Jurisprudence deals with law and audit deals with facts and synchronisation of both helps in effective discharge of tax audit function given the reporting requirement in Form 3CD on various contentions provisions. In this article we are going to discuss the reporting requirements under various clauses and impact of jurisprudence in understanding the requirement.

Guidance note on tax audit

Guidance note on tax audit in para 9.16 and 34.17 provides that the tax auditor may rely upon the judicial pronouncements while taking any particular view. Further para 67.4 states that if the claim of the assessee is well-founded and settled by judicial pronouncement, the tax auditor may accept the claim but he has to record in his working papers that admissible amount has been reported on the basis of such judicial pronouncement. In appropriate circumstances, such judicial pronouncements etc. should be mentioned in the report. Para 74.8 also states that if reliance has been placed on any judicial decision, a reference of the same may be given by the tax auditor as observations in clause (3) of Form No. 3CA or clause (5) of Form No. 3CB, as the case may be.

Therefore the reliance of jurisprudence in tax audit has a statutory recognition in the guidance note on tax audit issued by Institute of Chartered Accountants of India.

Impact of qualification in tax audit report

Tax audit report is an opinion of auditor which may differ with the view of Assessee. The view of auditor at times may be conservative resulting in qualifications and disclaimers which may not be accepted by Assessee while filing return of income and can be rebutted if confronted during assessment. The view taken by auditor is an expert opinion or view and the other view is always possible. In this regards the decision of Delhi High Court in case of PCIT v. Escorts Limited [2018] 98 taxmann.com 291 (Delhi) holds that Auditor’s opinion though relevant and material would not be final and conclusive even when against the Assessee. Auditor’s report in a way is a third party and an independent report that can be equated with an expert opinion. It may be accepted or rejected or partly accepted and partly rejected. It has to be considered with other material. It cannot be treated as final or binding on the Assessing Officer, or for that matter even on the Assessee, except when mandated by a statutory provision, which requires an unqualified auditor’s report or certification. In the absence of statutory provision it would not be right to hold that a reservation or qualifying note in the audit report would be a conclusive and bind finding against the Assessee. Similar view has been taken in case of Rajkot Engg. Association v. Union of India [1986] 162 ITR 28 (Guj).

Mistake in tax audit reports

‘To err is human’ and therefore it is possible that a mistake could have crept in the tax audit report. In such situation it is advisable to rectify the same by filing a revised report. In case of ACIT vs. J.P. Yadav [2022] 138 taxmann.com 320 (Allahabad – Trib.) it is laid down that if Assessee contends inadvertent error in Form No. 3CD, he should submit revised tax audit report/ addendum issued by the tax auditor. Further even department should not take advantage of a mistake in audit report. In case of Baroque Pharmaceuticals (P.) Ltd. [2022] 137 taxmann. com 94 (Gujarat) it is held that reopening notice merely relying on a technical mistake committed by an auditor was unjustified.

Further if mistake is notices subsequently and not rectified the same may invite the implications under Section 271J of the Act where a penalty of Rs.10,000 per report is levied on incorrect reporting. Therefore it is advisable to revise the report giving reason for revision of the report. It is pertinent to note that ICAI guidance note on revision of audit report requires that the auditor should communicate the fact of revision and the revised report to all the stakeholders and recipients of original report so that they may not refer the original report, now revised.

Implications of reporting in Form 3CD vis-à-vis processing under Section 143(1)

Section 143(1) of the Act now has a specific power to make adjustment to the returned income in respect of those items which have been indicated as inadmissible by the auditor in the tax audit report. This has created chaos in various cases where the Form 3CD required information which did not mean inadmissible amount but has been misunderstood as inadmissible. For eg. Payments made to related parties have to be disclosed irrespective of the fact that they may not be unreasonable or excessive. However Centralised Processing Centre misunderstood the reported amounts as unreasonable and adjusted the return by making addition thereof.

A similar situation arose in context of clause 16(d) of Form 3CD which was discussed in case of Brajesh Agrawal v. ADIT [2023] 151 taxmann. com 63 (Allahabad – Trib.). Clause 16(d) of the audit report requires details of ‘any other item of income not credited to profit and loss’. The tax auditor reported the certain non-business income amount under clause 16(d) of Form No. 3CD though the guidance note of ICAI suggests disclosure of items covered in S.28 of Act which have not been credited to P&L. On such facts it was held that a mere mistake on the part of the tax auditor in reporting the income not forming part of business income of the Assessee in clause 16(d) would not ipso facto lead to addition or adjustment in the business income particularly when the Assessee has already declared the said income in the return of income under respective heads of income.

Due to this automatic processing it is advisable that reporting of items already considered for taxation may be made in Form 3CB in observations to avoid any double taxation.

Applicability of Tax Audit

“Turnover” is the starting point which is most debated due to the plethora of case laws interpreting the word. One basic question which arises is whether the GST, Excise, Sales tax, etc. have to be included and Gross turnover has to be considered or not. This will also be relevant for reporting on the clause that whether the taxes u/s 43B of Act have been passed through profit and loss account. This has been answered by Supreme Court in the case of Chowringhee Sales Bureau (P) Ltd v. CIT (1979) 87 ITR (SC) would include the receipts of excise duty and sales tax, etc. Therefore it has to be considered in computing turnover and in turn would be passed through profit and loss account.

Another issue which is arising in context of traders in shares who have executed intraday transactions in shares and do not take delivery. In such case where the transaction is completed in intra-day without taking delivery, only the difference (irrespective of positive or negative) has to be aggregated for computing turnover as held in case of Growmore Exports Ltd. (78 ITD 95)(Mum). This turnover ignoring the negative and positive is only and only considered to decide the applicability of tax audit and not for incorporating in books of accounts.

Clause 13 – Method of accounting

There are only two methods of accounting i.e. Mercantile and cash system. An Assessee has to choose either of them as hybrid system of accounting is not permissible. However in practical life no entity can be said to follow strictly mercantile and certain items like Interest on refund, dividend, etc. are recognised. There can be one principal method of accounting for the major source however it is permitted to have a different method of accounting for a separate source of income. In case of J.K. Bankers v. CIT (94 ITR 107)(All) it is held that it was open to the assessee to follow one system of accounting in respect of one source and another system in respect of the other source. If an assessee followed the mercantile system in respect of its income from business, it does not mean that the Assessee could be compelled to adopt the same system in respect of the income failing under other provisions.

Clause 18 – Depreciation

For claiming depreciation twin conditions of ‘ownership’ and ‘use’ need to be satisfied. However question arises mainly when the legal and beneficial ownership are separate. The crucial test here is that of beneficial ownership and thus even if the legal registration is in name of another person still depreciation would be available. In CIT v. Podar Cement (P.) Ltd. 1997 (5) SCC 482 it is observed that the term ‘owned’ in section 32(1) should be assigned a contextual meaning and keeping in view the underlying object of the provision vesting of a title in the Assessee though short of absolute ownership should also entitle the Assessee to the benefit of section 32(1). In case of CIT v. Aravali Finlease Ltd. [2012] 21 taxmann.com 147 (Gujarat) it was held that where vehicle in question, though registered in name of director of Assessee- company, was used for purpose of business of company, income derived from leasing vehicle was shown as income of company, and entire fund for purchase of vehicle had also gone from coffers of company, Assessee was entitled to depreciation on said vehicle.

As regards the condition of use the question arises as to whether the asset has to be continuously be used every year for claiming the depreciation. If a unit shuts down temporarily whether for the period it is not under active ‘use’ the depreciation can be denied. In case of Swati Synthetics Ltd. [2010] 38 SOT 208 (MUM.) it is held that the condition/requirement of section of words ‘used for the purpose of business’ as provided in section 32(1) for the concept of depreciation on block of assets can be summarized, that use of individual asset for the purpose of business can be examined only in the first year when the asset is purchased. In the subsequent years use of block of assets is to be examined. Existence of individual asset in block of asset itself amounts to use for the purpose of business.

Clause 21(a) : Penalty or fine

Penalty or fine for infraction or violation of law is not allowable under Income tax under Section 37 of the Act however the penalty for breach of contract or compensatory nature should be allowable as deduction.

It may be noted that Late filing fee of GST and Income tax is not regarded as penalty and therefore not required to be reported in this clause. Further in the regular course of the business certain procedural non-compliances are not unusual, for which Assessee is required to pay some fines or penalties. In Mangal Keshav Securities Ltd. v. ACIT [2017] 85 taxmann.com 226 (Mumbai) it is held that these routine fines or penalties are “compensatory” in nature; these are not punitive. These fines are generally levied to ensure procedural compliances by the concerned persons. Their levy depends upon facts and circumstances of the case, and peculiarities or complexities of the situations involved. Sometimes elements of discretions of levying authorities are also involved therein.

Clause 21(a) Personal Expenses

Personal expenses would include expense on the person of the assessee or to satisfy his personal needs or purposes not related to the business for which deduction is claimed. The payment as per contractual agreement or normally accepted business practices to the employees are not considered for the purpose of this clause. In case of CIT v. U.P. Asbestos Ltd. [2014] 52 taxmann. com 452 (Allahabad) it is laid down that section 40A is to prevent the abuse of fund by the company for personal interest. There should be dividing line between personal interest and the interest of the company. A personal interest means the expenditure incurred not for the purpose of company but for own interest of the office-bearers of the company or their sons and relatives but in case an expenditure is incurred by the company to send someone for training or higher education and after returning back in pursuance to contractual obligation, such person joins the company itself, then in such circumstances, it may not be treated as expenditure for personal reason because of relationship with an office-bearer.

Clause 21(d) : Genuine payments in Cash

In clause 21 for Form 3CD, reporting of amount paid in cash over Rs.10,000 being disallowable under Section 40A(3) of Act needs to be done. This provision is contemplating disallowance of expenses paid in cash in excess of Rs.10,000 being an anti evasive provision to prohibit circulation of black money. However the ambit gets increased in some cases to cover genuine payments also resulting in disallowance while processing of return in S.143(1) intimation. For instance cash payment of electricity bills to Electric companies which are now independent corporations and not government. These payments of electricity bills are undoubtedly genuine but have to be reported under Section 40A(3) of Act by auditors. However from tax professional’s perspective it does not call for disallowance as the purpose of provision is not to cover such transactions. In such cases the same may be reported in Form 3CB instead of 3CD with appropriate note that the Assessee has not considered the same as disallowable based on following judicial pronouncements

• Padigela Rajeshwar Ginning Ind. ITA 1137/Hyd/2011
• Trivedi Corporation (ITA 2844/Ahd/2006)
• M.R. Soap 32 TTJ 505 (Del)

Clause 25: Old creditors beyond 3 years

Section 41(1) brings to tax those creditors the liability of which has ceased to exist. Normally creditor which are older than 3 years are sought to be taxed by department holding that limitation period is expired. However the same would not be required to be reported by auditor till the Assessee writes it back in the books of accounts. It is held in following cases that merely if unpaid creditors are standing in books beyond 3 years and even are not confirmed by creditors would not become income of Assessee:

• Sugauli Sugar Works (P.) Ltd. [1999] 102 Taxman 713 (SC)
• Vardhaman Overseas 343 ITR 408 (Del)
• Silver Cotton Mills Co Ltd (254 ITR 728) (Guj.)

Clause 26: Section 43B – Advance payment

In certain cases the liability of disputed dues is paid under protest in advance and in the year of attaining finality respective provision is made. Question arises that the provision in respect of tax, duty and cess is allowable on actual payment basis. In this regards attention is invited to the decision of Supreme Court in case of CIT v. Modipon [2017] 87 taxmann.com 275 (SC) where it is held that advance deposit of central excise duty in PLA constitutes actual payment of duty within meaning of section 43B entitled to benefit of deduction. Various other courts have also consistently held that advance deposit of taxes/duty constitutes actual payment of duty within the meaning of section 43B and, therefore, the assessee is entitled to the benefit of deduction of the said amount.

Clause 27(b) Prior period expenses Prior period has a different meaning in Accounting Standards and for the purpose of Income tax. As per accounting standards it is charges or credits which arise in the current period as a result of errors or omissions in the preparation of the financial statement of one or more prior years. However for Income tax audit expenditure/income is treated as being of an earlier year only when the liability to pay / the right to receive has accrued or arisen in an earlier year, in other words though the expenditure/ income relate to an earlier year, if the liability materialized/ crystallized during the year. In SMCC Construction India Ltd. v. ACIT [2013] 38 taxmann.com 146 (Delhi) it is held that expenses of earlier years are allowable in current year if crystallized during that year.

Clause 31: Acceptance or repayment of loans through book entries

Section 269SS and 269T require that loans and advances if accepted otherwise than account payee cheque are liable to penalty and are required to be reported in Tax Audit report. Many times it is seen that transactions through Journal entries in books of accounts are also considered as violation of S.269SS and 269T by auditors and is reported in audit report. This though is correct from reporting perspective however may create great hardship to the Assessee in form of penalty as the objective of the anti-evasive provision is only to cover cash loans and not book entries. The provisions have been considered and interpreted by various courts to hold that transaction through book entries would not be contravention and are not liable for penalty. In following cases acceptance or repayment through book entries has not been considered violative of Section 269SS or 269T of the Act.

• Natvarlal Purshottamdas Parekh 303 ITR 5 (GUJ.)
• Noida Toll Bridge Co. Ltd (262 ITR 260) (Delhi HC)
• Worldwide Township Projects 2014 (6) TMI 47
• Dinesh Jain – 2014 (6) TMI 140 – ITAT DELHI

Conclusion

Different provisions in Income tax have different ramifications and we need to understand the provision and its reporting requirement under Form 3CD based on such jurisprudence. Such jurisprudence read with the Guidance note issued by ICAI serves as a proper guide to audit and report to the requirements. The interplay between tax laws and legal principles ensures that tax audits are conducted fairly, protecting the rights of taxpayers and upholding the rule of law. As tax laws continue to evolve, jurisprudence will remain a cornerstone in shaping the future of tax audits, balancing the need for revenue generation with the imperative of justice.