Key issues-tax audit u/s 44ab

KEY ISSUES - Tax Audit under Section 44AB
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BY CA AMRESH VASHISHT

B.Com, LL.B, F.C.A, DISA(ICAI)
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No government in anywhere in this world has placed so much trust and confidence in Public Accountants like the Indian Government has placed on Chartered Accountants. Tax Audit by a Chartered Accountant is an Indian phenomenon and does not exist in any other country. Finance Act, 1984 introduced Tax Audit under Section 44AB with effect from the assessment year 1985-86. This not only broadened the area of practice by a Chartered Accountant to an unimaginable scale but also pinned so much trust on the Chartered Accountancy Profession. If you say that you are a Chartered Accountant to any stranger, he would say “Oh ! You are one of those people who are busy in the month of September” Yes friends the association between a CA and tax audit is inseparable.
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The main objective of the tax audit is to compute the taxable income according to the law and for maintaining transparency in the financial statements filed by the assessees with the Income-tax department.
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The tax audit u/s. 44AB of the Income-tax Act 1961 is significant practice area for Chartered Accountants. Since the introduction of tax audit, we have been given responsibilities to discharge the duties as tax auditors for the proper compliance of tax law by the assessees.
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AUDIT
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The Institute of Chartered Accountants of India has defined auditing as follows –
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“A systematic and independent examination of data, statements, records, operations and performances (financial or otherwise) of an enterprise for a stated purpose. In any auditing situation, the auditor perceives and recognises the propositions before him for examination, collects evidence, evaluates the same and on this basis formulates his judgment which is communicated through his audit report”.
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Documentation
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The auditor should document the matters, which are important in providing audit evidence that the audit was carried out in accordance with the basic principles, which are governing audit.
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audit evidence
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The auditor should obtain sufficient and appropriate audit evidence, which will enable him to draw reasonable conclusions there from on which base his opinion on the financial information.
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confidentiality
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The auditor should respect the confidentiality of information acquired in the course of his work and should not disclose any such information to a third party without specific authority or unless there is a legal or professional duty to disclose.
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skills and competence
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The audit should be performed and the report has to be prepared with due professional care by persons who have adequate training, experience and competence in auditing.
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Purpose of Tax Audit
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The purpose of Tax Audit is to ensure that books of Accounts have been maintained in accordance with the provisions of the Income Tax Act. Accordingly a proper audit for tax purposes would ensure that proper records are being maintained, and that the accounts properly reflect the income reported by the Assessee. This audit effectively curbs Tax Evasion and ensures Tax Compliance. Tax Audit also ensures that the Accounts are properly being presented to the Assessing Officers when called for. The precious time of the Assessing Officers is also saved from the routine and ineffective verifications like checking of totals and vouching of Purchase and Sales transactions. They can devote their time in more important investigation aspects of a Case. Thus Tax Audit saves considerable time to the Income Tax Department.
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Who has to get accounts audited?
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Now after knowing the purpose and necessity of Tax Audit, the next question arises as to the applicability of Tax Audit. Audit under section 44AB is applicable to four categories of Assessee. Now let me explain each category one by one.
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The First category covers any person carrying on a business whose total sales, turnover or gross receipts exceed Rupees Sixty Lakhs during the previous year. Here we should be careful about each word I said. Though the words Total Sales, Turnover and Gross Receipts seem to give the same meaning, each one has its own meaning. Various Legal forums have interpreted these words to have different meaning.
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The Second Category covers any person who is carrying on a profession whose gross receipts exceed Rs. 15 lakhs. This limit also was increased from Rs. 10 lakhs to Rs. 15 lakhs by Finance Act, 2010 with effect from 01.04.2011.
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The Third Category covers persons whose income is assessed on a presumptive basis under section 44AE, 44BB or 44BBB. Where such assessee declare an income lesser than that presumed under the Sections 44AE, 44BB or 44BBB, they are required get their accounts audited in accordance with Section 44AB.
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The Fourth Category is of recent origin. It was brought into the act by virtue of Finance (No. 2) Act, 2009, with effect from 01.04.2011. This category covers those persons who declare a lower income than the amount presumed under section 44AD. The difference between the fourth and the third category is that, in the case of the fourth category, the assessees are subject to audit under section 44AB only if their income exceeds the basic exemption limit.

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At this juncture it is worth quoting the amendments brought to Section 44AF and 44AD by Finance (No.2) Act, 2009. The said Act has now merged Section 44AF and Section 44AD of the Income Tax Act. The benefit of presumptive income under section 44AD and 44AF is now not restricted to civil contractions contracts and Retail Trade alone. Now any individuals and partnership firm excluding an LLP whose turnover does not exceed Rs. 60 lakhs can avail this benefit. They just have to declare an income of 8% of gross turnover or a higher amount as income.

Critical analysis of section 44AD
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Till the 31^st March,2010, the Chapter Profit & gains of Small business on Presumptive Basis was having majorly 3 sections for Indian entities.
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> Section 44AD civil construction
> Section 44AE Transporters
> Section 44AF Retail Traders
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From 01.04.2010 the honorable finance minister Mr. Pranab Mukharjee has kept the last two intact and has amended the first section i.e. 44AD along with 5 sub sections to facilitate the business operations of small taxpayers.
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Earlier this section was extended to civil constructions only but now this section has been extended to all small businesses. Apparently the section 44AD is very straightforward, but has lots of implications on the taxpayers. I have tried to analyse the section in all its tiny parts and upto all its implications.
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The new section 44AD is as follows:  44AD (1)
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Notwithstanding anything to the contrary contained in sections 28 to

43C, in the case of an eligible assessee engaged in an eligible business, a sum equal to eight per cent of the total turnover or gross receipts of the assessee in the previous year on account of such business or, as the case may be, a sum higher than the aforesaid sum claimed to have been earned by the eligible assessee, shall be deemed to be the profits and gains of such business chargeable to tax under the head Profits and gains of business or profession.
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For better understanding of sub section 1 of newly inserted section 44AD, we must know the meaning of following:
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> Eligible Assessee
> Eligible Business
> Total Turnover/Gross receipts
> Significance of Word Gross Receipts
> Claimed to have been earned
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1. Who is an Eligible Assessee?
(explanation 1 to Section 44AD)
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Eligible Assessee means:-
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(1) an individual

(2) Hindu undivided family

(3) a partnership firm

 (4)who is a resident.
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 but does not include a limited liability partnership firm as defined under clause (n) of sub-section (1) of section 2 of the Limited Liability Partnership Act, 2008 (6 of 2009).
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Additional Criteria:
A assesee who has not claimed deduction under any of the sections 10A, 10AA, 10B, 10BA or deduction under any provisions of Chapter VIA under the heading C. - Deductions in respect of certain incomes in the relevant assessment year;
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Who all are the aseessees not covered under Section 44AD?

> Individual who is not resident

> HUF who is not Resident

> Association of Person

> Firm having non resident Status.

> A local Authority

> A co-operative Society

> Limited Liability Partnership both Indian as well as Foreign

> Companies both Domestic and Foreign company

> Every Artificial Juridical Person

> Individual/HUF/Firms claiming deduction under chapter III of the Act i.e Section 10A,10AA,10B,10BA relating to units located in FREE Trade Zone, Hardware & Software Technology Park etc.

> Individual/HUF/Firms claiming deduction under Chapter VIA Part-C (deductions in respect of certain Incomes) i.e Section 80H to 80TT
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After understanding the meaning of Eligible assessee, now we move to Eligible Business:
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2. What is eligible Business ?
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eligible business means,
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(i)   any business except the business of plying, hiring or leasing goods carriages referred to in section 44AE; and
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 (ii)  whose total turnover or gross receipts in the previous year does not exceed an amount of [sixty lakh rupees].
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Meaning of the above section:
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Eligible Business covers any business except Transport Business (Transportation Business has special treatment under section 44AE).
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This provision is straightforward and includes all the business whether it is:
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> Manufacturing
> Trading
> Wholesale
> Retail
> Job Work
> Service business
> Speculative/ Non specultive.
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The only criteria is that, the turnover of eligible Business should not exceed Rs. Sixty lacs in the previous Year.
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What is not included in the Business?
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The profession is not included in the business because:
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There is specific reference to the word Business in Section 44AD, which does not include profession, and
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There is specific Turnover limit of Rs. 15 Lakhs for Profession under section 44AB, which means that profession is totally separate from Business.
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3. What do you mean by Total Turnover/Gross Receipts?
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Total Turnover / Gross Receipts are amount received/receivable from clients in respect of sale of Previous Year.
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Section 145 relating to Method of Accounting applicable to Section 44AD As per this section the assessees have an option to choose either Mercantile or cash method.
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Gross Receipts are the amounts received from clients for the services provided ot to be provided and does not include the value of material supplied by the client.
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What are the receipts which forms Part of Turnover?
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1) Sales Tax, excise duty, Cess, and other Levy.

2) Sales of unusables empties and Packages.

3) Service Charges charged for delivery
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Then what are the Receipts which does not form Part of Turnover?
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1)   Sale of Property, Plant and equipments

2)   Advance received from customers, deposits Received or retention money.

3)   Any Security, retention or other deposit obtained from employees.

4)   Interest Income or other similar receipts

5)   Value of Inventory
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How to calculate limit of 60 lakhs?
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The Total Turnover and Gross receipts should be less than 60 lacs in the previous Year.
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It includes all the eligible businesses carried on by a eligible assessee during the previous year and the 60 lakhs will be for all of them cumulatively.
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Few Examples:
1. X, A Resident individual, is carrying on three eligible business, the turnover of which is as under :
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> Business A (Manufacturing) Rs. 25 Lac

> Business B (Trading) Rs. 15 Lac

> Business C (Service) Rs. 25 Lac
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Whether section 44AD applicable on him?

 The Answer is NO because turnover of eligible business exceed Rs. 60 Lakhs.
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2. X, A Resident individual, is carrying on two business, the turnover of which is as under :
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> Business A (Eligible Business) Rs. 55 Lacs

> Profession Rs. 10 Lacs
> Business B (Transport u/s 44AE) Rs. 6 Lacs
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Section 44AD and 44AE both are applicable, as profession is not included under section 44AD and section 44AD and 44AE are independent of each other.
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Who bears the onus of proof to prove the turnover?
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The onus of proof is on the assessee. It is his duty to prove the turnover. If the assessee is maintaining the books of accounts, then it will be easy for him to prove the same, but if he is not maintaining the books of accounts, then it will be very difficult for him to prove, because there is no specific provision for the same.
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What documents you should provide to the AO to prove the turnover?
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- copies of invoices issued during the PY

- copies of cash memo

- copies of Purchase bill

- Bank statement

- Inventory details, if any maintained

- Average G.P rate applicable to Particular business

- Returns filed under sales tax/vat/excise/service Tax laws.
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What is the meaning of Notwithstanding Anything to contrary contained in section 28 to 43C
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Section 44AD(1) starts with wording Notwithstanding Anything to contrary contained in section 28 to 43C it means section 28 to 43C of Income Tax Act, 1961 is not applicable on eligible assessee carrying on small  business.
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The some of the benefits & losses of this wording is enumerated as under by way of examples :
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Few examples:
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Ramesh has paid Rs. 28000/- for purchase of goods in cash. No disallowance can be made under section 40A(3) for the same.
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Suresh has paid Rs. 42000/- to transporter for freight in cash. No disallowance can be made under Section 40A (3).
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Dinesh has contributed certain sum to national Laboratory which qualifies for deduction under section 35(2AA), if he chooses section 44AD , he will not eligible for benefit of this section.
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Ganesh has recovered certain bad debts written off in earlier years of Rs. 35000/-. It may not be added in specified amount declared.
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What is the meaning of Claimed to have been earned?
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By the introduction of these words in section 44AD(1), the legislature shows his intention to accept specified income as returned income even if higher sum is earned by eligible assessee unless it is claimed by assessee in his Income Tax Return.
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Example
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X is carrying on small business . The Turnover is Rs. 50 lakh. The profit as per his books or calculation is Rs. 8 Lakhs. However, he opts to return the income under section 44AD @ 8% i.e Rs. 4 Lakh. The proceeds of business are deposited in a bank account.
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Can the AO assess the difference amount as undisclosed income?
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No, The Answer is No due to following reasons:
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- The section has been amended for the benefit of the assessee.
- The word Claim signifies the right of assessee, and it is not an obligation of the assessee. 
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The distinction between Right and obligation is very necessary here.
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The language of section of section 44AD(1) requires claims to have been made by an assessee for returning higher income.
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If there is no claim made by assessee in return for higher income, there is no higher income.
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JUDICIAL DECISIONS
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The following judicial decisions support this view:
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- Samta construction Co  V. Pawan Kumar sharma(2000) 244 ITR 845 (MP)

-  CIT V. ARVIND MIILS LTD(1992) 193 ITR 255(SC)

-  AC,BANGLORE VELLIAPA TEXTILES LIMITED AND ANOTHER (2003) ITR 560(SC)
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Section 44AD(2)
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(2) Any deduction allowable under the provisions of sections 30 to 38

shall, for the purposes of sub-section (1), be deemed to have been already given full effect to and no further deduction under those sections shall be allowed :
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Provided that where the eligible assessee is a firm, the salary and interest paid to its partners shall be deducted from the income computed under sub-section (1) subject to the conditions and limits specified in clause (b) of section 40
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Computation of Taxable Profit u/s 44AD in case of Partnership Firm
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Profit from Business
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Section 44AD (3)
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The written down value of any asset of an eligible business shall be deemed to have been calculated as if the eligible assessee had claimed and had been actually allowed the deduction in respect of the depreciation for each of the relevant assessment years.
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Few Examples
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Tapan an Resident individual having a machinery of Rs. 1,00,000/- as on 31-03-2011 eligible for depreciation under section 32 @ 15%.In A.Y 2011-12, he opts for Section 44AD. In the Assessment Year 2012-13, his turnover is Rs. 65 lakh, so he calculated his profit as per normal provisions of the Act. In A.Y 2013-14, he again opts for Section 44AD, In this Assessment year he sold the Assets for Rs. 80,000/-.
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Calculation of WDV:
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Calculation of Capital Gains
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Whether the Assessee can carried forward unabsorbed depreciation?
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As per the subsection (3) of section 44AD, the Act clearly states that the Depreciation is deemed to have been allowed u/s. 32 and the same has been deemed to have been set off against the profit. Hence the same cannot be allowed to be allowed to be carried forwarded.
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Section 44AD(4)
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The provisions of Chapter XVII-C shall not apply to an eligible assessee in so far as they relate to the eligible business.
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Chapter XVII-C deals with provisions relating to Advance Payment of Tax.
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On plain reading of this subsection, we conclude that eligible assessees are exempt from payment of Advance Tax. But the second part of Provision creates a blunder so far it relates to eligible business, which creates lot of doubt.
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The following example will better clear your understanding :
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Profit under section 44ADRs.  = 4.00 lac

(Say Turnover is Rs. 50 lakhs)

Interest Income = Rs.5.00 Lac

Total Income = Rs.9.00 lac
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In this situation, whether the assessee is exempted from provisions of advance tax in all or whether the assessee is liable to Pay advance Tax on interest income of Rs.5.00 lac.
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From the understanding of Law, it is clear that the assessee have to pay advance tax on interest income of Rs.5.00 lac. But how this tax calculation is to be made is no where define in legislature?
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SECTION 44AD(5)
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This sub-section has created lots of doubts and debates in the mind of all the CAs and Tax consultants. This Sub-section is very much important for all the very small businessmen. Please give attention and read it care fully.
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Notwithstanding anything contained in the foregoing provisions of this section, an eligible assessee who claims that his profits and gains from the eligible business are lower than the profits and gains specified in sub-section (1) and whose total income exceeds the maximum amount which is not chargeable to income-tax, shall be required to keep and maintain such books of account and other documents as required under sub-section (2) of section 44AA and get them audited and furnish a report of such audit as required under

section 44AB
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The assessee is bound to get the books of accounts audited, if the following two conditions are satisfied:-
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1. His profits and gains from the eligible business are lower than the profits and gains specified in sub-section (1) i.e. his net profit is lower than 8% of turnover.
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and
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2. Whose total income exceeds the maximum amount which is not chargeable to income-tax.
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Here see both the conditions are simultaneous and the assessee required to get his accounts audit only and only if his profits from the business u/s 44AD are lower than 8% of this turnover and further his total income is more than maximum amount which is not liable to tax.
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Though the proposed provision is applicable from assessment year 2011-12 but if for example and to understand the effect of this provision we presume the minimum amount which is not liable to tax is Rs. 1.60 Lakh and the turnover of the eligible business is Rs. 38 Lakhs and the Net profit is Rs. 1.52 lacs which comes to only 4% hence the first condition for the compulsory audit is there but since the income is only Rs.1.52 Lakhs hence the second condition of section 44AD(5) is not complete, hence the audit is not mandatory.
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If whatever mentioned above is the intention of law then in most of the cases where the income of the assessee is below taxable limit, they are not required to get their books of accounts audited, even if the rate of profit is below 8
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Who can carry out Tax Audit?
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After the applicability of Tax Audit, the next question arises regarding who can conduct Tax Audit. Section 44AB requires that the accounts should be audited by an Accountant. The explanation to Section 44AB states that the word accountant shall have the same meaning as the explanation to Section 288(2). The Explanation to Section 288(2) states that
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“accountant” means a chartered accountant within the meaning of the Chartered Accountants Act, 1949 (38 of 1949), and includes, in relation to any State, any person who by virtue of the provisions of sub-section (2) of section 226of the Companies Act, 1956 (1 of 1956), is entitled to be appointed to act as an auditor of companies registered in that State.
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Section 226 of the Companies Act, 1956 says that a person holding a certificate issued by a Part B State may also be appointed as an auditor. But this provision has no relevance today. No person is eligible to be appointed as an auditor by virtue of this provision today. Hence effectively only a Chartered Accountant holding a valid Certificate of Practice can carry out Tax Audit under section 44AB. This proves the level of trust we has been entrusted with. It will be in the duty of us all future Chartered Accountants to uphold this trust. After all C and A are the Alphabets of trust.
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This monopolist trust vested on Chartered Accountants was also upheld by the Supreme Court in the Case of T.D. Venkata Rao v. Union of India [1999] 237 ITR 315 (SC).In this instant case, T.D.Venkata Rao, an Income Tax Practitioner, had questioned the legal validity of allowing only CAs to Audit under section 44AB. Supreme Court upheld the superiority of CAs by noting that noted thatChartered Accountants, by reason of their training have special aptitude in the matter of audits and no other person can be held eligible to conduct audit under Section 44AB.  Supreme Court further held that CAs are a Class by themselves meaning that CAs are the brand for auditing itself.
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Exception to Tax Audit:
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Once a person gets covered under any one of the four categories, Tax audit becomes mandatory. But there are two exceptions to tax audit. The first proviso to Section 44AB, exempts business covered under Section 44B and 44BBA from the purview of tax audit. But the second proviso is something more interesting. The second proviso says that if the accounts of a person are to be audited under any other law, it would be sufficient if the accounts are audited under that law before the 30^th of September. The accounts need not once again be audited by an Accountant but the report in form 3CA and 3CD needs to be obtained from an Accountant.

The effects of this section arouse much fascination. Since Companies are required to be audited under the Companies Act, 1956, they need not be audited once again under Section 44AB. It is sufficient if the audit reports in the prescribed forms are obtained. This is even more fascinating in the Case of Co-operative Societies. Co-ops are required to be audited under the Co-operative Societies Act, but the auditor of a co-op need not be a CA. Even then a co-op need not be once again audited under Section 44AB.
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Consequences if Companies follows different Accounting Year other than Financial Year:
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Another Fascinating situation arises out of this proviso. Everyone is aware that under the income tax act, previous year means the financial year beginning from 1^st April. But there is no such restriction under the Companies Act. Hence Companies may adopt the calendar year i.e. January to December as their Accounting Year. In such a situation a question arises where by using the above proviso, a Tax Auditor issue Form 3CA and Form 3CD for the previous year without auditing the accounts.
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The CBDT clarified this issue vide Circular no.561 dated 22/05/1990. CBDT said that the second proviso is applicable only when the accounting year is same as the previous year. If the accounting year is different from the previous year then fresh audit has to be conducted. In this case, even though, the company was subject to statutory audit, the Tax auditor has to issue his report only in form 3CB and not in 3CA. Isn’t it fascinating?
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Penalty for failure to get accounts audited:
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Non compliance of any provision of the Income Tax Act attracts huge penalty. Similarly the non compliance of Section 44AB attracts penalty under section 271B of the Income Tax Act, 1961. If any person who is required to get his accounts audited by an Accountant before the specified date fails to do so shall be liable for penalty under section 271B. The amount of penalty shall be half a percent of turnover / gross receipts or Rs. 150000/- whichever is lower. The maximum penalty under this section was increased from one lakh to one and a half lakhs by the Finance Act, 2010, with effect from 01.04.2011. This penalty shows the seriousness that the Government affixes towards Tax Audit under section 44AB.
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However no penalty may be levied if here is a reasonable cause for such failure. For e.g. in a firm it may so happen that the partner who manages the entire accounting and finance is not in the country and has gone abroad. In such a situation, the other partners will not be in a position to offer explanations to the Tax Auditor to complete his audit. Hence the accounts may not get audited by the due date. A similar situation also arises when the accountant quits the firm just before the end of September. But what serves as a reasonable cause is always uncertain.
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Limitation on No of Tax Audits
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In order to ensure quality and equitable distribution of audit work done by Chartered Accountants, ICAI has fixed a maximum limit for the Tax audit assignments that can be taken by a CA or a firm of CAs. This limit is set at 45 assignments per person. For if a firm of CAs has 3 partners, the maximum number of Tax audits that can be taken up by the firm will be 45*3 i.e. 135. If the firm takes all the 135, partners cannot take any audit in their personal capacity.  If a person is found to have accepted more than 45 assignments in a year, he would be deemed to have been involved in professional misconduct. Any one partner can sign all the audit reports. But it should specially be mentioned that he is signing on behalf of the firm. This right arises out of the partnership act since any partner can act on behalf of other partners, subject agreement between partners.
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Can the tax auditor revise his tax audit report?
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Guidance notes on Revision / Rectification of Financial statement, state that the auditor may revise the audit report provided; he gives it in the manner suggested by the institute. But normally the report u/s 44AB should not be revised. However, it may be revised on the following grounds.
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Revision of accounts of company after its adoption in the annual general meeting.

Changes in law (eg) retrospective amendment

Change in interpretation (eg) CBDT circular, judgment etc.,
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Change of tax auditor and code of ethics
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A chartered accountant in practice cannot accept a position as auditor previously held by another chartered accountant without first communicating with him in writing. It will be in violation of clause(8) of Part I of First Schedule to the chartered accountants Act 1949.
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Even though there is proper communication the incoming auditor should before acceptance must ensure all the undisputed fees must have been paid as per notification no 1CA(70/46/99dated28/10/99of ICAI.
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The communication must be effective one, hence it should be by registered acknowledgement due or by hand delivery with written acknowledgement.
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method of accounting
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The accounting standard of The Institute of Chartered Accountants of India and Accounting Standard of CBDT are applicable.
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The assessee must disclose the following information:
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Method of computation of stock:
Disclosure in financial statements:
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First time tax audit
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No tax audit was made in the previous assessment year, the tax auditor of current assessment year must verify previous year methods followed by the assessee.
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The tax auditor should report the method of accounting followed and if there is any change, it may not be difficult to verify the method of accounting followed in the earlier previous year. He should apply his professional experience and satisfy that there is no change in the method of accounting employed during the previous year. Hence it is not necessary for him to verify the previous year accounts.
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writeback of amount
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Though there is a write back of liability amounts to gross receipt and if the gross receipt exceeded Rs.60Lakhs, will the assessee be liable for tax audit?
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Guidance note on tax audit clarifies that writing back of liability may be deemed to be the income u/s 41(1) of the Act. The amount written back is a part of gross receipts for determining the tax audit u/s 44AB.