Tax Audit

“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”[1].

A tax audit is an investigation into the background of tax returns submitted by an individual or business to a tax agency. The idea of a tax audit normally conjures up feelings of anxiety even in persons who believe their tax documents are perfectly in order. While it is true that a tax audit may be called due to some perceived irregularity in one or more returns, it is also true that an audit may be done simply as part of a random sampling[2].

Tax Audit is a compulsary audit under the Income Tax Act in India which is conducted if the total turnover of a person exceeds Rs. 15,00,000 for professionals and Rs. 60,00,000 for persons other than professionals. Tax Audit has to be conducted by a Chartered Accountant appointed by the person itself. Tax Audit Report is given by the Chartered Accountant to the person in form 3CD prescribed under the Income Tax Act. At the time of filing of the return of income relevant data from the Tax Audit Report has to be filled in the Return of Income[3].

The tax audit was introduced by section 11 of the Finance Act, 1984, which inserted a new section 44AB with effect from 1st April, 1985. This section makes it obligatory for a person carrying on business to get his accounts audited by a chartered accountant, and to furnish by the ‘specified date’, the report in the prescribed form of such audit, if the total sales, turnover or gross receipts in business in the relevant previous year exceed or exceeds rupees Sixty lakhs. For a professional, the provisions of tax audit become applicable, if his gross receipts in profession exceed rupees Fifteen lakhs in the relevant previous year.

The vires of section 44AB has been upheld by Hon’ble Supreme Court in T.D. Venkata Rao v. Union of India[4] 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 (sic: turnover) exceeds Rs.60 lakhs and professionals whose income (sic: gross receipts) exceeds Rs.15 lakhs in any given year. There is no material on record and indeed in our view, there cannot be that an income-tax practitioner has the same expertise as chartered accountants in the matter of accounts. For the same reasons the challenge under article 19 must fail and it must be pointed out that these income-tax practitioners are still entitled to be authorized representatives of assessees.”

Section 44AB[5] reads as under:

“Audit of accounts of certain persons carrying on business or profession.  44AB. Every person, —

• • carrying on business shall, if his total sales, turnover or gross receipts, as the case may be, in business exceed or exceeds Sixty lakh rupees in any previous year; or

• • carrying on profession shall, if his gross receipts in profession exceed Fifteen lakh rupees in any previous year; or

• • carrying on the business shall, if the profits and gains from the business are deemed to be the profits and gains of such person under section 44AD or section 44AE or section 44AF or section 44BB or section 44BBB, as the case may be, and he has claimed his income to be lower than the profits or gains so deemed to be the profits and gains of his business, as the case may be, in any previous year, get his accounts of such previous year audited by an accountant before the specified date and furnish by that date the report of such audit in the prescribed form duly signed and verified by such accountant and setting forth such particulars as may be prescribed:

Accordingly, “accountant” [6] means a chartered accountant within the meaning of the Chartered Accountants Act, 1949 and includes, in relation to any State, any person who by virtue of the provisions[7] is entitled to be appointed to act as an auditor of companies registered in that State.

 “Business” includes any trade, commerce, or manufacture or any adventure or concern in the nature of trade, commerce or manufacture[8].

In case of Barendra Prasad Roy v ITO[9] 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.

Whether a particular activity can be classified as `business’ or `profession’ will depend on the facts and circumstances of each case.

In CIT v.Manmohan Das[10] 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.  

The following have been listed out as professions in section 44AA and notified there under 

• • Accountancy

• • Architectural

• • Authorised Representative

• • Company Secretary

• • Engineering

• • Film Artists/Actors, Cameraman, Director, Singer, Story-writer, etc.

• • Interior Decoration

• • Legal

• • Medical

• • Technical Consultancy

• • Information Technology

The following activities have been held to be business :

• • Advertising agent

• • Clearing, forwarding and shipping agents[11]

• • Couriers

• • Insurance agent

• • Nursing home

• • Stock and share broking and dealing in shares and securities[12]

• • Travel agent.

Audit Requirement for Individuals – 44AB & 44AD

Individuals are required to get their books of accounts audited even if they are running a sole proprietorship business and salaried individuals are also attracted under the provisions of audit in certain situations.

Scenerio1 – Compulsory Audit u/s 44AB:

Audit becomes mandatory in the following cases:

• • Person carrying on business if his total sales, turnover or gross receipts exceeds Rs.60lacs in the previous year relevant to the assessment year;

• • Person carrying on profession, if his gross receipts in profession exceeds Rs.15 lacs in the previous year relevant to the assessment year;

• • Person covered under section 44AE, 44BB or 44BBB, if such person claims that the profits from the business is lower than the profits computed under these sections;
    Person covered under section 44AD, if such person claims that the profits from the business is lower than the profits computed under this section and his income exceeds the maximum exemption limit.

Scenerio2 – Compulsory Audit u/s 44AD:

Presumptive taxation scheme (Section 44AD) has been incorporated to provide for special provisions for computing business profit on presumptive basis. It provides the following:

• • The provision of this section provides if the total sales, turnover or gross receipts does not exceeds Rs.60lacs in the previous year then the assessee is required to disclose at least 8 per cent of the gross turnover/receipts as income from his business.

• • In case the assessee does not discloses the same, that is, he declares his income less than 8 per cent of total turnover (or say loss), then he is required to maintain books of accounts and to get compulsory tax audit under provisions of section 44AA and 44AB.

• • Thus an assessee cannot escape from tax audit even if he is incurring loss in his business.

Books of Accounts

“Books or books of account” include ledgers, day-books, cash books, account-books and other books, whether kept in the written form or as print-outs of data stored in a floppy, disc, tape or any other form of electro-magnetic data storage device.

If the assessee[13] has maintained proper books of account, the provisions of Sec 145(1)[14] shall apply and the Income has to be assessed on the basis of the books of account.  Thus, unless, the books of account are rejected, or no books of account are maintained, the Income disclosed cannot be disturbed as held in ITO v Amar Singh Jain[15].

In Kishan Chand Chella v CIT[16], Non maintenance of stock register & non recording of sales with identifiable details was held to be good ground for rejection of account books. System of Accounting cannot be rejected merely because the disclosed gross profit was low[17]. 

First time tax audit

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. 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.

Whether addition can be made due to change in the method of accounts?

The Gujarat High Court in CIT v. Soma Textiles & Industries Ltd[18], observed that the change in the method of accounting was a bonafide and consistently followed in the subsequent years.  It was held that no addition was warranted as no substantial question of law was involved.

Filling of Tax Audit Report and Penalty

The tax audit report u/s. 44AB has to be filed along with the return of income of the assessee. However the audit report may be filed first before the due date of  filing even if the return of income is not filed, so as to avoid the penal provisions of section 271B[19]. If the tax audit report is not filed before the due date of filing of return, then penalty would be levied u/s.271B.

However penalty u/s.271B would not be levied if reasonable causes existed, that prevented the assessee from filing return of income and obtaining audit report u/s.44AB.           

 Penalty u/s.271B is discretionary and not mandatory. The use of word “may direct” in section 271-B indicates the power of the assessing officer[20].  Penalty u/s. 271-B is independent from assessment proceedings. It can be  initiated even before compliance of assessment[21].   

The counsel to whom the audit report u/s.44AB handed over could not file in time is a reasonable cause for not filing the report in time[22]. Completion of audit delayed due to statutory auditors is a reasonable cause for  not filing the report in time[23]. Change of auditor not proved for tax audit purpose. Levy of penalty justified[24].

Judicial Interpretation

Agriculture income:-

The Madras High Court in the case of CIT v. Soundarya Nursery[25] held that, Any person who is performing basic agricultural operation and who sells his products, the income earned there from is an agricultural income.  If any person, who has done basic agricultural operation and later on transfers it into saleable conditions like transferring into pots etc., sold in his nursery, is also an agricultural income.

Assessabilty of Income:-

Income earned from the business center is assessable as business income.  The assessee constructs a business complex and leases it to various parties and provides secretarial and other facilities.  The department treats it as “income from house property” – ACIT v. Saptharishi Services Ltd[26]

In case the assessee as owner of building was only exploiting the property as owner by leasing out the same and realizing income by way of rent, such rental income was liable to be assessed under the head “Income from house property”[27].

Income from Advertisement Hoardings:-

The above income is treated as income from other sources not as income from property. Ref in the case of Mukherjee Estate [P] Ltd v. CIT[28]

Profession Of information Technology:-

A Chartered Accountant after passing ISA or CISA surrendered his certificate of practice and started his own software consultancy, development and system audit and earned Rs.15Lakh as gross receipt – Is he liable for tax audit.

 Even though he has not been pursuing the profession of accountancy but he can be considered as a professional of information technology if his gross receipts exceeds Rs.10 lakhs attracts tax audit u/s 44AB[29].

Information technology is a vast area we have to analyse from case to case basis with reference to the nature of service rendered by each person like software consultancy, developer, Hardware Engineer etc.,

Conclusion

However, audits may also be conducted if the tax agency finds reason to believe deductions are not allowable or if there was a deliberate attempt to hide earned income. When this is the case, the government will often call for a tax audit to clear up and discrepancies. If the taxpayer can provide proof that the initial return was complete and correct, then all is well. If the tax agency finds that a deduction is not allowed, the return is recalculated and interest penalties may apply.

While a tax audit is normally considered routine, it has gained a reputation of being an extremely nerve wracking process for the taxpayer. However, many government tax agencies attempt to make the process of the tax audit as comfortable as possible for all parties concerned.

Hence it can be seen that the new provisions have a deep impact on the individual taxpayers especially on those salaried individuals who deals in Futures & Options transactions as part of their investments. Due to market fluctuations and daily ups and downs in the economy, these individuals incurs heavy losses in F&O transactions but due to the insertion of section 44AD, even they are now eligible to get their accounts audited.

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[1]   As Per The Institute of Chartered Accountants of India

[2]   http://www.wisegeek.com/what-is-a-tax-audit.htm

[3]   http://www.ahujaandahuja.in/services/auditing-services/tax-audit/

[4]   [1999] 237 ITR 315 (SC).

[5]   Sec. 44AB of the Income Tax Act, 1961

[6]   Sub-section (2) of section 288 defines “accountant

[7]   Sub-section (2) of section 226 of the Companies Act, 1956 (1of 1956),

[8]    Section 2(13) of the Income Tax Act, 1961

[9]    [1981] 129 ITR 295 (SC).

[10]   [1966] 59 ITR 699 (SC).

[11]   CIT v. Jeevanlal Lallubhai & Co. [1994] 206 ITR 548 (Bom).

[12]   CIT v. Lallubhai Nagardas & Sons [1993] 204 ITR 93 (Bom).

[13]   Sec. 2(7) of the Income Tax Act, 1961 “Assessee” means a person by whom any tax or any other sum of money is payable under this Act, [14]   Income chargeable under the head “Profits and gains of business or profession” or “Income from other sources” shall, subject to the provisions of sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee.

[15]   (1992) 43 TTJ   (Jp Trib) 11

[16]   (1978-114 ITR 671)

[17]  Chandra timber traders v CIT 1996 54 TTJ 544 Del Tri)

[18]   (253 ITR 137 Guj)

[19]   If any person fails to get his accounts audited in respect of any previous year or years relevant to an assessment   year or furnish a report of such audit as required under s. 44AB, the Assessing Officer may direct that such person shall pay, by way of penalty, a sum equal to one-half per cent of the total sales, turnover or gross receipts, as the case may be, in business, or of the gross receipts in profession, in such previous year or years or a sum of  one hundred thousand rupees, whichever is less.

[20]   Indian Handloom Textiles  v. ITO (1999) 68 ITD560, CIT v. Gayatri Traders (1996) 58 ITD 121

[21]   CIT v. Madani Rotles Flour Milss (1997) 71 ITD 274 (Asr)

[22]  Lalla Prasad Chaurasia v. (ITO) (1999) 104 Taxman  110 (Jab)

[23]  Solapuri Zilla Vinkar Sahakali  federation Niyamat v.. Dy.CIT (1999) 71 ITD 117.

[24]  C.Ramaswamy  v.. ITJ (1999)63 TTJ (Mad)

[25]  160 CTR 319 (MAD)

[26]   [2004] 265 ITR 379 [Guj] 

[27]   CIT v. Karnani Properties Ltd [1971] 82 ITR 547 [SC], CIT v. Indian Overseas Bank Ltd [2000] 246 ITR 206  

     [MAD].

[28]    [200] 244 ITR [Cal].

[29]   Profession of Information Technology notification No.50385 (E) dt.04-05-2001.