Issues in Tax Audit u/s 44 AB

1. Issues in Tax Audit u/s 44 AB CA Rajiv Jain NIRC of ICAI On 19th September 2009 At Hotel Crown Plaza New Delhi

2. Section 44 AB Every person-- • carrying on business shall, if his total sales, turnoveror gross receipts, as the case may be, in business exceed or exceeds forty lakh rupees in any previous year ; or • carrying on profession shall, if his gross receipts in profession exceed ten lakh rupees in any previous year; or • carrying on the business shall, if the profits and gains from the business are deemed to be the profits and gains of such person under section 44AD or section 44AE or section 44AF or section 44BB or section 44BBB , as the case may be, and he has claimed his income to be lower than the profits or gains so deemed to be the profits and gains of his business, as the case may be, in any previous year, ……. report by an accountant in the form prescribed under this section.

3. Business • S 2(13): Business includes any trade, commerce, or manufacture or any adventure or concern in the nature of trade, commerce or manufacture. • The word business is one of wide import and it means activity carried on continuously and systematically by a person by the application of his labour or skill with a view to earn income. The expression business does not necessarily mean trade or manufacture only- Barendra Prasad Roy v ITO [1981]129 ITR 295 (SC).

4. Profession • Section 2 (36):Profession to include vocation. • Profession is a word of wide import and includes vocation which is only a way of living.-CIT v. Ram Kripal Tripathi [1980]125 ITR 408 (All). • Whether a particular activity can be classified as business or profession will depend on the facts and circumstances of each case. The expression profession involves the idea of an occupation requiring purely intellectual skill or manual skill controlled by the intellectual skill of the operator, as distinguished from an operation which is substantially the production or sale or arrangement for the production or sale of commodities.- CIT vs. Manmohan Das (Deceased) [1966] 59 ITR 699 (SC). • The following have been listed out as profession in section 44AA (rule 6F) and notified there under (Notifications No. SO-17 (E) dated 12.1.77, No. SO 2675 dated 25.9.1992 and No. So 385(E) ,dated 4.5.2001): Accountancy, Architectural, Authorised Representative, Company Secretary, Engineering, Film Artists/Actors, Camera man, Director, Singer, Story Writer, Etc., Interior Decoration, Legal, Medical, Technical Consultancy, Information Technology

5. Whether Business or Profession • Advertising Agent. • Clearing, Forwarding and Shipping agents –CIT V. Jeevanlal Lallubhai & Co, [1994] 206 ITR 548 (Bom). • Couriers. • Insurance agent. • Nursing Home. 135 ITR 146, 90 ITD 235 • Stock and share broking and dealing in shares and securities-CIT v. Lallubhai Nagardas & Sons [1993} 204 ITR 93 (Bom). • Travel agent.

6. Sales - Turnover Computation of Specified Limit of Rs 40 Lacs • Excise Duty/ Sales tax • Cash Discount • Rebate and Discount • Sale return. • Sale of Fixed Assets • Sale of Investment. • Sales by Consignment Agent-(Circular 452, 17-3-86). • Speculative (Share – Commodity). • Derivatives-Future/Option transactions. • Delivery Based Share Transactions.

7. Speculation Transaction 43(5) It means a transaction, in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips.

8. Derivatives Exempted from Speculative Transaction Definition • Trading carried electronically on screen based system • Through stock broker registered with SEBI • by banks or MF on a recongised stock exchange • Supported by time stamped contract note indicating Unique Client Identity No and PAN

9. Determination of Turnover: Speculative vs Derivatives Speculative • The total of favorable and unfavorable differences shall be taken as turnover. Derivatives • The total of favorable and unfavorable differences shall be taken as turnover. • Premium received on sale of options is also to be included in turnover. • In respect of any reverse trades entered, the difference thereon, form part of the turnover.

10. Capital Gains Vs. Business Depends on facts and circumstances of each case taking into consideration nature, frequency and volume of transaction. Landmark Judgments : • CIT v. P.K.N. and Co. Ltd. (1966) 60 ITR 65 (SC). • Saroj Kumar Mazumdar v. CIT (1959) 37 ITR 242 (SC). • CIT v. Sutlej Cotton Mills Supply Agency (1975) 100 ITR 706 (SC). • Venkataswami Naidu & Co.(G) v. CIT (1959) 35 ITR 594 (SC).

11. Board Circular No. 4/2007, dated 15-6-2007 It is possible for tax payer to have two portfolios, i.e., an investment portfolio comprising of securities which are to be treated as capital assets and a trading portfolio comprising of stock in trade which are to be treated as trading assets. Where an assessee has two portfolios, the assessee may have income under both heads i.e., capital gains as well as business income.

12. Gross receipts Instances of Receipts forming part of Gross Receipts • Duty Draw Back • Commission - Brokerage • Job Work • Sale of License • Foreign Exchange surplus/ difference on Export Sales • Surplus on reimbursement e.g. packing forwarding, freight etc. • Advance receipt from customer forfeited • Interest Income if assessable as business income • Income of a partner from a partnership firm such as remuneration and interest on capital account.

13. Gross receipts Instances of receipts not forming part of Gross Receipts • Rental Income. • Reimbursement of expenses and other charges to a clearing / consignment agent. • Amount received by a traveling agent for reimbursement of expenses. Except a travel agent engaged in Package Tour. • Write Back of Provisions – Recoveries from Bad Debts. • Principle for ascertaining whether reimbursement is part of gross receipt or not. • Limits of Business and profession- independent or interdependent.

14. Assessee having Exempt income whether required to get its accounts audited u/s 44 AB • Trust / Association Exempt u/s 10(21), 10(23A), 10(23B), 10(23BB), 10(23C) and Section 11 • Agriculturist

15. Section 11. • Section 11 (4) For the purposes of this section "property held under trust“ includes a business undertaking so held, and where a claim is made that the income of any such undertaking shall not be included in the total income of the persons in receipt thereof, the Assessing Officer shall have power to determine the income of such undertaking in accordance with the provisions of this Act relating to assessment; and where any income so determined is in excess of the income as shown in the accounts of the undertaking, such excess shall be deemed to be applied to purposes other than charitable or religious purposes. • Section 11 (4A) Sub-section (1) or sub-section (2) or sub-section (3) or sub-section (3A) shall not apply in relation to any income of a trust or an Institution, being profits and gains of business, unless the business is incidental to the attainment of the objectives of the trust or, as the case may be, institution, and separate books of account are maintained by such trust or institution in respect of such business.

16. Trust Engaged in business • A business whose income is utilised by the trust or the institution for the purposes of achieving the objectives of the trust or the institution is, surely, a business which is incidental to the attainment of the objectives of the trust. (247 ITR 785 THANTI TRUST SC, 107 ITD 403 CIT V. Beer Shiva Educational Social Welfare Society, Haldwani, 105 ITD 29 Samaj Kalyan Parishad, Modinagar v. ITO.) Section 2(15) defining ‘Charitable Purpose’ amended w.e.f. 1-4-2009 Provided that the advancement of any other object of general public utility shall not be a charitable purpose, if it involves the carrying on of any activity in the nature of trade, commerce or business, or any activity of rendering any service in relation to any trade, commerce or business, for a cess or fee or any other consideration, irrespective of the nature of use or application, or retention, of the income from such activity;

17. Rule 6G 6G.Report of audit of accounts to be furnished under section 44AB. (1) The report of audit of the accounts of a person required to be furnished under section 44AB shall,- (a) in the case of a person who carries on business or profession and who is required by or under any other law to get his accounts audited, be in Form No.3CA; (b) in the case of a person who carries on business or profession, but not being a person referred to in clause (a), be in Form No.3CB. (2)The particulars which are required to be furnished under section 44AB shall be in Form No.3CD.

18. Audit Report Form 3CB • We have examined the BS & PL of XXXX.. • We certify that the BS & PL are in agreement with books maintained at the head office …and ….branches. • We report the following observations/comments/discrepancies/ inconsistencies “We have taken into consideration the audit report and the audited statement of accounts, and particulars received from auditors of the branches not audited by us” ……………Subject to above • We have obtained all the information and explanationswhich to the best of our knowledge and belief were necessary for the purpose of the audit. • In our opinion proper books of accounts have been kept by the assessee so far as appears from our examination of the books. 3CB..Contd..

19. 3CB Contd.. • In our opinion and to the best of our information and according to the explanations given to us, the said accounts, read with notes thereon, give atrue and fair view: • in the case of balance sheet, of the state of affairs… 31st March.. And • in the case of profit and loss account, of the profit… that date. • The statement of particulars required to be furnished under section 44AB is annexed herewith in Form No 3CD. • In our opinion and to the best of our information and according to the explanations given to us, the particulars given in Form No. 3CD and the Annexure thereto are true and correct.

20. True and Fair view Framework for Preparation and Presentation of financial statements issued by ICAI. Financial Statements are frequently described as showing a true and fair view of the financial position, performance and cash flows of an enterprises. Although this framework does not deal directly with such concepts,the application of the principal qualitative characteristics and of appropriate accounting standardsnormally result in financial statements that convey what is generally understoodas true and fair viewof such information.

21. TYPES OF AUDIT REPORTS MODIFIED REPORT CLEAN REPORT Modifications not affecting Audit opinion Modification affecting Audit opinion Emphasis on Matter Qualified Opinion Adverse Opinion Disclaimer of Opinion AAS-28 The Auditor’s Report on Financial Statements

22. Applicability of Accounting Standards • Issued by the ICAI It is hereby clarified that the mandatory accounting standards also apply in respect of financial statements audited u/s 44AB of the Income Tax Act, 1961. Accordingly, the members should examine compliance with the mandatory accounting standards when conducting such audit. (Published in The Chartered Accountant Journal, August 1994.) • Audit Procedures - AAS – SAP - Peer Review - ASI • Issued u/s 145 of the I.T.Act

23. Particulars of form 3CD CA Rajiv Jain Practical Issues

24. Give the following particulars of the capital asset converted into stock-in-trade: - (a) Description of capital asset, (b) Date of acquisition; (c) Cost of acquisition; (d) Amount at which the asset is converted into stock-in-trade The particulars to be stated are required to be furnished with reference to the previous year in which the conversion has taken place. The taxability of capital gains or business income arising from such deemed transfer is not required to be reported. The legislation has not visualized the situation where stock in trade is to be converted into capital asset. In the absence of a specific provision, the formula which is favorable to assessee should be accepted. (ITA 6374/MUM/2004, ACIT v Bright Star Inv P Ltd) Clause 12A- Conversion of Capital Asset into Stock in Trade at fair market value: Section 45(2)

25. Reporting of treatment of Excise Duty, VAT etc • Clause 12 • 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. • Clause 21: Residuary note 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. • Clause 22(a): 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.

26. Section 145A v/s AS-2 (ICAI) S-145 A: Notwithstanding anything to the contrary contained in section 145, the valuation of purchase and sale of goods and inventory for the purposes of determining the income chargeable under the head "Profits and gains of business or profession" shall be– (a) in accordance with the method of accounting regularly employed by the assessee; and (b) further adjusted to include the amount of any tax, duty, cess or fee (by whatever name called) actually paid or incurred by the assessee to bring the goods to the place of its location and condition as on the date of valuation. Explanation.--For the purposes of this section, any tax, duty, cess or fee (by whatever name called) under any law for the time being in force, shall include all such payment notwithstanding any right arising as a consequence to such payment. AS-2 ICAI: Valuation of Inventory Cost of Purchase • 7. The costs of purchase consist of the purchase price including duties and taxes (other than those subsequently recoverable by the enterprise from the taxing authorities), freight inwards and other expenditure directly attributable to the acquisition. Trade discounts, rebates, duty drawbacks and other similar items are deducted in determining the costs of purchase. Cost of Inventories • 6. The cost of inventories should comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. Exclusive Method for valuation of Purchases resulting in exclusive method for valuation of inventory.

27. Section 145A/ Service Tax/ 43B • Service Tax Charged in bills. • Payment not received till the date of filing of ITR as such no liability to pay service tax. • Mercantile System of accounting followed Disallowance u/s 43B ? ACIT V Real Image Media Tech P Ltd (Chennai) 114 ITD 573 • 145A does not apply to service tax. • If Service Tax not credited to P & L no expenditure is claimed. • If no expenditure is claimed - No disallowance u/s 43B

28. ASI-14 wrt AS-9-Revenue Recognition- Published Aug-06 ASI-14 2. The amount of turnover should be disclosed in the following manner on the face of the statement of profit and loss: Amount Turnover (Gross) XXXX Less: Excise Duty XXXX Turnover (Net) XXXX 3. The amount of excise duty to be shown as deduction from turnover as per paragraph 2 above should be the total excise duty for the year except the excise duty related to the difference between the closing stock and opening stock. The excise duty related to the difference between the closing stock and opening stock should be recognised separately in the statement of profit and loss, with an explanatory note in the notes to accounts to explain the nature of the two amounts of excise duty.

29. Presentation of excise duty and sales in Profit& Loss Accountas per ASI-14/AS-9 ICAI Sales Basic Rs 1200/- Excise Duty Rs 192/- Gross Sales Rs 1392/-

30. Exclusive Method v Inclusive Method vis a vis Raw Material Opening Stock Basic Rs 200 Excise Rs 32 Total Rs 232 Purchases Basic Rs 1000 Excise Cenvat Rs 160 Total Rs1160 Closing Stock Basic Rs 400 Excise Rs 64 Total Rs 464 • Valuation of Raw Material (purchases, consumption and stock)

31. Valuation of Finished Goods lying in bonded house Finished Goods in bonded House Opening Stock Basic Rs 100 Excise Rs 16 Total Rs 116 Closing Stock Basic Rs 250 Excise Rs 40 Total Rs 290

32. Shortcoming of inclusive method u/s145A - Cumbersome calculations - Guidance Note CENVAT inclusive method withdrawn w.e.f 1-4-1999. - Contradictory to mandatory AS-2 - Disallowance u/s 43B Point at which excise duty is incurred in respect of Finished Goods lying in bonded house: [2007] 14 SOT 475 (All) Shyam Biri Works Ltd. V. Asst. Commissioner of income tax, Allahabad

33. Suggested reporting - Exclusive method under respective clauses: • Clause 12(b): • The excise duty and VAT in respect of inventory consisting of finished goods lying in bonded house is neither debited to the profit and loss account nor considered for valuation of inventory. • The value of excise duty in respect of Inventory consisting of raw material is neither debited to the profit and loss account nor considered for valuation of inventory. • The entries of excise duty are accounted in the books through separate account which is passed through the profit and loss account read with Clause 21 Residuary Note. • The entries of VAT are accounted in the books through separate account which is not passed through the profit and loss account read with Clause 21 Residuary Note. The above accounting treatment has no impact on current year`s profit or loss. • Clause 21: Residuary note Refer para 12(b). Further Rs 192/- the amount of excise duty on sales is debited to Excise Duty on sales which is reduced from gross sales turnover in the Profit & Loss account.

34. Excise Duty • Clause 22(a): • Modified Value Added Tax credits (cenvat credits) • Rs Nil- Opening Balance • Rs 160/- Credit availed is reduced from the cost of purchases. • Rs Nil Credit availed is reduced from cost of capital asset. • Rs 160/- credit utilized for payment of excise duty on sales is debited to Excise Duty A/c which is ultimately reduced from sales in the Profit & Loss account. • Rs Nil Closing Balance recognized as Balance Recoverable • PLA • Rs32/-, the excise duty on sales paid through PLA is debited to Excise Duty A/c which is ultimately reduced from sales in the Profit & Loss account • Excise Paid Finished Goods- Sales through depot • Ratios of special bench 107 ITD 343 (CHD) DCIT V GLAXO SMITHCLINE

35. Clause 17 (e) • Clause 17 (e): Penalty • Explanation to s 37: -For the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure. 201 ITR 684 Prakash Cotton SC, 205 ITR 163 Ahemadabad Cotton. Penalty is required to be examined as per the provisions of the relevant statue notwithstanding the nomenclature. If the impost is compensatory in nature, it is to be allowed, however, if it is penal in nature it is to be disallowed.

36. Clause 17 (f) Clause 17 (f): 40(a) • Deduction of TDS at lower rates or non deduction • STT up to AY 2008-09 • FBT if shown above the line for MAT • Wealth Tax

37. Clause 17 (f): Section 40(a)(ia) • Interest u/s 193 or 194A, Payment to Contractors/sub-contractors u/s 194C, Commission or brokerage u/s 194H, Rent u/s 194-I, Fees for technical/ professional services u/s 194J, Royalty (Expl 2 s 9(1)(vi). • In case where the assessee submits that the tax is not required to be deducted on any payment under clause (ia), the tax auditor may exercise his judgment in the light of applicable laws and report accordingly about the compliance of this provision. • Inadmissible if :- • Tax is not deducted at all. • Tax was deductible and was so deducted during the month March but not paid on or before the due date of filing of return. • Tax was deductible (and was so deducted) during the month March but not paid on or before the due date of filing of return. • In any other case i.e (Tax deducted from April to Feb) TDS is not paid up to 31st March. • Query: Tax deductible in April to Feb but deducted in March and paid after 31st March before due date of filing of return of income.

38. Clause 17 (i): Section 14A • Deduction inadmissible u/s14A in respect of the expenditure incurred in relation to income which does not form part of the total income( Subsection 1). • The AO, if he is not satisfied with the claim of the assessee, shall determine the amount of expenditure incurred, in relation to income which does not form part of the total income in accordance with method prescribed under rule 8D (w.e.f. 24-3-2008), ( Subsection 2). • the expenditure which the AO seeks to disallow under s. 14A should be actually incurred and so incurred with a view to producing non-taxable income (101 TTJ 369, ACIT vs Eicher Limited.) • Rule 8D w.e.f. 24-3-2008: Method for determining amount of expenditure in relation to income not includible in total income. 8D. (1) Where the Assessing Officer, having regard to the accounts of the assessee of a previous year, is not satisfied with (a) the correctness of the claim of expenditure made by the assessee; or (b) the claim made by the assessee that no expenditure has been incurred in relation to income which does not form part of the total income under the Act for such previous year,he shall determine the amount of expenditure in relation to such income in accordance with the provisions of sub-rule (2).

39. Clause 17 (i): Rule 8D: Determination (2) The expenditure in relation to income which does not form part of the total income shall be the aggregate of following amounts, namely : (i) the amount of expenditure directly relating to income which does not form part of total income; (ii) in a case where the assessee has incurred expenditure by way of interest during the previous year which is not directly attributable to any particular income or receipt, an amount computed in accordance with the following formula, namely : A x B/C A = amount of expenditure by way of interest other than the amount of interest included in clause (i) incurred during the previous year ; B= the average of value of investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year ; C= the average of total assets as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year ; (iii) an amount equal to one-half per cent of the average of the value of investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year. 3. For the purposes of this rule, the 'total assets' shall mean, total assets as appearing in the balance sheet excluding the increase on account of revaluation of assets but including the decrease on account of revaluation of assets.

40. Clause 17(m) The auditor to compute the amount inadmissible under the proviso to section 36(1)(iii). Interest paid, in respect of capital borrowed for acquisition of an asset or extension of existing business or profession (whether capitalized in the books of account or not) for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was put to use, shall not be allowed as a deduction.

41. Clause 17 (A) 17A. Amount of interest inadmissible under section 23 of the Micro, Small and Medium Enterprises development Act, 2006(NOTIFICATION NO. 36/2009, DATED 13-4-2009) THE MICRO, SMALL AND MEDIUM ENTERPRISES DEVELOPMENT ACT, 2006 23. Interest not to be allowed as deduction from income.- Notwithstanding anything contained in the Income-tax Act, 1961, the amount of interest payable or paid by any buyer, under or in accordance with the provisions of this Act, shall not, for the purposes of computation of income under the Income-tax Act, 1961, be allowed as deduction.

42. Employer Contribution towards E.S.I. & P.F. Clause 21(B): In respect of any sum referred to in clauses (a), (b), (c), (d), (e)or (f) of section 43B, the liability for which 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. • Second proviso to clause 43B deleted w.e.f. AY 2004-05

43. Employee Contribution towards E.S.I. & P.F. Clause 16 (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). Provisions of Section 43B which is applicable in respect of the Employer’s Contribution, is quite different than the provisions of section 36(1)(va) which is applicable in case of the employee’s contribution. JCIT v ITC Ltd. (2008) 299 ITR(AT) 341 (Kol) dated 7-9-2007 Contrary –Prevailing View Now as per the present provisions of section 43B the payment made by the employer towards contribution of PF, ESI, and other welfare funds are allowable if the same are paid before filing the return of income. Now no disallowance of such payment would be made even if the same are made beyond the due dates prescribed in section 36(1)(va) ADD CIT v Vistas RRB (India) Ltd ,92 ITD 1 (Delhi) The view of the Tribunal deserves to be sustained as it is no longer res integra in view of the decision of the SC in the case of CIT v Vinay Cement 213 ITR 268 which was followed by DHC in CIT v Dharmender Sharma 297 ITR 320.CIT v P M Electronics Ltd (313 ITR 121 Delhi dated 3-11-2008) Also See: C IT v M. N. Chari. 310 ITR 445 (Kar), CIT v. Sabari Enterprises 298 ITR 141 (KOL)

44. Clause 25(b) - Change in shareholding of the company and carry forward of the losses u/s 79 of the Act. Business loss cannot be carried forward and set off in the previous year in which a change in shareholding takes place in case of a company in which public are not substantially interested , if on the last day of the previous year in which the change in shareholding took place and on the last day of the previous year in which the loss was incurred, the shares of the company carrying not less than 51% of the voting power were not beneficially held by the same persons.

45. Clause 26-Section wise detail of deduction admissible under Chapter VIA • This requirement restricted to the items appearing in the books of A/c audited by the assessee e.g. only for a branch in case of branch audit. • Where tax auditor is not aware of the gross total income of the assessee (due to return not prepared before tax audit/ audit only of a unit or branch ), suitable note for the same is also required as deduction can not exceed gross total income.

46. Clause 27: TDS

47. Unresolved Issues: 40 A(3)- Third Party Payments - Transfer of Balances. w.e.f 13-7-2006 after Amendment Act, 2006 Reporting under Clause 17(h): • 40A (3): ….Second Proviso Provided further that no disallowance under this sub-section shall be made where any payment in a sum exceeding twenty thousand rupees is made otherwise than by an account payee cheque drawn on a bank or account payee bank draft , in such cases and under such circumstances as may be prescribed, having regard to the nature and extent of banking facilities available, considerations of business expediency and other relevant factors. Rule 6DD d) where the payment is made by way of adjustment against the amount of any liability incurred by the payee for any goods supplied or services rendered by the assessee to such payee. • 269T.Mode of repayment of certain deposits. No branch of a banking company or a co-operative bank and no other company or co-operative society and no firm or other person shall repay any loan or 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 loan or deposit if- ….

48. Thanks CA Rajiv Jain