--Concept, emergence and prolongation of tax audit.

The year 2007 marks the completion of 22 years of Tax Audit

“It’s not enough that we do our best; sometimes we have to do what’s required”, a quote by Sir Winston Churchill aptly suits the tax audit system in which a chartered accountant while discharging his tax audit attest functions has to focus on accomplishing the objective of the emergence and prolongation of tax audit regime. Equally the business establishments have displayed ardent-stance to imbibe transactions transparency to sail strong in this era of India’s opening to the globe.  There are companies, managements and audit committees that have gone back and re-looked at what they’re doing and scrutinizing to make sure that their houses are in order and clean. The amended tax audit report that has incorporated changes in the report form to include FBT, TDS, Conversion of capital assets into stock trade, Section 40A(3), 43B etc intends to scrutinize a business from a more closer perspective.

Section 44AB of the Income-tax Act, 1961 was introduced by section 11 of the Finance Act, 1984 with effect from 1st April, 1985. Under section 44AB of the Income-tax Act, audit of the accounts of certain assessees is required if the total sales, turnover or gross receipts for the previous year exceeds the prescribed limits. In common parlance, section 44AB audit is popularly known as ‘tax audit’.

(A)  Objectives of Tax Audit:  The objectives of tax audit are:

Ø      To ensure that the books of account and other records of the assessee are properly maintained.

Ø      To ensure that the records faithfully reflect the correct income of the tax-payer and claims for deduction are correctly made.

Ø      To facilitate administration by proper presentation of accounts before the tax authorities and to save Assessing Officer’s time in carrying out routine verification.

Ø      To ensure that the revenue authorities are provided with audited financial statements along with the relevant data and information for assessment.

Let’s now get into the intricacies of tax audit - 

(B) Applicability of Tax Audit: Section 44AB of the Income-tax Act provides for compulsory audit of accounts of certain persons carrying on business or profession.

An assessee covered by presumptive sections 44AD, 44AE, 44AF, 44BB or 44BBB would also have to get an audit conducted, if the assessee claims that the income is lower than the presumptive income deemed under the respective sections. A non-resident assessee is also required to get the accounts of the Indian operations audited, if the global business sales/receipts exceed the specified limits.

(C) Non-Applicability of Tax Audit: Tax Audit shall not apply to the person who derives income of the nature referred to in section 44B or section 44BBA, on or from the 1^st day of April, 1985 or, as the case may be, the date on which the relevant section came into force, whichever is later. Moreover a person who is wholly outside the purview of Income-tax Act need not get his accounts audited u/s 44AB even though his total sales exceed Rs. 40 lakh.  Eg: An agriculturist.

(D) Compliance of conditions before acceptance of Tax Audit assignment: A person defined as a chartered accountant within the meaning of Chartered Accountant Act, 1949 and who hold a Certificate of Practice can perform tax audit u/s 44AB. An auditor is required to comply with the following conditions before acceptance of tax audit:

Ø      At the time of appointment a letter evidencing appointment shall be obtained by the auditor from –

·        An individual himself in case of audit of an individual.

·        A partner in case of audit of a firm.

·        A director, preferably with reference to a board resolution in case of audit of a company.

·        A member of AOP in case of audit of AOP.

Ø      In the interest of both client and auditor, the auditor should send an engagement letter, preferably before the commencement of the engagement, to help avoid any misunderstandings with respect to the engagement. This letter should state that the auditor shall have the right to access to the books of accounts and other documents and shall also have the right to seek information and explanations. This is necessary since section 44AB does not specify the rights of the auditor. It has become mandatory from 2003-04.

Ø      In case where the previous year’s audit is conducted by any other auditor, then “No Objection Certificate (NOC)” to be obtained from the previous auditor before the acceptance of the tax audit assignment.

(E) Ceiling on tax audit assignments: The specified number of tax audit assignments that an auditor, as an individual or as a partner of a firm, can accept is 45 numbers. The ceiling limit was increased from 30 to 45 numbers in the year 2007. ICAI has notified that a chartered accountant in practice shall be deemed to be guilty of professional misconduct, if he accepts in a financial year, more than the specified number of tax audit assignments u/s 44AB.

(F) Furnishing of reports: For the purpose of section 44AB, an audit report is to be given in Form No. 3CA if the person carrying on business or profession is required to get his accounts audited under any other law.

In all other cases, an audit report is to be given in Form No. 3CB. The report in Form No. 3CA or 3CB is to be accompanied with Form No. 3CD.

In the audit report, the tax auditor has to express his opinion as to

Ø      Whether or not the financial statements give a true and fair view of the profit or loss and the state of affairs (the auditor is required to state this where the accounts of the assessee have not been audited under any other law); and

Ø      Whether or not the prescribed particulars contained in the statement annexed to the audit report are true and correct.

(G) Form 3CD: Form 3CD is a statement of particulars annexed to the audit report in        Form 3CA / 3CB containing the entire information of significance for the assessment of taxable income. Notification No.208/2006 dated 10th August 2006 has made significant amendments in Form No.3CD. In sequel, the supplementary guidance note giving guidance on the above amendments was also released by ICAI.

(H) Annexure II and new clauses to tax audit report

Ø      Fringe Benefit Tax: Annexure II for the computation of the value of fringe benefits in terms of Section 115WC read with Section 115WB has been inserted. Accordingly, the tax auditor is responsible for the determination of the value of fringe benefit tax. The report provides for reporting FBT expenditure as debited to profit & loss account, accounted for in the balance sheet, reimbursement and any others. The auditor shall verify whether the auditee has followed proper accounting procedure in identifying and disclosure of expenses covered under FBT.

Ø      Conversion of Capital Asset Into Stock In Trade: Clause 12A was inserted in the report in 2006. For furnishing the particulars under the provisions of section 2(47), 45(2), 47(iv) and (v) and 47A have to be kept in mind. The auditor is required to report the details of capital asset converted into stock in trade in the following manner:

·        Description of capital asset,

·        Date of acquisition of asset and cost of its acquisition.

·        The amount at which the asset is converted into stock-in-trade and if the conversion value is at the book value of asset, he has to report the fact under this clause.

Ø      Inadmissible Expenditure u/s 14A: Clause 17(i) was inserted requiring the auditor to report on “amount of deduction inadmissible u/s 14A in respect of the expenditure incurred in relation to income which does not form part of Total Income”.

Ø      Inadmissible Expenditure under proviso to Section 36(1)(ii): Clause 17(m) was inserted in Form 3CD, which requires auditor to report “amount inadmissible u/s 36(1)(ii) by verifying the correctness of the particulars furnished along with the documentary evidence”. As per proviso to Section 36(1)(ii) read with Explanation 8 to Section 43(1) of the Act, interest on funds borrowed for the purpose of acquiring an asset need to be capitalized along with the cost the asset up to the date of capitalization and treated as revenue expenditure after the date of capitalization which is in accordance with the As-16 on “Borrowing Costs”.

Ø      Taking or accepting of loan or deposit and repayment through account payee cheque: As per new clause 24(c), the auditor has to report on whether a certificate has been obtained from the taxpayer regarding taking or accepting loan or deposit, or repayment of the same through an account payee cheque or an account payee bank draft. The reporting is not required in the case of a repayment of any loan or deposit taken or accepted from Government, Government Company, banking company or a Corporation established by the Central, State or Provincial Act.

Ø      Changes in Shareholding in case of Carried forward of losses u/s 79: As per new clause 25(b) of Form 3CD requires auditor to report whether losses of a company can be carried forward in terms of Section 79. As per Section 79 of the Act, losses incurred by a company cannot be carried forward unless at least 51% of the shareholding of the company continues to be held by the same shareholders in the year of loss.

Ø      Tax Deduction at Source: The newly inserted clause 27 requires reporting on the compliance with the provisions of Chapter XVII-B regarding deduction of tax at source and payment thereof to the credit of Central Government. Thus the scope of reporting under the new clause is much wider. In the case where the assessee has not complied with Chapter XVII-B, then the auditor has to provide the following details:

·        TDS deductible and not deducted at all,

·        Shortfall in deduction,

·        Tax deducted late and,

·        Tax deducted but not paid to Central Government.

(I) Due Date: The due date of furnishing audit report to the authorities by an assessee is October 31 of the assessment year.

(J) Penalty: U/s 271B, if a person fails to get his accounts audited as required under section 44AB or to furnish the report of such audit, a sum equal to 0.5% of the total sales, turnover or gross receipts, as the case may be, or a sum of Rs, 1, 00,000, whichever is less, can be levied as penalty.

With recent amendments Tax Audit Report is now considered a ‘mega report’. It is an undenying fact that the auditor has onerous responsibility in discharging his attest functions. In the making of this so called ‘mega report’, the duty of the auditor commences with various tasks like proper understanding of the nature of the business of the assessee, compilation of baggy data as required under form 3CD, receipt and verification of various certificates and documents from the assessee.