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Half day Training Workshop on How to conduct a Tax Audit

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BCAS HALF DAY WORKSHOP ON
�HOW TO CONDUCT TAX AUDIT’
4TH SEPTEMBER 2010
By Anil Sathe, FCA
How to Conduct Tax Audit - By CA Anil Sathe
INTRODUCTION
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Audit required vide section 44AB of IT Act
Audit of Companies vs. Other entities
Limit 40 lacs (10 lacs) since 1985 / Now revised to 60 Lacs ( 15 Lacs)
Appointment and NOC
Relying on another Statutory Auditor
Issues where accounting year followed by entity is different from financial
year.
Format of the Financial statements
пѓ‰ Recommended by ICAI
пѓ‰ For Firms to also state whether registered
Whether previous years’ figures to be given?
Minimum fees to be charged
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How to Conduct Tax Audit - By CA Anil Sathe
APPLICABILITY OF ACCOUNTING STANDARDS
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Corporate entities
пѓ‰ Mandatory as per Companies (AS) Rules, 2006
пѓ‰ Concessions to SMCs from some AS
Non-corporate entities
пѓ‰ Compliance not given by any statute (except for AS 1 & AS 2 issued
under section 145 of Income Tax Act)
 As per ICAI guidelines – mandatory for auditors while reporting –
exemptions for SMEs from some AS
пѓ‰ In practice, important AS like AS 1, AS 2, AS 7, AS 10, etc need to
be followed as otherwise the accounts may not give “True and Fair”
view
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How to Conduct Tax Audit - By CA Anil Sathe
CONCEPT OF TURNOVER
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Whether to include excise, sales tax, service tax?
For proprietorships: total turnover for each business
Whether to include sale of capital assets?
When to apply limit of 40 lakhs vs. 10 lakhs
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Nursing home
Interior decorators
Management consultants
Coaching classes
Gain on sale on investments
Insurance agents, Financial Planning Advisors, etc
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How to Conduct Tax Audit - By CA Anil Sathe
SALES, TURNOVER & GROSS RECEIPTS:
Nature of business
What is Turnover
ICAI Guidance Note [GN]
– reference
Day trader/speculator
Sum total of differences,
whether positive or
negative
Para 5.11(a) of ICAI GN
Security derivatives
transactions
Sum total of differences,
whether positive or
negative, also premium
on sale of options
Para 5.11(b) of ICAI GN
Commodity derivatives
transactions
– in case of settlement
without delivery, sum
total of differences,
whether positive or
negative
– in case of delivery,
total value of sales
Para 5.11(b) & (c) of
ICAI GN
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How to Conduct Tax Audit - By CA Anil Sathe
SALES, TURNOVER & GROSS RECEIPTS:
Nature of business
What is Turnover
ICAI Guidance Note reference
Clearing & forwarding
agent
Reimbursement of
customs duty & other
charges collected by an
agent not part of turnover
Para 5.13(vi) of ICAI GN
Amount received from
Travel agent, where no
commission is payable by clients for payment to
airlines is reimbursement
airlines
Advertising agency
booking space
Para 5.13(viii) of ICAI GN
Para 5.13(ix) of ICAI GN
Advertising charges
recovered not
turnover, provided by way
of reimbursement
[ABP(P) Ltd. v/s. ACIT 23
SOT 28(Kol)]
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How to Conduct Tax Audit - By CA Anil Sathe
DOCUMENTATION BEFORE COMMENCEMENT
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Appointment letter
Engagement Letter
NOC from previous auditor wherever applicable
Declaration of non-interest of auditor in auditee
Documents required & permanent file.
Audit Programme
Accounts / Trial Balance.
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FORM 3CA, 3CB
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When to use 3CA and 3CB?
Giving comments in Para 3(a) of Form 3CB
пѓ‰ Effect thereof?
пѓ‰ Whether safeguards the auditor?
Adding responsibility and scope Para in 3CB
пѓ‰ Results in amending Form 3CB
пѓ‰ Whether justifiable?
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How to Conduct Tax Audit - By CA Anil Sathe
FORM 3CA, 3CB …
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Notes to Accounts to normally specify:
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Method of accounting followed – accrual or cash
Method of inventory valuation
Fixed Assets and Depreciation
Investments
Method for accounting Foreign Exchange fluctuations
Items that may require qualification:
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Mandatory AS not followed (esp. for Companies)
Non provision of Income Tax
Employee benefits – especially retirement benefits
Confirmations for balances
Inventory valuation on estimated basis
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How to Conduct Tax Audit - By CA Anil Sathe
FORM 3CD
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Form 3CD – revised effective 10th August 2006
For a proprietor having 2-3 different business – whether
same or different Form 3CD?
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Primary responsibility of management
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To be certified by management
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Contains Parts A/B and 2 Annexures [ Annexure- 2 not
relevant for AY 2010-11 & subsequent years]
Annexure I contains 2 parts A/B
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FORM 3CD
3CD
Part A
Part
B
Clauses
1 to 6
Clauses
7 to 32
Annexures
I and II
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How to Conduct Tax Audit - By CA Anil Sathe
FORM 3CD
Annexures to 3CD
Annexure I
Part A
(similar to Part A of
main 3CD – Clauses
1 to 6)
Part B
(Parameters)
Annexure II*
Value of Fringe
Benefits
*not relevant for AY 201011 & subsequent years
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POINTS TO BE BORNE IN MIND WHILE CERTIFYING
PRESCRIBED PARTICULARS IN FORM NO.3CD
General Issues
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Information to be compiled and authenticated by the assessee Auditor’s duty to check the details, applying the auditing standards and
techniques.
In the case of conflicting Judicial precedents, Auditor should state the
Judgment relied upon.
In the case of conflicting views with the assessee, the Auditor may state
both the views and leave it to the Tax Department to decide the matter.
The Auditor will be normally be guided by the Income Tax Act while
reporting the particulars in Form 3CD.
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PART A: CLAUSES 1 TO 6 (ALSO IN ANNEXURE 1 – PART
A): BASIC DETAILS OF ASSESSEE
1.
Name of Assessee
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2.
Address
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3.
4.
5.
6.
In case of proprietor, name of business which is being
audited – with name [say., XYZ Exports (Prop. ABC)]
If audit of only branch carried out, then name of Branch
Normally of the registered office
In case of a branch, division, etc addresses thereof
Permanent Account Number
Status
Previous Year ended
Assessment Year
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How to Conduct Tax Audit - By CA Anil Sathe
CLAUSE 7(a), 7(b):
IF ASSESSEE IS FIRM OR AOP, …
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To indicate names of partners/members and profit sharing ratios
(including for sharing losses, if different)
Does not cover ratios for remuneration to partners
All changes in profit sharing ratios (since last date of preceding
year) to be mentioned
Audit Process
пѓј Verify the Partnership Deed and Addenda thereto (retain copy in
permanent file)
пѓј Whether relevant documents filed with concerned authorities like
Registrar of Firms, etc
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How to Conduct Tax Audit - By CA Anil Sathe
CLAUSE 8(a), 8(b):
NATURE OF BUSINESS OR PROFESSION, …
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To give broad nature of all business/profession
To give principal line of each business/profession
 “Manufacturing of aromatic chemicals”, not simply
manufacturing or chemicals manufacturing
Similar to information required in ITR
Match this with information required in Annexure 1 part B
In practice, activities that constitute > 10 % are given
Mention of any material change like:
пѓ‰ New business started
 Some business discontinued – (if only temporary suspension
need not be mentioned)
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How to Conduct Tax Audit - By CA Anil Sathe
CLAUSE 8(a), 8(b):
NATURE OF BUSINESS OR PROFESSION, …
Audit Process
пѓ� Verify the Partnership Deed / Memorandum / Minutes
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Verify actual activities carried out (from the components of
Income in P & L a/c)
New activities during the year to be mentioned
For companies – compare with:
пѓј Quantitative details in Part III Schedule VI and
пѓј particulars given in Part IV of Schedule VI
If in doubt – better to include
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How to Conduct Tax Audit - By CA Anil Sathe
CLAUSE 9(a), 9(b), 9(c):
WHETHER BOOKS PRESCRIBED U/S 44AA, …
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To give list of books prescribed, maintained and
examined
Rule 6F prescribes books for certain professionals
mentioned in sec 44AA(1) – not so prescribed for
business and others mentioned in sec 44AA(2)
Books constitute books of original entry and maybe
prescribed under some other statute
To give the list for all locations (incl stock registers)
If maintained in a computer system – to mention so
Books would be for recording financial as well as nonfinancial information
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How to Conduct Tax Audit - By CA Anil Sathe
CLAUSE 9(a), 9(b), 9(c):
WHETHER BOOKS PRESCRIBED U/S 44AA, …
Audit Process
пѓ� To obtain list from the management
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All 3 lists may not be same:
пѓј Some books though prescribed, may not be maintained
пѓј Some books though maintained may not be examined
(say., Petty Cash Book)
To take care to include list for all branches, depots.
To exercise professional judgement and give reservations if
certain books required are not maintained
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How to Conduct Tax Audit - By CA Anil Sathe
CLAUSE 10: WHETHER P & L A/C INCLUDES PROFITS
ASSESSABLE ON PRESUMPTIVE BASIS?
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Relevant sections for presumptive taxation are:
44AD
44AE
Civil Construction Business ( all business w.e.f.
AY 2011-12)
Transport Business
44AF
44B
Retail Trade ( will not apply from AY 2011-12)
Shipping buisness of a non-resident
44BB
Providing services in prospecting or extraction of
mineral oils
44BBA Operation of aircraft by non-resident
44BBB Civil construction in turnkey power projects by
non-residents
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CLAUSE 10: WHETHER P & L A/C INCLUDES PROFITS
ASSESSABLE ON PRESUMPTIVE BASIS? …
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Reporting is for amounts included in P & L a/c
Amount assessable under the presumptive section need not be
given
If 2 or more business exist and presumptive section applicable
for some businesses, allocation of expenses may become
necessary if common books are maintained
Audit Process
пѓј To confirm whether any of the businesses fall under this
category
пѓј If amount included in P & L a/c does not match the amount
assessable under the presumptive section a note maybe added
to that effect
пѓј Confirm whether common or separate books maintained for
such businesses
пѓј Verify allocation if common books maintained
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How to Conduct Tax Audit - By CA Anil Sathe
CLAUSE 11(a), (b), (c), (d):
METHOD OF ACCOUNTING
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Method of accounting followed
пѓ‰ Accrual vs. Cash method (mixed method not allowed)
 If cash basis of accounting – then Specific disclosure in
Audit report
пѓ‰ Method to be consistently followed
пѓ‰ Isues regarding different methods of accounting for two
businesses
пѓ‰ Allowability of remuneration in case of professional firm
following Cash basis
пѓ‰ Cash basis not possible for companies
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How to Conduct Tax Audit - By CA Anil Sathe
CLAUSE 11(a), (b), (c), (d):
METHOD OF ACCOUNTING
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Deviation from accounting standards prescribed u/s 145.
Sec 145 has notified 2 Accounting Standards:
 AS 1 (IT) – similar to AS 1 of ICAI
 AS 2(IT) – similar to AS 5 of ICAI
Exception to Sec 145 – interest on compensation or
enhanced compensation taxable in the year of receipt
irrespective of method of accounting
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How to Conduct Tax Audit - By CA Anil Sathe
CLAUSE 11(a), (b), (c), (d):
METHOD OF ACCOUNTING …
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AS 1(IT) requires disclosure of all significant accounting
policies
Change in method of accounting
пѓ‰ Allowed as per para 9 of AS 2(IT) in 2 cases
пѓђ Adoption required by statute
пѓђ Change would result in more appropriate presentation of
financial Statements.
пѓ‰ Materiality to be considered
пѓ‰ Effect on profit/loss to be stated
пѓ‰ Changed policy to be followed consistently
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How to Conduct Tax Audit - By CA Anil Sathe
CLAUSE 11(a), (b), (c), (d):
METHOD OF ACCOUNTING …
Audit Process
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To find all accounting policies followed for:
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Revenue Recognition
Inventory valuation,
Fixed Assets and depreciation
Investments
Foreign exchange fluctuations
Employee benefits, etc
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Confirm whether the same are disclosed at one place
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If any change in policy, confirm the same is as per 2 exceptions
provided by para 9 of AS 2 (IT)
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Change needs to be reported even though there may not be a
change in taxable income – e.g. depreciation
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How to Conduct Tax Audit - By CA Anil Sathe
CLAUSE 12(a), (b):
METHOD OF VALUATION OF CLOSING STOCK
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Closing stock consists of RM, WIP, FG, Stores, etc
Normal valuation principles to be followed:
At cost or NRV whichever is lower;
пѓ‰ To follow Absorption Costing;
пѓ‰ To include all costs incl. excise duty (sec 145A)
пѓ‰ To mention how cost is determined
 If cost arrived at as SP less GP margin – whether ok?
пѓ‰ Allowed at SP in certain cases
пѓ‰ SC decision of British Paints (188 ITR 44)
To also value stores, packing items
Change in method of valuation covered in Clause 11
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How to Conduct Tax Audit - By CA Anil Sathe
CLAUSE 12(a), (b):
METHOD OF VALUATION OF CLOSING STOCK …
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To mention effect of 145A on
пѓ‰ Any tax, duty, cess ,etc paid/incurred on inputs to be added
to the cost of the inputs, if not already added;
пѓ‰ Any tax, duty, cess ,etc paid/incurred on sale of goods to be
added in sales, if not already added;
пѓ‰ Any tax, duty, cess ,etc paid/incurred on inventory to be
added to inventory valuation, if not already added;
Section 145A thus requires “Inclusive method” as against
“Exclusive method” mandated by AS 2
ICAI GN on “Tax Audit u/s 44AB” mentions (with an illustration)
that in both methods, impact on profit/loss is Nil
For an entity following “Exclusive method” ICAI GN has
suggested disclosure in the following table (see next slide)
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How to Conduct Tax Audit - By CA Anil Sathe
CLAUSE 12(a), (b):
METHOD OF VALUATION OF CLOSING STOCK …
Particulars
Increase in
Profit (Rs.)
Decrease in
Profit (Rs.)
1
Increase in cost of opening stock on inclusion of
excise duty on which Cenvat available/availed
Xxx
Xxx
2
Increase in purchase cost of RM on inclusion of
excise duty on which Cenvat available/availed
Xxx
Xxx
3
Increase in sales of finished goods on inclusion of
ED
Xxx
Xxx
4
ED paid on Sale of FG due to inclusion in Sales
Xxx
Xxx
5
Increase in closing stock of RM on inclusion of ED
Xxx
Xxx
6
Increase in closing stock of FG on inclusion of ED
xxx
Xxx
7
Increase in ED on closing stock of FG as a result of
its inclusion in closing stock of FG
xxx
Xxx
8
Accounting of Cenvat credit availed and utilised on
RM consumed in payment of ED on FG accounted
on basis of RM consumed
Xxx
Xxx
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How to Conduct Tax Audit - By CA Anil Sathe
CLAUSE 12(a), (b):
METHOD OF VALUATION OF CLOSING STOCK …
Audit Process
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Get list of Closing Inventory;
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Confirm whether all items like RM, WIP, FG, Stores,
Packing materials, consumables, etc are valued
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Confirm method of valuation (incl determination of cost, etc)
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Tally inventory list with that submitted to the bank – quantity
should match – value may differ due to different valuation
method applied
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Confirm applicability of sec 145A
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Disclosure as per ICAI GN, if 145A not followed
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How to Conduct Tax Audit - By CA Anil Sathe
CLAUSE 12A(a), (b), (c):
CAPITAL ASSET CONVERTED INTO STOCK-IN-TRADE
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Sections 2(47), 45(2), 47(iv),(v) and 47A relevant for
reporting under this clause
Following particulars to be given:
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Description of capital asset;
Date of acquisition;
Cost of acquisition;
Amount at which the asset is converted into stock-in-trade
Reporting is only for assets converted into stock-in-trade in
the previous year – Taxability of the gains from such transfer
need not be commented.
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CLAUSE 12A(a), (b), (c):
CAPITAL ASSET CONVERTED INTO STOCK-IN-TRADE
Audit Process
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Confirm whether any asset has been converted to
stock-in-trade in the previous year;
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Verify contemporaneous evidence in this regard.
Whether any entry passed for the same
If amount at which asset is converted is stated other
than at cost, to ascertain the basis thereof
whether disclosure made for the above
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CLAUSE 13(a) TO (e):
AMOUNTS NOT CREDITED TO P & L A/C
Auditors responsibility is restricted to information contained in the
books of accounts & records.
a.
Items falling within scope of section 28 [i.e. ss. (i) to (vi)]
b.
Proforma credits, refunds, are admitted as due by authorities
c.
Escalation claims accepted during the previous year
d.
Any other item of income
e.
Capital receipt, if any
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Reporting for (a), (d) and (e) with reference to entries passed in
the books of account
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Reporting for (b) and (c) with reference to documents made
available
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If reporting done for items under (b), (c), (d) same again need
not be reported in (a).
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How to Conduct Tax Audit - By CA Anil Sathe
CLAUSE 13(a) TO (e):
AMOUNTS NOT CREDITED TO P & L A/C …
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Receipts directly taken to reserves or capital/current
accounts of partners
Reporting necessary irrespective whether amounts are
taxable or exempt e.g.
пѓ‰ Income tax refunds,
пѓ‰ subsidies received,
пѓ‰ remission of loans,
пѓ‰ Share of profit from firm
пѓ‰ Compensation for surrender of tenancy rights, etc
пѓ‰ Compensation from breach of contracts
пѓ‰ Capital subsidies.
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CLAUSE 13(a) TO (e):
AMOUNTS NOT CREDITED TO P & L A/C …
Audit Process
пѓј Confirm whether any receipt covered u/s 28 has been taken
directly to reserves or capital accounts
пѓј To examine all relevant correspondence for proforma credits,
refunds, claims, etc
пѓј If such credits, etc have been admitted, though not received, the
same should be reported
пѓј Consider implications of above on provision for tax
пѓј If assessee disputes any item based on legal decisions: to
mention the same
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General disclaimer maybe given that the auditor has
not gone beyond the books of accounts produced to
him during audit and has not conducted an
investigation to find out if the assessee has not
credited any amounts in the books.
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CLAUSE 14(a) TO (f):
FIXED ASSETS & DEPRECIATION
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Particulars of Block of Assets and depreciation
a.
b.
c.
d.
e.
f.
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Additions normally bifurcated into:
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Description
Rate of depreciation
Actual cost or WDV
Additions/Deductions with dates of acquisition/put to use – whether net
of Cenvat credit, Foreign exchange fluctuations, subsidies
Depreciation allowable
WDV at end of the year
Used for more than 180 days and others
Cut-off date would be 2nd October (not 30th Sept)
If list of additions very voluminous summarised information can
be given
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How to Conduct Tax Audit - By CA Anil Sathe
CLAUSE 14(a) TO (f):
FIXED ASSETS & DEPRECIATION …
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Date when Asset put to use – can differ with date of start of
commercial production
Capital assets claimed as deduction
пѓ‰ R & D assets (also refer clause 15)
пѓ‰ Assets less than Rs. 5,000?? (Sch. XIV of Companies Act)
Computer Software: whether asset? (Decision of Amyway)
Adjustments for currency fluctuations (as per sec 43A)
Adjustments for subsidies received (as per expl 10 to sec 43)
In case of disputes (which are under litigation) regarding
depreciation claim in earlier years – to clearly mention the same
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How to Conduct Tax Audit - By CA Anil Sathe
CLAUSE 14 (b): RATE OF DEPRECIATION
Recommended Note in the ICAI Guidance Note vis-Г -vis
“Disputes with tax authorities”:
NOTE: Certain disputes about (a) the rate of depreciation on
________ (b) determination of WDV of block of assets relating
to ___________ and (c) ownership of ____________ have
arisen in the assessment years ___________ for which
assessments are pending/appeals are pending. The figures of
WDV and/or rate of depreciation mentioned in the above
statement may require modification when these disputes are
resolved. Therefore, the amount of depreciation allowable as
stated in the above statement will have to be accordingly
modified.
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CLAUSE 14 (b): RATE OF DEPRECIATION
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Depreciation allowed @ 60% on computer
including computer software.
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Scope enlarged by recent decision of the Special
Bench in the case Datacraft India Ltd.
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Routers and switches should be classified as part of computers and be
eligible for 60% depreciation.
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CLAUSE 14 (b): RATE OF DEPRECIATION –
DEPRECIATION ON INTANGIBLES
Item
Citation
License of “toll collection”
Ashoka Info. (P) Ltd. - (2009) 22 DTR 60
(Pune) (Trib)
Non-compete fees
Medicorp Technologies India Ltd. - (2009) 30
SOT 506 (Mad)
Real Image - (2009) 120 TTJ 983 (Mad)
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CLAUSE 14 (b): RATE OF DEPRECIATION –
DEPRECIATION ON INTANGIBLES
Item
Citation
Brand name
KEC International Ltd. v/s. ACIT –
unreported decision in ITA No.
4420/Mum/2009
Commercial rights of exploration of
mineral oil
ONGC Videsh Ltd. – (2010) 33
DTR 22 (Trib).
Acquiring skill and know-how of
employees of business taken over
Bosch Ltd. v/s. CIT – unreported
decision in ITA No. 329/Bang/09
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How to Conduct Tax Audit - By CA Anil Sathe
CLAUSE 14(a) TO (f):
FIXED ASSETS & DEPRECIATION …
Audit Process
пѓј Confirm opening block from last year
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Tally Additions/deductions with Fixed Assets Schedule
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Confirm dates when asset is put to use – when commercial
production has started
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Confirm whether adjustment for Cenvat, Foreign exchange
gains/losses is as per relevant section
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Confirm depreciation rates and whether additional
depreciation claimed in appropriate cases
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How to Conduct Tax Audit - By CA Anil Sathe
CLAUSE 15 (A) TO (L):
AMOUNTS ADMISSIBLE
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List of amounts admissible under 33AB, 33ABA, 33AC, 35,
35ABB, 35AC, 35CCA, 35CCB, 35D, 35DD, 35DDA, 35E
To mention whether or not the above is debited to Profit &
loss a/c
As 26 does not now permit any expenditure to be classified
as Deferred Revenue Expenditure
Due to this, in most cases amount will not be debited to P &
L a/c, but may be appearing as Deferred Tax Asset (on
account of ensuing timing difference)
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How to Conduct Tax Audit - By CA Anil Sathe
CLAUSE 15 (a) TO (l):
AMOUNTS ADMISSIBLE …
Audit Process
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Ascertain whether assessee eligible for claim of any
expenses as per the above sections
If amount being treated as DRE (esp. if prior to applicability
of AS 26), confirm whether the same has been appropriately
amortised
If amount fully written off, to confirm with the statement of
calculation of Deferred Tax (unamortised amount is to be
considered as DTA)
If claim pertains to a capital asset, confirm that no
depreciation on the same is claimed u/s 32 (Clause 14 of
Form 3CD)
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How to Conduct Tax Audit - By CA Anil Sathe
CLAUSE 16 (a), (b):
SUM PAID TO EMPLOYEE AS BONUS, ETC
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Relevant sections are:
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For 16(a) – sec 36(1)(ii), For 16(b) – sec 2(24)(x) and 36(i)(va)
Sec 36(1)(ii) would not be applicable in most cases, unless bonus
or commission is paid, which would be otherwise been payable to
him as profits or dividend
Under 2(24)(x) sums received from employees as contributions to
any PF, ESI, etc are included as income
Deduction allowed u/s 36(i)(va) if the said amounts are deposited
on or before the due date – Due date would also include Days of
Grace allowed under the respective legislation
Amount deducted, due date for repayment and actual date are to
be mentioned.
44
How to Conduct Tax Audit - By CA Anil Sathe
CLAUSE 16 (a), (b):
SUM PAID TO EMPLOYEE AS BONUS, ETC …
Audit Process
пѓј
пѓј
Verify agreements, if any, with employees to ascertain
whether any amount payable as profits or dividends,
but paid as bonus or commission
Obtain list of contributions of employees to PF, ESIC,
etc and dates of their payments (cross reference to
bank statements)
пѓј
Confirm due dates as per the concerned legislation
пѓј
If data voluminous, test check can be done and so
mentioned
45
How to Conduct Tax Audit - By CA Anil Sathe
DOCUMENTATION AFTER AUDIT
пѓ’
Register for Tax Audits carried out during the year
пѓ’
Documentation for 3CD should be separate
пѓ’
Check list for 3CD, if possible
пѓ’
пѓ’
For debatable issues, separate management
representations, if required
Query listing / sign off
46
How to Conduct Tax Audit - By CA Anil Sathe
THANK YOU !!
47
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