We have covered Tax Audit in our previous posts.In this post we will explain the remaining aspects of Tax Audit u/s 44AB
Though Tax Audit is always covered u/s 44AB but the requirements are initiated due to coverage of various conditions under different sections which are explained as follows:
As can be seen from above that the requirements of Tax Audit though invoked through sec 44AB but they are by virtue of sec 44AD ,44ADA,44AE etc as explained above
Consequences of failure to get books Audited:
A penalty equal to 1/2% of Turnover subject to maximum Rs 150000.00 is leviable however if the assessee proves that the failure or delay was due to genuine cause then the penalty may be waived
For the tax audit due date is 30/09/2018 for A Y 2018-19 .please note that not only it is important to get Audit Done but the report should be uploaded by the due date along with Income Tax return.
Payments made to related persons:
A related person is defined as follows:
Individual: Any relative
HUF: Any member of HUF
Partnership firm: Any partner or relative of any partner
Company:Any Director or relative of director
OR a person or entity who has a substantial interest in the concern where substantial interest means controlling stake more than 25%
Now clause 23 requires that any payment made to any related party more specifically those defined in sec 40A(2)(b) be reported (explained as above)
The logic behind this clause is that any expenditure claimed as unreasonable by involving any of the related person shall be disallowed.
Allowance of certain payments if not made within the due date:
Sec 43B imposes a restriction that any statutory payment if not made by the due date of filing of income tax return shall be disallowed .It shall however be allowed in the year of payment.The payments in this category are TDS,Interest on loan from bank, contribution towards PF etc
Remission of liability: Sec 41
There may be cases when liability ceases towards a payment eg a creditor dies with no one to claim the amount .This is called remission of liability .These type of amounts are to be reported under clause 25
We have tried to explain major points reported by the Auditors in their Tax Audit Reports.These details have been discussed from point of view of the Assessee. There are other details but these are readily available from the books of accounts and the Auditor derives them himself for eg Sales,Purchases,Closing Stock Value and related Ratios so these are not discussed here.
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Tax Audit is covered under sec 44AB of Income tax Act and broadly speaking it is meant for those Assessee having specific turnover beyond which their books are to be Audited by a Chartered Accountant and the report is to be uploaded with the Income tax return .
Audit is very important because in case of failure to get the Audit done or to get the report filed with Income tax return will land a penalty of 1/2 % of turnover.In this post and the post to follow we will analyse the requirements of Audit and the important points to be taken due care before getting the books Audited.
By turnover it is meant the amount of gross receipts in business or profession as the case may be.Turnover is the main bone of contention for Audit because the limit is different in different scenarios
Business : It means Gross Sales after deducting all discounts but including any receipts from the business or if there are more than one business then aggregate of all businesses.It do not include any statutory tax eg VAT,GST etc
Profession: Like wise it include the amount of gross receipts from the profession net of all discounts .
Reimbursement: In case of reimbursements if the actual amount is reimbursed then it is not part of turnover but if composite billing is made then it is part of turnover
Some Specific cases can be considered as:
(i) 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.
(ii) 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.
(iii) 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.
(iv) Sale proceeds of fixed assets would not form part of turnover since these are not held for resale.
(v) Sale proceeds of property held as investment property will not form part of turnover.
(vi) 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.
Turnover in case of speculative Transactions:
A speculative transaction 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.
Thus, in a speculative transaction, the contract for sale or purchase which is entered into is not completed by giving or receiving delivery so as to result in the sale as per value of contract note. The contract is settled otherwise and squared up by paying out the difference which may be positive or negative.
As such, in such transaction the difference amount is ‘turnover’.
In the case of an assessee undertaking speculative transactions there can be both positive and negative differences arising by settlement of various such contracts during the year. Each transaction resulting into whether a positive or negative difference is an independent transaction. Further, amount paid on account of negative difference paid is not related to the amount received on account of positive difference. In such transactions though the contract notes are issued for full value of the purchased or sold asset the entries in the books of account are made only for the differences. Accordingly, the aggregate of both positive and negative differences is to be considered as the turnover of such transactions for determining the liability to audit vide section 44AB.
(b) Derivatives, futures and options: Such transactions are completed without the delivery of shares or securities. These are also squared up by payment of differences. The contract notes are issued for the full value of the asset purchased or sold but entries in the books of account are made only for the differences. The transactions may be squared up any time on or before the striking date. The buyer of the option pays the premia. The turnover in such types of transactions is to be determined as follows:
(i) The total of favourable and unfavourable differences shall be taken as turnover.
(ii) Premium received on sale of options is also to be included in turnover.
(iii) In respect of any reverse trades entered, the difference thereon should also form part of the turnover.
(c) Delivery based transactions: Where the transaction for the purchase or sale of any commodity including stocks and shares is delivery based whether intended or by default, the total value of the sales is to be considered as turnover.
Further, an issue may arise whether such transactions of purchase or sale of stocks and shares undertaken by the assessee are in the course of business or as investment. The answer to this issue will depend on the facts and circumstances of each case taking into consideration the nature of the transaction, frequency and volume of transactions etc.
If Capital Gains then no turnover:
In case such transactions are for the purposes of investment and income/loss arising there from 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.
Once turnover has been arrived now comes the modality of Audit .Important points to be considered are as follows:
Nature of business: Depending upon the nature of business various ratios are derived since the system compares the profit and various other ratios of different assessee of same segment it is very important to consider following ratios:
Gross Profit Ratio,Net Profit Ratio,Stock Turnover
It should be kept in mind that in a manufacturing unit the GP ratio will always be higher from that of a trading business and further that the GP ratio should not be in decreasing trend and if it is then there must be proper explanation for the same.
Same goes true for NP ratio.
Stock turnover is important for reorder level and for production loss for if the stock falls short then there will be a production loss
Sundry Debtors/Sundry Creditors:
It should be borne in mind that all the balances with parties have to be confirmed from the statements and in case of any difference there should be proper explanation for the same
Balances with Banks :
Needless to say that the balances should be reconciled with any outstanding entries old than 3 months to be reversed
Change in business or constitution of in members:
If there is any change in the nature of business or in the constitution or in case of any change in members eg partners then the fact has to be mentioned so the proof of the change must be made available to the Auditor.
Change in Method of accounting:
sometimes due to a statutory requirements or as per business prudence there is a need for change in accounting policy.In this case the amount of change in fair profit/loss due to such change have to be quantified.
This is most important aspect in Tax Audit.TDS is to be deducted on various payments made with threshold limits in each case.Brief provisions are as follows:
Every section specifies a threshold beyond which tds at applicable rates is to be deducted and deposited with Income tax.Various heads may be as follows
Payment under a contract u/s 194C where threshold is 30000.00 in a single slot and 75000.00 annual TDS is to be deducted @ 1% or 2% depending upon the status of Assessee
Brokerage u/s 194H TDS is to be deducted @ 5% if the payment exceeds Rs 15000.00
Rent etc u/s 194I if amount paid in excess of Rs 180000.00
Relevance with Tax Audit:
Any expenditure claimed in profit and loss account on which there was liability to deduct TDS but it has not been deducted or if deducted but not deposited before the date of filing ITR then 30% of the amount will be disallowed while calculating the taxable Income as per sec 40a(ia) of Income Tax Act
The amount however will be allowed in the year of actual payment of TDS
Late Filing of TDS returns:
In case of late filing there is penalty of 234E amounting to Rs200.00 per day which is to be deposited and reported in the Audit Report
Quantitative Analysis of Stock:
In case of Manufacturing concern and trading concern it is required to provide the details of stock as at year’s end in quantitative form.Now this is simple in case of trading concern but in case of manufacturing concern the matter becomes trivial as each entry of production involves many items hence it needs to be provided for carefully.It should be taken due care that the yield of the goods should be in sync with other business in vicinity and further that it should also be in line with the standard yield of the products.
Expenses in cash in excess of Rs 10000.00
No expenditure in cash in excess of Rs 10000.00 is allowed and if it so happens then the same shall be disallowed in whole as per sec 40(A)(3) however in case of freight payments the payment can be upto 35000.00 .However there are certain exception under rule 6DD which are as follows:
1) Payments made to banking and other credit institutions such as RBI, commercial banks, cooperative banks, LIC etc.
2) Payments made through the banking system i.e. Letters of credit, mail or telegraphic transfers, bills of exchange etc.
3) Payment by adjustment of a liability for goods supplied or services rendered: – 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, no disallowance operates.
4) No disallowance is applicable where such expenses are made to growers, producers or cultivators of agriculture, horticulture, fish and animal produce.
5) Payment is made to a producer for the purchase of the products manufactured or processed without the aid of power in a cottage industry.
6) Payment is made to a person who resides or carries on his/her business in a village not served by banks and financial institutions.
7) Any payments made to Government (whether State or Central Government). Such payments are direct taxes, indirect taxes, duties, cess etc.
8) No disallowance operates where any payment by way of gratuity, retrenchment compensation or similar terminal benefit, is made to an employee of the assessee or his heirs of any such assessee on or in connection with the retrenchment, resignation, discharge or death of such employee, if the income chargeable under the head salaries of the employee in respect of the financial year in which such retirement, resignation, discharge or death took place or in the immediately preceding financial year did not exceeds Rs. 50000.
9) In case of a bank closure either due to a holiday or strike and payments in cash were made on such a day, then this section will not be applicable and there will be no disallowance
10) Payment made by any person to his agent who is required to make payment in cash for goods or services.
11) Authorized dealers and foreign exchange money changers as registered with RBI are required to pay cash for purchase of foreign currency. Therefore the disallowance under this section is not applicable to them.
12) where the payment is made by an assessee by way of salary to his employee after deducting the income-tax from salary in accordance with the provisions of section 192 of the Act, and when such employee—
If there is any purchase of a property for a consideration lower than the fair market value (circle rate) then the difference is added to the income of the business as income from other sources .This fact is to be reported in the Tax Audit Report
We will cover the remaining part relevant to Tax Audit in next post
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