The voluntary tax compliance by the taxpayers considerably widened after the insertion of tax audit under section 44AB in the Income-tax Act, 1961 by the Finance Act, 1984. An important revision to Tax Audit reporting Forms was done in 1999. This revision further enhanced the scope of the tax audit.
The Constitutional validity of section 44AB was challenged under article 19 in T.D. Venkata Rao v. Union of India [1999] 237 ITR 315 (SC). The Apex Court has made the following significant observations:
“Chartered Accountants, by reason of their training have special aptitude in the matter of audits. It is reasonable that they, who form a class by themselves, should be required to audit the accounts of businesses whose income exceeds Rs.40 lacs and professionals whose income exceeds Rs.10 lacs in any given year. There is no material on record, and indeed, there cannot be, that an Income Tax Practitioner has the same expertise as a Chartered Accountant in the matter of accounts. Thus the challenge under Article 19 fails. However, the Income Tax Practitioners are still entitled to be authorised representatives of assesses”.
Tax audit requirement
An assessee is liable to get audit of his/her accounts done by a Chartered Accountant mandatorily, if in the previous year,
The total turnover of his business exceeds Rs. 1 Crore (Limit increased wef 1st April 2012); or
Gross receipts from his/her profession exceeds Rs. 25 Lakhs (Limit increased wef 1st April 2012); or
He /she is carrying on business or profession and is covered under the provisions of section 44AD, 44AE, 44AF, 44BB or 44BBB and claims that his/her income from the said business is lower than the deemed profits and gains computed under the relevant section.
As per proviso to section 44AB of the Income Tax Act, if an assessee is liable to get his accounts audited by an Accountant under any other Law for the same accounting period, the assessee is not mandatorily required to get his audit done again and is only required to submit a report in the form mentioned below.
However, some companies may adopt an accounting period other than the financial year under the Companies Act. In such cases, since, the previous year is the financial year, the tax auditor would have to carry out the audit under section 44AB in respect of the period covered by the previous year (Circular No. 561 dated 22-05-1990 issued by CBDT).
‘Profession’ and ‘business’ explained
The term "business" is defined in section 2(13) of the Income Act, 1961 as "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 earning an income.
The expression "business" does not necessarily mean trade or manufacture only - Barendra Prasad Roy v ITO [1981] 129 ITR 295 (SC).
Section 2(36) of the Act defines 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).
An individual who has income from different sources including income from business is not bound to have his income other than the business also audited under section 44AB of the Income Tax Act, 1961. [Ghai Construction v. State of Maharastra (2009) 184 Taxman 52 (Bom)].
The following have been listed out as professions in section 44AA and notified thereunder (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):
a. Accountancy
b. Architectural
c. Authorised Representative
d. Company Secretary
e. Engineering
f. Film Artists/Actors, Cameraman, Director, Singer, Story-writer, etc.
g. Interior Decoration
h. Legal
i. Medical
j. Technical Consultancy
k. Information Technology
The following activities have been held to be business:
1. Advertising agent
2. Clearing, forwarding and shipping agents - CIT v. Jeevanlal Lallubhai & Co. [1994] 206 ITR 548 (Bom).
3. Couriers
4. Insurance agent
5. Nursing home
6. Stock and share broking and dealing in shares and securities – CIT v. Lallubhai Nagardas & Sons [1993] 204 ITR 93 (Bom).
7. Travel agent.
When nursing-home income should be treated as professional income? If the doctors are carrying on the activities of a nursing home (polyclinic) for the purpose of treating their own patients, the income from the nursing home must be treated as their professional income. But if any business activity is carried on by the nursing home such as running of a drug store for selling drugs to patients or others, admitting patients and charging fee such as room fees, etc. it may be considered to be a business and that part of the income would be in the nature of business income [CIT v K.K. Shah (1982) 135 ITR 146(Guj)].
It may be noted that a company cannot be said to be engaged in a profession. Since, the profession involves labour, skill, education and special knowledge and implies a vocation requiring higher education and learning. All these qualities can be possessed by an individual and not by a person who is not a living being. Thus, company cannot carry on a profession by itself and where such activities are undertaken by company with a profit motive, it would be related to its business and not to profession. [DCIT v. Daljit Singh Eye Hospital Private Limited 90 ITD 235 (Amritsar)].
Sales, turnover, gross receipts
The term "sales", "turnover" or "gross receipts" are not defined in the Act, and therefore the meaning of the aforesaid terms has to be considered for the applicability of the section.
As per Guidance Note issued by ICAI on Tax Audit under Section 44AB of the Income tax Act, 1961 -
The term ‘turnover’ for the purposes of this clause may be interpreted to mean the aggregate amount for which sales are effected or services rendered by an enterprise. If sales tax and excise duty are included in the sale price, no adjustment in respect thereof should be made for considering the quantum of turnover. Trade discounts can be deducted from sales but not the commission allowed to third parties. If, however, the Excise duty and / or sales tax recovered are credited separately to Excise duty or Sales tax Account (being separate accounts) and payments to the authority are debited in the same account, they would not be included in the turnover. However, sales of scrap shown separately under the heading ‘miscellaneous income’ will have to be included in turnover.
Considering that the words "Sales", "Turnover" and "Gross receipts" are commercial terms, they should be construed in accordance with the method of accounting regularly employed by the assessee. Section 145(1) provides that income chargeable under the head "Profits and gains of business or profession" or "Income from other sources" should be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee. The method of accounting followed by the assessee is also relevant for the determination of sales, turnover or gross receipts in the light of the above discussion.
Applying the above generally accepted accounting principles, a few typical cases may be considered:
1. Discount allowed in the sales invoice will reduce the sale price and, therefore, the same can be deducted from the turnover.
2. Cash discount otherwise than that allowed in a cash memo/sales invoice is in the nature of a financing charge and is not related to turnover. The same should not be deducted from the figure of turnover.
3. Turnover discount is normally allowed to a customer if the sales made to him exceed a particular quantity. This being dependent on the turnover, as per trade practice, it is in the nature of trade discount and should be deducted from the figure of turnover even if the same is allowed at periodical intervals by separate credit notes.
4. Special rebate allowed to a customer can be deducted from the sales if it is in the nature of trade discount. If it is in the nature of commission on sales, the same cannot be deducted from the figure of turnover.
5. Price of goods returned should be deducted from the figure of turnover even if the returns are from the sales made in the earlier year/s.
6. Sale proceeds of fixed assets would not form part of turnover since these are not held for resale.
7. Sale proceeds of property held as investment property will not form part of turnover.
8. Sale proceeds of any shares, securities, debentures, etc., held as investment will not form part of turnover. However if the shares, securities, debentures etc., are held as stock-in-trade, the sale proceeds thereof will form part of turnover.
9. In case of sales by a commission agent/or consignee, if, the property in the goods, significant risks and reward of ownership belongs to him, the sale price received/receivable by him shall form part of his sales/turnover.
10. In case of share brokers, only brokerage should be taken into account for considering the limits for the purpose of section 44AB. If any transactions entered into by share broker on his personal account, the sale value should also be taken into account for considering the limit for the purpose of section 44AB.
11. In case income/loss arising from sale of investment is to be computed under the head 'Capital Gains', then the value of such transaction is not to be included in sales or turnover for deciding the applicability of audit under section 44AB. However, in case such transactions are in the course of business, then the total of such sales are to be included in the sale, turnover or gross receipts as the case may be, of the assessee for determining the applicability of audit under section 44AB.
The term "gross receipts" is also not defined in the Act. It will include all receipts whether in cash or in kind arising from carrying on of the business which will normally be assessable as business income under the Act. Broadly speaking, the following items of income and/or receipts would be covered by the term "gross receipts in business":
1. Profits on sale of a licence granted under the Imports (Control) Order, 1955 made under the Imports and Exports (Control) Act, 1947;
2. Cash assistance (by whatever name called) received or receivable by any person against exports under any scheme of the Government of India;
3. Any duty of customs or excise re-paid or repayable as drawback to any person against exports under the Customs and Central Excise Duties Drawback Rules, 1995;
4. The aggregate of gross income by way of interest received by the money lender;
5. Commission, brokerage, service and other incidental charges received in the business of chit funds;
6. 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 purposes of Section 44AB;
7. The net exchange rate difference on export sales during the year on the basis of the principle explained in (vi) above will have to be added;
8. Hire charges of cold storage;
9. Liquidated damages;
10. Insurance claims - except for fixed assets;
11. Sale proceeds of scrap, wastage etc. unless treated as part of sale or turnover, whether or not credited to miscellaneous income account;
12. Gross receipts including lease rent in the business of operating lease;
13. Finance income to reimburse and reward the lessor for his investment and services;
14. Hire charges and installments received in the course of hire purchase;
15. Advance received and forfeited from customers.
The following items would not form part of "gross receipts in business" for purposes of section 44AB.
1. Sale proceeds of fixed assets including advance forfeited, if any;
2. Sale proceeds of assets held as investments;
3. Rental income unless the same is assessable as business income;
4. Dividends on shares except in the case of an assessee dealing in shares;
5. Income by way of interest unless assessable as business income;
6. Reimbursement of customs duty and other charges collected by a clearing agent;
7. In the case of a recruiting agent, the advertisement charges received by him by way of reimbursement of expenses incurred by him;
8. In the case of a travelling agent, the amount received from the clients for payment to the airlines, railways etc. where such amounts are received by way of reimbursement of expenses incurred on behalf of the client. If, however, the travel agent is conducting a package tour and charges a consolidated sum for transportation, boarding and lodging and other facilities, then the amount received from the members of group tour should form part of gross receipts, and
9. In the case of an advertising agent, the amount of advertising charges recovered by him from his clients provided these are by way of reimbursement. But if the advertising agent books the advertisement space in bulk and recovers the charges from different clients, the amount received by him from the clients will not be the same as the charges paid by him and in such a case the amount recovered by him will form part of his gross receipts.
Where the assessee acted as the agent of the advertiser of T.V. Channels and collected advertising receipts and appropriated his commission and remitted the balance to the T.V. Channels, it was held that the gross receipt of the assessee shall be the commission amount and not the total advertising receipts collected by him. [CIT v. Heros Publicity Services (2001) 248 ITR 256 (Bom)].
10. Share of profit of a partner of a firm in the total income of the firm excluded from his total income under section 10(2A) of the Income tax Act.
11. Write back of amounts payable to a creditors and/or provisions for expenses or taxes no longer required.
Thus the principle to be applied is that if the assessee is merely reimbursed for certain expenses incurred, the same will not form part of his gross receipts. But in the case of charges recovered, which are not by way of reimbursement of the actual expenses incurred, they will form part of his gross receipts.
In the case of a professional, the expression "gross receipts" in profession would include all receipts arising from carrying on of the profession. A question may, however, arise as to whether the out of pocket expenses received by him should form part of his gross receipts for purposes of this section. Normally, in the case of solicitors, advocates or chartered accountants, such out of pocket expenses received in advance are credited in a separate client's account and utilised for making payments for stamp duties, registration fees, counsel's fees, travelling expenses etc. on behalf of the clients. These amounts, if collected separately either in advance or otherwise, should not form part of the "gross receipts". If, however, such out of pocket expenses are not specifically collected but are included/collected by way of a consolidated fee, the whole of the amount so collected shall form part of gross receipts and no adjustment should be made in respect of actual expenses paid by the professional person for and/or on behalf of his clients out of the gross fees so collected. However, the amount received by way of advance for which services are yet to be rendered will not form part of the receipts, as such advances are the liabilities of the assessee and cannot be treated as his receipts till the services are rendered.
In case of an assessee carrying on business and at the same time engaged in a profession as to what are the limits applicable to him under section 44AB for getting the accounts audited. In such a case if his professional receipts are, say, rupees thirty lakhs but his total sales, turnover or gross receipts in business are, say, rupees fifty five lakhs, it will be necessary for him to get his accounts of the profession and also the accounts of the business audited because the gross receipts from the profession exceed the limit of rupees twenty five lakhs. If however, the professional receipts are, say, rupees eighteen lakhs and total sales turnover or gross receipts from business are, say, rupees eighty five lakhs it will not be necessary for him to get his accounts audited under the above section, because his gross receipts from the profession as well as total sales, turnover or gross receipts from the business are below the prescribed limits.
It may, however, be noted that in cases where the assessee carries on more than one business activity, the results of all business activities should be clubbed together. In other words, the aggregate sales, turnover and/or gross receipts of all businesses carried on by an assessee would be taken into consideration in determining whether the limit of Rs.100 lakhs as laid down in this section has been exceeded or not. However, where the business is covered by section 44B or 44BBA turnover of such business shall be excluded. Similarly where the business is covered by section 44AD, 44AE or 44AF and the assessee opts to be assessed under the respective sections on presumptive basis, the turnover thereof shall be excluded. So far as a partnership firm is concerned, each firm is an independent assessee for purposes of Income-tax Act. Therefore, the figures of sales of each firm will have to be considered separately for purposes of determining whether or not the accounts of such firm are required to be audited for purposes of section 44AB.
It must also be understood that the issue whether the turnover exceeds Rs.100 lakhs in the case of business or the gross receipts exceed Rs.25 lakhs in the case of profession is to be determined in each year independent of the results obtained in the preceding year or years.
Further, this section applies only if the turnover exceeds the prescribed limit according to the accounts maintained by the assessee. If the Assessing Officer wants the assessee to get his accounts audited in cases where the figures of turnover as appearing in the books of account of the assessee do not exceed the prescribed limits, he has no option but to pass an order under section 142(2A) directing the assessee to get his accounts audited from a particular chartered accountant as may be nominated by the Commissioner of Income-tax or the Chief Commissioner of Income-tax.
E-filing of tax audit report
As per notification No. 34 dated 01/05/2013 e-filing of tax audit report is mandatory from the assessment year 2013-14 onwards. As per Rule 6G tax audit report is to furnished in Form 3CA or Form 3CB and the particulars required to be furnished in Form 3CD.
Limitation on CA’s for the number of Tax Audits
The ICAI has restricted the maximum no. of tax audit assignments by Chartered Accountant under section 44AB to 45. Thus if a firm of Chartered Accountants has 4 partners, the maximum no. of Tax Audits that can be taken by that firm would be 180 (45x4).
Penalty for non-compliance of section 44AB:
Non-compliance of the provisions tax audit attracts penalty under section 271B of the Income Tax Act, 1961. If any person required to get his accounts audit under section 44AB, fails to do so before the specified date, shall be liable for penalty of ½% of the turnover/gross receipts subject to a maximum penalty of Rs. 1,50,000.
However, section 273B states that no penalty shall be levied under section 271B if there is a reasonable cause for such failure. Some instances which have been accepted by the Tribunals/Courts as “Reasonable Cause” are:-
1. Resignation of the tax auditor and consequent delay;
2. Death or physical inability of the partner in-charge of the accounts;
3. Labour Problems such as strikes, lock-outs for a long period;
4. Loss of books account because of fire/theft etc. beyond the control of the assessee;
5. Natural calamities; etc.
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