpose of section 44AB. However, in case of transactions entered into by share broker on his personal account, the sale value should also be taken

11

into account for considering the limit for the purpose of section 44AB.

(b) Arbitrage

16. Where the turnover from the activity of arbitrage, exceeds Rs.40 lakhs, should tax audit be done?

Ans. Yes. Section 44AB is applicable to all cases where the gross receipts in business exceed Rs.40 lakhs in any previous year.

(c) Selling agent

17. (i) A & Co. (partnership firm) is appointed as selling agent of a textile mill. The firm canvasses orders for the mill. The goods are despatched by the mill to the customers introduced by A & Co. The sales bills are prepared by the mill. A & Co., recovers the sale proceeds and remits the same to the mill. The total sales organised by A & Co., during the year ended 31-3-1999 amounted to Rs.20 crores. The commission @ 1% earned by A & Co., amounted to Rs.20 lakhs. Should A & Co., get their accounts audited under section 44AB?

(ii) In the above case if A & Co., had purchased cloth for Rs.35 lakhs and sold cloth worth Rs.30 lakhs will the provisions of section 44AB apply?

Ans.(i) In this case, A & Co. is a selling agent of the textile mill. From the facts stated in the above issue, it is evident that the selling agent does not become the owner of the goods. The ownership continues to be that of the mill and it passes from the mill to the customer. The goods are despatched directly by the mill to the customers and sales bills are prepared by the mill. A & Co. is recovering the sale proceeds on behalf of the mill. Therefore, the amount of the sales made by the mill cannot be taken into consideration for determining the liability of A & Co., to get its accounts audited under section 44AB. Since the commission income of A & Co. is only Rs.20 lakhs and if there are any sales or other trading receipts of A & Co., which are less than Rs.20 lakhs, it will not be required to get its accounts audited under section 44AB.

12

(ii) As stated above, because the commission income of A & Co. is Rs.20 lakhs and the sales of cloth amount to Rs.30 lakhs the total turnover and gross receipts of A & Co. will exceed Rs.40 lakhs and it will be necessary for it to get its accounts audited under section 44AB.

(d) Consignment sales

18. Mr. ‘B’ has received goods worth Rs.50 lakhs on consignment from P & Co. These goods were sold by Mr. ‘B’ at Bombay for Rs.52 lakhs. He has issued his own bills disclosing therein that the goods belong to P & Co. On completion of sales he had rendered accounts sales to P & Co. and remitted the sale proceeds after deducting Rs.1 lakh being expenses incurred for sales and Rs.50,000 being his commission. For sales-tax purposes, he is required to record the above sales in his sales records. Should Mr. ‘B’ get his accounts audited under section 44 AB?

Ans. In this case, Mr. B is acting as consignment agent for P & Co. The sales made by Mr. B at Bombay for Rs.52 lakhs are made on behalf of P & Co. These sales cannot be considered as sales of Mr. B. He is only entitled to his commission of Rs.50,000/- which will form part of his gross receipts. Therefore, Mr. B. will not be required to get his accounts audited under section 44 AB if his total sales and gross receipts including commission income of Rs.50,000/- does not exceed Rs.40 lakhs.

(e) Commission agent

19. A commission agent purchases goods from an upcountry producer and sells the same to his customers. He debits the purchase price to his purchases account and credits the sale price to his sales account. The prices at which the sales are made are more or less the same as the prices at which the purchases are made. The agent gets a commission from the upcountry producer. In such a case should the sales/turnover be computed with reference to the sale price charged to the customers or should the commission income and the net surplus in trading account alone be considered as gross receipts for computing the monetary limit under section 44AB?

13

Ans. It is not possible to state that the commission agent automatically becomes the owner of the goods when he purchases the same from the producer. It depends on the facts of each case. In the given issue, the fact that he debits his purchases account with the price of the goods and credits his sales account with the sale proceeds indicates that he is treating the goods as his own before he effects the sale. Therefore, in such a case if the property in the goods has passed to the commission agent, the sales made by him and credited to his sales account will be considered for computing the monetary limit under section 44AB. Please refer to paragraph 5.8.

(f) Sales through stalls

20. ‘AK’ Pvt. Ltd. is running a departmental store. There are several stalls. Each stall belongs to a different person. According to the arrangement by the stall owners with ‘AK’ Pvt. Ltd., all sale proceeds are to be collected on the printed bills of ‘AK’ Pvt. Ltd. The delivery counter is common for all stall owners and the same is managed by ‘AK’ Pvt. Ltd. The premises belongs to ‘AK’ Pvt. Ltd. who takes out insurance and also makes security arrangements. The proceeds of all sales made by various stall owners are collected by ‘AK’ Pvt. Ltd. At the end of every week ‘AK’ Pvt. Ltd. makes up the sales account of each stall owner and after deducting charges/commission at the agreed rate remits the balance amount to each stall owners. The total turnover on the above basis works out to about Rs.3 crores. However, the income of ‘AK’ Pvt. Ltd. from charges/commission recovered from the stall owners is Rs.30 lakhs. Is ‘AK’ Pvt. Ltd. liable to get its accounts audited under section 44AB?

Ans. It will not be necessary for ‘AK’ Pvt. Ltd. to get its accounts audited under section 44AB. The sales in this case cannot be considered as the sales of ‘AK’ Pvt. Ltd. These are sales of the stall owners. ‘AK’ Pvt. Ltd. has only undertaken to render services like providing space, making security arrangements, taking out insurance, collection of sale proceeds on behalf of the stall owners and rendering account to them. The commission earned for these services does not exceed the limit of Rs.40 lakhs

14

prescribed in section 44AB. Therefore, the provisions of section 44AB are not attracted in this case.

Regular and presumptive business - option

21. Please discuss whether in the following cases the assessee is exigible for audit under section 44AB.

Case I

An individual assessee has 2 businesses

(i) civil construction

(ii) trading

Turnover : (i) civil cons. 15 lakhs

(ii) trading 30 lakhs

Case II

Assessee as above

(i) civil construction

(ii) retail trade

Turnover : (i) civil construction 15 lakhs

(ii) retail trade 30 lakhs

The assessee wants to exercise the option under section 44AD and 44AF.

Case III

Assessee : Individual

Business : Retail trade

Truck plying

Gross receipts : Retail trade 30 lakhs

Truck plying 15 lakhs

The assessee wants to exercise the option under sections 44AF and 44AE.

15

Ans. Case 1: Yes, since the sales and gross receipts in business, taken together exceed Rs.40 lakhs.

Case 2: No, since the assessee wants to exercise the option under sections 44AD and 44AF. Tax audit would be necessary only if the assessee claims his income to be lower than the deemed income. Paragraph 3.5 states that if a person is carrying on business(es), coming within the scope of sections 44AD, 44AE or 44AF, but he exercises his option given under these sections to get his accounts audited under section 44AB, tax audit requirements would apply, in respect of such business(es) even if the turnover of such business(es) does not exceed Rs.40 lakhs. In the case of a person carrying on businesses covered by section 44AD, 44AE or 44AF and opting for presumptive taxation, tax audit requirement would not apply in respect of such businesses. If such person is also carrying on other business(es) not covered by presumptive taxation, tax audit requirements would apply in respect thereof, if the turnover of such business(es), other than the business(es) covered by presumptive taxation thereof, exceed Rs.40 lakhs.

Case 3: No. - see answer to case 2.

Speculation business

22..

Speculation P & L A/c

Dr Cr.

Loss on sale of 100000 shares of TISCO

8,00,000 Profit on sale of 10,000 shares of Zee Tel

20,00,000

Profit on 5000 Shares of Infosys

15,00,000

Net Profit 27,00,000 ------------- ------------- 35,00,000 35,00,000

The above is the profit and loss account of a share-broker in respect of his speculative dealing in shares. As can be seen, the

16

total profit is less than Rs.35 lakhs. However, the issue for consideration is whether the total of profits can be considered as “gross receipts” or should the entire sales value of the shares be considered for the purpose of determining the applicability of section 44AB. The connected issue is what are the various components that would constitute gross receipts in the case of a broker? Should we club together his commission receipts, profit in his share dealings and other miscellaneous receipts for the purpose of determining the applicability of section 44AB?

23. In the case of a person who is doing speculation business in shares with no intention of taking/giving delivery but merely earning/losing through squaring up of transactions, what will constitute the turnover/gross receipts of business?

Will it be:

(a) the aggregate of sale value of the sale transactions entered for squaring-up of the position?

(b) the aggregate of the earnings in various sets of transactions wherein he has earned profit?

(c) the aggregate of the net earnings (after considering both loss transactions and income transactions) at the end of each settlement period?

Ans. In both the issues 22 and 23 the point for consideration is whether in the case of a person engaged in speculation business, the whole value of shares sold should be taken into account for determining the limits for the purpose of section 44AB or whether only the aggregate of the differences received should be considered. This question assumes importance in view of the fact that in speculation business no delivery takes place. Reference is invited to M/s. Babu Lal Enterprises v ACIT (Mumbai Bench of Appellate Tribunal - ITA No.6031/MUM/1996) wherein it was, inter alia, held as follows:

“It is the accepted position that the assessee indulged in speculation business and no other business activity was carried out by it. It is also admitted that physical delivery of any item did not take place and only the difference in price was settled on the

17

basis of the contract notes. This being so, we are of the view that the amount of transactions as noted in the contract notes cannot be taken as turnover of the assessee and the case is squarely covered by the decision of the Tribunal already indicated……” (ITAT’s order dated 4.1.1994 in Royal Cushion Vinyl Products Ltd.).

In view of the above a stand can be taken that the net earnings should be considered as the gross receipts for the purpose of section 44AB.

Financing business

(a) Money lending

24. (i) The assessee is engaged in a money lending business.

Total turnover of moneys by way of loans and repayment of loans are given as under :

(a) loans given Rs.2 crores

(b) repayment of loans Rs.1.80 crores

His interest income for the year worked out to Rs.20 lakhs. Interest paid on his borrowings amounted to Rs.18 lakhs.

Should he get his accounts audited under section 44 AB?

(ii) If the assessee is purchasing cheques of his clients and also engaged in financing (business of shroff-private banking) how will his turnover/gross receipts be computed for the purpose of section 44 AB?

Ans.(i) In the case of a money lender it cannot be said that the turnover of the money given on loan and re-paid by the borrowers is to be considered for the purpose of determining the limit for tax audit under section 44 AB. In this case, only the interest income can be taken into consideration as part of his gross receipts. If the gross receipts from interest and all other gross receipts do not exceed Rs. 40 lakhs the provisions of section 44 AB will not be attracted.

(ii) In the case of a person engaged in private banking business (i.e. business of shroff) the turnover/gross receipts will have to be

18

computed in the same manner as stated in (i) above. In this case also, the assessee is the financier and his gross receipts will have to be computed with reference to his interest income from such business. The turnover of money (including cheques purchased from his clients) will not be taken into consideration for the purpose of determining the turnover of his business.

(b) Chit funds

25. The assessee is engaged in the business of “chit funds”. How will the turnover/gross receipts be calculated in his case for the purposes of section 44 AB?

Ans. The terms “sales, turnover or gross receipts” have to be interpreted with reference to the items which go into the profit and loss account in accordance with the method of accounting regularly employed by the assessee.

Therefore, in the case of a chit fund, the turnover/gross receipts will be only the commission, brokerage and service and other incidental charges received by the assessee.

(c) Leasing

26. (i) In the case of a company engaged in the business of equipment leasing will the provisions of section 44AB for tax audit apply ?

(ii) In the case of a company engaged in leasing finance, will the provisions of section 44AB for tax audit apply?

(iii) In the above cases how will the monetary limit of Rs.40 lakhs for turnover or gross receipts be computed?

(iv) In the case of a company supplying equipment on hire purchase basis how will the monetary limit of Rs.40 lakhs be computed for the purposes of section 44AB?

Ans.(i) In the case of a company engaged in the business of equipment leasing the provisions of section 44AB for tax audit will apply if its gross receipts from lease rent exceed Rs.40 lakhs.

19

(ii) In the case of a company engaged in the business of leasing finance, the provisions of section 44AB for tax audit will apply if its gross receipts from the leasing finance exceed Rs.40 lakhs.

(iii) The monetary limit of Rs.40 lakhs will be computed in the above cases with reference to lease rent or interest on financing. The value of the equipment given on lease or the amount advanced under leasing finance cannot be considered for this purpose.

(iv) When equipment is supplied on hire-purchase basis, the sale is complete when the person taking the equipment exercises his option to purchase. Therefore, during the years when hire charges (excluding instalments of principal amount) are received by the company, the figure of such charges will form part of its gross receipts. When the purchaser exercises his option to purchase, the price at which the equipment is sold to him will form part of total sales or turnover of that year.

Building contract

27. A building contractor has taken a contract for construction of a commercial complex from ‘B’ Ltd. at a total price of Rs.70 lakhs. Under the contract, the contractor is to receive steel and cement from ‘B’ Ltd. During the year ended 31-3-1999, the contractor has completed the construction work. He received cement and steel worth Rs.38 lakhs from ‘B’ Ltd. In the final bill, the contractor has given credit for the above supply by ‘B’ Ltd. and shown the net amount of Rs.32 lakhs after the above deduction. He has not done any other work during the above year. Should the contractor get his accounts audited under section 44AB?

Ans. From the facts stated in the issue it appears that the building contractor has quoted a total price of Rs.70 lakhs and submitted final bill for the said amount. ‘B’ Ltd. has supplied steel and cement worth Rs.38 lakhs for which credit is given by the building contractor in the bill. This does not mean that the total price of the contract work is reduced to this extent. It can be stated that the contractor has received the total price of the contract in two parts i.e., Rs.38 lakhs in kind and Rs.32 lakhs by cheques. Therefore, the total turnover/gross receipts of the contract for the year ended

20

31-3-1999 will be Rs.70 lakhs and the contractor will be required to get his accounts audited under section 44 AB.

Business/Profession

28. A nursing home is held to be an activity of business and not profession. What will be the status of a pathologist running a diagnostic centre (A pathological laboratory) as a proprietor?

Ans. A pathologist running a diagnostic centre is nothing but an illustration of a professional carrying on a business activity. A professional activity can also be characterised as an activity of carrying business, if it is carried on like a commercial activity [see Natvarlal Ambalal Dave v. CIT [1997] 225 ITR 936, 942-43 (Guj)].

29. How will the persons engaged in the following activities be classified for ascertaining the limits of Rs. 40 lakhs or Rs. 10 lakhs under section 44 AB?

(a) motor garage—repairs to motor cars, trucks and servicing of vehicles.

(b) stock broker, dealer and investor in shares and securities.

(c) nursing home run by persons other than medical practitioners and nursing home run by medical practitioners

(d) recruiting agents.

(e) travel agents

(f) clearing and forwarding agents

(g) advertisement agent

(h) interior decorators

(i) money lender

(j) insurance agent

(k) management consultants

(l) technical consultants

(m) dealer and speculator in shares, bullion and other commodities.

21

(n) vyaj-badla income on shares in badla account.

(o) person engaged in processing of diamond

(p) persons engaged in preparing computer software programme and selling the same to others who are operating computers

(q) a chartered accountant engaged in running coaching classes with gross receipts exceedig 10 lakhs.

(r) any other person owning an educational institution with gross receipts from fees of Rs. 35 lakhs.

(s) person engaged in processing cloth.

(t) a limited company engaged in professional and technical services.

Ans. The above activities can be broadly classified into (A) persons carrying on business and (B) persons carrying on profession. In the first category, the limit of Rs.40 lakhs is applicable and in the second category the limit of Rs.10 lakhs applies.

(A) Persons who fall in the category of business :

(a) motor garage - repairs to motor cars, trucks and servicing of vehicles;

(b) stock broker, dealer and investor in shares and securities;

(c) nursing home run by persons other than medical practitioners. If the nursing home is run by medical practitioners who are also carrying on their medical practice at that place it is possible to argue that the assessee is carrying on profession. Alternatively, it is a case of composite activity of business and profession;

(d) recruiting agents;

(e) travel agent;

(f) clearing and forwarding agents - CIT v Jeevanlal Lallubhai & co. [1994] 206 ITR 548 (Bom);

(g) advertisement agent;

22

(h) money lender;

(i) insurance agent;

(j) dealer and speculator in shares, bullion and other commodities;

(k) vyaj-badla income on shares in badla account;

(l) processing of diamond;

(m) persons engaged in preparing computer software programme and selling the same to others who are operating computers;

(n) income from educational institution run by a person who does not possess any professional qualifications;

(o) processing of cloth.

(B) Persons who fall in the category of profession :

(a) interior decorators;

(b) management consultants;

(c) technical consultants;

(d) income from coaching classes run by a chartered accountant or a person possessing professional qualifications. Since teaching is a vocation and since profession includes vocation, this view is possible;

(e) company engaged in rendering professional or technical service.

30. The assessee is maintaining three sets of account books as under :

(i) books relating to his business where the sales turnover etc. exceeds Rs.40 lakhs.

(ii) books relating to professional services where the gross receipts are Rs.6 lakhs.

(iii) books relating to his investments in shares, house property, fixed deposits etc. where the gross receipts are (a) Rs.2 lakhs from dividends (b) Rs.1 lakh from rent of house

23

property and (c) Rs.1.5 lakhs from interest on fixed deposits.

In such a case is it sufficient if only the accounts relating to his business are audited? If not, should his accounts relating to professional activities and investments also be audited?

Ans: It will be necessary to get the accounts relating to business and profession audited under section 44AB. It may be noted that section 44AB applies to persons carrying on business or profession and the audit report prescribed by CBDT requires information about business/professional activities. Therefore, it can be presumed that there is no obligation to get the books regarding rental income from house property, income from investments, interest on fixed deposits etc. audited under section 44AB.

If, however, the income relating to rent, dividends, interest etc. is recorded in the same books in which business or professional transactions are recorded, such receipts from investment will be subject to audit under section 44AB. This is because the auditor has to express an opinion about the true and fair view of the financial statements prepared from the set of books recording business income as well as investment income.

31. In some large cities there is a system of forming polyclinic where 6 or 7 medical practitioners render professional services in different branches of medicines. The fees collected are credited to the accounts of each of the doctors. The common expenses are shared in an agreed proportion. Some of the staff members are common and assist the doctors in rendering such common services. Accounts are maintained by one accountant in one set of books for the sake of convenience. If the total receipts of the polyclinic exceed Rs.10 lakhs, will tax audit under section 44AB have to be conducted?

Ans. In the case of a polyclinic there is no partnership between the doctors sharing the common facilities. Income of each doctor is recorded separately in his account and only common expenses are shared in an agreed manner. The doctors practise in their

24

own names and not in any firm name. A common set of accounts are maintained only for the sake of convenience. Therefore, if the professional receipts of any of the doctors do not exceed Rs.10 lakhs it will not be necessary to get the accounts audited under section 44AB. Such audit will have to be conducted in the case of only those doctors whose professional receipts exceed Rs.10 lakhs in any year.

Where polyclinic is a separate entity, its share in the fee alone is to be taken for the purpose of calculating turnover. In such cases, it would be a case of carrying business activity and therefore tax audit arises if the amount exceeds Rs.40 lakhs.

Exchange fluctuations

32. In case of exports realised after 31st March, but before completion of audit, can the sales figure be amended by the amount actually realised as against the rate on transaction day? Is it necessary to give any note?

Ans. Paragraph 5 of AS 11 - Accounting for the Effects of changes in Foreign Exchange rates states that a transaction in a foreign currency should be recorded in the reporting currency by applying to the foreign currency amount the exchange rate between the reporting currency and the foreign currency at the date of the transaction. An exception is provided in paragraph 4 of the standard in respect of inter-related transactions. Hence, sales figures as such should be reported at the rate on the transaction day. Difference in realisation can be accounted for as exchange fluctuations.

33 (a). Does exchange fluctuation on account of exports of the year and earlier years received form part of gross turnover/ receipt? For instance, turnover consists of :

(i) exports 35 lacs

(ii) local turnover 4.5 lacs

(iii) exchange fluctuations Cr.0.65 lacs Dr. 0.20 lacs

(0.40 relating to current year exports and 0.25 of earlier years export).

25

(b) In case exports are CIF, but for purpose of accounting, a notional FOB value is taken and credited to sale account and balance credited to freight account, what would be the turnover for the purposes of audit requirement?

Ans.(a) Para 5.10 mentions the following items of income/receipts as covered by the term “gross receipts in business”.

“(vi) reimbursement of expenses incurred (e.g. packing, forwarding, freight, insurance, travelling etc.) and if the same is credited to a separate account in the books, only the net surplus on this account should be added to the turnover for the purpose of section 44AB.

(vii) the net exchange rate difference on export sales during the year on the basis of this guiding principles explained in (vi) above will have to be added.”

It follows from the above that net exchange rate difference on export sales will constitute gross receipt. If the assessee consistently follows the accounting policy of recognising exchange difference relating to earlier year’s export but received during the year as a part of gross receipts of the current year, the same will be included in the gross receipts of the current year.

(b) Para 5.6 mentions that the method of accounting followed by the assessee is relevant for the determination of sales, turnover or gross receipts. In the given case while the notional value credited to sales account forms part of turnover, the balance credited to freight account will form part of gross receipts of the business vide item (vi) of para 5.10. Consequently the entire amount (CIF Value) will be considered for the purpose of section 44AB.

Penalty for non-compliance with section 44AB

34. Does the penalty of 0.5% of the turnover (Rs.20,000 where the turnover is Rs.40 lakhs) operate as a minimum penalty? Or does the ceiling of Rs.1 lakh under section 271 B operate as a minimum penalty? Has the I.T.O. any discretion to reduce the above penalty? Can the I.T.O. adjust the penalty amount with reference to the period of delay in getting the accounts audited under section 44AB?

26

Ans. Section 271B provides that if a person “without reasonable cause” contravenes the provisions of section 44AB, he will be liable to pay penalty at the rates specified in the said section. Therefore, if the Income-tax officer comes to the conclusion that the contravention is “without reasonable cause” he has to levy penalty at the rate of 0.5% of the total sales, turnover or gross receipts subject to a maximum of Rs.1 lakh. Although, the section does not appear to give any discretion to the Income tax officer to reduce or waive the quantum of penalty once he comes to the conclusion that penalty is leviable. Moreover, the Income-tax officer cannot make any adjustment in the quantum of penalty with reference to the period of delay in getting the accounts audited under section 44AB. Attention is invited to Bombay ‘D’ Bench ITAT decision in the case of Unique Construction v. DCIT, (1995) 52 TTJ (Bom) 96, in case of penalty under section 271D/271E where it held that the Tribunal and Income-tax Authorities have discretion in the matter and it is not obligatory to impose penalty equal to 100% of the transactions done in contravention of section 269SS/269T. Penalty was reduced to 50% looking to the technical nature of the offence.

35. (a) Should an assessee get his accounts audited under section 44AB after he has been penalised under section 271B and he has paid the penalty? If an assessee fails to furnish the tax audit report with his return of income, what are the consequences?

(b) Can the Assessing Officer direct the assessee to get his accounts audited under section 44AB or under section 142 (2A)?

Ans.(a) An assessee may not get absolved from his obligation to get the accounts audited under section 44AB even after he has been penalised under section 271B of the Act. The return of income is required to be accompanied by audited accounts. Therefore, if the tax audit report is not filed along with income-tax return, the Assessing Officer can treat such return as defective under section 139(9) of the Income-tax Act and on failure of the assessee to rectify the defect by filing the audited accounts within the time given by the Assessing Officer to rectify the defect the return filed can be treated as having not been filed and penal provision for non furnishing the return such as penalty under section 271F and

27

prosecution under section 276CC may be attracted. Apart from this, the following consequences may follow :

(i) interest under section 234A may be attracted

(ii) the Assessing Officer may proceed to make the assessment under section 144 to the best of his judgement.

(b) The Assessing Officer can also direct the assessee to get his accounts audited under section 142(2A) of the Act if the requisite conditions are satisfied.

28

B. AUDIT PROCEDURES AND AUDIT REPORT Audit procedures

(a) Concept of materiality

1. What are the criteria to be considered for determining the 'materiality' of items?

Ans. The auditor should consider materiality and its relationship with audit risk when conducting an audit. SAP-13 deals with audit materiality. The following broad guidelines have been extracted therefrom.

Information is material if its mis-statement (i.e., omission or erroneous statement) could influence the economic decisions of users taken on the basis of the financial information. Materiality depends on the size and nature of the item, judged in the particular circumstances of its mis-statement. Thus, materiality provides a threshold or cut-off point rather than being a primary qualitative characteristic which the information must have if it is to be useful.

The objective of an audit of financial information prepared within a framework of recognised accounting policies and practices and relevant statutory requirements, if any, is to enable the auditor to express an opinion on such financial information. The assessment of what is material is a matter of professional judgement.

The concept of materiality recognises that some matters, either individually or in the aggregate, are relatively important for true and fair presentation of financial information in conformity with recognised accounting policies and practices. The auditor considers materiality at both the overall financial information level and in relation to individual account balances and classes of transactions. Materiality may also be influenced by other considerations, such as the legal and regulatory requirements, non-compliance with which may have a significant bearing on the financial information, and considerations relating to individual account balances and relationships. This process may result in

29

different levels of materiality depending on the matter being audited.

So far as tax audit is concerned the materiality factor governs not only the audit reports in Form No.3CA/3CB but also furnishing of particulars in Form No.3CD.

(b) Representations

2. Is it permissible/allowable to include the representations/ views of the assessee in the body of the audit report itself, wherever it is necessary to protect assessee’s interests?

Ans. There is nothing wrong in recording the representations/views of the assessee at the appropriate places in Form No.3CD. In fact, if the tax auditor has a different view, it would be advisable to record the views of the assessee as well. In this connection paragraph 16.3(b) states that if there is any difference in the opinion of the tax auditor and that of the assessee in respect of any information furnished in Form No.3CD, the tax auditor should state both the view points and also the relevant information in order to enable the tax authority to take a decision in the matter.

3. Will it be advisable in all cases to obtain detailed management representations?

Ans. The tax auditor must obtain detailed management representations on all matters which are required to be considered and reported upon by him, while giving his tax audit report. Paragraph 16.2 specifically requires the tax auditor to obtain from the assessee, the statement of particulars in Form No.3CD duly authenticated by him. Reference may also be made to SAP-13.

(c) Revision of tax audit report

4. Can a tax auditor revise his tax audit report and Form No.3CD?

Ans. A tax auditor should exercise extreme care and caution while discharging his responsibilities. He should ensure that correct information has been given in Form No. 3CA/3CB and 3CD. However, if he feels that there is a need for revising the audit report and/or Form No.3CD, it is advisable to do so in a timely manner and he should clearly indicate the reasons for giving a

30

revised report. Attention is also invited to paragraph 13.10 and to the Guidance Note on Revision of Audit Report which deals with this aspect elaborately.

(d) Audit under other sections of Income-tax Act vis-à-vis tax audit

5. Pradeep industries is engaged in the manufacture of electrical goods. The total sales/turnover exceeds Rs.40 lakhs. It owns the following industrial units.

(i) Enterprise engaged in infrastructure development- deduction available under section 80IA.

(ii) Industrial unit in a backward area - deduction under section 80IB.

If the assessee gets its accounts audited under section 44AB, is it necessary to get separate audit reports under sections 80IA(7) and 80IB(13) read with 80IA(7)? In case audit is conducted under section 80IA(7) and/or 80IB(13) read with section 80IA(7) which form should be used, From No.3CA or 3CB?

Ans. Yes. It will be necessary to get a separate audit report under section 80(IA)(7) and 80(IB) (13) for each of the industrial unit. The Finance Act, 2002 has amended these provisions making it mandatory for all assessees including companies and cooperative societies to submit a report under these sections. It is to be noted that audit report under section 80(IA)(7) and 80(IB)(13) is in respect of an industrial unit covered by the relevant provision whereas audit under section 44AB is in respect of an assessee covered by any of the clauses (a), (b) or (c). It is to be clarified that audit report in such cases will be in Form No.3CB in case the accounts of the assessee have not been audited under any other law such as Companies Act or Cooperative Societies Act etc. Audit under section 80(IA) or 80(IB) of the Income-tax Act will not be considered as audit under any other law. The requirement of section 44AB is a general one covering the overall position of the accounts of the assessee. This applies to the accounts of the assessee for the relevant year covering the results of all the industrial units situated at different places. Therefore, when the sales/turnover of all the units put together exceeds Rs.40 lakhs,

31

the assessee will have to get the audit conducted under section 44AB and obtain the audit report in Form No.3CB.

(e) Intimation of appointment to Income-tax Officer

6. Is there any procedure for giving intimation to the I.T.O. about the appointment and removal of a tax auditor under section 44AB so that the I.T.O. may ensure that the assessee gets the audit report only from the auditor who is validly appointed?

Ans. Under the Companies Act, there is a procedure for the incoming auditor to file his consent with the Registrar of Companies (Form No. 23B). There are no similar provisions under the Income-tax Act.

(f) Relying on the work of statutory auditor

7. A tax auditor does not agree with the treatment given in the audited financial statements in respect of: (i) personal expenses, (ii) capital expenditure, (iii) valuation of stock-in-trade (iv) method of accounting or (v) other matters covered in Form No.3 CD.

If the statutory auditor has not qualified his audit report on these matters, can the tax auditor quality his report in Form No.3CA and make appropriate comments in Form No.3CD?

Ans. In a case where statutory audit under any other law has been conducted by an auditor other than the tax auditor the requirement of section 44AB read with Rule 6G(1)(a) is to enclose a report of such audit and the tax auditor is required to furnish a statement of particulars in Form No.3CD and certify that the particulars given in the said Form No.3CD are true and correct. The tax auditor is not required to comment upon the audit report given by the statutory auditor. As such there will be no requirement on the part of tax auditor to qualify his report in Form No.3CA.

The tax auditor, however, has the primary responsibility of the verification of the particulars prescribed in Form No.3CD and he should ensure that the particulars stated are in conformity with the provisions of the Income-tax Act. Normally the tax auditor should accept the treatment given to various items in the financial statements which have been audited by the statutory auditor. If,

32

however, while conducting tax audit he is unable to agree with the treatment given to a particular item in the audited financial statement, he should first ascertain preferably from the statutory auditor, the reasons for his giving such a treatment in his statement. It is possible that statutory auditor while considering the items on (i) personal expenses, (ii) capital expenditure, (iii) valuation of stock and trade, (iv) method of accounting or other matter covered in Form No.3CD might have dealt with the item from the angle of generally accepted accounting principle or statutory provisions covering the entity. The responsibility of furnishing true and correct particulars in Form No.3CD is that of the entity. For this purpose, statutory provision and judicial pronouncement under tax laws have to be taken into consideration. The tax auditor should verify and ensure that particulars in respect of the above items such as personal expenses, capital expenditure, valuation of stock and trade, method of accounting etc. are given on the basis of explanations above. However, any difference between the figures given in the audited financial statements and figures given in Form No.3CD should be explained by giving appropriate notes. If, however, there is any difference in the opinion of the tax auditor and that of the entity in respect of any information furnished in Form No.3CD, the tax auditor should state both the view points and also the relevant information. Attention is invited to paragraph 16.3.

(g) Accounts written in Hindi or other languages

8. If the accounts of the assessee are written in Hindi or any regional language, what procedure should the tax auditor adopt for conducting the audit if he does not know the language in which the accounts are written?

Ans. In the normal course, the tax auditor should not accept the audit of accounts written in a language which he does not understand, unless he is in a position to verify the authenticity of transactions either by himself or with the help and assistance of audit staff conversant with the language. Special care has to be taken by him to ensure authenticity of the prescribed particulars being reported upon by him.

33

(h) Reliance on judicial decisions

9. The head office of an an assessee (corporate or non-corporate) is in Bombay. It has a branch at Baroda. In respect of one of the issues relevant to tax audit, the Bombay High Court has given a judgement which is in favour of the assessee. On the same issue, the view taken by Gujarat High Court is against the assessee. While taking out particulars in respect of this item relating to Baroda, can the assessee rely upon the view of the Bombay High Court?

Ans. The judgement of the High Court of the State in which the assessee is assessed to income tax will be the basis of assessment. Therefore, in the above case, the assessee should rely on the view expressed by the Bombay High Court on the issue involved, although some of the transactions have taken place in Baroda.

Audit report

Qualifying audit report

10. A is trading in over a hundred items of parts of small value relating to air-conditioning industry. He does not maintain any stock records nor item-wise stock and no valuation is done at the year end. The closing stock figures are determined as a percentage of gross profit which also varies from year to year though not materially. Should the tax auditor make any comments/ observations in Form No.3CD?

Ans. The method of determining the closing stock as a percentage of gross profit is not correct. Attention is invited to Guidance Note on Audit of Inventories (Compendium of Guidance Notes - Vol. III Page 54-1 to 54-18) for a scientific method of stock taking.

It follows therefore that if the physical verification of the closing stock has been done, no qualification is necessary. But, total absence of stock records as well as physical verification would certainly call for appropriate qualifications by the tax auditor.

11. Most of the non-corporate assessees do not have a system of maintaining vouchers for the expenditure and payments made by

34

them. Should the tax auditor insist on production of vouchers and if the same are not available, should he qualify his report?

Ans. In case the relevant vouchers for the expenditure and payments made by the entity are not available it will be necessary for the tax auditor to call for any other evidence in support of such expenditure and payments in order to express his opinion as to whether the accounts give a true and fair view. The entity should be advised to maintain vouchers/records in evidence of transactions to avoid a qualification in the matter by the tax auditor. The qualifications in respect of this matter would, in the normal course, be necessary in case the vouchers or other evidence required to be maintained are not produced in evidence of the income/expenditure or assets/ liabilities. The entity should be encouraged to maintain office vouchers with the recipients’ signatures for the amount reimbursed on account of expenditure like local conveyance etc. for which other supporting evidence is not possible.

12. In the case of a non-corporate assessee’s audit, should the tax auditor qualify his report in respect of the following matters :

(a) if no interest is charged on loans advanced to friends and relatives.

(b) if the withdrawals of partners (proprietor) for household expenses are not adequate according to the opinion of the auditor.

(c) if quantity records are not maintained by the assessee.

(d) if the account books are not closed and closing entries are not passed.

(e) if some of the assets like ownership flat or shares in companies belonging to the assessee firm are not held in the name of the firm but in the names of one or more partners of the firm.

(f) if all expenses are debited to miscellaneous expenses account instead of bifurcating the expenditure under various heads.

35

Ans.(a) The tax auditor is not required to qualify his report or disclose information for non-charging of interest on loans to friends and relatives unless the same is chargeable under the terms of the loan.

(b) The tax auditor is not required to state the adequacy or otherwise of the withdrawals for household expenses by a proprietor or partner(s).

(c) In case quantitative records are not maintained, it will be difficult for the tax auditor to express an opinion whether the accounts give a true and fair view. Similarly, it will also be difficult for him to give the information required to be furnished against the relevant items in Form No. 3CD. He may therefore, have to qualify his report in appropriate cases.

In certain circumstances, it may not be possible to maintain day-to-day quantitative records having regard to the nature of business, for example, in the case of a large departmental store dealing with a variety of small items. In such a case, the entity itself will have its own internal controls/checks on the stock movements. Such an entity would verify stocks at regular intervals as well as at the year end. The auditor can take into consideration the above circumstances and accept the explanation that it is not possible for the entity to maintain day-to-day stock records and in such a case he may not qualify his audit report. A suitable note to this effect can be put in the financial statements as well as against the relevant clause in Form No. 3CD.

(d) If the account books maintained by the assessee are not closed and the closing entries are not made, the auditor should ensure that this is done before he gives his audit report.

(e) Under the Indian Partnership Act, 1932, a firm is not a legal entity. As such the assets would normally stand in the names of one or more of the partners. Therefore, no qualification in audit report is necessary on this count.

(f) The tax auditor should advise the assessee to ensure the disclosure of information by the entity in respect of the various items in the formats of financial statements recommended by the

36

Institute in its Guidance Note on Tax Audit (See Appendix X and XI of the Guidance Note) and will have to ask for a break-up of the ‘miscellaneous expenditure’ to the extent relevant for his tax audit report.

13. If the quantity details shown as per the stock records do not tally with the quantity of closing stock stated in the statement submitted to the bankers (hypothecation account) should the tax auditor qualify his report?

Ans. The tax auditor is expected to make an enquiry as to the reasons and nature of variation between the quantitative details furnished to the bankers and those furnished to him for audit in respect of the stocks hypothecated to bankers and preferably obtain an explanation in writing from the management. In case of minor variations or discrepancies which can be reasonably explained to the satisfaction of the tax auditor, there should be no need for any qualification on the accounts. In case of material discrepancies, the tax auditor should qualify his report.

37

C. PRESCRIBED PARTICULARS IN FORM NO.3CD

FORM NO.3CD

Statement of particulars required to be furnished under

section 44AB of the Income-tax Act, 1961

PART – A

1. Name of the assessee : ___________________

2. Address : ___________________

(i) A proprietary firm, running a business from place ‘X’ which attracts tax audit provisions under section 44AB files its return in the name of the H.U.F. (proprietor) at place ‘Y’. The H.U.F. does also have some other income like interest, etc. outside the books of account of the first mentioned business firm.

Should the name & address of the firm or the name & address of the H.U.F. (assessee) be mentioned here?

Ans. From the facts stated in the issue, since the return is filed at place “Y”, the Income-tax Officer who has jurisdiction over place “Y” will be the Assessing Officer. Further, paragraph 17.2 clarifies that the address to be mentioned under clause (2) should be the same as has been communicated by the assessee to the Income-tax Department for assessment purposes as on the date of signing of the audit report. Hence, it is suggested that the trade name of the assessee along with the fact that the Hindu Undivided Family is the proprietor, should be clearly mentioned. Obviously, the address will be that of the Hindu Undivided Family.

3. Permanent Account Number : _________________

4. Status : _________________

5. Previous year ended : 31st March _______

6. Assessment year : _________________

38

PART – B

7. (a) If firm or Association of Persons, indicate names of partners/members and their profit sharing ratios.

(b) If there is any change in the partners/ members or their profit sharing ratios, the particulars of such change.

(i) What is the date with reference to which the information in sub-clause (a) is to be given? Is it on the first day of the previous year or last day thereof?

Ans. Paragraph 18.1, inter alia, clarifies that the details of partners or members during the entire previous year will have to be furnished. Hence, the names of partners of the firm or members of the association of persons and their profit sharing ratios during the entire previous year will have to be stated and not merely on the first day of the previous year or last day thereof.

(ii) Should the dates on which the change referred to in sub-clause (b) occurred, be mentioned?

Ans. Paragraph 18.2 clarifies that if there is any change in the partners of the firm or members of the association of persons or their profit or loss sharing ratio, the particulars of such change must be stated. The word “particulars” is significant and it includes the relevant dates also. The date on which there is a change in the membership of partner(s) of a firm or member(s) of an association of persons or a change in the profit sharing ratios (including changes, if any, in the terms of remuneration, interest) is extremely significant data for the purpose of calculating interest, remuneration etc. Further, once there is a change in the partners/members or their profit sharing ratio, it will obviously be reflected either in a fresh partnership deed or a supplementary partnership deed. Hence, it is necessary to mention the dates on which such changes occurred. Even in a case where there is a change in the salary to partners it is necessary to mention the dates on which such changes have occurred, as change in salary to partners is as significant as changes in the profit sharing ratios among the partners.

39

(iii) Keeping in view the requirements of section 184, is it necessary to confirm the particulars of change with the records of Registrar of Firms?

Ans. Paragraph 18.3 gives guidance about the supplementary documents which the tax auditor may verify in order to satisfy himself about the genuineness of change in the partners or change in the profit sharing ratios. Sub point (ii) of the above paragraph points out that the tax auditor may verify whether notice of change, if required, has been given to the registrar of firms. Thus the verification of records of the registrar of firms is discretionary and has to be done in accordance with the professional judgement of the tax auditor.

(iv) When a partner in a representative capacity, say, karta of HUF, retires from a firm and is admitted to that firm in his individual capacity, is it a change in the constitution of the firm as envisaged by this clause?

Ans. It is a change in the constitution of the firm as envisaged by this clause.

8. (a) Nature of business or profession.

(b) If there is any change in the nature of business or profession, the particulars of such change.

(i) An assessee was doing business of manufacturing and export of garments up to 31.3.1998. During the year 1998-99, the assessee also did business of high seas sales i.e. (sale of goods during the course of voyage). But the above transactions of high seas sales were not material as compared to the existing export sales business. Will the business of high seas sales amount to change of business?

Ans. Considering the nature of particulars to be given in Form No.3CD, the aspect of materiality should be considered. The facts in the given issue clearly point out that the transactions of high seas sales were not material as compared to the existing export sales business. Obviously, it cannot amount to a change in the nature of business. Further, the transactions appear to be incidental to the business of manufacturing and export of garments. In case of

40

export business, the exporters are entitled to certain licences; the exporters import the goods based on the strength of such licences; and the imported goods are sold. Such transactions would be incidental to the business and, as such, cannot be separated from the main business or cannot be considered as a separate or different business.

(ii) A manufacturer of electrical goods has also to sell spares & accessories. Will he be treated as manufacturer or trader?

Ans. An assessee engaged in manufacture may also do trading. Such trading may be of goods and articles manufactured by the assessee himself. For example, an automobile manufacturing company may manufacture several parts of an automobile inside its factory itself. Such a company may sell a portion of its parts. Secondly, a manufacturing company may sell the goods purchased by it principally for its own consumption. Continuing with the above example, the same company may purchase headlights to be fitted in the automobiles to be manufactured in its factory. Occasionally it may sell some of the headlights. Such a trading activity in both the cases is only incidental to the main manufacturing activity and does not make the assessee a trader.

(iii) Since the nature of business may cover a vast number of activities, is it sufficient for the tax auditor to obtain management representations in this regard?

Ans. Paragraph 19.3 provides guidance to the tax auditors about the evidences he has to verify to satisfy himself about the change in the nature of business or profession. The tax auditor is expected to make his own independent enquiries regarding any such changes. The management representation, if any, should act as a collateral evidence to support the particulars given under this clause. In a given case, the process of inquiry may be initiated through management representation. However, that alone should not be considered as sufficient. The tax auditor will have to make such inquiries and verify such records, as may be necessary, to ascertain the nature of business carried on as well as the changes, if any, therein.

41

(iv) A is having a semi-wholesale business and part of the sales are retail sales but cannot be ascertained with precision - what are the reporting requirements here?

Ans. Apparently, the business carried on is essentially a trading business. The tax auditor has to exercise his professional judgement to determine the nature of business for the purposes of reporting. In that, having regard to the facts and the circumstances of the case, it should be considered whether the nature of business should be reported as "trading in general" or the nature of business should be reported also having regard to the nature of operations e.g. semi-wholesale or wholesale etc. While doing so he must have due regard to the nature of activities like the nature of customers, the method of executing the sales i.e. in large quantities or in small quantities etc.

(v) (a) A sells T. V. in retail and also provides “repairing services”.

Please clarify,

(i) whether he can claim benefit of section 44AF, in respect of “retail sale”?

(ii) if yes, if he is using same building, furniture etc. for both business, how the apportionment of depreciation between both business can be done?

(b) If a businessman sells some goods “in retail” for “industrial purpose”, please clarify whether he can get the benefit of section 44AF.

Ans.(a) (i) The term “retail trade” has not been defined in section 44AF and has to be judged from the facts and circumstances of each case having regard to the nature of business and the relevant business practices thereunder. Normally, selling goods in the same conditions as they are purchased amounts to trading and if such selling is to be ultimate user or consumer, it is construed as retail trading. If the composite activities of retailing-cum-repairing services constitute a retail trade as a whole and the other conditions mentioned in the section 44AF are satisfied, there can be

42

no bar for the assessee in exercising the option under section 44AF.

(ii) Where the repairing service by itself constitutes a separate business which can be segregated from the retail trade, necessity for allocation would arise and the tax auditor has to be guided by paragraph 21.3.

(b) Once a business satisfies the essentials of a retail trade, it does not matter whether the goods are sold for industrial purposes or any other purpose.

(vi) From the current year, a chartered accountant starts rendering services on indirect taxes also. Is this a change in the nature of profession?

Ans. The core area of practice of a chartered accountant consists of accounting, auditing, finance and taxation. Hence, commencement of rendering of services by a chartered accountant in indirect taxes cannot be regarded as a change in the nature of his profession.

9. (a) Whether books of account are prescribed under section 44AA, if yes, list of books so prescribed.

(b) Books of account maintained. (In case books of account are maintained in a computer

system mention the books of account generated by such computer system.)

(c) List of books of account examined.

(i) In case where stock records are not properly maintained by the assessee due to big volume of operations e.g. particularly in case of retail trade how should the tax auditor report on such imperfect records maintained by the assessee.

Ans. Paragraph 20.6 advises the assessees engaged in trading/ manufacturing activities to maintain quantitative details of principal items of stores, raw material and finished goods.

Inventories normally constitute a significant portion of the total assets particularly in the case of manufacturing and trading entities as well as some service rendering entities. The Auditing

43

Practices Committee has issued a Guidance Note on Audit of Inventories [Compendium of Guidance Notes, as on January 1, 1998 (Second Edition) Page 54-1 to 54-18]. Under the paragraph entitled “examination of records” it has been observed in the above Guidance Note that the auditor may come across cases where the entity does not maintain detailed stock records other than basic records relating to purchase and sales. In such situations, the auditor would have to suitably extend the extent of application of the audit procedures in regard to the inventories. In this connection the following extracts from paragraph 33 of the above Guidance Note on Audit of Inventories are worth noting.

“The auditor should obtain from the management of the entity a written statement describing in detail the location of inventories, methods and procedures of physical verification and valuation of inventories. While such a representation letter serves as a formal acknowledgement of the management’s responsibilities with regard to inventories, it does not relieve the auditor of his responsibility for performing audit procedures to obtain sufficient appropriate audit evidence to form the basis for the expression of his opinion on the financial information”. (Italics for emphasis).

While giving the particulars in Form No.3CD the concept of materiality has to be kept in mind. If the value of inventories constitutes a very significant portion of the total assets and even then the assessee does not maintain proper stock records, the tax auditor will have to exercise his professional judgement whether the absence of such records would affect his reporting requirements.

(ii) Where an individual assessee is maintaining combined books for business and profession,

(a) is there a need for special mention?

(b) will it be advisable to maintain separate books of account for business and profession?

Ans.(a) If combined books of account are maintained therein, the tax auditor will have to bring out this fact under this clause.

44

(b) It is better that separate books of account are maintained in respect of business and profession.

(iii) What is the exact meaning of “books generated by computer”? Can it be read as “capable of being generated” if no print copy is generated?

Ans. The requirement of sub-clause (b) is that in case books of account are maintained in a computer system, the books of account generated by such computer system are required to be mentioned. Paragraph 20.7 clarifies that only such books of account and other records which properly come within the scope of the expression “proper books of account” should be mentioned. Further, the paragraph advises that the tax auditor should insist on proper printout of books of account being taken out.

The Finance Act, 2001 has inserted the definition of "books or books of account", by way of clause (12A) in section 2 of the Income tax Act, 1961, which reads as follows:

"includes ledgers, day books, cash book, account books and other books, whether kept in the written form or as a printout of data stored in a floppy, disc, tape or any other form of electro-magnetic data storage device".

A computer system is capable of generating a variety of books and records once the basic data is fed into it. But, in the context of the reporting requirements as clarified in the said para as well as the above definition, what is relevant is not the capability of the computer system to generate a variety of books and records. What is relevant is the books generated by the computer system in respect of which printouts are available.

The tax auditor has to assess the extent of computerisation of the accounting records and the visibility of audit trail. Based upon this, he has to exercise his professional judgement to ask for such print outs as would enable him to discharge his responsibility as a tax auditor and would provide evidence of the audit work performed to support the auditor’s opinion. It is significant to note that paragraph 7 of Statement on Standard Auditing Practices: Documentation (SAP 3) observes that the extent of documentation is a matter of professional judgement.

45

In this connection it is relevant to note the following discussion in the Statement on Standard Auditing Practices. This statement vide paragraph 2.17 (Compendium of Statements and Standards - AUDITING (including international standards on auditing) as on October 31, 1995, page No. A-10 deals with computers. Two situations, inter alia, have been considered. One situation speaks about a computer system whereby a “print out” (i.e. a visible record) is available at every stage. In that case the audit trail remains complete and free of the EDP influence and virtually gives the auditor all the freedom he needs to determine the extent and the manner of verification of transaction, taking into account the internal check and control that exists within the organisation but outside the data processing centre. The second situation is where the audit trails have been affected resulting in poorer “visibility” of the records.

(iv) Please clarify whether stock records form part of books of accounts.

Ans. Paragraph 20.6 clarifies that for a person whose accounts of the business or profession have been audited under any other law, the requirement for maintenance of books of account is contained in the relevant statutes. In the case of other assessees, normal books of account to be maintained will be cash book/bank book, sales/purchase journal or register and ledger. Further, section 44AA of the Income tax Act, 1961 requires an assessee to maintain books of account. Recently, the said Act has been amended to define “books of account”. The definition under section 2(12A) of the Act is to the effect that books of account: "includes ledgers, day books, cash book, account books and other books, whether kept in the written form or as a printout of data stored in a floppy, disc, tape or any other form of electro-magnetic data storage device". Assessees engaged in trading/ manufacturing activities should also maintain quantitative details of principal items of stores, raw materials and finished goods. Paragraph 20.8 states that books of account examined would constitute the books of original entry and the other books of account. While the assessee is required to maintain proper evidence in the form of bills, vouchers,

46

receipts, documents, etc., it may be noted that these are essential to support the entries in the books of account and no reference to such supporting evidence need be made under this clause. The concept of materiality is to be the governing factor for the tax auditor to come to a professional judgement whether maintenance or non-maintenance of stock records would affect his reporting requirements.

(v) Rule 6F does not prescribe any books of account for business. In such cases can the tax auditor report “No specific books of account are prescribed under section 44AA”.

Ans. Yes. Since rule 6F does not prescribe any books of account for business, the tax auditor can report as indicated above.

(vi) Should the tax auditor mention specifically whether accounts are maintained in computer system or is it enough if he gives only the list of books of account generated through the computer system?

Ans. It is not the duty of the tax auditor to mention specifically whether accounts are maintained in a computer system. It is enough if he gives only the list of books of account generated through the computer system.

(vii) In case of professions where books of account are specified, would the reporting requirements under sub-clause (b) and (c) be restricted to those specified books of account?

Ans. The objective of tax audit is to enable the Assessing Officer to compute the correct income for the purpose of recovering the tax dues to the Government. The entire objective underlying Forms 3CA, 3CB and 3CD must be understood in the context of the above requirement of law.

CBDT in Rule 6F has prescribed the books of account and other document to be kept and maintained by the specified professional persons. However, an assessee is free to maintain any other books of account in addition to the statutory minimum.

Clause 9(a) of Form No.3CD talks about books prescribed while sub-clause (b) talks about books maintained and sub-clause (c) talks about the books examined.

47

Paragraph 20.1 clearly explains the linkage between these three sub-clauses and places due emphasis on the professional judgement and skill of the tax auditor. Once books of account statutorily prescribed have been maintained, a reasonable conclusion can be drawn to the effect that maintenance of such books will satisfy the requirements. However, where the assessee gives more books and information for examination by the tax auditor, the tax auditor may state the factual position.

10. Whether the profit and loss account includes any profits and gains assessable on presumptive basis, if yes, indicate the amount and the relevant section (44AD, 44AE, 44AF, 44B, 44BB, 44BBA, 44BBB or any other relevant section).

(i) ‘A’ is engaged in retail trading of office & home appliances, and in repairing of these appliances. Common books of account are maintained for both businesses. Total receipts from repairing business, and sales of retail business exceed Rs.40 lakhs. Ratio of repairing receipts and sales vary considerably from year to year. The technicians also works as salesmen. Both the businesses are carried on from the same premises. Please state the basis on which the administrative and general expenses can be allocated.

Ans. The facts given in the issue clearly indicate that the retail trading of home and office appliances and repairing thereof form an integrated business activity. Since the turnover exceeds Rs.40 lakhs tax audit is necessary. As explained earlier, where repairing is incidental to the main activity of manufacture or trading as the case may be, the turnover of the whole business is to be taken into consideration for determining the applicability of section 44AB. Having regard to the facts, as such, the question of any allocation should not arise. Paragraph 21.3 states that the endeavour of the tax auditor should be to arrive at the fair and reasonable estimate of such expenditure on the basis of evidence in possession of the assessee. Further it states that it is also necessary to mention the basis of apportionment of common expenditure.

48

(ii) Please clarify whether only the gross presumptive income is to be reported or the income arrived at after considering all expenses is also required to be reported.

Ans. The amount to be mentioned under this clause means the net amount included in the profit and loss account computed in accordance with the paragraph 21.3. The tax auditor is not required to indicate as to whether such amount corresponds to the amount assessable under the relevant section relating to presumptive taxation. As such, the reporting requirement gets satisfied if the amount as per profit and loss account is furnished.

(iii) A tax audit was carried out under section 44AB read with section 44AF. What are reporting requirements under this clause? Should we show the net profit of business?

Ans. Since the assessee has opted for tax audit in respect of retail trade, only the net profit of the business should be shown.

(iv) If profits and loss account includes, inter alia, the amount offered on presumptive basis, is the auditor required to verify the working of such amount offered?

Ans. Please refer to paragraph 21.3 explained under issue (ii) for suitable guidance.

(v) If the assessee does not opt for presumptive taxation, even then would such income specified in sections 44AD, 44AE, etc. be required to be separately reported by making calculations under those provisions as if the assessee had opted for that scheme?

Ans. Once the assessee does not opt for presumptive taxation and prefers to get his books of account audited, there is no requirement to report the income assessable in terms of sections dealing with presumptive taxation.

11. (a) Method of accounting employed in the previous year.

(b) Whether there has been any change in the method of accounting employed vis-à-vis the method employed in the immediately preceding previous year

49

(c) If answer to (b) above is in the affirmative, give details of such change, and the effect thereof on the profit or loss.

(d) Details of deviation, if any, in the method of accounting employed in the previous year from accounting standards prescribed under section 145 and the effect thereof on the profit or loss.

(i) The assessee changed the method of accounting in the preceding previous year which was not accepted by the authorities. However, no change was made during the current previous year. Is any disclosure required?

Ans. So far as the assessee is concerned he has not changed the method of accounting employed vis-à-vis the method employed in the immediately preceding previous year. Hence, the tax auditor has to simply state under sub-clause (b) ‘No’.

(ii) Section 145A provides for method of accounting applicable w.e.f. 1.4.99. Thus the method may be different in the previous year ending 31.3.99 as compared to previous year ending 31.3.98. As the change is due to the introduction of a statutory provision, what are the reporting requirements?

Ans. Section 145A has been enacted by the Finance (No.2) Act, 1998 and has come into force from the accounting year 1.4.1998 to 31.3.1999 (assessment year 1999-2000). The section provides for a method of valuation of purchase and sale of goods and inventory for the purpose of computation of income from business or profession. This section is applicable notwithstanding anything contained in section 145. It is not necessary to change the method of valuation of purchase, sale and the inventory regularly employed in the books of account. The adjustments provided in this section can be made while computing the income for the purpose of preparing the return of income. Further, the statutory adjustments under section 145A would amount only to change in accounting policy and are therefore normally to be indicated in the financial statements. But since such adjustments are made outside the books of account, they have to be stated under clause 11(d).

50

Further, Accounting Standard 2 has been made mandatory from accounting year beginning on or after 1.4.1999. In view of the above, all assessees have to be follow exclusive method specified by Accounting Standard 2 and have to make the adjustments under section 145A outside the books of account with effect from assessment year 2000-2001. Hence, it appears that there would be no reporting requirement regarding any change in the method of accounting.

Section 145A does not require an assessee to change the method of accounting followed. It only contemplates an adjustment in computation of the income in the nature of profits and gains of business. In other words, an assessee can continue to follow the method of accounting as laid down in AS-2.

(iii) Should a change in an accounting policy be considered as a change in the method of accounting employed?

Ans. No. Paragraph 22.7 clarifies that a change in an accounting policy will not amount to change in the method of accounting and hence such change in the accounting policy need not be mentioned under sub-clause (b). This is due to the fact that as per the requirements of AS-1 and AS(IT)-1 such changes and the impact of such changes will be disclosed in the financial statements.

(iv) In the case of a concern where previous year’s accounts are not audited the tax auditor gives the following note.

“Although previous year’s accounts are not audited, as per information and explanations given to us, there is no change in the method of accounting employed”.

Is the above note appropriate?

Ans. The duty of the tax auditor is to give the audit report either in Form No.3CA or 3CB along with the required particulars in Form No.3CD for the previous year relevant to the concerned assessment year. The method of accounting is different from accounting policy. Since the reporting requirement is with reference to method of accounting, it may not be difficult to verify the method of accounting followed in the earlier previous year.

51

Once the tax auditor is satisfied that there is no change in the method of accounting employed during the previous year which is under tax audit as compared to the method of accounting employed in the immediately preceding previous year, his reporting duty under this clause is complete. It is not necessary for him to go into the question of audit of the accounts of the immediately preceding previous year. However, in a case where, according to the professional judgment of the tax auditor, it is not possible to verify the method of accounting employed in an earlier year, after reasonable efforts, it may be appropriate for the tax auditor to put in a note to the effect suggested in the question, with such modifications as may be required having regard to the facts and circumstances of each case.

(v) The Accounting Standards (AS-IT) notified by Central Government under section 145 do not deal with method of accounting. They deal with disclosure of accounting policies and how should deviations from such standards be disclosed?

Ans. The Central Government has notified two Accounting Standards in exercise of the powers conferred by section 145(2). They are Accounting Standard I relating to disclosure of accounting policies and Accounting Standard II relating to disclosure of prior period and extraordinary items and changes in accounting policies. These standards are applicable only to those assessees who are following the mercantile system of accounting.

If an assessee has deviated from the said Accounting Standards, having regard to the nature of deviations, it may be necessary for the tax auditor to qualify or disclose the nature thereof in terms of the guidance given in "Announcements of the Council regarding various documents issued by the Institute of Chartered Accountants of India" under the heading "Manner of making qualification/ disclosure in the audit report" (paragraphs 15 to 18).

12. (a) Method of valuation of closing stock employed in the previous year.

(b) Details of deviation, if any, from the method of valuation prescribed under section 145A, and the effect thereof on the profit or loss.

52

(i) Where an assessee is following cash system of accounting, should he account for the closing stock or alternatively, can the entire purchases be claimed as an expense?

Ans. Even if the assessee is following cash system of accounting, he should account for the closing stock as per the principles laid down in Accounting Standard - 2 (Revised) valuation of inventories. The trading account has to be prepared and the opening stock, purchases and closing stock have to be accounted for. The concept of materiality is to be kept in mind while making valuation of closing stock.

In this connection, a reference may be made to the decision of the Supreme Court in CIT v. A. Krishnaswami Mudaliar (53 ITR 122, 132), wherein it was held "But whatever may be the system, whether it is cash or mercantile, … , in a trading venture it would be impossible accurately to assess the true profits without taking into account the value of the stock in trade at the beginning and at the end of the year".

(ii) Please elucidate the meaning of the expression “valuation of sales”. In the context of section 145A. Should sales tax be included in such a valuation? .

Ans. Though section 145A refers to “valuation of sales”, the meaning of the said words should be taken to be “actual sales”. This is so because sales are accounted at the actual values and therefore there is normally question of no “valuation of sales”. However, in the case of barter transactions, the question of valuation will arise. Whether sales tax is to be included in sales account or not depends upon the accounting policy which the assessee follows. Paragraph 5.5 of the Guidance Note makes this clear.

(iii) In clause 3(i) of the old Form No.3CD, reference was to “opening and closing stock-in-trade”. In sub-clause (a) of clause 12 of revised Form No.3CD, the reference is to closing stock. What is the significance of this change?

Ans. The significance of this change is explained in paragraph 23.3. In clause 3(i) of the old Form No.3CD reference was to “opening and closing stock-in-trade”. In sub-clause (a) of clause 12 of revised Form No.3CD, the reference is to “closing stock”. The expression

53

“stock-in-trade” means finished goods and raw materials. Since sub-clause (b) refers to section 145A where the term “inventories” is used, the term “closing stock” will include all items of inventories. AS-2 defines the term “inventories” to include finished goods, raw materials, work-in-progress, material maintenance supplies, consumables and loose tools. Therefore, method of valuation of items of closing inventories will have to be given under sub-clause (a).

(iv) In paragraph 23.13, it has been stated that to give effect to section 145A, the opening stock as on 1.4.98 will have to be increased by any tax, duty, cess or fee actually paid or incurred with reference to such stock if the same has not been added for the purpose of valuation in the accounts. When the value of the opening stock is increased please explain the adjustments to be passed.

Ans. As discussed above, section 145A does not contemplate any adjustments in books of account. It only contemplates an adjustment in computation of income. Accordingly, while giving effect to the provisions of section 145 A, there would not be any necessity "to pass any adjustments", as stated in the query.

As regards raw material the effect of the credit entries is shown in Modvat credit account [Item (m)] in the illustrations given in the Guidance Note. As regards finished goods the effect is explained in the paragraph 23.13. Accordingly, it may be noted that when the adjustments are made in the valuation of inventories, this will affect both the opening as well as closing stock. Whatever adjustment is made in the valuation of closing stock, the same will be reflected in the opening stock also. Question for consideration is whether the opening stock as on 1.4.1998 should be adjusted as required under section 145A. It is now well settled that if any adjustment is required to be made by a statute, effect to the same should be given irrespective of any consequences on the computation of income for tax purposes. Section 145A starts with the non obstante clause "Notwithstanding anything to the contrary contained in section 145". Therefore, to give effect to section 145A, the opening stock as on 1.4.98 will have to be increased by any tax, duty,

54

cess or fee actually paid or incurred with reference to such stock if the same has not been added for the purpose of valuation in the accounts. This is only a transitional difficulty for the assessment year 1999-2000.

(v) If the assessee is not complying with the provisions of section 145A in the books of account and the same is reported in Form No.3CD, can the Assessing Officer reject the books of account on the ground that the books of account are not properly maintained?

Ans. The Assessing Officer cannot reject the books of account on the ground that books of account are not properly maintained. In fact section 145A mentions “Notwithstanding anything to the contrary contained in section 145” and “for the purposes of determining the income chargeable under the head “Profits and gains of business or profession”. The aforesaid clearly brings out the fact that the adjustment is necessary only for the purpose of computing income and are to be made outside the books of account.

(vi) Please clarify whether adjustment of Modvat against excise duty payable is considered as “paid” for the purposes of section 43B.

Ans. Yes, adjustment of Modvat against excise duty payable is considered as “actually paid” for the purpose of allowance under section 43B. It is a constructive payment. Reference can also be made to the Hon’ble Supreme Court decision in Standard Triumph Motor Company Limited v CIT 201 ITR 391.

(vii) Imported raw material is lying in customs bonded warehouse. The same is shown as stock in transit in the books. Should the customs duty components, not yet paid, be added to the value of imported raw material in order to satisfy the requirements of section 145A?

Ans. Section 12 of the Customs Act is the charging section thereunder. It provides that except as otherwise provided in the Customs Act, or any other law for the time being in force, duties of customs shall be levied at such rates as may be specified under the Customs and Tariff Act, 1975 or any other law for the time being in force, on goods imported into, or exported from, India. Clause (23) of section 2 defines “import” as meaning bringing into India from a place outside India. Clause (27) defines “India” as

55

including the territorial water of India. Therefore, the taxable event occurs the moment the goods entered the territorial waters of India. There cannot be different taxable events for different purposes. Section 13 of the Customs Act provides that if any imported goods are pilfered after the unloading thereof and before the proper officer has made an order for clearance for home consumption or deposit in a warehouse, the importer shall not be liable to pay the duty leviable on such goods except where such goods are to be restored to the importer after pilferage. Section 68 of the Customs Act provides for clearance of warehouse goods for home consumption. Accordingly, the importer of any warehoused goods for home consumption if (a) a bill of entry for home consumption in respect of such goods has been presented in the prescribed form (b) the import duty leviable on such goods and all penalties, rent, interest and other charges payable in respect of such goods have been paid, and (c) an order for clearance of such goods for home consumption has been made by the proper officer. A combined reading of these provisions will indicate that while liability for duty under the customs Act arises in the event of import, the payment may be postponed if the goods are stored in a bonded warehouse. It appears therefore that the duty element should be added for the purpose of making the statutory adjustments under section 145A.

(viii) AS-2 (Revised) Valuation of Inventories states clearly that cost of purchase should exclude duties that are recovered subsequently for e.g.

Duty

Cost 10 2 12 Manufacturing cost 10 - 10 ---- 22 ---- Duty on purchased goods 3 AS-2 145A Valuation for cost 22 22 Less Modvat 2 - ---- ----

56

20 22 Excise duty 3 3 ---- ---- 23 25 ---- ---- Is the above understanding correct?

Ans. The valuation of closing stock shown under column 145A would need to be reduced by Modvat credit (Rs.2) since in the inclusive method Modvat credit would have been accounted in arriving at consumption of raw material. The net raw material cost only should be taken into account in valuation of closing stock of finished goods. As such the valuation of goods under column 145A will be Rs.23 and not Rs.25. Refer to second paragraph of note no.2 in paragraph 23.15.

(ix) Section 145A is supposed to be tax neutral. This argument does not hold good in a case where excise duty is payable by a manufacturer in a financial year on account of his sales exceeding the basic exemption limit, but in the next year the turnover is within the basic exemption limit and the unit is not liable to pay the excise duty. In such a situation, how can the credit of excise duty on closing stock be claimed?

Ans. In the first year debit of excise duty and adjustment of excise duty to the closing stock would offset each other and as such there would be no impact on the profit as per accounts. However, the debit on account of excise duty would be disallowed under section 43B. In the next year the opening stock would be closing stock of the first year, duly adjusted with excise duty. The earlier year’s excise duty debit would be no longer required as such the same would be credited to profit and loss account of the next year. However, this credit would not be taxable in view of disallowance of the amount in the first year under section 43B. It is also significant to note that paragraph 13 of AS 4 - Contingencies and Events occurring after the balance sheet date provides that assets and liabilities should be adjusted for events occurring after the balance sheet date that provide additional evidence to assist the estimation of amounts relating to conditions existing at the balance sheet date.

57

(x) Liability on closing stock of finished goods are provided. The goods are yet in the godown. There is a fire and goods are destroyed. Is the assessee required to include the amount of excise duty in the valuation of stock for the purpose of section 145A?

Ans. Excise is a duty on manufacture of goods and the liability for duty arises as soon as such goods are manufactured. The duty payable on such goods will have to be included for the purpose of valuation of closing stock. If such goods are lost or destroyed in storage, remission of duty can be given by the Commissioner on application. However, once the goods are cleared from the factory and subsequently they are destroyed there is no provision for granting refund of duty.

(xi) The words 'to bring the goods to the present location or condition' occurring in section 145A(b) are applicable to sales, purchases and stocks and not only to stocks. Since sales tax is not incurred or paid to bring the goods to the present location or condition, should the same be added for the purpose of valuation of “sales”?

Ans. For purposes of valuation of sales, the sales-tax should be included in sales to comply with the provisions of section 145A. However corresponding debit adjustments will made as explained in paragraph 23.5 read with Note 3. Note No.4 also provides that it may be noted that liability for sales tax arise on sale as against liability for excise duty which arises on manufacture. As such the liability of sales-tax need not be adjusted in the closing stock of finished goods before the same are sold.

(xii) In regard to the method of valuation of closing stock should the relevant cost formulas used for valuing such stock be mentioned.

Ans. As per paragraph 23.1, the method of valuation of closing stock is to be stated under clause 12(a). It is the normal practice to disclose the same as a part of disclosure of significant accounting policy. Accordingly, a reference may be invited to the same. Since the application of relevant cost formulae forms part of

58

accounting policy, such cost formulae need not be separately disclosed in Form No.3CD.

(xiii) If there is no closing stock in a particular year, should the method of valuation of closing stock be mentioned there also?

Ans. Since there is no closing stock the tax auditor need not state anything. However, it is advisable to state the accounting policy followed by the assessee for valuation of closing stock, in the finance statements.

(xiv) Where stock is valued at ‘market value’ (being lower than cost), should excise duty be added thereon for the purpose of complying with section 145A?

Ans. The excise duty on finished goods is required to be added to stock to arrive at the cost. If, the stock is valued at “Market value” there would be no requirement to add such excise duty to stock. Usually market value is inclusive of excise duty. It is not, therefore, added. However, in case where excise duty is recoverable in addition to the market value such excise duty should be added.

(xv) During the year after announcement of AS-2 as mandatory, Modvat has been excluded for the purpose of valuation of opening stock though Modvat portion was considered for valuation of closing stock of last year. Since clause 12(b) asks for details of deviation, if any, from section 145A, should the deviation for valuation of opening stock be given? Alternatively please clarify whether this issue is covered in clause 11(d).

Ans. Yes, the excise duty should be included in the valuation of stock in order to comply with provisions of section 145A. Once the statutory adjustments are shown as part of computation of income, no separate disclosure is necessary under sub-clause 12(a). The issue is not covered by clause 11(d) since 11(d) requires reporting of deviation, if any, in the method of accounting employed in the previous year from accounting standards prescribed under section 145.

(xvi)(a) While giving effect of deviation from section 145A, as per the Guidance Note, excise duty payable on finished goods has to be

59

covered in the information related to section 43B i.e., it is allowable as deduction on payment basis. Kindly elaborate.

(b) Subsequent to the year end but before furnishing of return, excise duty of an amount which is more than the payable amount, has been paid.

Ans.(a) The component of excise duty on finished goods forms part of value of stock in trade. This is because the moment the manufacture of the goods is complete in all respects and ready for dispatch the liability of excise duty arises. The deduction for excise duty is allowed only when the excise duty on such goods is paid on the finished stocks cleared and/or dispatched. The information relating to section 43B is only to see that claim is not made on the basis of advance payments made without clearance and/or dispatch of goods.

(b) Section 43B is a provision intended to disallow certain items of expenditure which are otherwise admissible on account of non-payment within the stipulated date. It cannot be used to allow an item of expenditure which is not relating to the year merely on account payment made. Hence, excise duty paid in excess of amount payable cannot be claimed as deduction. Reference to Gopikrishna Granites India Ltd. v. DCIT 251 ITR 337 (AP) and Hindustan Liver Limited v. V.K. Pandey, JCIT, 251 ITR 209 (Bom) can be relevant in this regard.

(xvii) For complying with the requirements of section 145A, should effect for Modvat be given on item by item basis or on a global basis?

Ans. In respect of closing stocks, excise duty has to be worked out item-wise. Effect for Modvat can be given on a global basis. However, proper records should be readily available to support such aggregate adjustments.

13. Amounts not credited to the profit and loss account, being,-

(a) the items falling within the scope of section 28;

(b) the proforma credits, drawbacks, refund of duty of customs or excise, or refund of sales tax, where such

60

credits, drawbacks or refunds are admitted as due by the authorities concerned;

(c) escalation claims accepted during the previous year;

(d) any other item of income;

(e) capital receipt, if any.

General

(i) In regard to items covered within the scope of section 28 should they be restricted to books of account? For example, they might not have been credited to the profit and loss account but might have nevertheless been credited to general reserve.

Ans. The information under sub-clause (a), (d) and (e) of clause (13) is to be given with reference to the entries in the books of account and records made available to the tax auditor for the purpose of tax audit. For giving the information under sub-clauses (b) and (c) the tax auditor may have to verify subsequent records. However, even such information is to be given with reference to the books of account. Therefore if some items have not been credited to the profit and loss account but have been credited to general reserve, the tax auditor has a duty to report under clause 13.

(ii) An assessee has incomes like debenture interest, bond interest, profit on sale of capital items. They have not been credited to the profit and loss account of the business but have been credited to the capital account of the proprietor. What are the reporting requirements under clause 13?

Ans. Paragraph 49.2 states that the tax audit report in Form No.3CA/3CB relates to the business or professional activity of the assessee covered by section 44AB. Form No.3CD is an annexure to this form giving particulars relating to the business/profession covered by the tax audit report. Therefore, the requirement under clause 26 relating to the deductions admissible under chapter VIA will have to be restricted to the items appearing in the books of account audited by the tax auditor. Further, paragraph 49.3 clarifies that in the case of a sole proprietor being an individual or HUF it may so happen that the tax auditor is auditing the accounts of the

61

business/profession and the sole proprietor is having other activities and other sources of income in respect of which tax audit is not mandatory. In such cases the particulars of deductions admissible under Chapter VIA will have to be given only with reference to the items appearing in the books of accounts of the business/profession which is subject to audit under section 44AB. Accordingly, the particulars relating to the amounts not credited to profit and loss account should be given with reference to the books of account only, which is subject to the audit.

(iii) In regard to the items falling within the scope of section 28 is the tax auditor required to report on any such receipts by the assessee? What are the reporting requirements under such circumstances?

Ans. The tax auditor has to make his report in Form No.3CA/3CB and give the prescribed particulars in Form No.3CD based on the books of account and other records and information and explanations made available for the purpose of tax audit. He has to report about items of receipts falling within the scope of section 28 that could be found in the books of records and information and explanations obtained.

(a) The items falling within the scope of section 28

(iv) Nowadays many companies are organising foreign tours for their dealers if they achieve targeted sales. In such situations either the proprietor or the partner of the dealer firm or the director of the dealer company may avail of the foreign tour. What are the duties of the tax auditor in this regard?

Ans. Clause (iv) of section 28 brings to charge the value of any perquisite or benefit convertible into money or not arising from the exercise of business or profession. Such benefit might have not been credited to the profit and loss account or in the books of account.

As stated earlier, the tax auditor is required to report in regard to items falling within the scope of section 28 whether or not they are entered into the books of account. If the books of account or any other supporting documents or records reflect or indicate

62

enjoyment of some such benefit, he may make further inquiries. Based on such inquiries, in exercise of his professional judgment, he may report about such benefit appropriately. Where circumstances warrant it may be clarified that the information is not necessarily exhaustive and is given on the basis of the knowledge he acquired in the course of audit carried out in accordance with the normally accepted auditing practices.

(b) The pro forma credits, drawbacks, refund of duty of customs or excise, or refund of sales tax, where such credits, drawbacks or refunds are admitted as due by the authorities concerned

(v) An octroi incentive admitted by Government under Package Scheme of incentive 1988/89 has not yet been received. As per the Package Scheme the entity has to comply with certain conditions for 15 years. Even then there is no certainty as to actual receipt.

Should such octroi incentives admitted under the relevant schemes be reported under clause 13(b)?

Ans. A strict reading of sub-clause (b) of clause 13 appears to exclude octroi incentives from its scope. Nevertheless it may come within the scope of sub-clause (d). However, the taxability of any incentive admitted/received under the relevant scheme depends upon the fulfillment of prescribed conditions.

(vi) Industries set up in backward areas are getting State incentive through waiver of sales tax up to certain limit. The unit also receives set-off on their purchases for sales tax paid on purchases by such units.

Ans. The benefit of sales-tax set off is governed by the concerned incentive scheme announced by various State Governments. Whether a sales tax set off would go to reduce the cost of plant and machinery or whether it would be considered as a revenue bridging measure depends upon the provisions of the relevant schemes. However, once the same is admitted as per the provisions of the relevant scheme, the same has to be reported. When the assessee follows cash method of accounting, paragraph 24.2 clarifies that the tax auditor should bring out the

63

fact that since the admittance of claims during the relevant previous year has no significance.

(vii) If the sales tax set off availed on purchase of machinery is credited to the respective machinery account should the same be reported under clause 13(b)?

Ans. As per normally accepted accounting principles, such set-off is required to be reduced from the cost of the asset. In other words, such set-off is not required to be credited to the profit and loss account. In the circumstances, such set-off need not be reported under this clause. Further, the set-off cannot be equated with refund. Also, it would be necessary to disclose accounting policy for the mode and method of arriving at the cost of fixed assets and in that, usually, the disclosure is made about adjustments of such set-off etc. The Tax Auditor may, in his professional judgment, if thought fit, invite a reference to such policy while reporting under this clause.

(viii) Duty drawback claim was made during the year ended 31-03-1999 for Rs.10,000. The department has accepted the claim for Rs.8,000 in March, 2000 and paid the amount in May, 2000. Is the above item covered by this sub-clause?

Ans. Under this sub-clause only such amounts as are admitted by the concerned authorities but not credited to the profit and loss account are to be mentioned. In the above case, if the assessee is maintaining accounts on mercantile basis in respect of drawback claims, the entry would appear in the accounts. If not so audited, the tax auditor is required to report the same. If the accounts are maintained on cash basis in respect of this item, the credit will not appear in the accounting year ending 31-03-2000. In that case, it will be necessary to state that the claim for Rs.8,000 has been accepted but not credited to profit and loss account as the accounts are maintained on cash basis.

(c) Escalation claims accepted during the previous year

(ix) In case where an assessee is following cash method of accounting, is it necessary to give details of escalation claims accepted during the previous year?

64

Ans. The tax auditor has to give the necessary details. However, paragraph 24.3, inter alia, clarifies that if the assessee is following cash basis of accounting with reference to escalation claims, it should be clearly brought out by the tax auditor that acceptance of claims during the relevant previous year without actual receipt has no significance in cases where cash method of accounting is followed.

(d) Any other item of income

(x) What would be the scope of clause 13(d) in view of the position that clause 13(a) covers the items falling within the scope of section 28.

Ans. Paragraph 24.1, inter alia, observes that clause 13 (b), (c) & (d) require information in respect of items which may be covered under section 28 and as such will also fall in clause 13 (a). However, those items, already reported in clauses 13(b), (c) and (d), need not be reported in clause 13(a).

(xi) In case of an individual assessee certain incomes are exempt like:

- share of profit from partnership firms – exempt under section 10(2A);

- income of minor children exempt under section 10(32).

Should such incomes also be disclosed under clause 13(d)?

Ans. Any income which could be ascertained from the books of account, records and information made available to the tax auditor has to be reported. However, the tax auditor should clearly state that such incomes are excludible under the relevant provisions of section 10.

(xii) Clause 13(a) to (e) speaks about amounts not credited to profit & loss account. Under which sub-clause should the foreign exchange fluctuations be shown if it does not fall under clause 14(d)(ii)?

Ans. Whether exchange fluctuation constitute a revenue or a capital item depends upon the facts and circumstances of each case. Reference can also be made to CIT v. Tata Locomotive & Engg.

65

Co. Ltd. [1966] 66 ITR 405 (SC) and also CIT v. Canara Bank Ltd. [1967] 63 ITR 328 (SC). If such fluctuations constitute an item of income and not credited to the profit and loss account clause 13(d) will apply and if it is a capital receipt clause 13(e) will apply. If such fluctuations have to be adjusted in the actual cost for the purpose of calculating depreciation allowable, the tax auditor has to state the same under clause 14(d)(ii). It is, however, advisable to indicate the fact under sub-clause (b) of this clause also.

(e) Capital receipt, if any

(xiii) Will the term “capital receipts, if any” cover capital contribution like gifts, share capital etc.?

Ans. The term “capital receipt” in clause 13(e) does not cover share capital or items of gifts etc.

(xiv) In case of any credits to the capital account, should the tax auditor verify the transactions?

Ans. Clause 13(d) and (e) would definitely require the tax auditor to examine the books of account including the capital account to see whether any item of income or a capital receipt not credited to the profit and loss account is credited therein and to report accordingly.

(xv) What types of capital receipts should be indicated?

Ans. As per paragraph 24.5, the following is an illustrative list of capital receipts which, if not credited to the profit and loss account, are to be stated under this sub-clause.

(a) Capital subsidy received in the form of Government grants which are in the nature of promoters’ contribution i.e., they are given with reference to the total investment of the undertaking or by way of contribution to its total capital outlay. For e.g., Capital Investment Subsidy Scheme.

(b) Government grant in relation to a specific fixed asset where such grant is shown as a deduction from the gross value of the asset by the concern in arriving at its book value.

(c) Compensation for surrendering certain rights.

66

(d) Profit on sale of fixed assets/investments to the extent not credited to the profit and loss account.

14. Particulars of depreciation allowable as per the Income-tax Act, 1961 in respect of each asset or block of assets, as the case may be, in the following form:-

(a) Description of asset/block of assets.

(b) Rate of depreciation.

(c) Actual cost or written down value, as the case may be.

(d) Additions/deductions during the year with dates; in the case of any addition of an asset, date put to use; including adjustments on account of-

(i) Modified Value Added Tax Credit claimed and allowed under the Central Excise Rules, 1944, in respect of assets acquired on or after 1st March, 1994,

(ii) change in rate of exchange of currency, and

(iii) subsidy or grant or reimbursement, by whatever name called.

(e) Depreciation allowable.

(f) Written down value at the end of year.

(i) Please clarify as to how the tax auditor should approach the following:

(a) calculation of WDV of the assets as on 1.4.1998;

(b) treatment of disallowances made for personal use of assets in earlier years;

(c) past disallowances pending in appeals.

Ans. Paragraph 25.4, inter alia, states that under sub-clauses (a) and (b), information in respect of description of assets, block of assets under which the concerned asset is classifiable and the rate of depreciation are to be stated, which will obviously include information about the existing assets. In respect of the existing assets, the computation of depreciation would involve stating the

67

opening written down value of the block of assets which should be taken from the relevant income-tax records. The tax auditor will be conducting the audit in the current year only. As such he can rely upon the classification of asset and written down value stated in the income-tax records available with the assessee. He should mention the fact that he has relied upon the income-tax records of the assessee in respect of the information regarding the classification of assets and written down value of the existing assets. If there is a dispute regarding classification or the rate of depreciation or if there is dispute in the earlier years between the assessee and the department regarding classification, rate of depreciation, disallowance etc. The tax auditor should make suitable disclosures depending upon the facts and circumstances of the case.

(ii) Please clarify the basis upon which depreciation will be allowed under cash system. Will it be allowed on full cost or will it be limited to the actual payment made during the relevant previous year?

Ans. For the purpose of calculating the depreciation allowable under the Income-tax Act the basis will be the actual cost as defined in section 43(1) of the Income-tax Act. Accordingly, even if an assessee is following cash method of accounting depreciation has to be allowed on the full actual cost even if only a portion of it might have been paid in cash during the relevant previous year. It is because of the fact that when the asset is used in business, the whole of the asset is used and not a part proportionate to the cash paid.

(iii) (a) Are the new rates applicable only for the new computers purchased during the year or are they also applicable to old computers? Please clarify.

(b) Can an assessee segregate the cost of computer included in the plant and machinery block for claiming 60% depreciation if it can conveniently be segregated on the basis of books of account maintained. What is the auditor’s responsibility for reporting?

(c) In the block of assets as at the commencement of the 1.4.1998, there remains only a computer. Can we charge 60% depreciation

68

on the opening WDV? The main heading shown in earlier years was plant and machinery.

Ans. All the three issues are disposed of through one answer. The Income-tax (Twelfth Amendment) Rules, 1998 inserted item (2B) in Appendix I to the Income-tax Rules under the heading “machinery and plant” whereby a new rate of depreciation at 60% was provided for computers. The amendment is effective from assessment year 1999-2000. Accordingly, the increased rate of 60% is applicable in respect of computers.

According to section 2(11), “block of assets” means a group of assets falling within a class of asset comprising,-

(a) tangible assets, being building, machinery, plant or furniture;

(b) intangible assets, being know-how, patents, copy-right, trademarks, licences, franchises or any other business or commercial rights of similar nature,

in respect of which the same percentage of depreciation is prescribed. It follows therefore, that the essential characteristics of a “block of assets” are that they should belong to a group of assets falling within either the tangible assets or intangible assets and it has the same rate of depreciation. From the above it is clear that when the amendment allows an increased rate of depreciation at 60% in respect of computers purchased after 1.4.1998 such computers will constitute a separate block of assets. Further, prior to Assessment Year 1999-2000, computers were classified under the block “plant and machinery” and the applicable rate of depreciation was 25%. The issue for consideration is how to treat the computers which formed part of the block of assets namely “plant and machinery” as on 1.4.1998. Two views are possible. The first view is that computers acquired prior to 1.4.1998 which formed the block of assets “plant and machinery” cannot be segregated from that block and allowed a higher depreciation at the rate of 60% from the previous year commencing from 1st April, 1998. The other view is that the WDV of the computers grouped under the block “plant and machinery” should be segregated from that block and added to the new block

69

of computers purchased after 1.4.1998 and be allowed depreciation at the rate of 60%.

The Income-tax (Twelfth Amendment) Rules, 1998 is a beneficial amendment in that it enables the assessee to write-off computers acquired after 1.4.1998 in a lesser period of time in view of the fast changing technology and the resulting obsolescence. When the Board is convinced of the presence of obsolescence even in respect of the latest computers, it applies even to the older computers acquired prior to 1.4.1998 with more force. If the assessee is to write-off the old computers at a lower rate of depreciation he will be burdened with a huge obsolete block of computers. Hence, applying the principles laid down by the Hon’ble Supreme Court in Ellerman Lines Ltd. v. CIT [1971] 82 ITR 913 and Navnit Lal C. Javeri v. K.K. Sen, AAC [1965] 56 ITR 198 it is reasonable to conclude that even computers acquired prior to 1.4.1998 and forming part of the block of assets “plant and machinery” having a rate of depreciation of 25% are eligible for the increased rate of depreciation at 60%. It is significant to note that item (2)(iia) in Appendix I under the block “machinery and plant” giving increased rate of depreciation to old commercial vehicles has specifically stated that such commercial vehicles must be acquired on or after 1st October, 1998 but before the 1st day of April, 1999. In respect of computers the increased rate of depreciation has been given without mentioning any dates whatsoever.

(iv) In the above situation, whether under clause 14(f) (WDV at the end of the year), any specific treatment/note has to be given?

Ans. Yes. The tax auditor has to indicate the depreciation allowable and compute the WDV at the end of the previous year.

(v) (a) In the circumstances where depreciation has not been claimed in the accounts and is not likely to be claimed in the return also, should the tax auditor state the particulars of depreciation under clause 14 or not?

(b) The assessee wants to claim less depreciation than allowable under Income-tax Act. Is it permissible? What is the duty of the tax auditor in this regard?

70

Ans. Issues (vi) (a) and (b) being similar are answered together. The Hon’ble Supreme Court in Mahindra Mills Ltd. v CIT 109 Taxman 225 (SC) has taken a view that an assessee can claim depreciation as per the rates prescribed in the Income-tax Rules or can opt not to claim depreciation in which case the same cannot be thrust upon him. It may, however, be noted that the Finance Act, 2001, with effect from 1st April 2002, has inserted Explanation 5 below section 32 (1) to provide that the provisions of sub section (1) shall apply whether or not the assessee has claimed the deduction in respect of depreciation in computing total income. In other words, the effect of the Explanation is that the depreciation would be considered in computing total income irrespective of the fact whether a claim is made or not. Further, it is not open to an assessee to claim lesser depreciation than the prescribed rate. Where, however, an assessee chooses to claim depreciation at a lower rate or does not claim or does not intend to claim depreciation, the tax auditor, as such, does not have to calculate the depreciation on his own. It would be sufficient for him to state in the report that the assessee does not intend to claim the depreciation or has claimed depreciation at a lower rate and give the necessary facts, if any, relating thereto. There may also be a situation where the assessee does not want to claim depreciation but is willing to give all the particulars necessary for calculating depreciation. The tax auditor in that case can compute the allowable depreciation and provide the required information under the clause.

(vi) If depreciation is not provided in the books can the tax auditor mention “No depreciation provided” under clause 14?

Ans. While giving the audit report in Form No.3CA/3CB the tax auditor has to satisfy himself that the assessee has complied with the accounting standards issued by the Institute. AS-6 Depreciation Accounting clearly provides that depreciation is allocated so as to charge a fair proportion of the depreciable amount in each accounting period during the expected useful life of the asset. Where appropriate depreciation has not been provided in the books of account, the financial statements will not represent a true and fair view. The tax auditor has to qualify his report

71

accordingly. Further, the assessee may claim depreciation for the purposes of computing his total income, although, no provision therefor is made in the accounts. In that case, requisite information, as per the provisions of the Act would be furnished by the assessee and can be reported accordingly.

(vii) Where the incomes of companies are exempt under sections 10, 10A or 10B should they give details of depreciation allowable under Income-tax Act? Till date they have not provided such details with their income-tax returns. Please clarify.

Ans. Exemptions are available under sections 10A, 10B and 10C in respect of newly established industrial undertakings in free trade zones, newly established 100% export oriented undertakings and certain industrial undertakings in North Eastern region. It is significant to note that there are specific provisions in sections 10A, 10B and 10C to the effect that in computing the total income of the assessee of the previous year relevant to the assessment year immediately succeeding the last of the relevant assessment year or of any previous year, relevant to any subsequent year in computing the allowance under section 32, the written down value of any asset used for the purposes of the business of the industrial undertaking shall be computed as if the assessee had claimed and been actually allowed the deduction in respect of depreciation of each of the relevant assessment year. Therefore it is necessary to keep proper details of depreciation allowable even where the assessees claim exemption under sections 10A, 10B or 10C. It is significant to note that the Finance Act, 2000 has substituted a new section 10A w.e.f. Assessment Year 2001-2002 sub-section (5) whereof provides that the deduction under section 10A will be allowed only if the assessee furnishes the report of a chartered accountant that the exemption under section 10A, 10B or 10C has been computed correctly. It may also be noted that the Finance Act, 2002 has inserted a second proviso in sub section (1) of sections 10A and 10B to provide that the deduction would be restricted to 90 percent of the profits and gains for assessment year 2003-04. In other words, 10 percent of the profits and gains would become taxable in the case of assessees claiming deductions under sections 10A and 10B.

72

Accordingly, it would become necessary for such assessees to compute total income in respect of the units eligible for deduction under the said sections, which would also necessitate computation of depreciation. In that case and even otherwise, the assessees may furnish particulars of depreciation and accordingly the tax auditor may report about the same. If the assessees do not furnish the information of depreciation, for whatever reason, the tax auditor may clarify the fact appropriately, as discussed earlier in response to query No (vii).

(viii)(a) What is the position if the subsidy received, as mentioned in Explanation 10 to section 43(1), is in excess of the WDV?

(b) An assessee started a business in the year 1990. The actual cost of the block of assets in the beginning of the year 1990 was Rs.10 lakhs. The WDV as at 1.4.1998 was Rs.2 lakhs. A subsidy was received from the Government 1998-99 amounting to Rs.3 lakhs in respect of the assets belonging to above block. Kindly indicate the treatment to be accorded to the excess of subsidy to the extent of Rs.1 lakh over the WDV.

Ans. Both issues (ix)(a) and (b) are answered together. The subsidy received should be reduced from the WDV so as to reduce the balance in the block to zero. The excess, if any, over and above WDV does not appear to be taxable in absence of a specific provision to that effect. Section 50 also does not appear to be attracted as there is no transfer of the asset.

(ix) Please confirm whether subsidy sanctioned but not received will go to reduce the actual cost of the asset.

Ans. The answer to this issue depends upon the method of accounting followed by the assessee in respect of such subsidies. If he is following accrual method of accounting he has to reduce the actual cost of the asset at the point of sanctioning of the subsidies and no further treatment is necessary when the subsidy is received subsequently.

(x) Please clarify whether subsidy sanctioned before Explanation 10 to section 43(1) came into effect but disbursed after the Explanation became effective should be deducted from the value of block of assets for calculating depreciation?

73

Ans. Paragraph 25.10, inter alia, clarifies that subsidy coming within the scope of Explanation 10 to section 43(1) in respect of asset acquired in any earlier year(s) and received during the year has to be deducted from the written down value of such assets in the year of receipt.

(xi) From a plain reading of clause 14(d)(i) it appears that in regard to the details of Modvat credit claimed and allowed in respect of assets acquired after 1st March 1994, all details are to be given right from 1st March, 1994 and not only for accounting year 1998-99.

Here, attention is invited to the heading of sub-clause (d) “Additions/deductions during the year”.

Hence how is it possible to interpret the above clause to require the auditor to give the details of additions/ deductions made prior to the year under consideration.

Ans. Sub-clause (d) of clause 14 requires details of additions/ deductions during the year with dates. This requirement is in respect of additions/deductions to the assets/block of assets made during the relevant previous year. The objective of the sub-clause in asking for the details of adjustments on account of Modified Value Added Tax credit claimed and allowed under the Central Excise Rules, 1944 in respect of assets acquired on or after 1st March, 1994, is to verify the proper compliance of Explanation 9 to section 43(1) which provides that where an asset is or has been acquired on or after the 1st day of March, 1994 by an assessee, the actual cost of asset shall be reduced by the amount of duty of excise or the additional duty leviable under section 3 of the Customs Tariff Act, 1974 (51 of 1975) in respect of which a claim of credit has been made and allowed under the Central Excise Rules, 1944. It is necessary, therefore, for the tax auditor to examine the details of assets acquired on or after 1st March, 1994 and the details of MODVAT credit claimed and allowed in respect of those assets.

(xii)(a) An assessee being a hotel has charged depreciation in its profit and loss account for 3 shifts for plant & machinery under the

74

Companies Act. Should it be reported under clause 14 of Form No.3 CD?

(b) A company claimed extra shift depreciation for the assessment year 1998-99 during the year and the auditors qualified the same and showed below the line. Should it be reported under clause 14 of the Form No.3 CD?

Ans. Both the issues (xiii)(a) and (b) are answered together. The details to be given under clause 14 are intended for arriving at the correct depreciation allowable as per the provisions of the Income-tax Act. Details of depreciation debited in the profit loss account prepared as per the requirements of Schedule VI to the Companies Act need not be reported under clause 14.

(xiii) How does one determine the date on which an asset is put to use as required by clause 14(d)? Is it better if reliance is placed on the certificate given by the assessee or should an expert’s opinion be taken?

Ans. To ascertain when the asset has been put to use, paragraph 25.6 advises the tax auditor to call for basic records like production records/ installation details/excise records/ records relating to power connection for operating the machine and any other relevant evidence. In the absence of any specific documentation with regard to the effective date from which the asset is put to use, he could get a representation letter from the management, in respect of the assets acquired. He should examine whether the apportionment of depreciation in cases like succession, amalgamation, demerger etc. has been properly made.

(xiv) When additional depreciation is allowable under section 32(1)(iia) w.e.f. A.Y. 2003-04, how the same is to be reported?

Ans. The Finance Act, 2002 inserted clause (iia) in section 32(1) with effect from A.Y. 2003-2004 accordingly, in the case of any new machinery or plant (other than ships and air craft) which has been acquired and installed after the 31st day of March, 2002, by an assessee engaged in the business of manufacture or production or any article or thing, a further sum equal to 15 per cent of the actual cost of such machinery or plant shall be allowed as depreciation. Such further deduction of 15 per cent

75

shall be allowed to a new industrial undertaking during any previous year in which such undertaking begins to manufacture or produce any article or thing on or after the 1st day of April, 2002 or to any industrial undertaking existing before the 1st day of April, 2002 during any previous year in which it achieves the substantial expansion by way of increase in installed capacity by not less than 25 per cent. Further, no deduction shall be allowed in either of the cases unless the assessee furnishes the details of machinery or plant and increase in the installed capacity of production in such form as may be prescribed along with the return of income and the report of a chartered accountant certifying that the deduction has been correctly claimed in accordance with the provisions of the new clause.

The additional deduction is also in the nature of depreciation and hence the tax auditor has to give the allowable depreciation under the new clause. Since the additional deduction is not permissible without the certificate of the chartered accountant a copy of the same is also to be enclosed with Form No.3CD.

(xv) How the change in rate of exchange of currency in terms of provisions of section 43A (amended w.e.f. 1/4/2003) to be reported?

Ans. Prior to amendment in section 43A, broadly stated, exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets mere adjusted to the costs of fixed assets. Similar treatment is given for the purposes of accounting in terms of AS-11.

The amendment in section 43A makes a departure therefrom and permits adjustments to the cost only to the extent of payment irrespective of the method of accounting followed.

Thus, there may be a divergence in treatment of the differences for tax and financial statements.

Particulars of depreciation, inter alia, require in details about :

(i) Actual cost of WDV of the asset/block;

(ii) Additions/deductions to the cost/WDV on account of change in rate of exchange of money;

76

(iii) Depreciation allowable; and

(iv) Written down value at the end of the year.

An assessee may continue to follow AS-11 for the purposes of preparation of financial statements.

Accordingly, for the purposes of calculation of depreciation allowable, it would be essential to rework the actual cost/WDV of the fixed assets, in respect of which an adjustment for the differences is necessary.

In that, the differences only to the extent of actual payment should be adjusted.

To illustrate ;

(a) An assessee had acquired machinery worth US $ 10,000 on 31.3.2002.

(b) The exchange rate was say, Rs.48.5. Accordingly, its cost accounted was Rs.4,85,000.

(c) The loan is repayable in 4 equal installments over two years. 1st instalment falls due on 1st November, 2002 and the second on 1st May, 2003.

(d) On 1st November, 2002 the exchange rate is Rs.49. On 31st March the exchange rate is Rs.49.50.

(e) In accounts, on payment of installment on 1st November, 2002, the exchange difference of Rs.1,250 is accounted and adjusted to the cost of machinery.

(f) On 31.3.2003, the outstanding liability of US $ 7500 is revalued and the exchange difference of Rs.7,500 accounted and adjusted to cost of machinery.

For the purposes of depreciation allowance under section 32 :

(a) The cost of machinery can be adjusted only to the extent of Rs.2,500, being the amount of the difference actually paid;

(b) That amount will have to be shown separately; and

(c) the depreciation allowable would be on Rs.4,87,500.

77

In other words, the difference to the extent of Rs.7,500 (since not paid) cannot be adjusted to the cost for the purposes of depreciation allowable.

Thus, the above would necessitate a separate working and/or information would be necessary for the purposes of reporting.

15. Amounts admissible under section 33AB, 33ABA, 33AC, 35, 35ABB, 35AC, 35CCA, 35CCB, 35D, 35E:-

(a) debited to the profit and loss account (showing the amount debited and deduction allowable under each section separately);

(b) not debited to the profit and loss account.

(i) The tax auditor is required to give the admissible amounts under sections 33AB, 33ABA, 33AC, 35, 35ABB, etc. However under certain sections, i.e. 33AB, 33ABA etc., audit is prescribed for claiming expenses under these sections.

Now if some other auditor is appointed for carrying out the audit under these sections, and if that audit report is not available with the assessee at the time of tax audit, then should the tax auditor give his own calculation and certify the admissibility in Form No.3CD or should he observe that the amount admissible will be as per the report of other auditor appointed for these specific assignments?

Ans. Once the assessee appoints other auditors for carrying out the audit in respect of provisions other than section 44AB, it would be ideal and also professionally ethical to rely upon the work done by the other auditor after satisfying himself by applying the appropriate checks and furnish the particulars in Form No. 3CD accordingly. However, if by the time the tax audit is completed, the reports of other auditors in respect of the audit carried out under other sections are not available, it may not be appropriate for the tax auditor to avoid reporting under this clause by citing the non availability of the report of other auditors as a reason. In that situation, he has either to persuade the assessee to get other audits completed to enable the tax auditor to discharge his statutory obligations or to examine the records himself.

78

(ii) In case of change of auditors, can the tax auditor rely on earlier year’s statutory report and computation of total income and mention the amount of deduction allowable under section 35D or should the tax auditor scrutinise the expenses incurred in the earlier year as debited to preliminary expenses?

Ans. Normally the tax auditor is entitled to rely upon the report of the statutory auditor in respect of expenses incurred in an earlier year to arrive at the deduction allowable under section 35D, unless there are circumstances warranting non-reliance on the report of the statutory auditor.

16. (a) 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)].

(b) 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).

Clause (a)

(i) Please clarify whether:

(a) performance/efficiency bonuses, especially if such bonus/commission is linked to the profitability of the assessee,

(b) commission paid to directors calculated as a percentage of profits computed under section 350 of the Companies Act;

(c) loans granted to employees linked to achievement of sales target etc.,

have to be reported under this clause.

Ans. None of the above items need be reported under this clause.

(ii) M/s A Pvt. Ltd. pays service charges to its Director Mr. Z, amounting to Rs.1 lakh. Mr. Z is holding 50% of the shares in M/s.

79

A Pvt. Ltd. Please clarify whether the same has to be reported under this clause?

Ans. It is not clear whether Mr. Z is an employee of the company. Assuming that he is also an employee of the company, if it is established that the amount of Rs.1 lakh in sum and substance constituted dividend, the tax auditor has to report under sub-clause (a). However, if such service charges are payable to Mr. Z for services rendered to the company and have no connection with the appropriation of profits in any manner, there is no reporting requirement.

Clause (b)

(iii) Kindly clarify whether it is mandatory to mention the cases where employers have not deducted/collected P.F. etc. from the employees.

Ans. There is no specific requirement in sub-clause (b) to mention the cases where employers have not deducted/collected provident fund etc. from their employees. The objective of the above sub-clause is to see whether the sum so recovered from employees has been treated as income under section 2 (24)(x).

(iv) Where the provident fund contributions are not remitted within the due date but remitted within the financial year after due date.

Please clarify

(a) whether it is to be reported for employee’s contribution?

(b) Whether it is an allowable expenditure?

Ans. Paragraph 27.4 clearly says that section 36(i)(va) of the Act permits deduction of such sum if it is credited by the assessee to the account of the employees in the relevant statutory fund on or before the due date, i.e., the date by which it is required to be credited as per the provisions of the applicable law etc. It may be noted that Employees’ P.F Act provides for 5 days of grace period for payment of contribution. This can be taken into consideration for determining the due date of payment.

80

(v) In the month of April 1999, the State of Delhi declared an increase in wages w.e.f. 1st February, 1999. In such case what will be the due date for payment of PF, ESI as per section 36(1)(va)?

Ans. Since the wage increase has been declared by the State Government only in the month of April, 1999 the appropriate recoveries of employees’ contributions towards the increased provident fund would obviously be made in the previous year 1999-2000. The provisions of section 36(1)(va) will apply accordingly.

(vi) The assessee applied for a P.F. No. in time but the same was not allotted within a reasonable time due to departmental delay. The assessee duly made a provision for the contribution by the employer in its profit and loss account and balance sheet. But the same could not be remitted to the authorities because of the non-allotment of P.F. No. Please clarify the duty of the tax auditor in this regard.

Ans. The objective of sub-clause (b) is to get information in respect of sums recovered from employees towards provident fund contributions etc. and the dates on which such contributions were remitted to the statutory authorities. This information is necessary to determine the allowability of the payment of such contributions under the provisions of section 36(1)(va). In the given issue the assessee has not remitted the contribution to the statutory authorities, whatever be the reasons therefor. The tax auditor has to indicate the factual position in this regard.

(vii) Please clarify whether the grace period of 5 days should be considered while determining due date for payment of PF, ESIC contributions for reporting under section 36(1)(va) read with sections 2(24)(x) and 43-B.

Ans. The following extracts from the judgement of the Income-tax Appellate Tribunal in Hunsur Plywood Works Ltd. v. Deputy Commission of Income-tax (1995) 54 ITD 394 will make the position clear.

“Paragraph 38 of the Employees’ Provident Funds Scheme, 1952 says that the amounts under consideration in respect of wages of the employees for any particular month shall be paid within 15

81

days of the close of every month. Clause (iii) of CPFC’s Circular No.E. 128(1) 60-III dated 19-3-1964 as modified by Circular No. E. 11/128 (section 14-B Amendment)/73 dated 24-10-1973 allows five days of grace period to the employers for payment of provident fund contribution, administrative charges and inspection charges. The said Circular also states that if payment be made within the said period of grace, no damages as per section 14-B of the Employees’s Provident Funds and Miscellaneous Provisions Act, 1952 shall be levied. Furthermore, our attention has also been drawn to CPFC’s Circular No. E.128(1)60-IV dated 29-4-1967 in clause (iii) of which it has been stated that the Central Board of Trustees at its meeting on 13-4-1967 agreed that if payment was made within grace period already allowed by it, then such payments should not be counted as default even for the purpose of counting the number of defaults………… (Page 399)

Thus, we find that from strict judicial angle, the period or days of grace would seem to be falling within a twilight region. The period certainly follows the exact due date but at the same time no action by the other side is possible within the said period except for registering a protest. Since the present issue is required to be resolved from practical angle, as discussed by us above, we are required to examine the consequences of making of payment of the employees’ contribution to the EPF etc., within five days’ period of grace. We find that if an employer makes payment within such period of grace, not only is he not liable to pay any damages in accordance with the Employees’ Provident Fund Scheme and the relevant Act, but by virtue of the Circular dated 29-4-1967 as mentioned above, he will also not be treated to be in default. Hence, we ultimately hold that from practical point of view, the five days’ period of grace after 15th of the succeeding months is to be considered merely as an extension of the early 15 days and all the consequences of making payment within the said 15 days should be considered to follow if the payment be made within the grace period following the said period of 15 days.”……..(Page 400).

Also refer to CIT v. Salem Cooperative Spinning Mills Ltd. [2002] 258 ITR 360 (Mad).

82

(viii) A non-corporate assessee is maintaining books of account on cash basis. It has not deposited its P.F. contributions before the end of the relevant previous year but remitted the same within the statutory due dates. Will it be allowed deduction of the same on payment basis?

Ans. If an assessee is maintaining books of account on cash basis, any remittance of P.F. contributions recovered from its employees, to the statutory authorities after the end of the relevant previous year, even if it is before the statutory due date should not be allowed as a deduction under section 36(1)(va) because as per the provisions of section 145 the income of the assessee is to be computed in accordance with the cash method of accounting.

(ix) Please clarify how a tax auditor can verify the details of payments of P.F. contributions etc. in the case of tax audit of the accounts of a sub-contractor particularly where the liability on this account is on the main employer?

Ans. Many a time in the construction industry the main contractor sub-contracts portions of the main contract to various sub-contractors. Such sub-contracting may of two types. Firstly, the sub-contractor may be asked to execute the sub-contract merely as an agent while the main contractor will assume responsibility for recoveries of P.F., ESI contributions and remittance of the same to the statutory authorities. In this case the tax auditor of the sub-contractor need not report under this clause because the sub-contractor is not responsible either for collection or remittance of the P.F. contributions etc. There may also be cases of sub-contractors who may independently execute such sub-contracts by employing labourers etc. In such a situation the employer - employee relationship exists between the sub-contractor and the workers and the responsibility for recovering P.F. contribution etc. and remitting the same to the statutory authorities wholly rests with the sub-contractor. In this case the tax auditor has to comply with the requirements of this clause.

17. Amounts debited to the profit and loss account, being:-

(a) expenditure of capital nature;

(b) expenditure of personal nature;

83

(c) expenditure on advertisement in any souvenir, brochure, tract, pamphlet or the like, published by a political party;

(d) expenditure incurred at clubs,-

(i) as entrance fees and subscriptions;

(ii) as cost for club services and facilities used;

(e) (i) expenditure by way of penalty or fine for violation of any law for the time being in force;

(ii) any other penalty or fine;

(iii) expenditure incurred for any purpose which is an offence or which is prohibited by law;

(f) amounts inadmissible under section 40(a);

(g) interest, salary, bonus, commission or remuneration inadmissible under section 40(b)/40(ba) and computation thereof;

(h) amount inadmissible under section 40A(3) read with rule 6DD and computation thereof;

(i) provision for payment of gratuity not allowable under section 40A(7);

(j) any sum paid by the assessee as an employer not allowable under section 40A(9);

(k) particulars of any liability of a contingent nature.

General

(i) The Guidance Note under para 32.1, clause 17(e) says that “the tax auditor while reporting under this clause is not required to express any opinion as to allowability or otherwise of the amount of penalty or fine for violation of law. He has only to give details of such items as have been charged in the accounts.”

However, unless allowability or otherwise is decided (may not be reported), reporting on certain matters may not be possible. E.g. deduction under Chapter VIA, allowability of remuneration to

84

partners, etc., which are based on computation of taxable income. Please comment.

Ans. Paragraph 32.1, inter alia, specifies that the tax auditor should obtain in writing from the assessee the details of all payments by way of penalty or fine for violation of any law as have been made and paid or incurred during the relevant previous year and how such amounts have been dealt with in the books of account produced for audit. He may not be aware of the intricacies of all the laws of the land. Hence, it has been clarified that he is not required to express any opinion as to the allowability or otherwise of the amount of penalty or fine for violation of law. He should exercise his professional judgement only to ascertain whether the sum debited in the profit and loss account is by way of penalty or fine for any violation of law. All the relevant figures of deductions under Chapter VIA etc. have to be obviously arrived at after considering the deductions in respect of penalty etc. so arrived at. However, while computing the deductions permissible under chapter VIA, the tax auditor can rely upon the relevant judicial decisions and bring out the facts appropriately. Paragraph 16.2 also clarifies that the assessee, while preparing the statement of particulars, (a) can rely upon the judicial pronouncements while taking any particular view about inclusion or exclusion of any items in the particulars, (b) if there is a conflict of judicial opinion on any particular issue, may refer to the view which has been followed while giving the particulars under any specified clause and (c) should follow the accounting standards, guidance notes, statements of auditing practices issued by the Institute from time to time.

(a) Expenditure of capital nature

(i) Please clarify whether entrance fees are to be treated as revenue expenditure or capital expenditure.

Ans. Payment of entrance fees have normally to be treated as capital expenditure. However, there are views treating the same as revenue expenditure also.

(ii) Where replacement of asset is claimed as revenue expenditure should it be reported here?

85

Ans. The tax auditor has to exercise his professional judgement in the light of the facts and the circumstances of the case and also the relevant judgements in this regard and give the necessary particulars under this clause. Whether an expenditure is of revenue nature or capital nature is to be ultimately decided by the courts of law. Reference can be made to Balimal Naval Kishore and Another v. CIT (1997) 224 ITR 404 (SC), CIT v. Madras Cements Ltd. 255 ITR 293 (Mad) SLP dismissed by SC 257 ITR 18 (St), CIT v. Mahalaxmi Textiles Mills Ltd. [1967] 66 ITR 710 (SC) and CIT v. Coimbatore Motor Transport Cooperative Society [1968] 70 ITR 165 (Mad).

(iii) Replacement of parts of machinery is held to be revenue expenditure for the purpose of tax laws (e.g., replacement of ring frames in a textile mill or replacement of a diesel engine for petrol engine in a motor truck). If the assessee has debited the cost of parts so replaced to the profit and loss account, is it necessary for the tax auditor to report?

Ans. Any expenditure incurred in replacement of parts of a machinery as referred to in the query is a revenue expenditure. This is by now well settled. As such, if the cost of such replacement is debited to the profit and loss account it is not necessary to report the matter.

(b) Expenditure of personal nature

(i) Can a tax auditor rely on the report of the statutory auditor for reporting that no personal expenses have been charged to profit and loss account.

Ans. In terms of section 227(1A) (e) of the Companies Act the statutory auditor has to enquire whether any personal expenses have been charged to the profit and loss account. The tax auditor can rely on the report of the statutory auditor. However, it is to be borne in mind that the responsibility of the tax auditor is governed by the provisions of Income-tax Act and he has to safeguard himself by adopting proper verification procedure while relying upon the work of either statutory auditor or internal auditor or other professionals. Please refer to SAP-10 “Using the work of another auditor”.

86

(ii) In the case of a limited company, a director is allowed to use the car for his personal purposes, as per the terms of his appointment. Will the expenditure on motor car used for personal purposes be considered as personal expenses?

Ans. When a director of a limited company is provided with a motor car and under the terms of his appointment, such director is entitled to use the motor car both for personal as well as for official purposes, no portion of the expenditure incurred by the limited company can be said to be a personal expenditure of the assessee company. As such no portion of such expenditure should be indicated under this sub-clause.

(iii) In the case of a partnership firm, if a partner is using part of house property belonging to the firm for his personal residence (other part being used for the business of the firm), how will the element of personal expenses be determined in respect of use of house property, electric charges, water charges, use of telephone etc.?

Ans. The tax auditor may rely upon past assessment records of the assessee firm for the purpose of estimating the element of personal expenditure in respect of use of a house property which is used by a partner of the assessee firm partly for his personal residence and party for the business of the firm. If possible, the expenditure by way of rent can be estimated on the basis of area occupied. The expenses for personal use of telephone will have to be estimated on the basis of past assessment records.

(d) Expenditure incurred at clubs,-

(i) as entrance fees and subscriptions;

(ii) as cost for club services and facilities used;

(i) Is it necessary to show the membership fee paid to Lions/Rotary Club under this clause?

Ans. Lions, Rotary Clubs and bodies of similar type are considered as service associations. Paragraphs 31.2 observes that payments made to service organisations, such as Rotary, Lions, Jaycees, Giants etc. would not necessarily be covered by this clause.

87

(e) (i) Expenditure by way of penalty or fine for violation of any law for the time being in force;

(ii) Any other penalty or fine;

(iii) expenditure incurred for any purpose which is an offence or which is prohibited by law;

(i) (a) Please clarify as to how the tax auditor can collect information in respect of petty fines and penalties like fine paid by staff for violation of traffic rules in respect of vehicles parked in wrong zones.

(b) An assessee paid Rs.100 for car parked in no-parking zone and Rs.100 for towing charges. Should the same be reported under clause (e)?

Ans. Since both the issues are similar, a common answer is being given. It is the primary responsibility of the assessee to give classified information for the purposes of tax audit. This is in the interest of efficient conduct of tax audit. The same principle applies in respect of information on penalties, fines, etc. The concept of materiality has to be borne in mind while reporting under this clause.

(ii) Please clarify the nature of compounding fee paid to various departments. Is it penalty or fine?

Ans. It is felt that compounding fee paid to various departments is generally paid as a full settlement. An element of pardon is involved. It cannot be equated with penalty but it can be considered as a payment of compensatory nature. The issue may be decided having regard to the principles laid down by decisions referred to para 32.5.

(iii) A company pays compensation to its distributors whenever they incurred abnormal expenses during the course of the business dealings. Such abnormal expenses sometimes include penalty payable by such distributors and the company reimburses such penalty also. Should the tax auditor report about such penalties?

Ans. A company makes a variety of payments to its distributors in the course of its business dealings and it is not possible to give a

88

comprehensive idea about the various possible forms which such payments may take. It depends upon the nature of business, the exigencies of the business situation etc. It is quite possible that the distributors during their efforts to distribute the products of their principal company may incur penalty which may be reimbursed by the company. Once any expenses are reimbursed by the company they become the expenditure of the company itself and it is the duty of the tax auditor to give details in Form No.3CD. If it is possible to find out the exact nature and amount of penalties reimbursed from the various claims submitted by the distributors then the tax auditors should give such details under this clause. However, if composite bills are submitted by the distributor which may include penalties and the tax auditor is unable to segregate such penalties from the available information, he cannot be expected to report about such penalties.

(iv) Interest paid under sections 234A/234B/234C under the Income-tax Act have been debited to the profit and loss account. Where should such interest be mentioned? Is it under clause 17(e)(i) or under clause 17(f)?

Ans. This will not be covered under clause 17(e). However, it is very much in the nature of tax as held in Assam Forest Products P Ltd. v. CIT (180 ITR 478 - Gau) and Federal Bank Ltd. v. CIT 180 ITR 37 and hence requires disclosure under clause 17(f). Incidentally it, may be mentioned that the Supreme Court has held in Bharat Commerce and Industries Ltd. v. CIT 230 ITR 733 that interest paid on delayed payment of income-tax is not a permissible deduction under section 36(1)(iii). See also National Engg. Industries Ltd. v. CIT (1978) 113 ITR 252 (Cal). Roopchand Chabildas & Sons v. CIT (1967) 631 ITR 166 (Mad).

(v) Offence is no offence unless proved. In the light of this fact, kindly enlighten whether expenditure for any purpose which is yet to be proved an offence, would be covered under this clause.

Ans. The statement that offence is not an offence may be true as a proposition of criminal law. In the commercial environment situations may arise where the expenditure relates to an item where assessee does not deny that it is an offence. In such

89

circumstances the auditor would be required to report the same under this clause.

However, where the assessee denies his having committed an offence or denies his liability to incur any such expenditure/ payment, the auditor needs to make a suitable disclosure regarding the assessee’s view.

(vi) How should the following items be reported?

(a) interest on delayed payments - paid to a supplier for contravention of terms of payments as per contract agreement.

(b) penal interest paid to bank on account of late/non- submission of stock statement or quarterly statements etc.

Ans. In regard to item (a) such payments are in the nature of interest because it is levied for delaying the payments. In regard to item (b) even if it is called penal interest it is really in the nature of compensatory payment. “Hence the above payments need not be reported.” Refer to para 32.1

(vii) Should legal expenses paid for defending a suit for violation of law be mentioned here?

Ans. Legal expenses paid for defending suits, whatever be the nature of suits, cannot be considered as penalties and such expenses need not be mentioned under this clause.

(viii) Should penalty paid to electricity board for higher consumption of power than sanctioned, and penalty paid to bankers for non submission of details of stock in time, to be mentioned in sub-clause (e)?

Ans. The penalty paid to electricity board for higher consumption of power than sanctioned is not a penalty paid for any violation of law, since there is no statutory requirement to that effect. Only for administrative purpose and maintenance of adequate load capacity, the electricity board normally enters into an agreement with the consumer. The amount paid is only for breach of an agreement, which is essentially compensation in nature, though called a penalty. This is in addition to the normal charges levied

90

on additional consumption. In our view this need not be disclosed under clause 17(e)(ii).

The amount paid to bank for non submission of stock statements partakes the character of compensatory interest, and is not in the nature of any penalty. This need not be disclosed under this clause at all. Refer to para 32.1.

(f) Amounts inadmissible under section 40(a)

(i) Should tax be deducted at source from payments made to a non-resident for services rendered outside India? These payments have been made through an authorised dealer without deducting tax at source. What are the reporting requirements?

Ans. Paragraph 33.2 states that where an actual remittance overseas has been made by the assessee during the relevant previous year withouting deducting any tax at source, the tax auditor may rely upon the legal opinion and/or certificates from chartered accountants based upon which remittances have been made without deduction of tax at source. The tax auditor needs to report under this clause only if he has a different opinion on the issue. Where no remittances have been made during the relevant year, the tax auditor may examine the relevant provisions vis-à-vis the agreement or correspondence in pursuant to which the liability is provided by the assessee in his books of account in order to determine whether any amount so provided is at all chargeable to tax under the Act. The tax auditor may use his professional judgement in these matters based upon decided cases and he may rely upon a legal opinion obtained by the assessee where no tax is required to be deducted in respect of the amount so provided. In case he disagrees with the stand taken by the assessee, he should given both the views in his report.

(g) Interest, salary, bonus, commission or remuneration inadmissible under section 40(b)/40(ba) and computation thereof.

(i) A firm paid to its partners interest and salary for the entire previous year 1998-99, while the partnership deed was executed

91

only on 24/4/98. Should the interest and remuneration for the period from 1/4/1998 to 24/4/1998 be disallowed?

Ans. The provisions of sections 40(b)(iv) & (v) make it clear that only such payments of interest to any partner and remuneration to any partner who is a working partner which are authorised by, and are in accordance with, the terms of the partnership deed and relate to any period falling after the date of such partnership deed will be allowed as a deduction subject to the limits mentioned therein. Hence it is clear that the interest and remuneration for the period from 1.4.1998 to 24.4.1998 will be disallowed.

(ii) While computing book profit, whether carried forward losses of earlier years can be considered for calculating remuneration to partners allowable under the Income-tax Act?

Ans. Explanation 3 to section 40(b) defines “book profit” for the purposes of calculating admissible interest and remuneration to partners. It means the net profit, as shown in the profit and loss account for the relevant previous year, computed in the manner laid down in chapter IV-D. Hence, it is clear that carried forward losses of earlier years cannot be considered for calculating allowable remuneration to partners.

(iii) (a) Please clarify whether the tax auditor has to give the details of total calculation of interest paid to partners on their capital (In Form NO.3CD), if such interest is paid on product basis.

(b) Please clarify whether it is necessary to give the full working of interest and remuneration or is it sufficient to state only inadmissible amount thereof.

Ans. Issues (a) and (b) are answered together. The clause specifically requires disclosure of both the inadmissible amount and the computation thereof. Hence whatever be the amount of interest/ remuneration paid to the partners, the tax auditor should verify the computation thereof under section 40(b)/40(ba) as well as the provisions of partnership deed and related documents and disclose the computation.

(iv) Please indicate the reporting requirements in the following situations.

92

(a) Assessee is a firm following cash system of accounting. At the end of the year, it earns profit of Rs.1 lakh and debits Rs.90,000 by way of journal entry to partner’s remuneration. The amount is not withdrawn by partners.

(b) In the second year also it earns a profit of Rs.1 lakh and debits Rs.90,000 by journal entry to partner’s remuneration. In this year, there are withdrawals by partners of Rs.2 lakhs. What will be the amount of remuneration allowable in the second year? Whether Rs.90,000 of Rs.1,80,000 for two years?

Ans. In view of the decision in Standard Triumph Motor Company Limited v. CIT 201 ITR 391 (SC), which upheld the principle of constructive payment, assuming that the remuneration is credited to a partner’s account and accordingly unconditionally made available to him, it shall be deemed to have been paid to him. On the above basis, Rs.90,000 shall be the remuneration paid for each of the year to the partner, irrespective of the fact whether it is withdrawn or not.

(v) Is it required to modify the terms of the partnership deed due to amendments made by the Finance Act, 2002 in section 40(b)?

Ans. In view of the conditions prescribed under section 40(b), the terms of the partnership deed should be looked into in order to ascertain the admissibility of the interest and salary payable to partners by the firm. The admissibility with reference to the ceiling limits prescribed under the law vis-à-vis the stipulations in the partnership deed needs to be examined. CBDT circular no.739 dated 25.3.96 needs to be borne in mind with reference to remuneration to partners. This circular does not draw reference to interest payment.

The Finance Act, 2002 has reduced the rate of interest allowable to 12%. In case the partnership deed provides for 18% with a stipulation that the same shall be restricted to the limit permissible under section 40(b) of the Income-tax Act as may be amended from time to time, there will be no need to change the deed. Where the deed prescribes 18% as interest payable and the partners desire to continue to pay interest at 18% the firm can pay

93

18% and debit the same in the profit and loss account. In the computation of taxable income, 6% should added back to the income of the firm, restricting the claim to 12%. In the partner's case interest income should be offered to the extent of 12% for taxation as the proviso to section 28(v) makes it clear that what is disallowed in the firm’s case cannot be taxed in the partner’s case.

In case the partners desire to modify the rate of interest payable at 12% instead of 18%, it will be advisable to modify the terms of the deed accordingly. In other words, if the deed stipulates 18% but the firm pays 12% as interest to partners, there could be litigation as the Assessing Officer may choose to disallow the entire 12% as it is not in accordance with the terms of the partnership deed.

Q. Where an individual represents his HUF as partner in a firm, how should the provisions of section 40(b) be applied and what are relevant aspects to be considered?

Ans. The Supreme Court in CIT v. Bagyalakshmi & Co. 55 ITR 660, held that HUF itself cannot be a partner but can be represented by an individual. In Rashik Lal and Co. v. CIT 229 ITR 458 (SC), it has been held that where an individual represents HUF, he may be accountable to the HUF for the funds but he is a partner in his individual capacity so far as the firm and partners are concerned. Any remuneration paid to such partner shall be governed by section 40(b) as it governs any other working partner. Therefore, the firm can claim salary paid to such a partner subject to the terms of the deed and stipulations under section 40(b). As per the provisions of section 40(b) salary paid to a working partner is allowable. Even though the individual represents the HUF, since salary is paid for services rendered by the individual and not for the investment made by the HUF, it is appropriate to offer such salary income in the individual assessment of that person instead of offering the same in the case of the HUF. Such salary income will be liable to taxation in the hands of the partner. The Hindu Gains of Learning Act, (1930) also supports the analogy.

Such salary income is liable to be taxed under the head “profits and gains of business or profession” and not under the head

94

“salaries”. Consequently, no standard deduction can be claimed. This is by virtue of the specific provisions of section 28/Explanation 2 to section 15 and also in view of the Supreme Court decision in CIT v. R.M. Chidambaram Pillai, 106 ITR 293.

However, the interest paid by the firm on the capital is assessable in the hands of HUF which has introduced the capital. The treatment for interest is different as dual capacity is permitted for payment of interest as per Explanations 1 and 2 to section 40(b). The Madras High Court decision in R.M. Appavu Chettiar & Sons v. CIT, 256 ITR 289 throws more light on the subject by bringing clarity on the differential treatment between salary and interest. It may also be mentioned that where only a bigger HUF is a partner in a firm and the smaller HUF is paid interest, such interest is not covered by section 40(b) - Shenbagam Auto Works v CIT, 124 Taxman 75 (Mad).

(h) Amount inadmissible under section 40A(3) read with rule 6DD and computation thereof.

(i) An assessee made a credit purchase of raw materials for Rs.25,000. It discharges the above liability by paying cash of Rs.10,000 and issuing a cheque for Rs.15,000 for the balance. Are the restrictive provisions of section 40A(3) attracted in this case?

Ans. It is presumed that the cheque paid for Rs.15000 is crossed. In such a case, the requirements of section 40A(3) are complied with and hence disclosure is not required.

(ii) ‘A’ makes one purchase of Rs.25,000/- from ‘B’. As per instructions of ‘B’ ‘A’ makes payment for the above purchase from A’, to ‘C’ by way of crossed cheque. Please indicate whether this

is to be reported in Form No. 3CD.

Ans. The tax auditor has no reporting responsibility under this sub-clause in respect of the above transaction since the expenditure has been paid by means of crossed cheque.

(iii) Please clarify whether the following payments exceeding Rs.20,000 are covered by section 40A(3)?

95

(a) gross salary of Rs.21,000 p.m. - net amount paid after deduction of P.F., taxes etc. Rs.19,500.

(b) purchase of grains from farmers directly for distribution to employees (debited to staff welfare account).

(c) payment to truck driver for transport charges. It is common knowledge that truck drivers do not accept cheque and bank draft.

(d) loan of Rs.25,000 given by the assessee to any person.

(e) advance of Rs.30,000 to an employee for meeting his travel cost. Subsequently he renders account of Rs.28,000 towards expenditure and refunds Rs.2,000 on completion of his tour.

(f) cash paid directly into the bank account of the payee.

(g) reimbursement of expenses incurred by an employee if the amount exceeds Rs.25,000.

Ans.(a) No. This view is taken as the actual payment to the employee is less than Rs.20,000.

(b) No. Please see Rule 6DD(f).

(c) Yes. The aggregate of such payments in any particular previous year may be indicated in one lump sum with appropriate narration.

(d) No.

(e) No.

(f) A view is possible to be taken that such payments attract disallowance under section 40A(3). However, on the basis of the intent and objective of the provision and merits of the case the other view that it is not disallowable is arguable.

(g) Yes. However, If each item of expense reimbursed is less than Rs.20,000, section 40A(3) will not apply.

96

(k) Particulars of any liability of a contingent nature.

(i) Please clarify whether leave encashment expenses booked on the basis of leave standing to the credit of the employee at the closing of the year, should be shown as contingent liability.

Ans. AS 15 - Accounting for Retirement Benefits in the financial statements of employer deals with accounting for retirement benefits such as (a) provident fund, (b) superannuation/ pension, (c) gratuity, (d) leave encashment benefits on retirement, (e) post retirement health and welfare scheme and (f) other retirement benefits. In respect of retirement benefit schemes the accounting treatment will depend on the type of arrangement which the employer has chosen to make.

(a) If the employer has chosen to make payment for retirement benefits out of his own funds, an appropriate charge to the statement of profit and loss for the year should be made through a provision for the accruing liability.

(b) In case the liability for retirement benefits is funded through creation of a trust, the cost incurred for the year should be determined actuarially. If such actuarial valuation is taken, say, once in three years the employer has to make an annual contribution and the difference between the annual contribution and actuarial valuation should be a charge to the profit and loss account if the contribution is less than the actuarial value or should be considered as a prepayment if the contribution is more than the actuarial value.

(c) In case the liability for retirement benefit is funded through a scheme administered by an insurer, a similar role described above for the employer, should be played by the insurer.

In view of this, leave encashment expenses booked on the basis of leave standing to the credit of the employee at the closing of the year do not constitute contingent liability but have to be treated in accordance with the above principles.

(ii) Normally contingent liabilities are not debited to profit and loss account. Therefore, what could be the instance of contingent liabilities for the purposes of sub-clause (k)?

97

Ans. When a provision is made in respect of a claim which has been disputed it would normally be treated as a contingent liability. Some of the instances of contingent liabilities are as under:

(a) provision in respect of wage demands which are disputed by the assessee.

(b) provision for disputed sales tax/central excise duties in respect of which assessments are pending.

(c) provision in respect of the claims made by the customers which have been disputed.

18. Particulars of payments made to persons specified under section 40A(2)(b).

(i) In case of an association of persons (AOP) should the tax auditor report any payment made to a member of such association for supply of goods?

Ans. Yes. Section 40A(2)(b)(ii) clarifies this.

(ii) Should the particulars of payments made to persons covered by section 40A(2)(b) for capital expenditure also be given under this clause?

Ans. Section 40A(2) empowers the ITO to disallow any expenditure in respect of which payment is made to the persons mentioned in section 40A(2)(b) which he considers to be excessive or unreasonable. This refers to only revenue expenditure. Therefore, it is not necessary to give particulars of capital expenditure under this clause.

(iii) How can the auditor ascertain the details about the persons covered by section 40A(2) and how can he verify all the transactions with such persons?

Ans. The auditor should obtain from the assessee the list of persons covered by section 40A(2) and the verification should thereafter be made with reference to the payments made as shown in the books of account to the persons referred to in the said list as indicated in para 39.2. The auditor is advised to follow the procedure outlined in SAP 23.

98

(iv) If the assessee has purchased goods from a company registered outside India and a relative of the assessee has substantial interest in that company, do the provisions of section 40A(2) apply? In such a case how can the market value of such goods be compared by the ITO for finding out its reasonableness.

Ans. Yes, the income tax officer may make enquiries in the foreign market and obtain quotations of the relevant period from other reputed dealers of the goods.

19. Amounts deemed to be profits and gains under section 33AB or 33ABA or 33AC.

20. Any amount of profit chargeable to tax under section 41 and computation thereof.

(i) If a liability becomes unenforceable due to expiry of period of limitation or otherwise, but is not written back in the books of account of the borrower, would it be treated as cessation of liability? If yes, would it be an income under section 41?

Ans. The mere fact that a liability has become unenforceable due to operation of limitation cannot be treated as cessation of liability. Explanation 1 to section 41(1) provides that for the purposes of above sub-section, the expression “loss or expenditure or some benefit in respect of any such trading liability by way of remission or cessation thereof” shall include the remission or cessation or any liability by a unilateral act by the assessee by way of writing off such liability in his accounts. So long as an assessee has the intention to settle a liability, it appears that it cannot result in its cessation.

(ii) A liability is written back in the books because it remained unclaimed, but the claim is not barred by operation of law. Would it be treated as remission/cessation under section 41?

Ans. Yes, by virtue of Explanation 1 to section 41(1).

(iii) In case of refund of excise duty/sales tax, can section 41 be invoked, if the matter is pending in appeal before a higher authority?

99

Ans. In Union of India v J.K. Synthetics Ltd. [1993] 199 ITR 14 (SC) it was held that the liability to tax under section 41 would depend upon the outcome of the appeal before the Supreme Court. It was also stated that no cessation of liability could be postulated until the matter pending before the tribunal had been decided.

In CIT v Hindustan Housing and Land Development Trust Ltd. [1986] 161 ITR 524 (SC) the principle was established that there was a clear distinction between cases where the right to receive payment is in dispute and it is not a question of merely quantifying the amount to be received, and cases where the right to receive payment is admitted and what remained was only the quantification. In the given issue if the appeal is decided against the assessee, the very foundation of the refund due to the assessee would fall. Hence, section 41 cannot be invoked.

21.* (i) In respect of any sum referred to in clause (a), (c), (d) or (e) of section 43B, the liability for which:-

(A) pre-existed on the first day of the previous year but was not allowed in the assessment of any preceding previous year and was

(a) paid during the previous year;

(b) not paid during the previous year.

(B) was incurred in the previous year and was

(a) paid on or before the due date for furnishing the return of income of the previous year under section 139(1);

(b) not paid on or before the aforesaid date.

(ii) In respect of any sum referred to in clause (b) of section 43B, the liability for which –

(A) pre-existed on the first day of the previous year but was not allowed in the assessment of any preceding previous year:

(a) nature of liability;

100

(b) due date of payment under second proviso to section 43B;

(c) actual date of payment;

(d) if paid otherwise than in cash, whether the sum has been realised within fifteen days of the aforesaid due date;

(B) was incurred in the previous year:

(a) nature of liability;

(b) due date of payment under second proviso to section 43B;

(c) actual date of payment;

(d) if paid otherwise than in cash, whether the sum has been realised within fifteen days of the aforesaid due date.

* 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.

(i) Should we attach documents for proof of payment even when the tax auditor is certifying such payments as true and correct in Form No. 3CD?

Ans. It is the primary responsibility of the assessee to furnish all the particulars necessary to enable the tax auditor to verify those particulars and certify the truth and correctness for the purposes of Form No.3CD. It is not necessary to attach documentary proof for all the details mentioned in Form No.3CD which would obviously be only a duplication of the books of account and other supporting vouchers. Once the tax auditor appends his signature in Form No.3CD it is obvious that he vouches for the truth and correctness of the particulars mentioned therein.

(ii) When the provident fund contributions are deposited by cheques and such payments are “subject to realisation of cheques”, what date should the tax auditor give as the actual date of payment.

101

Ans. The subsequent realisation is important in view of the specific provisions of section 43B. Both the actual date of tendering of payment and the date of realisation of cheque are required to be reported.

(iii) Please clarify whether the P.F. payments made beyond due dates but within the same financial year are allowable?

Ans. No. However, reference may be made to paragraphs 42.3, 27.4 and 27.5 which discuss the treatment when payment is made within grace period and lenient treatment of reasonable delays in respect of allowance.

(iv) Please clarify whether profession tax liability should be reported under section 43B.

Ans. Yes, professional tax liability of the assessee is required to be reported since it is a tax levied under a statute. However, professional tax deducted from salary of the employees and payable to the Government is not required to be reported since the same is not tax payable by the assessee.

(v) Any tax, duty, etc. referred to in section 43B may be paid after tax audit is completed but before the due date of filing of the return of income. How should the tax auditor deal with such a situation?

Ans. Paragraph 42.5 states that under the first proviso to section 43B, deduction is available in respect of any sum referred to in clause (a), (c), (d) or (e) which is actually paid by the assessee on or before the due date applicable in his case for furnishing the return of income under sub-section (1) of section 139. Since the due date of filing of the return would usually be subsequent to the signing of the tax audit report the tax auditor would be able to give information in respect of matters only upto the date of signing of the tax audit report. The payment made subsequent to that date but before the date of filing of the return, will still be eligible for deduction under section 43B. Hence the tax auditor should advise the assessee to include necessary evidence of payments made after the signing of the tax audit report but before the due date of filing. This evidence may also be in the form of a certificate from a chartered accountant obtained specifically

102

for this purpose - Circular No.601 dated 4.6.1991 vide Appendix XVII.

22. (a) Amount of Modified Value Added Tax credits availed of or utilised during the previous year and its treatment in the profit and loss account and treatment of outstanding Modified Value Added Tax credits in the accounts

(b) Particulars of income or expenditure of prior period credited or debited to the profit and loss account.

Clause (a)

(i) What is the significance of introducing the clause relating to treatment of Modvat credit utilisation in the profit and loss account and treatment of outstanding Modvat credit?

Ans. The significance of introducing this clause in the tax audit report is that the department wants audited information on :

(a) the amount of Modvat credit availed during the year.

(b) the amount of Modvat credit utilised during the year.

It may be appreciated that both the aforementioned amounts as per excise records must be reflected in the books of account. This clause brings in the treatment in the books of accounts.

Paragraph 43 clearly brings out a table which shows the complete movement of Modvat credit including outstanding Modvat credit in the books of account.

(ii) Modvat on fixed assets purchased is credited to the respective asset account. What should be reported under clause 22(a) as treatment in profit and loss account of the Modvat availed?

Ans. The Modvat credit on fixed asset would not be credited to profit and loss account but would be credited to fixed asset account. Paragraph 43 clearly brings out a table which shows capital goods separate from other goods. Modvat availed on capital goods will go to reduce their actual cost and to that extent depreciation will not be available. This is made clear in

103

Explanation 9 to section 43(1). So far as reporting under clause 22(a) is concerned, the details suggested in the table given in paragraph 43 will comply with the requirements.

(iii) In case where Modvat accounting is done in the books and there is a reconciliation between Modvat as per books and Modvat as per excise, which entries are to be considered under this clause - whether Modvat as per book or whether Modvat as per excise.

Ans. The Modvat credit figures must be reported as per books of account and not as per excise records. However, it is important that there is a proper reconciliation between books & excise records. If any entries are necessary to be passed in the books, they should be made before certifying the financial statements.

(iv) What effect is to be given in respect of Modvat credit availed/utilised in the computation of income, in view of valuation of stocks as per section 145A?

Ans. The complete movement of Modvat credit and its adjustment to profit and loss account applying the provisions of section 145A is discussed in detail with illustration under clause 12 in the guidance note. The effect of such adjustments is also shown in the computation of income in paragraph 23.17.

(v) There is Modvat credit in the month of May 98. In the month of June, 98 due to changes in Excise Laws the assessee is not liable for excise. Should he mention the excise credit (which is never receivable) under clause 22 (a)?

Ans. The Modvat credit on inputs which has been availed by an assessee will have to be reported under clause 22 irrespective of the fact whether the assessee is liable to pay excise on finished goods or not. In this connection attention is draw to paragraph 9.1 of the Guidance Note on Accounting Treatment for Modvat which states as follows:

“Balance in Modvat Credit Receivable Accounts, pertaining to both inputs and capital goods, should be reviewed at the end of the year and if it is found that the balances of the Modvat credit are not likely to be used in the normal course of business within a reasonable time, then, notwithstanding the right to carry forward

104

such excess credit in the Excise Rules, the non-useable excess credit should be adjusted in the accounts. The consequence would be that the balances of the Modvat Credit Receivable Accounts in the financial accounts may be lower than the credit available as per the RG 23A/RG 23C registers. A reconciliation statement would have to be prepared indicating the amounts adjusted so that a track is kept for the difference between the balances and the difference between the financial accounts and the credit as per the excise registers can be explained in subsequent years also”.

(vi) The assessee is a manufacturer and he is accounting his purchases and sales on gross basis (i.e. inclusive of excise duty). He is purchasing goods from the companies who are paying excise duty at a higher slab. The turnover of the assessee is in the lower slab of excise duty. Hence there always remains Modvat credit in RG 23 register. There is no PLA account.

Please clarify:

(a) whether we have to consider this excise duty and Modvat for valuation of stock under section 145A?

(b) what is to be reported in clause 22(a)?

Ans.(a) Yes, the excise duty paid should be considered for valuation of stock under section 145A in view of its mandatory application.

(b) The treatment of Modvat credit in books should be reported in clause 22(a).

(vii) While calculating cost of fixed assets, Modvat credit is reduced. Similarly, should the sales tax set off be also reduced from the cost of fixed assets?

Ans. Yes, sales tax set off should also be reduced from the cost of fixed assets.

(viii) Should sales tax set off be also treated in the same way as Modvat credit?

Ans. Yes, sales tax set off should be treated in the same manner as Modvat credit in view of its similar characteristics.

105

Clause (b)

(i) The assessee company paid Rs.1,30,000/- as assessment dues for the assessment year 1996-97 during the year 1998-99. Should this amount be shown below the line? Can it be deducted while computing income?

Ans. The question is not clear about the law under which the stated assessment dues arose. If it is under income tax law, no deduction is permissible since any income tax paid is disallowable under section 40(a)(ii). The amount paid cannot be considered as prior period expenditure since assessment was made during the current year. The amount can be debited in the profit and loss account above the line.

(ii) Please state whether the following expenses debited to profit & loss account for the year ended on 31.3.1999 should be disclosed against sub-clause (b)?

(a) Wage disputes started during the year ended on 31.3.1998 but settled during the year ended on 31.3.1999. During the year ended on 31.3.1999, Rs.5 lakhs were paid towards increase in wages pertaining to earlier years.

(b) Sales returns debited to sales account of financial year 1998-99 relating to sales effected during earlier years.

Ans.(a) Since the wage settlement took place in the year ended 31st March, 1999, such expenditure cannot be considered as prior period expenditure. Paragraph 44.2, inter alia, clarifies that material adjustments necessitated by circumstances which, though related to previous periods but determined in the current period, will not be considered as prior period items. In such cases, though the expenditure may relate to the earlier year, it can be considered as arising during the year on the basis that the liability materialised or crystallised during the year.

(b) Sales return should be accounted in the year of its return and as such cannot be treated as prior period expenditure.

(iii) If the statutory auditor of a company has not considered a particular item as prior period expenditure but the tax auditor

106

considers it as a prior period expenditure, what is the duty of the tax auditor?

Ans. In Accounting Standard 5 as also in AS(IT) - II notified by the Government under section 145, dealing with prior period items, it has been explained that material charges or credits which arise in the current year as a result of errors or omissions in the accounts of the earlier years will be considered as prior period items. In view of this, the statutory auditor would normally take into consideration all items of prior period expenditure while giving his report on the financial statements. It would, therefore, be advisable for the tax auditor to ascertain the circumstances under which a particular expenditure has not been considered as prior period expenditure. If, on making the enquiries, he comes to the conclusion that a particular item has to be treated as prior period expenditure he should disclose the same under this sub-clause.

(iv) Should the following income be considered as income of earlier years and disclosed?

(a) Sales tax refund determined as a result of the order passed in the last month of the accounting year (i.e., March,1999) but received in the month of April, 1999.

(b) Claim for short supply of raw materials made during the year ended 31.3.99 but settled during the month of May 1999 and compensation received in May 1999.

Ans.(a) If the assessee has been maintaining books of account on mercantile system of accounting, the sales tax refund should be disclosed under this sub-clause as on 31st March, 1999. However, if the method of accounting is cash system, the same should be disclosed in the year of receipt.

(b) The claim for short supply of raw materials, even though made during the year ended 31st March, 1999, was settled only during the month of May, 1999 and the compensation was received. The Supreme Court in CIT v A Gajapathy Naidu [1964] 53 ITR 114 has clearly held that where a right to receive an amount arose in a particular accounting year, the same can be included only in that particular accounting year and it cannot be related back to an earlier year on the ground that the said income arose

107

out of an earlier transaction. Hence this need not be shown under this sub-clause as a prior period item.

23. Details of any amount borrowed on hundi or any amount due thereon (including interest on the amount borrowed) repaid, otherwise than through an account payee cheque. [Section 69D].

24. (a)* Particulars of each loan or deposit in an amount exceeding the limit specified in section 269SS taken or accepted during the previous year:-

(i) name, address and permanent account number (if available with the assessee), of the lender or depositor;

(ii) amount of loan or deposit taken or accepted;

(iii) whether the loan or deposit was squared up during the previous year;

(iv) maximum amount outstanding in the account at any time during the previous year.

(v) whether the loan or deposit was taken or accepted otherwise than by an account payee cheque or an account payee bank draft.

* (These particulars need not be given in the case of a Government company, a banking company or a corporation established by a Central, State or Provincial Act.)

(b) Particulars of each repayment of loan or deposit in an amount exceeding the limit specified in section 269T made during the previous year:-

(i) name, address and permanent account number (if available with the assessee) of the payee;

(ii) amount of the repayment;

(iii) maximum amount outstanding in the account at any time during the previous year;

108

(iv) whether the repayment was made otherwise than by account payee cheque or account payee bank draft.

Clause 24(a)

(i) Is the reporting requirement restricted only in respect of fresh loans accepted during the year?

Ans. Paragraph 46.7 (v) provides that opening credit balance of loan taken in earlier year is not specifically required to be disclosed. However, while giving figures of maximum amount outstanding at any time during the year or while giving information about repayment of loan/deposits, the opening balances in the loan accounts will have to be taken into consideration.

(ii) If any deposit is received with interest, kindly indicate as to how to report as the amount is not accepted by an account payee cheque or an account payee demand draft.

Ans. In accepting deposits various practices are adopted by business enterprises. Some times interest on such deposits is paid separately. Alternatively, the interest payable on such deposits may be added to the deposit and considered as additional deposits. Again the deposit account and interest account may be maintained separately or the interest may also be accounted for in the deposit account itself. Normally the interest element does not fall within the scope of section 269SS. However, if the interest is converted into a loan or a deposit and if the aggregate of the loans and the interest so converted as loan exceed the limit mentioned in section 269SS the tax auditor has to report on the same.

(iii) When current account is maintained in respect of a sister concern, in which goods purchased, cheques received etc. are reflected, how should the tax auditor approach such a situation in order to comply with the requirements of clause 24(a). Please illustrate this in the form of a sample loan account.

Ans. A current account, maintained in respect of a sister concern, may consist of entries reflecting purely trading transactions like purchases, sales, payments made, payments received for such

109

purchases or sales. It may also be a mixed account where amounts advanced by way of loans or deposits made with the sister concern and repayments by the sister concern may also be routed through such a current account. Paragraph 46.7 (ii) provides that a current account is not excluded from the definition of “deposit”. Therefore, if the transactions in a current account exceed the amount of Rs.20,000, it will be necessary to give the information against this sub-clause. This is the position even if no interest is paid on current account. Further, when there is a mixed account, the transactions relating to loans and deposit (temporary advances) should be segregated from other accounts and the transactions relating to loans/deposits only should be stated under this clause.

(iv) Will booking amount received against sale of goods (say, cars) fall under situation (iv) or under situation (viii) of paragraph 46.7?

Ans. Paragraph 46.7 (iv) provides that advance received against agreement of sale of goods is not a loan or deposit. Further, sub-clause (viii) also clarifies that transfer entries that relate to transactions with a supplier and customer will not be treated as loans or deposits accepted.

(v) An assessee buys machinery under hire purchase finance for which payment is made by account payee cheque by the financier to the supplier of machinery. The issue is whether the loan taken by the assessee for purchase of machinery for which payment is made by the financier to the supplier and not to the assessee, infringes the provisions of section 269SS. If so, how it is to be reported.

Ans. There is no doubt that there is movement of money in this case. Here a rough similarity exists with the principle of application of income. Without the specific instruction of the assessee the financier would not have remitted the money to the supplier. Hence, it is clear that the assessee has taken the loan from the financier which he instructed to be directly paid to the supplier of the machinery. Once the tax auditor is satisfied after examining the documents, correspondence, agreement etc. between the

110

assessee and the financier that the assessee has accepted a loan, the provisions of section 269SS are squarely applicable.

(vi) Where equity shares are issued in satisfaction of loans borrowed, would it tantamount to repayment of loan otherwise than by account payee cheque or draft?

Ans. Yes. Clause 24(b)(iv) covers the above situation.

(vii) A partner retires from a firm and his capital amount is treated as loan in the current previous year. Is it a loan received otherwise than by an account payee cheque?

Ans. Yes. Clause 24(b)(iv) covers the above situation.

(viii) A person has given loan to a firm in financial year 1998-99. On 1st April, 1999 he is admitted as a partner in the above firm and the amount standing to his credit in his loan account is transferred to his capital account. Please clarify whether this would amount to repayment of a loan otherwise by an account payee cheque.

Ans. Yes. Clause 24(b)(iv) covers the above situation.

(ix) If the opening balance of a loan is 1,00,000/-, interest credited during the previous year Rs.24,000/- and the closing balance is Rs.1,24,000/-, what are the reporting requirements under clause 24(a)? If interest is not credited and opening and closing loan balance is Rs.1,00,000 should we give details?

Ans. In this connection reference may be made to Circular No.479[F.No.225/47/86-IT(A.II)], dated 16.1.1987. This circular clarifies whether payment in cash of periodical interest amount alone exceeding Rs.10,000 (earlier limit) would attract the provisions of section 269T. It was clarified that the payment of interest of Rs.10,000 (earlier limit) or more will have to be made in the manner provided in section 269T. So far as the repayment of deposit together with any interest is concerned, there is no room for doubt. If the amount of repayment after including the interest is Rs.10,000 or more, the provisions of section would be attracted. This is because the interest accrued on the deposit and credited to the account periodically or otherwise partakes the character of a deposit and as such becomes deposit itself.

111

The logic of the above circular is applicable to the given issue. Here the interest credited being above the limit mentioned in section 269SS, can be considered to be in the nature of loan and reporting becomes necessary. Since the interest amount itself exceeds Rs.20,000 there is no necessity to consider the opening balance. However, if, for example, the opening balance of the loan is Rs.18,000 and the interest credited is Rs.2,500 the same has to be reported since the aggregate amount exceeds the limit mentioned in section 269SS.

(x) Does section 269SS include loans taken from finance company and loans taken from co-operative banks?

Ans. The scope of section 269SS includes loans taken from finance company but excludes loans taken from co-operative banks.

(xi) (a) There are two sister concerns A & B. A, government undertaking is the supplier for both the concerns. Demand draft purchased by A are credited in B’s books in the name of “A” and debited to the supplier Co. and vice versa. Will these transactions be covered by clause 24(a). The accounts of both A and B are under audit.

(b) Two finance companies A Ltd. & B Ltd. belong to same group of promoters. Both companies accept fixed deposits from public. Due to financial constraints A Ltd. is unable to repay the fixed deposits accepted from public. Co B Ltd. comes to help A Ltd. and repays the fixed deposits of A Ltd. directly by issuing account payee cheques in favour of fixed deposit holders of A Ltd.

Do the auditors need to give particulars of all such payments under clause 24(a) and (b)?

Ans. Issues (xi)(a) and (b) are answered together. The above transactions constitute transfer entries. Paragraph 46.7(viii) clarifies that loans and deposits taken or accepted by means of transfer entries constitute acceptance of deposits or loans otherwise than by account payee cheques. Hence, such entries have to be reported under this clause. The entries that relate to transactions with a supplier and customer will not be treated as loans or deposits accepted.

112

(xii) A has given a crossed cheque of Rs.50,000 to B as a loan/deposit. Subsequently as per instructions of A, B repays the above loan/deposit to C by crossed cheque of Rs.50,000 and debits it to “A”. Will it be covered by clause 24(a)?

Ans. The tax auditor has to report under both clauses 24(a) and 24(b).

(xiii) Earlier it was stated that if each loan entry is less than of Rs.20,000/- excluding opening balance then it is not required to be reported. But now paragraph 46,5 of the Guidance Note says that even opening balance will be considered. Please elucidate.

Ans. Paragraphs 44.3 (iv) and (vii) of the earlier Guidance Notes states as follows:

“44.3 (iv) Under Clause 10, the particulars of each loan or deposit of Rs.20,000/- or more taken or accepted by the assessee are required to be given. Therefore, it will be necessary to consider items of Rs.20,000/- and more for the purpose of giving the information. Total of all loans/deposits in a year from a particular person cannot be considered for this purpose. If the total of all loans/deposits in a year exceed Rs.20,000/- but each individual item is less than Rs.20,000/-, the information is not required to be given.

44.3(vii) Opening credit balance of loan taken in earlier years is not specifically required to be disclosed. However, while giving figures of maximum amount outstanding at any time during the year or while giving information about repayment of loan/deposit, the opening balances in the loan accounts will have to be taken into consideration”.

As compared to the above paragraph 46.5 and 46.7 (v) of the revised Guidance Note are given below:

“46.5 If the total of all loans/deposits in a year exceed Rs.20,000/- but each individual item is less than Rs.20,000/-, the information will still be required to be given in respect of all such entries starting from the entry when the balance reaches Rs.20,000/- or more and until the balance goes down below Rs.20,000/. As such the tax auditor should verify all loans/deposits taken or accepted where balance has reached

113

Rs.20,000 or more during the year for the purpose of reporting under this clause.

46.7 (v) Opening credit balance of loan taken in earlier years is not specifically required to be disclosed. However, while giving figures of maximum amount outstanding at any time during the year or while giving information about repayment of loan/deposit, the opening balances in the loan accounts will have to be taken into consideration”.

(xiv) An assessee has a loan account in which there is only the opening balance. Interest due on the loan has been credited. There are no other transactions except entries for tax deducted at source on interest due. Please clarify whether such accounts are to be reported under this clause.

Ans. The tax auditor has to examine the conduct of the account and the intention of the parties as to whether they propose to treat the interest credited as part of the loan. Depending on this he has to make a report.

(xv) In case of advances received which is not clarified whether it is unsecured loan or advance against sales please clarify the reporting requirements.

Ans. The tax auditor has to examine the trade practice adopted by the parties, the conduct of the relevant account to come to a conclusion whether the amounts received are in the nature of advances against sales or unsecured loans.

(xvi) In case where unsecured loans are being squared up by making sales, what should be reported?

Ans. This is covered by clause 24(b)(iv).

(xvii) In case where creditors for supplies are subsequently converted into unsecured loans, what are the reporting requirements?

Ans. The tax auditor has to make a report under clause 24(a)(v). He has to examine the necessary correspondence and other documents to verify at what point of time the creditors for supplies were converted into unsecured loans.

114

(xviii) A finance company takes loans on current account basis throughout the year and such loans are repaid on various dates during the year. Should the tax auditors report each credit entry under clause 24(a) (ii)?

Ans. Yes. The duty of the tax auditor to report arises the moment the aggregate exceeds Rs.20,000.

(xix) Mr. X has taken a loan of Rs.18000/- by cheque each from ‘A’ three times during the year. The aggregate loan is therefore Rs.54000/-. Will reporting be required under loan/deposit taken or accepted?

Ans. The maximum balance is Rs.54,000. Since, at the point of taking the second loan of Rs.18,000, the aggregate amount exceeds Rs.20,000 the tax auditor has to report the last two loans of Rs.18,000 each.

(xx) Should renewal of deposits be included as deposit repaid and accepted under clause 24(a)(v)?

Ans. Yes.

(xxi) A person is carrying on the business as a sole proprietary concern. He has taken certain loans in his individual name and routed them in the concern through his capital account. The concern is paying interest on these loans and debiting such interest to its profit and loss account.

Ans. The given issue does not make it clear whether the loans taken by the person were utilised for the purposes of the business. There are two aspects to the type of transaction referred to in the issue. Firstly, the person might have taken the loan and introduced the same as his capital contribution. In such a case payment of interest on capital is not allowable as a deduction in computing the income of the concern. Further, since the amount really constitutes capital, the tax auditor has no reporting requirements under this sub-clause. On the other hand, if the person introduces the amount in the concern, not as capital, but as loan, then interest is allowable if such loans are utilised for the purposes of business. In such as case that tax auditor has to

115

make an analysis of the capital account, segregate the loan element and report under this sub-clause.

(xxii) Should the tax auditor verify the documents relating to each loan transaction and also ascertain about the genuineness of each loan?

Ans. The primary responsibility to provide the particulars against this sub-clause lies with the assessee. The tax auditor should verify the particulars from the records maintained by the assessee. The documents relating to the transaction will form part of the records of the assessee and will be subject to audit in the normal course. There is no obligation on the tax auditor to ascertain about the genuineness of the loans.

Clause 24(b)

(i) Should repayment made be reported under clause 24(b)(ii) if repayment has been made more than once?

Ans. A plain reading of sub-clause (b) indicates that if repayment has been made more than once the same is to be reported.

(ii) If an assessee firm makes payment of LIC premiums or advance income-tax on behalf of the depositors through account payee cheques in an amount exceeding the limits mentioned in section 269T, should such payments be reported?

Ans. Section 269T(2) says that no branch of a banking company or a co-operative bank and no other company or co-operative society and no firm or other persons shall repay any deposit made with it otherwise than by an account payee cheque or account payee bank draft drawn in the name of the person who has made the deposit if the relevant conditions are satisfied. The given issue gives rise to reporting under clause 24(b)(iv).

(iii) What is the position if transfer entries are made in the books as authorised by the letter of depositor?

Ans. Paragraph 46.7(viii) clarifies that loans and deposits taken or accepted by means of transfer entries constitute acceptance of deposits or loans otherwise than by account payee cheques. Similarly, paragraph 47.4 clarifies that deposits discharged by

116

means of transfer entries constitute repayment of deposit otherwise than by account payee cheques or account payee bank drafts. Hence, such entries have to be reported. The position does not change whether such transfer entries are made by the assessee by himself or as authorised by the letter of depositor.

(iv) It has been stated that a current account is not excluded from the definition of deposit. Can you elaborate on the nature of current account?

Ans. A current account is in the nature of a running account. For example, in banks generally saving banks account are opened for individuals who are not having business transactions while current account is opened for business entities. In a current account a customer can overdraw up to sanctioned limits. In the same way business entities maintain current accounts in respect of suppliers, sister concerns, associated concerns etc. Purchases, sales, payments for purchases, receipts in respect of sales are routed through such current accounts. Advances given for arranging supplies are also entered in the current account. Sometimes even loans and deposits are entered in such current account and in this context the relevance of clause 24 will arise. According to paragraph 46.7 (iii) when there is a mixed account, the transactions relating to loans and deposits (temporary advances) should be segregated from other accounts and the transactions relating to loans/deposits only should be stated under this clause.

(v) Should the reporting be done only if the deposit amount exceeds Rs.20,000/-? There may be an account with an opening balance of Rs.1 lakh and only Rs.10,000 accepted during the year. In such a case should the deposit be reported?

Ans. Paragraph 46.5 states that if the total of all loans/deposits in a year exceed Rs.20,000/- but each individual item is less than Rs.20,000/-, the information will still be required to be given in respect of all such entries starting from the entry when the balance reaches Rs.20,000/- or more and until the balance goes down below Rs.20,000/. As such the tax auditor should verify all loans/deposits taken or accepted where balance has reached

117

Rs.20,000 or more during the year for the purpose of reporting under this clause.

(vi) If there is any onetime settlement with banks or others, how it is to be reported?

Ans. Even onetime settlement with banks is nothing but a repayment of loan taken from the bank and hence such settlement is to be reported under clause 24(b)(iv).

(vii) In case of a partnership/ proprietary firm loans from family members are taken and a payments like life insurance premium advance tax/MTNL bills etc. are directly paid from firm’s accounts by an account payee cheque in name of LIC/RBI/MTNL. Would this tantamount to repayment made otherwise than by account payee cheque?

Ans. Yes and such transactions are to be reported under clause 24(b)(iv).

(viii)(a) Should repayment of loans to banks and public financial institutions be reported under clause 24(b)?

(b) Should repayment of cash credit account and term loans from banks be reported?

(c) In case of cash credit limits with banks, if cash is deposited, is reporting necessary or will a note that cash credit transactions with banks are not reported in view of such transactions being innumerable be sufficient?

Ans. Issues (viii)(a), (b) and (c) above are answered together. Clause 24(b) does not exclude repayment of deposits to Government Company, banking company etc. from its scope. Hence, details of repayments of deposits falling within the scope of section 269T as mentioned in clause 47.1 have to be stated. Section 269T also does not exclude Government company, banking company or a corporation established by a Central, State or Provincial Act. As such, repayment of deposits by banking companies falling within the scope of section 269T are also to be stated. However, both in the case of repayment to banking companies etc. and repayment by banking companies etc. considering the voluminous nature of information to be provided,

118

the tax auditor can exercise his professional judgment and state only those cases of repayment of deposits which are made otherwise than by account payee cheque or account payee bank draft and should state this fact by way of a suitable note.

(ix) Should the tax auditor make any comment about contravention of section 69D, 269SS or 269TT?

Ans. The tax auditor is not required to make any comment about contraventions of section 69D, 269SS or 269SS.

25. Details of brought forward loss or depreciation allowance, in the following manner, to the extent available:

Serial Number

Assessment Year

Nature of loss/ allowance (in rupees)

Amount as returned (in rupees)

Amount as Assessed (give reference to relevant order)

Remarks

(i) While giving details of brought forward losses/allowances, the requirement as per the new form is to give the details to the extent available. In the case of assessees whose assessments are in various stages of litigation will it be correct to merely mention.

“Information not readily available and hence not furnished”.

Ans. If the assessments of the assessee are in various stages of litigation, the tax auditor can give the information up to the stage in which relevant Appellate orders are available. For example, if the assessee has gone in appeal against the order of Commissioner (Appeals) the tax auditor can give the information up to the stage decided by the Commissioner (Appeals) and then indicate the factual position regarding the litigation. However, information up to the first four columns should always be given.

(ii) With effect from A.Y. 2000-2001, brought forward losses under section 72 is allowed to be carried forward even if the business to which it relates has been discontinued in the relevant previous year. What is the position in regard to carry forward of unabsorbed depreciation under section 32(2)?

119

Ans. Section 32(2) deals with carry forward of unabsorbed depreciation. To enable such a carry forward, the above proviso provided that the business or profession for which the allowance was originally computed should be continued to be carried on by him in the previous year relevant for that Assessment Year. The Finance Act, 2000, has omitted the first proviso to section 32(2) with effect from Assessment Year 2001-2002.

(iii) How should the tax auditor certify the amounts of brought forward losses/depreciation, where necessary records of earlier years are not produced? Also, such carry forward may be in litigation before various authorities. In such a situation, what safeguards are necessary?

Ans. The tax auditor should give suitable disclaimer wherever proper records are not produced by the assessee in respect of brought forward losses/depreciation of earlier years. In regard to litigation, kindly see the answer to issue (i) above.

26. Section-wise details of deductions, if any, admissible under Chapter VIA.

(i) Can a tax auditor rely on a certificate issued by professionals other than chartered accountants?

Ans. The tax auditor has to exercise his professional judgement as to what extent he can rely on a certificate issued by professionals other than chartered accountants. Where he relies on such certificates, it is advisable to keep proper documentation.

(ii) Where payments qualifying for deduction under section 80D etc. might not have been paid out of business income but paid out of personal income, should such deductions be also disclosed?

Ans. Paragraph 49.2 clarifies that the tax audit report in Form No.3CA/3CB relates to business or professional activity of the assessee covered by section 44AB. Form No.3CD is an annexure to this Form giving particulars relating to the business/profession covered by the tax audit report. Therefore, the requirement under clause 26 relating to the deductions admissible under Chapter VIA will have to be restricted to the

120

items appearing in the books of accounts audited by the tax auditor.

(iii) Is it the duty of the tax auditor to verify whether all the relevant conditions have been complied with for claiming deduction under chapter VIA?

Ans. Paragraph 49.5 clarifies that the admissibility of deductions under chapter VIA is dependent upon various conditions laid down in the section under which the deduction is admissible. It is, therefore, advised that while working out the amount of admissible deduction the tax auditor has to ascertain whether those conditions stand fulfilled or not. For ascertaining this, the tax auditor has to obtain all necessary evidence on his record which would enable him to express the opinion on the admissibility of deduction.

(iv) In a proprietorship concern the proprietor has deposited surplus funds with a bank and got interest of Rs.5,000 which has been credited to his capital account. Besides this, he has income of Rs.15,000 from accrued interest on NSC which are not accounted for in the books. Considering the ceiling limit of Rs..12,000 under section 80L can the tax auditor report the admissible deduction under section 80L as Rs.5,000?

Ans. Paragraph 49.2 clarifies that the tax audit report in Form No.3CA/3CB relates to business or professional activity of the assessee covered by section 44AB. Form No.3CD is an annexure to this form giving particulars relating to the business/profession covered by the tax audit report. Therefore, the requirement under clause 26 relating to the deductions admissible under chapter VIA will have to be restricted to the items appearing in the books of account audited by the tax auditor.

In the given issue it appears that one of the items qualifying for deduction under 80L has been entered in the books of account namely the capital account of the proprietor, and the other one is outside the books. It is advisable for the tax auditor to confine himself only to the entries appearing in the books of account and report accordingly.

121

He may ask the assessee to produce all the relevant documents and evidence in support of the deduction claimed under section 80L and then give the necessary particulars.

(v) Where, in any previous assessment year, the return of income of the assessee had been scrutinised and the admissibility of deduction under section 80I, 80HH, 80-IA and similar sections was not questioned and was allowed, should the tax auditor verify all over again as to whether deduction under section 80-I etc. is allowable?

Corollary to the above question would be that where there has been no assessment in earlier years and the client has claimed any of the above deduction, should the auditor go into correctness of the claim and allowability of the same in the subsequent years?

Ans. The tax audit is done with reference to the books of account for the relevant previous year. Hence, normally, it is not necessary for the tax auditor to go into the details of the previous year/s preceding the relevant previous year. In some cases there is a specific requirement in Form No.3CD requiring the tax auditor to examine the papers relating to earlier previous years. An example would be clause 14(d)(i) where the tax auditor is to indicate the adjustments on account of Modified Value Added Tax Credit claimed and allowed under the Central Excise Rules, 1944, in respect of assets acquired on or after 1st March, 1994. At the same time it is also to be kept in mind that an opinion on the admissibility of the deductions under various sections in chapter VIA may not be completely correct if the tax auditor does not examine the relevant past records. If for example, the tax audit for the previous year preceding the relevant previous year has been completed, say, by another auditor, the tax auditor can rely on the particulars given by the previous auditor so far as relevant for the purposes of determining the admissibility of deductions under chapter VIA for the relevant previous year. If no such audit has been done in the earlier previous year/s the tax auditor may have to examine the records himself for the purpose of furnishing the true and correct particulars in the relevant previous year. This is an area where much professional judgement is necessary.

122

(vi) The owner of a proprietary firm has paid mediclaim premium from his personal saving account. Hence, no detail appears in the books of account of the business. What is the duty of the tax auditor?

Ans. Paragraph 49.2 clarifies that the tax audit report in Form No.3CA/3CB relates to business or professional activity of the assessee covered by section 44AB. Form No.3CD is an annexure to this form giving particulars relating to the business/profession covered by the tax audit report. Therefore, the requirement under clause 26 relating to the deductions admissible under chapter VIA will have to be restricted to the items appearing in the books of account audited by the tax auditor.

27. (a) Whether the assessee has deducted tax at source and paid the amount so deducted to the credit of the Central Government in accordance with the provisions of Chapter XVII-B.

(b) If the answer to (a) above is in the negative, then give the following details:

Serial Number

Particulars of head under which tax is deducted at source

Amount of tax deducted at source in (rupees)

Due date for remittance to Government

Details of payment date amount (in rupees)

Remarks

(i) Is the tax auditor responsible for reporting professional tax

deducted from salary paid to employees but not paid?

Ans. The tax auditor is not responsible to report whether professional tax deducted by the employer from salary paid to the employee has been paid to the credit of the State Government.

28. (a) In the case of a trading concern, give quantitative details of the principal items of goods traded:

(i) Opening stock;

(ii) Purchases during the previous year;

(iii) Sales during the previous year;

(iv) Closing stock;

123

(v) shortage/excess, if any.

(b) In the case of a manufacturing concern, give quantitative details of the principal items of raw materials, finished products and by-products.

A. Raw materials:

(i) opening stock;

(ii) purchases during the previous year;

(iii) consumption during the previous year;

(iv) sales during the previous year;

(v) closing stock;

(vi) *yield of finished products;

(vii) *percentage of yield;

(viii) *shortage/excess, if any.

B. Finished products/By-products:

(i) opening stock;

(ii) purchases during the previous year;

(iii) quantity manufactured during the previous year;

(iv) sales during the previous year;

(v) closing stock;

(vi) shortage/excess, if any.

* Information may be given to the extent available.

(i) (a) How quantitative details can be disclosed in case of general stores or a super market or a departmental store where thousands of items are lying in the store?

(b) What should the tax auditor report in the case of trader in cloth, Kirana etc. in which item wise quantitative details cannot be maintained by the client because of so many varieties?

Ans. Issues (i)(a) and (b) are answered together. Sub-clauses (a) and (b) require, in the case of a trading concern or a manufacturing

124

concern respectively, the quantitative details of the principal items of goods traded. This should be the guiding principle while giving the particulars under sub-clauses (a) and (b). Therefore, as given in paragraph 52.2, information about petty items need not be given. What would constitute principal items will depend on the facts of each case. Normally, items which constitute more than 10 per cent of aggregate value of purchases, consumption or turnover may be classified as principal items. In this connection a reference may be made to the ICAI’s “Statement on Amendments to Schedule VI to the Companies Act, 1956.”

(ii) Is a tax auditor justified in accepting a "management representation" with respect to the "quantitative details" of stocks where the assessee "cannot have" a full-fledged system for recording quantitative details of purchases/sales and closing stocks owing to large volume of items, lack of proper stock evaluation systems, or any other practical problems?

Ans. Paragraph 52.1 has clarified that the relevant information should be given only in respect of those items where it is practicable to do so, having regard to the records maintained by the assessee. In other cases, the tax auditor may indicate in his report that the relevant records were either not maintained or were inadequate for the purpose of furnishing the requisite information. However, the concept of materiality is also relevant while giving the particulars in Form No.3CD. If the value of stock is so material in the overall scheme of tax audit, it is advisable for the tax auditor to insist upon the maintenance of reasonable quantitative details in regard to the principal items. In its absence, proper qualificatory remarks have to be made.

(iii) Clause 28(b) A (vi) and (vii) requires details of yield of finished products and the percentage of yield. Normally yield itself is calculated in terms of percentage and hence it appears that the requirement as to percentage of yield is superfluous. Please clarify.

Ans. “Yield of finished product” and “percentage of yield” are different as the first one deals with the quantity and the second one deals

125

with the percentage of yield. Hence, the requirement as to the percentage of yield is not superfluous.

(iv) (a) A civil contractor does not trade or manufacture. Should the tax auditor give quantitative details in Form No.3CD and if so, how?

(b) How should a tax auditor furnish the quantitative details for a construction company?

Ans. Issues (iv)(a) and (b) are answered together. The tax auditor need not furnish quantitative details for a construction company or in respect of a civil contractor because construction is neither trading nor manufacturing activity. The Hon’ble Supreme Court in CIT v. N.C. Budharaja & Co. [1993] 204 ITR 412 has held that construction of a dam or canal could not be equated to a manufacturing activity.

(v) (a) A manufacturing concern manufactures products whose raw materials are received in kgs. and finished goods are sold in pieces/dozens. The items manufactured are also of different sizes and varieties running into approximately 200 types. Quantitative records of raw materials and scrap are kept but records of finished goods are not compiled.

The tax auditor has given a note stating that the quantity of opening and closing stocks have been stated on the basis of physical inventory taken by partners of the firm.

Is the above note appropriate looking at the practical difficulty of maintaining records?

(b) A partnership/ proprietor firm was not valuing its work-in-progress for all the past years since its processing period is hardly 2 days. How should the tax auditor deal with this issue?

Ans. The Issues (v)(a) and (b) are answered together. The particulars required under clause 28 will vary from business to business and it is extremely difficult to give guidance that would be applicable to all situations. This is a clause that requires a very large degree of professional judgement on the part of the tax auditor. As already stated materiality is a key factor in determining the extent of particulars to be given in Form No. 3CD. It is for the tax auditor to judge.

126

(vi) In the case of an assessee engaged in the manufacture of goods the quantity of raw materials are recorded in kgs/tonnes. The finished product is recorded in pieces. In such a case how can the percentage of yield and shortage of raw materials be ascertained and stated under this clause?

Ans. In the case of an assessee engaged in the manufacture of goods where the input of raw materials and the output of finished goods are recorded in different units of measurement, unless an alternative method is available for conversion of the end product into the same unit of measure, the yield and shortage cannot be ascertained. In some cases where the end product is a standard item and can be converted back and related to the input of the raw material in the same unit of measurement, the same should be done to ascertain the shortage, yield etc. In case it is not possible, the fact should be so stated under this clause.

(vii) Is it necessary for an assessee rendering technical consultancy services to give quantity details of raw materials such as tracing papers, drawings, designs etc?

Ans. No. Items of stationery, papers, drawings, designs etc. constitute stores and they are not in the nature of raw materials in the case of an assessee rendering technical services. In any case, this information is not required to be given.

29. In the case of a domestic company, details of tax on distributed profits under section 115-O in the following form:-

(a) total amount of distributed profits;

(b) total tax paid thereon;

(c) dates of payment with amounts.

(i) It is possible that tax audit in respect of a particular previous year might be completed before a domestic company distributes dividend coming within the scope of chapter XII-D. In that case will it be proper compliance with the requirements of the clause if details of dividend declared in the last previous year but distributed and paid in the current previous year are given?

127

Ans. Yes. The tax auditor is conducting the audit for the relevant previous year. Hence, he has to give the details of the amount of distributed profits, total tax paid thereon during the previous year.

(ii) Should the tax auditor give detail of dates of payment both in respect of dividend distributed and tax paid?

Ans. Yes. Paragraph 53.4 states that information about the date of declaration /distribution of the dividend or payment of dividend is not required to be given. However, it will be advisable to give the above information of distribution because the company is required to deposit the tax due under section 115-O within 14 days of the date of declaration/distribution or payment whichever is earlier.

30. Whether any cost audit was carried out, if yes, enclose a copy of the report of such audit [See section 139(9)].

(i) Clause 30 requires that if cost audit was carried out, a copy of such report should be enclosed. Would it mean that if cost audit is not carried out or delayed, the clause does not apply?

Ans. Paragraph 54.2 brings out that in cases where cost audit, though ordered, has not been completed by the time the tax auditor gives his report, he has to state the fact under this clause.

31. Whether any audit was conducted under the Central Excise Act, 1944, if yes, enclose a copy of the report of such audit.

(i) Guidance is required regarding the excise audit report of which period is required to be submitted since normally the excise audit pertains to an earlier year.

Ans. Basically the assessee should give the details of audit, if any, conducted under the Central Excise Act, 1944. The tax auditor has to enclose the copy of the report as made available for the latest year.

(ii) If an assessee does not enclose the cost audit report with the return the return will be deemed to be defective. This restriction is not applicable when the excise audit report is not enclosed with the return. Is it correct?

128

Ans. Yes, the return in which the excise audit report is not enclosed cannot be considered as a defective return in terms of the provisions of section 139(9).

32. Accounting ratios with calculations as follows:-

(a) Gross profit/Turnover;

(b) Net profit/Turnover;

(c) Stock-in-trade/Turnover;

(d) Material consumed/Finished goods produced.

General

(i) In the absence of definitions of turnover, gross profit, net profit, etc., is it advisable to enclose working of all these factors also because these terms may be interpreted differently by different people which may result in the working out the same ratios in different manner?

Ans. Paragraph 56.2 clarifies that while calculating these ratios, the tax auditor should assign a meaning to the terms used in the above ratios having due regard to the generally accepted accounting principles. As a matter of general guidance, paragraph 56.3 gives the definitions given by the ICAI in its Guidance Note on the terms used in financial statement in respect of gross profit, turnover and net profit. In view of the divergent nature of accounting policies that may be followed by different businesses, it is difficult to give a standard meaning to the above terms in respect of all businesses. That is why the Guidance Note leaves it to the professional judgement of the tax auditor.

(ii) Will income which is exempt under section 10(33) form part of turnover?

Ans. Section 10(33) of Income-tax Act exempts dividends, etc. If an assessee is a dealer in shares, in his own right, as explained in paragraph 5.9, the sale value will be taken into account for considering the limit for the purpose of section 44AB. In such a situation, dividend, if any, received by him is incidental to business and will also be included for the purpose of calculating the limit even if such dividends are exempt under section 10(33).

129

This is made clear in paragraph 6.1. Extending the analogy, the same principle will apply even if such dividends constitute investment income and form part of gross receipts of the assessee.

(iii) (a) For the purpose of calculating ratios required by clause 32, is it appropriate to take the value of purchases, sales and inventories after complying with the requirements of section 145A?

(b) Please clarify whether the above accounting ratios are to be calculated on the basis of data printed in the profit and loss account and balance sheet or on the basis of data used for computation of income for filing income-tax returns.

Ans. The two issues being similar are answered together. The ratios to be calculated under this clause are to be based on the data to be found in the books of account maintained by the assessee as per his method of accounting. The statutory adjustments under section 145A are to be made outside the books for determination of total income for the purpose of Income-tax Act and it is not appropriate to take the value of purchases, sales and inventories after making the statutory adjustments mentioned in section 145A.

(iv) In the case of a share-broker the gross profit ratio or the net profit ratio may not have the same significance as in the case of a manufacturing or a trading company. Can you please give some guidelines as to how the concepts of gross profit and net profit can be applied to a share-broker?

Ans. In the case of a share broker who is dealing only for commission, the commission will constitute gross receipts and the gross profit ratio will not have any relevance to him. However, net profit ratio is to be calculated. However, if such a share broker purchases and sells shares in his own right, he is doing business and hence the turnover is to be calculated and gross profit is also relevant for him. If such a share broker acts both as an agent and a principal he would be doing a composite activity. Here also gross profit is relevant.

(v) Suppose a charitable institution is carrying on business and claims exemption in respect of profits arising from such business

130

by satisfying the conditions mentioned in section 11(4A). Since it is a business carried on by a charitable institution primarily with the purpose of attaining the objects of the charitable institution, the profit motive may not be there to the same degree as may be prevalent in the case of a business concern pure and simple. In such a case the gross profit ratio and the net profit ratio may not be comparable between the business carried on by the charitable trust and a similar business carried on by other business concerns. It is felt that some specific guidance is necessary in such a situation.

Ans. It is not for the tax auditor to sit in judgement whether the ratios calculated for the purpose of clause 32 are fair for the purpose of tax assessment. He has to calculate the ratios on the basis of the data given in the financial statements of the assessee.

(vi) While calculating the ratios mentioned in clause 32, is it necessary to split manufacturing and trading activities and give the ratios respectively?

Ans. Paragraph 56.1 clarifies that the ratios have to be given for the business as a whole and it is not necessary to split the manufacturing and trading activities and calculate ratios separately.

(vii) What are the points to be kept in mind while calculating ratios in respect of a construction company engaged in constructing tunnels, bridges, dams etc. where the ratios are not likely to be uniform for every year and for every contract? This guidance is necessary particularly in view of the wide variations possible in the ratios from year to year.

Ans. Construction of tunnels, bridges, dams etc. is only a service activity and it cannot amount to a manufacturing activity. Reference may also be made to the decision of the Hon’ble Supreme Court in N.C. Budharaja & Co. [1993] 204 ITR 412 referred to earlier. Hence the ratios under this clause need not be calculated in respect of such a company. The tax auditor can report that this clause is not applicable in such case.

(viii) How the ratios are to be presented i.e.

131

(i) x / y

(ii) x : y

Ans. Both ways of presentation may be adopted. For example, it is better to present stock turnover ratio in the method given in (i).

(ix) An assessee is having industrial units. He is also engaged in trading activities. Please give suitable guidelines as to how to calculate and report the relevant ratios as required by clause 32..

Ans. The ratios have to be calculated for the business as whole.

(x) Should extra-ordinary items be included or excluded while calculating ratios?

Ans. Paragraph 4 of AS5-Net Profit or Loss for the period, prior period item and changes in Accounting Policies defines “extraordinary items” as income or expenses that arise from events or transactions that are clearly distinct from the ordinary activities of the enterprise and, therefore, are not expected to recur frequently or regularly. Paragraph 7 states that the net profit or loss for the period comprises both profit or loss from ordinary activities and extraordinary items each of which should be disclosed on the face of the statement of profit and loss. It is also significant to note that paragraph 8 of AS (IT)- II - states that extraordinary items of the enterprise during the previous year shall be disclosed in the profit and loss account as a part of net profit or loss for the period. However, it is felt that while calculating the ratios, the extraordinary items may normally be excluded, since tax audit is essentially carried out for the relevant previous year, unless such items materially affect the situation.

Clause (a)

(xi) While on the point of calculating gross profit ratio, it may be noted that as per AS-2 (Revised) - Valuation of Inventories, depreciation on plant and machinery is taken into account for valuation of finished goods. In view of this, please clarify whether the said depreciation is to be deducted while arriving at the gross profit?

132

Ans. Once depreciation on plant and machinery is taken into account for valuation of finished goods, it is necessary to deduct the same while arriving at the gross profit to satisfy the matching concept.

(xii) Where a company prepares only a profit and loss account and not trading account, please indicate as to how to calculate gross profit ratio.

Ans. Calculation of GP ratio is mandatory as per Form No.3CD requirement. In view of the same even though an assessee prepares only a profit and loss account and not a trading account, it is incumbent on the assessee to segregate the figures and rework to arrive at the GP ratio. In such case a GP ratio calculation must be carried out in a consistent way year after year.

(xiii) An assessee is trading in a number of goods and the gross profit of each item is different. Is it necessary to give G.P. Ratio of each item separately in Form No. 3CD or is it enough if only an overall G.P. Ratio of all the items is given?

Ans. It is enough if only an overall gross profit ratio is given.

Clause (b)

(xiv) In the case of a partnership concern, while calculating the net profit ratio, please indicate whether we can take the profit before partners’ interest and remuneration.

Ans. As noted earlier, the ratios are to be calculated on the basis of financial statements of the assessee. As per generally accepted accounting principles, interest and remuneration payable to partners constitute charge on the profit and hence the net profit ratios has to be calculated after charging such interest and remuneration.

(xv) In case of adatiya cum-broker who is having trading turnover in addition to his adat income and brokerage income, how can the tax auditor compare the net profit which also includes the adat income and brokerage with the turnover?

Ans. The ratios under this clause have to be calculated for the business as a whole. If a broker is having a composite business

133

of purchasing and selling shares in his own right, it is better to calculate these ratios taking the business as a whole.

(xvi) What are the guiding principles to be followed while calculating the gross profit and net profit ratios in the case of kachha/pakka adatiyas.

Ans. Paragraph 5.8 states that a question may also arise as to whether the sales by a commission agent or by a person on consignment basis forms part of the turnover of the commission agent and/or consignee as the case may be. In such cases, it will be necessary to find out, whether the property in the goods or all significant risks, rewards of ownership of goods belongs to the commission agent or the consignee immediately before the transfer by him to third person. If the property in the goods or all significant risks and rewards of ownership of goods continue to belong to the principal, the relevant sale price shall not form part of the sales/turnover of the commission agent and/or the consignee as the case may be. If, however, the property in the goods, significant risks and rewards of ownership belongs to the commission agent and/or the consignee, as the case may be, the sale price received/receivable by him shall form part of his sales/turnover.

Accordingly, it follows that depending upon the passing of property in the goods or the significant risks and rewards of ownership of goods, either the turnover as such or the gross receipt by way of commission will constitute the base for calculating the ratios.

Clause (c)

(xvii) Please clarify whether the stock turnover ratio is to be calculated by taking average stock or opening or closing stock? While mentioning the stock turnover ratio is it appropriate to report in decimal points?

Ans. Paragraph 56.4 clarifies that for the purpose of calculating the ratio mentioned in this sub-clause, only closing stock is to be considered. Wherever closing stock is there, the relevant ratio can also be given using decimal point.

134

(xviii) Where closing stock is nil, please indicate as to how to work out the ratio of stock with turnover (i.e. if 0 is to be divided by any amount the result would be zero).

Ans. Paragraph 56.4 clarifies that for the purpose of calculating the ratio mentioned in this sub-clause, only closing stock is to be considered. In this issue, since the closing stock is nil the tax auditor can report that this sub-clause is not applicable.

Clause (d)

(xix) Please indicate as to how the material consumed/finished goods ratio and stock-in trade/turnover ratio are to be calculated in the case of a company engaged in manufacturing as a job worker to whom the raw materials are supplied by the customers. The company spends only on stores/ consumables. The company in this case has valued finished goods only at conversion cost.

Ans. The ratios need not be calculated in the case of a company engaged in manufacturing as a job worker.

(xx) Once the accounting ratio viz material consumed by finished goods is given in terms of quantity, is it necessary to give the same ratio in terms of value also?

Ans. Paragraph 56.2 clarifies that all the ratios mentioned in this clause are to be calculated in terms of value only.

(xxi) An industrial unit consumes raw materials for the purpose of its own production. It also sells such raw materials. Since such sales include the profit element, kindly indicate the procedure to calculate the material consumed ratio.

Ans. If a company sells surplus raw materials, it is an activity in the course of its business. It is neither correct nor advisable to segregate the profit element arising out of such sales.

135

D. CODE OF CONDUCT AND OTHER MATTERS

1. Can the ITO or any other tax authority issue a summons to auditor and compel him to give evidence or produce any documents relating to the audit conducted by him?

Ans. The Income-tax Officer or any other authority who is authorised to issue summons and to call for evidence or documents can call upon the auditor who has audited the accounts to give any evidence or produce documents. For this purpose, a notice under section 131 of the Income-tax Act can be issued by the Income-tax Officer or other tax authority mentioned in the said section. The auditor has to take care to protect the confidentiality of the documents of the client as prescribed by the Code of Ethics.

2. If any action is taken against the assessee for concealment of particulars of income, can the department take any action against the tax auditor who has given tax audit report without any qualification?

Ans. In case the assessee is found guilty of having concealed the particulars of his income it would not ipso facto mean that the tax auditor is also responsible. If the Income-tax Officer comes to the conclusion that the tax auditor was grossly negligent in the performance of his duties, he can refer the matter to the Institute so that an appropriate action can be taken against the tax auditor under the Chartered Accountants Act, 1949.

3. If the audit is conducted under section 44AB and audit report is filed with the Income-tax Officer, can the ITO pass an order under section 142 (2A) directing another audit?

Ans. The fact that an audit under section 44AB has been conducted and the report filed with the Income-tax Officer will not ipso facto prevent the ITO from directing another audit under section 142(2A). If the ITO feels that the requirements under section 142(2A) have been satisfied, it would be open for him to direct another audit under section 142(2A) of the Act.

4. Will the following matters contravene the provisions of Code of Conduct?

136

(i) If the tax auditor also accepts the assignment of tax representation.

(ii) If the tax auditor charges professional fees by way of percentage of turnover or percentage of gross total income.

(iii) If the tax auditor does not complete the audit and give his report to the assessee before the due date as a result of which the assessee is made liable to pay penalty under section 271B.

Ans.(i) A tax auditor can accept the assignment of tax representation.

(ii) Under the Code of Conduct no auditor can charge professional fees by way of percentage of turnover or percentage of profits. In this connection, reference is invited to clause (10) of Part I of the First Schedule to the Chartered Accountants Act and the commentary on the subject in the Code of Conduct. Certain exceptions are made in Regulation 168/192 but these exceptions do not apply for charging of fees for tax audit.

(iii) If the tax auditor does not complete the tax audit assignment before the due date and if it is proved that the delay is because of his gross negligence, he will be answerable to the Council of the Institute. According to the Chartered Accountants Act, disciplinary action can be taken against such an auditor.

5. For the purpose of disclosure requirements under the Companies Act, how should the tax audit fees paid to the statutory auditors or any one of their partners or associate concerns be disclosed in the financial statements?

Ans. The audit fees paid to a statutory auditor of a company should be disclosed separately. Since tax audit fees will be considered as fees paid in other capacity, the same should be disclosed separately indicating the nature thereof. This requirement will apply also to tax audit fees paid to any of the partners of the statutory auditors or to any of the concerns in which such partners are interested.

6. (i) Are the tax authorities bound to accept the figure as verified by the tax auditor for the purpose of computing income of an assessee?

137

(ii) If the tax auditor has qualified his report and expressed an opinion on a particular item, can the assessee take a different view while preparing his return of income?

(iii) Is the opinion of the tax auditor on a particular item binding either on the assessee or the tax authorities?

Ans.(i) Since the particulars stated in Form No. 3CD are duly verified by a chartered accountant, they should normally be accepted by the tax authorities. If, however, there is a specific reason for differing from the view taken by the tax auditor, the Income-tax Officer may compute the income of the assessee by adopting different particulars after making due verification of the books and records of the assessee.

(ii) Yes. The opinion expressed by the tax auditor is not binding on the assessee. It is possible for the assessee to take a different view while preparing his return of income. It is advisable for the assessee to state his viewpoint and support the same by any judicial pronouncements on which he wants to rely.

(iii) As stated earlier, the opinion of the tax auditor is not binding either on the assessee or on the tax authorities. It is possible for the assessee to take a different view of the matter and it is also possible for the tax authorities to take their own view depending on the facts and circumstances of each case.

138

E. FORMAT OF FINANCIAL STATEMENTS

1. Can the tax auditor give his report in Form No. 3CA/3CB and 3CD on a set of financial statements which are prepared in a manner different from the formats recommended by the Institute (Formats printed in Appendices X and XI in the Institute’s Guidance Note on Tax Audit)?

Ans. The formats recommended by the Institute for non-corporate assessees are recommendatory in nature and it would be open for the assessee to choose any other suitable formats as explained in paragraphs 59.1 to 59.3.

2. (i) Should an assessee give the preceding year’s figures in the financial statements?

(ii) If the accounts of the preceding year are not audited should any qualification be made in respect of the preceding year’s un-audited figures?

(iii) If the original cost of fixed assets is not known, how should the information about this item be given in the balance sheet of a non-corporate entity?

Ans.(i) There is no requirement under section 44AB of the Income-tax Act unlike the Companies Act - for the comparative figures of the previous year to be given. However, it would be a healthy practice to give the preceding year’s figures in the accounts.

(ii) If the opening balances had been taken with reference to unaudited accounts, a note should be given to the effect that the opening figures have been taken on the basis of preceding year’s unaudited balance sheet. There is no necessity to qualify in case where opening balances are extracted from unaudited accounts, but a suitable disclosure be made in the notes on accounts.

(iii) If the original cost of the fixed asset is not known a note on accounts can be made to the effect that book value has been considered as a cost for the purpose of financial statements. Reference may be made to Paragraph 14.1 of the Guidance Note on Audit of Accounts of Non-corporate Entities (Bank Borrowings) issued by the Institute.