Tax audit under the section 44AB Income-tax Act 1961 has been introduced with an effect of the Assessment year 1985-86. The Tax audit report is issued in form either 3CA or 3CB along with the questionnaire in Form 3CD. Form 3CD has been revised/updated from time to time and it was last updated on 20-8-2018. The objective of introduction of Tax Audit as stated in the Memorandum explaining the provisions of the Finance Bill, 1984 “Compulsory audit is intended to ensure proper maintenance of books of account and other records, in order to reflect the true income of the taxpayer and to facilitate the administration of tax laws by a proper presentation of the accounts before the tax authorities. This would also save time of the AO considerably in carrying out the verification.” The virus of the section 44AB was challenged and the Hon’ble Supreme Court in T. D. Venkata Rao v. UOI  237 ITR 315 has held that Chartered Accountants, by reason of their raining have special aptitude in the matter of audit. It is reasonable that they, who form a class by themselves, should be required to audit the accounts of business and profession.
As such tax audit is a very vast topic and it may be practically difficult to capture in an article. In view of this I trying to cover a few aspects.
Applicability of Tax Audit
Any person carrying business or profession and having a turnover or gross receipts exceeding ₹ 1 Crore (assessee engaged in business); ₹ 2 Crore (assessee engaged in business and opted for presumptive taxation) or ₹ 50 lacs (assessee engaged in the profession) is required to get its accounts audited u/s 44AB. Tax audit is applicable to all assessees irrespective of the fact whether such assessee is resident or non-resident. Tax audit is also required to be carried irrespective of the fact that income is exempt from tax by reason of a specific exemption/deduction provided under the Act. However if an agriculturist who does not have any income under the head “profits and gains of business or profession” chargeable to tax under the Act and who is not required to file any return under the Act, need not get his accounts audited for the purposes of section 44AB even though his total sales of agricultural products exceeds the specified limits.
Regulatory Responsibilities on Chartered Accountants
Tax Audit is carried by Chartered Accountant and they are bound by the Institute of Chartered Accountants Regulations (ICAI) viz.
Restriction of a number of Tax Audit: ICAI has prescribed a maximum 60 tax audits that can be carried by a Chartered Accountant. However, in the case of the firm, this limit is reckoned per partner e.g. Chartered Accountants firm with 3 partners can undertake a maximum of 180 audits. But such case a partner can sign more than 60 tax audit reports. However part-time practising partner of a firm shall not be taken into account for the purpose of reckoning the tax audit assignment of the firm. The ICAI has issued show-cause notice Chartered Accountants when C & A G in its report has given finding that some Chartered Accountants have issued tax audit report in excess of prescribed limits. While determining the limit of 60 tax audits, tax audit of the head office and branch or audit of more than one branch of same concern is considered as one tax audit assignment. A further audit carried under Companies Act, Trust Act, 44AD, 44ADA etc. are also not to be considered.
Code of Ethics: Auditor is required to comply with the code of ethics of ICAI e.g. communication with the previous auditor, internal auditor cannot act as tax auditor, cannot accept the appointment of auditor of a concern or where given any guarantee or provided security in connection with the indebtedness to any third person to the concern, for limits fixed in the statute and in other case for amounts exceeding ₹ 10,000/-, not accept the appointment as auditor of an entity in case the undisputed audit fee of another Chartered Accountants for carrying out the audit etc.
Compliance of Auditing Standards: Various Auditing Standards as issued by the ICAI or other applicable authorities are required to be complied with. To name a few important as
SA 210 – Agreeing to the terms of Audit Engagement
SA 230 – Audit Documentation
SA 610 – Relying on work of Internal Auditors
SA 315– Identifying and assessing the risk of material misstatement through understanding the entity and its environment
SA 330 – Auditors’ Responses to Assessed Risks
SA 505 – External Confirmations
SA 520 – Analytical Procedures
Non-compliance of the auditing standards will invite disciplinary action against the tax Auditor. Chartered Accountant ‘M’ had obtained the External confirmations of 14 Banks out of 18 Banks. The Appellate Authority1 has observed that no suitable reply was given as to how the Auditor assessed the Risk of Material Misstatement in the Financial Statements. The procedure is clearly laid down in Standard on Auditing (SA 315) “Identifying and Assessing the Risk of Material Misstatement through Understanding the Entity and its Environment”. It also observed that the Standard on Auditing (SA 330) “The Auditor’s Responses to Assessed Risks” provides that after assessment of the Risk, the auditor is required to consider whether external confirmation procedures are to be performed as substantive audit procedures.
The Appellate Authority also opined that the fact that the account statement of ‘K’ Bank was not properly authenticated increased the risk and the Appellant was required to use his expertise about how to mitigate the same, including obtaining External Confirmations. The detailed procedure of obtaining and examining such external confirmations are prescribed in Standard on Auditing (SA-505) “External Confirmations” which was followed for 14 banks out of 18 but not for others including the ‘K’ which turned out to be fabricated. Accordingly, it was held that the Chartered Accountant did not exercise due diligence expected from him as per Auditing Standards and also did not obtain sufficient information for the expression of opinion on the Financial Statements of the Company.
Minimum audit fees: Minimum audit fees in respect of audit has been withdrawn by the Council at its meeting held on 7th & 8th June 2011. However, ICAI has issued Minimum Recommended Scale of Fees for the Professional Assignments done by the Chartered Accountants. The fee has been recommended separately for Class A i.e. ₹ 40,000 and above and Class B Cities i.e. ₹ 30,000 and above.
Maintenance of Register of Audit: Auditor is required to maintain a register of the audit reports signed by him. In case of need arises ICAI can call for such register to verify its particulars
Statutory Auditor and Tax Auditor different in case of a Company
In case appointed tax auditor has not carried statutory audit of the auditee company, tax auditor is not required to carry the whole audit again. According to the SA 600 Using the work of Another
Auditor such Tax Auditor can rely on the work of the Statutory auditor. In case need arises he can issue a questionnaire to the statutory auditor for his reporting requirement. However such tax auditor is required to apply appropriate audit procedures for reporting in Form No. 3CD.
Format of Financial Statements
In the case of the corporate entity, Financial Statements are prepared in the format as prescribed by the Companies Act. However, the issue may arise in case of non-corporate entity or entities set up under other laws but the format for financial statements is not prescribed e.g. LLP. While issuing a report in Form No. 3CB/3CD auditor has to ensure that the financial statements are prepared in such manner that adequate information which is necessary to convey a true and fair view of the state of affairs of the assessee is given in the financial statement. Maintenance of books of accounts and preparation of financial statement is the responsibility of the assessee. Guidance note on tax audit recommends a separate format for preparation of profit and loss account and balance sheet for manufacturing and trading concern. It also states that assessee engaged in the profession and other service activities can use the format prescribed for a trading entity with appropriate modification. The format also requires to provide comparative figures for the previous year. The assessee has given the option either to follow vertical or horizontal format.
The opinion of Tax Auditor not binding on Assessee
The opinion expressed by the tax auditor is not binding upon the assessee. Assessee may take a different view while preparing his return of income from that what has taken by the Tax Auditor especially when he has issued qualified report or makes certain adverse required disclosures. Now tax audit report is uploaded by tax auditor on the e-filing portal and asseesse is required to accept it. The issue may arise whether still, assessee can take different view once he has accepted the tax audit report? In my view, assessee can still take different view since the acceptance of the tax audit report on e-filing portal is merely procedural compliance to confirm that he has authorised Auditor to issue a report and also to file a return of income. Common example can be that of late payment of employees’ contribution to Provident Funds.
Clause 20b of Form No. 3CD requires the details of contribution received from employees for various funds as referred to in Section 36(1)(va) wherein the following information needs to be furnished:—
Nature of fund
Sum received from employees
Due date of payment
Actual amount paid, i.e, employees share of contribution
Actual date of payment to the concerned authorities.
In case the actual date of payment of employees contribution is after the due date of payment under respective law like ESI, PF, etc., and if assessee in return of income has not made suo motu disallowance, CPC issues notice proposing adjustment to disallow the payments made post due date under the provisions of section 36(1)(va). In such as cases assessee needs to state his viewpoint and support the same on the basis of any judicial pronouncement viz. CIT v. Aimil Ltd.  321 ITR 508 (Delhi); CIT v. Kichha Sugar Co. Ltd.  35 taxmann.com 54 (Uttarakhand); CIT v. Ghatge Patil Transports Ltd.  53 taxmann.com 141 (Bombay). In the series of these decisions it was held that employees’ contribution towards provident fund and ESI would qualify for deduction even if paid after the due date prescribed under the Provident Fund Act/ESI Act but before the due date of filing of return and Section 43B covers both employee’s & employer’s share of contribution.
Disciplinary action for the incorrect discloser
Incorrect and incomplete disclosure in the Form No. 3CD may disciplinary action against the tax auditor. Under Clause 34 an Auditor is required to report instances where tax was deductible by the auditee but not deducted by him. In the instant case, it was observed that auditor has completely ignored the new reporting requirements imposed by the CBDT. Appellate Authority under these circumstances has held that the Auditor did not exercise due diligence in carrying out his professional duties, which is expected from him and was guilty under the Clause (7) of Part-I of the Second Schedule to the Chartered Accountants Act, 1949 and upheld the same.2
Amendment to Form No. 3CD
Amendment and introduction of the various section in the Act have necessitated the amendment in Tax Audit Form No. 3CD. The last amendment was made vide Notification No. GSR 666(E) dated 20-7-2018 wherein various clauses were added and few of the existing clauses were modified. The revised Tax Audit Form No. 3CB was made effective from 20-8-2019. Various representations were made to the Central Board of Direct Taxes (CBDT) that the implementation of reporting requirements under the proposed Clause 30C (pertaining to General Anti-Avoidance Rules (GAAR)) and proposed Clause 44 (pertaining to Goods and Services Tax (GST) compliance) of the Form No. 3CD may be deleted or deferred. The CBDT vide Circular No. 6/2018 dated 17th August 2018, has kept in abeyance the reporting under the proposed Clause 30C and proposed Clause 44 till 31st March 2019. Subsequently, this was further extended till 31st March 2020.
Reporting with respect to income taxed as other sources income
Tax auditor is required to provide its opinion on certain deemed income which may be taxed under income from other sources. The trigger for a tax audit is having specified turnover. But the objective of tax audit is to determine the correct income of the assessee on the basis of books of account. Hence Form No. 3CD has prescribed particulars to be provided which are taxable under other heads of Income.
a. Clause 29A – Amount Chargeable under section 56(2)(ix) – Whether any amount is to be included as income chargeable under the head ‘income from other sources’ as referred to in clause (ix) of sub-section (2) of section 56? (Yes/No) If yes, please furnish the specified details:
This is a newly introduced clause pertaining to section 56(2)(ix). Said section is effective from AY 2015-16. It provides any sum of money received as an advance or otherwise in the course of negotiations for the transfer of a capital asset if such sum is forfeited and the negotiations do not result in the transfer of such capital asset shall be considered as income. Provisions of said section are applicable only if such sums are not deducted from the cost for which the asset was acquired or the written down value or the fair market value, as the case may be, in computing the cost of acquisition as per the section 51. Further, if advance received in relation to stock-in-trade is forfeited, the same would not be reported under this clause as it is taxable u/s. 28(i) and hence would be reported under clause 16(a) only if not credited to profit and loss account. There is no responsibility of the auditor to report any such forfeited amount if it is in respect of a personal capital asset, where neither the asset, the advance nor the forfeiture is recorded in the books of account relating to the business or profession.
The Supreme Court, in the case of Bankura Municipality v. Lalji Raja and Sons AIR 1953 SC 248, 250 has observed: “According to the dictionary meaning of the word ‘forfeiture’, the loss or the deprivation of goods has got to be in consequence of a crime, offence or breach of engagement or has to be by way of penalty of the transgression or a punishment for an offence Unless the loss or deprivation of the goods is by way of a penalty or punishment for a crime, offence or breach of engagement, it would not come within the definition of forfeiture.” A forfeiture has to be either in terms of the right to forfeit such advance under the contractual terms of the agreement, or as agreed upon with the prospective purchaser. It has to have the sanction of law or the contract. It has to be a positive action on the part of the assessee. Mere write back of amounts would not tantamount to forfeiture. Merely issue of notice for forfeiture or when such forfeiture is contested is not required to be reported.
The tax auditor should, therefore, obtain a certificate from the assessee regarding all such advances received towards the transfer of capital assets which have forfeited during the year and same need to be corroborated applying the audit procedures.
b. Clause 29B – Income chargeable under section 56(2)(x): Whether any amount is to be included as income chargeable under the head ‘income from other sources’ as referred to in clause (x) of sub-section (2) of section 56? (Yes/No) If yes, please furnish the specified details i.e. Nature of income and Amount (in ₹)
Deemed gifts are made taxable u/s. 56(2)(x) and said section is effective from AY 2017-18. Amount taxable under the said section is determined by valuation rules specified in rules 11U and 11UA. The tax auditor shall obtain a certificate from assessee regarding receipt of amount/property covered by section 56(2)(x) during the year and scrutinise the books of account of business/profession to see whether any receipt of amount/property covered by section 56(2)(x) is credited therein. For the correct and appropriate amount to be reported, tax auditor may ask the assessee to obtain a report from the registered valuer.
c. Clause 36A: Whether the assessee has received any amount in the nature of dividend as referred to in sub-clause (e) of clause (22) of section 2? (Yes/No); If yes, please furnish the specified details.
Taxability of sums received u/s. 2(22)(e) is subject to fulfilment of provision specified therein. The auditor is required to understand the terms loans and advances, accumulated profits, concern, substantial interest etc. Reporting under this clause may be complicated. Hence Auditor needs to obtain various clarification in order to comply with requirements. Obtain an appropriate certificate from auditee:
i. containing a list of closely held companies in which he is the beneficial owner of shares carrying not less than 10% of the voting power and list of concerns in which he has a substantial interest.
ii. particulars of any loans or advances received by any concern in which he has substantial interest from any closely held company in which he is the beneficial owner of shares carrying not less than 10% voting power.
However, the auditor is required to apply appropriate audit procedures to verify the same. These certificates are important since the same could not be verified books of accounts. Auditor may include appropriate remarks for inability to independently verify certain information and he has relied on the certificates obtained from the assessee e.g. any payment by the closely held company made on behalf of or for the individual benefit of the assessee is concerned; the beneficial shareholder is not the registered shareholder and the closely held company has given loan or advance to the beneficial shareholder or to a concern etc.
For the purpose of this clause certain loans and advances shall not be included as dividend:
i. Any advance or loan or trade advance made to a shareholder in the ordinary course of its business. Circular No. 19/2017 dated 12-6-2017
ii. Any advance or loan made to a shareholder or the concern by a company in the ordinary course of its business, where the lending of money is a substantial part of the business of the company. The term ‘substantial part’ has not been defined. However, in some case, it has been held that where 20% or more funds have been deployed in the business of lending money the test of the substantial part will be satisfied – refer CIT v. Parle Plastics Ltd. 332 ITR 63 (Bom.), CIT v. Shree Balaji Glass Manufacturing (P.) Ltd. 386 ITR128 (Cal.)
Accumulated profits are required to be determined in accordance with the provisions of Explanation 1, Explanation 2 and Explanation 2A below section 2 (22) and also in light of judicial pronouncements. The accumulated profits are to be computed up to the date of payment. If at any time earlier any amount has been taxed under any of the clauses of section 2(22), the accumulated profits will have to be reduced by the amount so taxed.
Now TDS is also applicable on deemed dividend payment. The auditor may also verify 26AS to determine the sums paid chargeable as deemed dividend.
Verify Form 26AS of the assessee to know if the closely held company has deducted tax at source from any payment made by it to the assessee or the concern under section 194.
Disclosure with respect to specified transactions to tackle tax evasion
1. Clauses 31(ba), (bb), (bc) and (bd) has been introduced considering the provisions of section 269ST
Section 269ST was introduced with effect from AY 2017-18. It provides that no person shall receive sum of ₹ 2 lakh or more
a) in aggregate from a person in a day; or
b) in respect of a single transaction; or
c) in respect of transactions relating to one event or occasion from a person
otherwise than by an account payee cheque or an account payee demand draft or by use of electronic clearing system through a bank account. Contravention of section 269ST attracts penalty under section 271DA.
The new sub-clauses 31(ba), (bb), (bc) and (bd) deal with reporting of transactions of receipts and payments in excess of the specified limit made otherwise than by the modes specified therein
ICAI Implementation Guide provides that considering the provisions of the section, particulars of the payments made to the government need not be included under sub-clauses (bc) and (bd) and a suitable note may be given to the effect that details of payments made to Government have not been included in the particulars. Reporting of the sums are required irrespective of the fact where it revenue receipt or capital receipt since Section 269ST does not distinguish between receipt on capital account and revenue account.
Sub-clauses 31(ba), (bb), (bc) and (bd) require particulars to be furnished of receipts or payments, as the case may be, in an amount exceeding the limits specified in section 269ST, in aggregate from a person in a day or in respect of a single transaction or in respect of transactions relating to one event or occasion from a person. Thus, particulars are required to be given if receipts or payments, even though individually are lower than ₹ 2 lakh but in aggregate amount to ₹ 2 lakh or more if such receipts or payments are to or from one person in a day (whether related to a single transaction or otherwise) or relate to a single transaction (even if the receipts or the payments, as the case may be, are on different dates and individual receipts or payments are less than ₹ 2 lakh) or are in respect of more than one transaction but relate to a single event or occasion (even if the receipts or the payments, as the case may be, are on different dates and individual receipts or payments are less than ₹ 2 lakh).
The Auditor is required to exercise care and caution while arriving at the particulars of receipts or payments pertaining to a single transaction or relating to a single event or occasion. Link all receipts or payments, as the case may be, otherwise than by the modes specified in this section received/made in respect of a single transaction and verify if the aggregate amount exceeds the limits specified in section 269ST.
The tax auditor will have to exercise judgement in deciding whether received/payments though pertaining to more than one transaction, pertain to a single event or occasion. For example, for a function organised by a person, assessee contractor may have been given catering contract as well as a contract for flower decoration. In such a case, while the transactions may be different the occasion or event would be the same and provisions of section 269ST will be attracted if the receipts exceeding the limits specified under section 269ST are by mode other than those specified in the section.
The certain transaction may be set off without making payment and receiving money. E.g. transaction of purchase and sales. If the amount of such set-off exceeds ₹ 2 lakh, the tax auditor may give an appropriate note to the effect that such set-off not being a receipt or payment has not been included in the particulars given and the relevant sub-clause.
Where the receipts or the payments, as the case may be, pertaining to a single transaction or transactions relating to one event or occasion, such receipts/payments may be grouped together while reporting. The tax auditor may also keep in his record date of the receipts and date of the payments reported under sub-clauses 31(bb) and 31(bd), although not required to be reported under the said sub-clauses.
Where payment is made by cheque or demand draft there will be practical difficulties in verifying whether the relevant receipt or payment is by account payee cheque or account payee draft. In such cases, the tax auditor should verify the transactions with reference to such evidence which may be available. In the absence of satisfactory evidence, the tax auditor, in his report may make comment as suggested below while reporting under sub-clauses 31(bb) and 31(bd): “It is not possible for me/us to verify whether the receipts/payments have been accepted/made otherwise than by an account payee cheque or an account payee bank draft, as necessary evidence is not in the position of the assessee”.
2. Clause 42. (a) Whether the assessee is required to furnish statement in Form No. 61 or Form No. 61A or Form No. 61B? (Yes/No) (b) If yes, furnish specified details:
a. Form No. 61 – Under section 139A(5)(c) every person is required to quote his Permanent Account Number (PAN) in all documents pertaining to prescribed transactions entered into by him. Relevant rules are 114B, 114C and 114D. Rule 114B prescribes transactions where quoting of PAN is mandatory. The second proviso to Rule 114B provides that any person who does not have PAN and who enters into a prescribed transaction shall make a declaration in Form No. 60. Rule 114D contains a provision regarding the filing of Form No. 61. Form No. 61 is to be filed by certain persons who have received any declaration in Form No. 60.
The tax auditor should verify whether the assessee has entered into any transaction where the other party was required to quote PAN. He should verify whether the assessee has obtained a declaration in Form No. 60 where the other party has not furnished his PAN. Wherever the assessee has received declarations in Form No. 60, the auditor should verify if the assessee has filed Form No. 61 including therein all the necessary particulars.
b. Form No. 61A: Under section 285BA an assessee and certain other specified/prescribed persons are required to furnish a statement in respect of specified financial transactions. The statement in respect of specified financial transactions is to be furnished to the Director of Income-tax (Intelligence and Criminal Investigation) or Joint the Director of Income-tax (Intelligence and Criminal Investigation) in Form No. 61A. The relevant rule is Rule 114E. Rule 114E provides that statement of financial transactions required to be furnished under section 285BA shall be furnished in Form No. 61A. The statement is to be furnished in respect of the financial year on or before 31st May of the immediately following financial year. The Rule 114E(3) provides for aggregation of amounts for arriving at the threshold limit for reporting, except in couple of cases.
The tax auditor should ascertain whether the assessee is required to report any transactions under section 285BA read with Rule 114E. It may be noted that specified transactions include the issue of bonds, issue of shares buyback of shares by a listed company. These transactions may not happen every year and hence special attention should be given in the year when a company assessee issues any security or a listed company undertakes buyback of shares. Specified transactions include receipt of cash payment exceeding ₹ 2 lakh for sale by any person (who is liable for audit under section 44AB) of goods and services of any nature other than those specified at serial numbers 1 to 10 in the Table in sub-rule (2). The tax auditor should verify whether the assessee has received more than ₹ 2 lakh in cash in the financial year for sale of goods and services, without applying the rule of aggregation
c. Form No. 61B: USA, in 2010, enacted a law known as “Foreign Account Tax Compliance Act” (FATCA) with the objective of checking tax evasion. The USA entered into Inter-Governmental Agreement (IGA) with various countries including India. The G20 and OECD countries together have developed a Common Reporting Standard (CRS) on Automatic Exchange of Information (AEOI). With a view to implementing the IGA and the CRS on AEOI, by Notification No. 62 of 2015 [F. No. 142/21/2015 TPL] dated 7 August 2015 rules 114F to 114H and Form 61B were inserted requiring maintenance and reporting information about ₹Reportable Accounts’ by ₹Reporting Financial Institutions’.
The tax auditor should verify that the above information is appropriately maintained and reported in Form No. 61B. He should verify that all reportable accounts are reported. In case any reportable account has been omitted or there is any error or omission in Form 61B, the same may be reported under clause 42 of the Form No. 3CD.
It is an onerous duty of the Tax Auditor to report in the Form No. 3CA/3CB/3CD. The tax auditor will have to take a considered view while reporting. If reliance has been placed by him on any judicial decision or he is unable to verify certain transaction considering various evident and apply the audit procedures, a reference of the same should be given by him as observations in clause (3) of Form No. 3CA or clause (5) of Form 3CB, as the case may be.
1. Mahavir Jain v. Disciplinary Committee, Institute of Chartered Accountants of India (ICAI) Appeal No. 09/ICAI/2018 [The Appellate Authority (Constituted under the Chartered Accountants Act, 1949)] Order Dt. 5/10/18
2. Ishaq Esmail Lakkadghat v. ITO 11(3)-1 Mumbai Appeal No. 10/ICAI/2018 [The Appellate Authority (Constituted under the Chartered Accountants Act, 1949)] Order Dt. 27/08/2018 (5 member bench)