For Private Circulation Only • September 2012 • Vol 6 Issue 9
Society of Auditors Chennai Inside this Issue... •
80th year celebration - moments to cherish
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From the Edit Pad
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President’s Message
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Society of Auditors - The Eighty Inspiring Years
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Basic Facilities in jointly developed Residential Property forms part of cost of New Property
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Unintended impact of Revised Schedule VI
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Guidance Note of ICAI on the Revised Schedule VI
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Review Engagements aka Limited Review
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Recent Judicial Decisions Reported
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80 th year celebration - moments to cherish
FROM THE EDIT PAD Rather difficult time to bring out an edition th what with the fact that the 80 anniversary celebrations of the Society just got over and the pressures of bringing out a Collectors' edition still holding us down and that it is September easily the busiest month for all practising CAs! The only consolation I have is that no one will have time to read in the last week in which the Auditor is scheduled to come out and hence I can actually take the liberty of bringing this issue slightly later so that it reaches your hands when you are done with September. We received very encouraging feedback on the Collectors' edition and many of our professional brethren were quite generous in praising the content and the format. However, I would still urge the members to actually take some time to pen down their views, more importantly the critical ones, and send them to us so that we know what we do right and where we go wrong, in others' perceptions. A report on the commencement of the 80 th anniversary celebrations can be found in this issue as also some of the photographs of the occasion. The CA institute elections have been announced and the would be contestants (those who seek re-election and those newly contesting) have started their campaign, which will turn vigorous after September ends. Times are changing and so are the campaign styles. I am not just referring to the use of modern communication facilities like SMS, e-mails etc. The existing council members are tacitly (and some times even openly, albeit to small groups) decry the so-called achievements and functioning styles of their council colleagues (whom they 'warmly' acknowledge as 'brothers' in the conference and seminar dais) which amply demonstrate what kind of 'bonhomie' (aka 'proven hostility') exists among them and what good can ever be expected of them for the betterment of profession. The new aspirants want to show that they can make a difference and articulate, rather apparently, their contempt for the manner in which the present incumbents have been conducting AUDITOR • June 2012
P.S. Prabhakar themselves and running the ICAI's affairs. All of them are making a mockery of the so called Code of Conduct in some way or the other. (Just look at the freebies, free CPE credits, free seminars and free lunches in those frenzied fortnights just before the Code of Conduct began to operate!). The 'ethics' and the 'earthly purpose' of fourth time and fifth time contesting are being commented openly. Constiutuencies, caste and community affiliations, promises of VAT and What not audits to gullible small timers, wet parties, despatch of 'useful' publications to all members OMG! All kinds of ugly things are already happening and one is positive that uglier things are on the offing. One thing is certain. The promised 'difference' of the new aspirants and the proven 'indifference' of the veterans will make only one directional change in the governance of the institution. And that will be for worse. This is neither an expression of frustration nor of clairvoyance. Simply a statement based on records of accomplishment. Let us discuss more on the impending elections in the next issue. The current hot issue is the revised Schedule VI, on which several members seem to be exercised about. One member was angrily commenting that this new format is completely unwarranted and exclaimed as to to who is benefitting from this. I said that he cannot say that no one is benefitting. Book writers who have written on the topic, publishers, ICAI and other professional bodies which conduct seminars, seminar speakers are all greatly benefitting by it! However, I requested two of our erudite members to send me write-ups. Rajan has dwelt on the macro issues and NS Srinivasan has dealt with the finer aspects. CA Krishnan has penned an article on an important issue of Capital Gains and CA Veda has come out with a timely article on the Mid Te r m Re v i e w E n g a g e m e n t s . T h e r o u t i n e features “Off Beat” and “Elsewhere” do not find a place in the issue. That's all for now, friends. Will connect again next month. 3
President’s Message Dear All, Greetings and best wishes. Thanks to the efforts of everyone of you the th inaugural ceremony for our 80 year Celebrations commenced admirably well. The expressed satisfaction of the participants on the conduct of events was really something that enormously energised the organizers to go ahead with the rest of the programs planned for this year. The registration of delegates crossed the limits beyond the anticipated level by a pessimist like me. The program content for the oneday seminar was appreciated by everyone for its relevance and the choice of speakers. The attendance right through was proof enough. During the inaugural function, creation of endowments in the name of Past presidents of the Society who are no more with us and use it to encourage students pursuing the commerce stream and later into the CA profession was mooted and it met with a huge success and we landed with much more than we anticipated. More than 20 persons agreed to be creators of endowments which means the endowment landed beyond the Past presidents. The contents of the delegate kit, which contained two invaluable books (Gita for Professionals by CA. Chetan Dalal and Beyond Auditing by Sri GN) and some goodies were definitely different and offered a real VFM (Value For Money) proposition for the delegates. The few persons who conceived such ideas and worked on the sponsors deserve unreserved appreciations.
AUDITOR
I received numerous calls appreciating the Collector's edition of the “Auditor” magazine. Some even wanted an extra copy to be sent to their friends to make them members. The catering arrangements, which saw a tasteful spread on both the days also exceeded the expectations. The music programme by Ghatam Karthick & Party was a fitting finale for the inagural function. From conception to culmination, the SOA conference committee, the sub committees put in their best possible efforts and ensured the excellent function. Though I am enormously tempted to mention people by names, the fear of my unitentional omissions makes me to adopt the safer route of not naming any in particular! Also, as everyone knows SOA is an organisation that consists of self effacing individuals, who, even before reading Chetan Dalal's treatise on Bhagwad Gita, have perfected the concept of “Karmanye Vaadhikaarasthe Maa paleshu kadaachana”, especially while working for SOA. However, to all those, I convey my unbridled appreciation and heartfelt gratitude. Needless for me to add that I do look forward to your continued support for making everyone of this year's program a grand success. With warm regards, P. Anand
Editorial Board
A periodical from Society of Auditors Chennai CA P S Prabhakar, Editor Society of Auditors “Platinum Chambers” 33, TNHB Complex, 4, Luz Church Road, Mylapore, Chennai - 600 004. Phone : 044-2498 6979 E-mail : society.auditor@gmail.com editor@societyofauditors.in Website URL: www.societyofauditors.in
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CA B Ramana Kumar CA Mahesh Krishnan CA Subramania Sarma CA P Anand, President, Ex-officio Member CA R Sivakumar, Vice President, Ex-officio Member CA S Ramakrishnan, Vice President, Ex-officio Member CA B K Moorthy, Secretrary, Ex-officio Member
AUDITOR • September 2012
Society of Auditors - The Eighty Inspiring Years Of course it was a low cost affair. What else would you expect with a meticulous set of men tracking Finances for the event? And no - this event was not marked by an expensive venue or a hundred appeal letters for sponsorships. There was no back lit stage with elaborate floral decorations or the latest laser visual effects to hold (or divert?) your attention. There were no freebies such as suitcases, computer cases or travel bags. No elaborate budgets were drawn to balance expenditure to income or vice versa. In short, there was nothing of the usual that generally benchmarks a successful event. Yet it made all our guests, participants and members very happy. This was our 80Th anniversary celebration for you. And rock it did. There was something far beyond the ordinary that led to its phenomenal success. This was a conference as human as it could get. It was natural and exuded a warmth and a slight bit of casualness that is typical of us! We did pay attention to details but tonly to the right ones and not to those pompous but yet the frivolous ones. This could have well been a 1000 member event. Conservatism prevailed (and perhaps rightly so) and the larger event has been scheduled for the culmination of the 80th year). There was a bit of an apprehension over the dates (Aug 23 and 24, 2012) being too close to the SIRC regional conference and about meeting the delegate targets. That we actually beat the target and had to struggle to increase the kits in the eleventh hour was another matter altogether! Let's start with our sponsors. The SOA aura was such that our sponsors felt privileged to be part of this event and no hard selling was needed at all. Support included contributions in cash and delegate take-aways. Day 1 started with the inaugural. The hall was pretty much packed. Justice Ramasubramanian of the Madras High Court delivered the 80 th year address. The highlights of the evening included the release of a Collector's Edition of the Auditor magazine published by the SOA. This was meticulously put together by an editorial team andhad it delivered straight and hot from the press that very evening. This included articles as off beat as Swadharma for Chartered Accountants by Gurumurthy and short sketches of illustrious Chartered Accountants such as Brahmayya, D Rangaswamy, N Rangachary and PB Vijayaraghavan. AUDITOR • September 2012
This is our small effort in the hope that their contributions and memories are indeed preserved for posterity. We obtained 23, yes 23 endowments aggregating to about Rs 10 lakhs to further the activities of the Society. And this was possible due to the efforts of Sri R Balakrishnan who took on this work most passionately. In fact, so vibrant was his segment of announcements that impromptu offers for endowments filled our coffers. The evening was much too packed to be able to close early. We were scheduled to close the evening with a Cultural performance by Ghatam Karthik and his ensemble. Most of us were worried if there would be an audience after 8.00 pm. To our surprise most of the members stayed back to make the musical event a well attended success so much so we are actually considering a repeat performance! Day 2 was filled with Technical Sessions on Harmonisation of Accounting Standards, Documentation, FEMA, Domestic TP, Point of Taxation rules in Service Tax and NRI related TDS etc., meticulously planned with a strategic beginning with the erudite P R Ramesh and culmination by our proven crowd puller Vaithiswaran. And let us not miss out an important part of the event - the food. It was a new caterer - an awesome, wholesome, rich gourmet spread. Again our thanks to a confident referral by an old time member of the SOA. What did the Delegate take aways contain? Amongst other goodies and exclusive stationery it contained 2 valuable treasures one a book on Bhagavad Gita by ChetanDalal and Beyond Auditing an autobiography of GN - a famous CA in our midst. This was indeed a first time novelty for any CA conference. Both these works are intended to inspire the new generation in our midst to enhance the image of our beloved profession This conference, the 80th year and the decades hereafter would be defining moments for our beloved profession a make or break. We, for our part used this conference to re-dedicate this SOA for the cause of this profession and will constantly remind ourselves to reinvent ourselves to remain as relevant as ever and as we always did ! 5
Basic Facilities in jointly developed Residential Property forms part of cost of New Property ISSUE As joint development of property has become the order of the day one question which is likely to crop up is whether basic facilities such as interior décor including wood work, fitting of air conditioners in bed rooms and drawing room, modular kitchen etc. would form part of investment in residential property for the purpose of claiming exemption under section 54 or section 54F of the Income-tax Act (the Act). The point which is likely to be argued on behalf of Revenue is that such basic facilities would form cost of improvements and therefore cannot be added to the cost of the residential property for the purpose of working out exemption under section 54 or section 54F of the Act. As to how this issue can be tackled/answered is explained in the ensuing paragraphs. CASE LAWS ANALYSED The Kerala High Court in the case of Dr. P.A. Varghese vs. Commissioner of Income-tax [1971] 80 ITR 180 (Ker.) has held that no building would be fit for habitation without some of the necessary amenities and that it is not possible to treat a building separate from the fittings therein which go along with it as part thereof. The High Court also observed that the extent of the amenities may vary, depending upon several considerations The facilities agreed to be provided in that case were partitions, lavatories, air-conditions, closets, fluorescent tubes, water and electric metres etc.and the issue arose whether these fittings formed part of building and the court answered in the affirmative. The Mumbai Bench of ITAT in the case of Saleem Fazelbhoy Vs. Deputy Commissioner of Incometax [2007] 291 ITR (A.T.) 0169/ (2007)-106-ITD167(Mum) has held that investment in residential house would not only include the cost of purchase of the house but also the cost incurred in making the house inhabitable subject to the condition that the payment was made during the period specified in section 54F 6
CA S. Krishnan
of the Act. The beneficial provisions of section 54F and section 54 of the Act are similar except that under section 54F of the Act the assessee can hold only one residential property other than the one transferred in order to get exemption and the entire sale consideration (and not the capital gains alone unlike under section 54 of the Act) will have to be invested. It is to be noted that the words “inhabitable” and 'habitable” carry the same meaning and are interchangeably used by the judicial authorities. The Mumbai Bench of ITAT in this case in Saleem Fazelbhoy Vs. Deputy Commissioner of Income-tax(supra) while deciding the issue in favour of the assessee referred to the following observations made by the Supreme Court in the case of Bajaj Tempo Ltd. v. CIT [1992] 196 ITR 188 so far applicability of beneficial provisions is concerned. “The provision in a taxing statute granting incentives for promoting growth and development should be construed liberally; and since the provision for promoting economic growth has to be interpreted liberally, restriction on it too has to be construed so as to advance the objective of the provisions and not to frustrate it.” To the similar effect is the decision of Mumbai Bench of ITAT in the case of Mrs. Sonia Gulati v. ITO [2001] 115 Taxmann 232 (Mum.)(Mag.). wherein it was held that the investment in house would be complete only when such house becomes habitable. In fact this decision in Mrs. Sonia Gulati v. ITO (supra) has been followed in Saleem Fazelbhoy vs. Deputy Commissioner of Income-tax (supra). The Mumbai Bench of ITAT Mrs. Gulshanbanoo R. Mukhi vs. Joint Commissioner of Income-tax [2002] 83 ITD 649 (Mum.) has held that “ the words used about the amount spent on (continued on next page)
AUDITOR • September 2012
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purchase of new asset are “cost thereto” and not “price thereto”. The cost includes purchase as well. Consequently, we are of the view that the word used signifies that the amount of purchase will include other necessary expenditure in this behalf to make a residential house habitable and taken together will be the cost of the new asset.” The benefit in this case was claimed under section 54 of the Income-tax Act. It is also to be noted that the definition of a word or phrase as found in the dictionary can be adopted, has been reiterated by the Constitution Bench of the Supreme Court in the case of Sunrise Associates vs. Government of NCT of Delhi & others (and other appeals, special leave petitions and writ petitions) [2006] 145 STC 0576 wherein at para 42-page 594 of STC the Court referred to the definition of a ticket as found in Webster's Words & Phrases, permanent edition vol 25A supplement and para.42 is reproduced below: “Webster's Words and Phrases, permanent edition, volume25A supplement defines a "ticket" as "a printed card or a piece of paper that gives a person a specific right, as to attend a theatre, ride on a train, claim or purchase, etc." (The definition-para.42-can be found at page nd 1907-2 Edition-WEBSTER'S NEW TWENTIETH CENTURY DICTIONARY UNABRIDGED EDITION). The Court basing its observations on this definition and on its earlier decision in the case of H. Anraj (3) (1986) 1 SCC 414 held that “a lottery ticket has no value in itself. It is a mere piece of paper. Its value lies in the fact that it represents a chance or a right to a conditional benefit of winning a prize of a greater value than the consideration paid for the transfer of that chance. It is nothing more than a token or evidence of this right.” This decision of the Supreme Court goes to show that reliance can be placed on the dictionary meaning whenever necessity arises to decide an issue. So when reference to the word “Habitable” is AUDITOR • September 2012
made to Webster's New Twentieth Century Dictionary (unabridged Second Edition Deluxe Colour) it is defined as “capable of sustaining human beings” and the word “habitation” means place of abode; a settled dwelling house; a house or other place in which to live in.(page 815) CONCLUSION Hence basic facilities such as interior décor including wood work, fitting of air conditioners in all bed rooms and drawing room, modular kitchen etc.would form part of investment made in new house(residential) property eligible under section 54 or section 54F of the income-tax Act. NOTE OF CAUTION-ADDITIONAL POINTS However expenditure incurred on whitewashing electrical rewiring wood work etc. by the assessee after purchasing the property would not be treated as part of acquisition cost after the house is occupied as held by the ITAT Chennai Bench in the case of Smt. S. Sudha v. Assistant Commissioner of Income-tax [2011] 010 ITR (Trib) 0206. This disallowance may be more pronounced in cases where the house is purchased on “as is where condition”. The decision of the Mumbai Bench of ITAT in the case of Saleem Fazelbhoy(supra) was distinguished by the Chennai Bench as “in the case before the Mumbai Bench incurring of that expenditure was part of the sale contract of the property and those activities were carried out by the assessee for and on behalf of the seller of the property and it was in such circumstances that the Tribunal has held that those amounts also would form part of the acquisition cost. But in the present case there is no such contractual obligation”. So adequate care has to be bestowed in drafting sale agreement whenever an old property is purchased and remodeling has to be done to suit the requirements of the assesseepurchaser to make it habitable. The assessee should also be advised to deposit the money required for providing basic facilities in the Capital Gains Scheme Account in case the property is not purchased before the due date for filing of the return. 7
Unintended impact of Revised Schedule VI The government using its own wisdom(?) in Feb/Mar 11 and as usual with the inimitable nonchalance of not consulting any important stakeholders and more importantly, the ICAI (who they know will be nothing short of sycophantic cheerleaders for anything the MCA does) notified the revised schedule VI and made it applicable to all the corporates irrespective of the size. The objective of revised schedule VI is said to align the financial statement presentation with that of the accounting standards. Though the government meant in form the present set of standards (NACAS pre IFRS standards) in substance it ushered IFRS/Ind AS backed financial statement presentation. This compelled companies which never aspired beyond their local domain to understand the terms and terminologies of IFRS/Ind AS. Some of these companies' managements may not have seen a foreign nation even on a map, but compelled to learn foreign terminologies. There cannot be a better way to globalize the business. ICAI, as usual without analyzing the impact of the revised schedule came forward in a jiffy and issued a guidance note. It is pertinent to note that on the earlier schedule VI, it was called a statement, implying mandatory compliance whereas for revised schedule VI it was christened as Guidance Note, implying deviations are permissible. Now let us analyze some of the crucial threats arising out of revised schedule VI. The most important change that has been brought by the revised schedule is the current and non-current classification of assets and liabilities. In the current confused economic scenario, the corporates would want any help but not trouble. But the revised schedule does the exact opposite. India being predominantly a debt driven economy, borrowings from banks play a major role and whenever there is a default in repayment, the client and bank negotiate its settlement in a manner considered appropriate between them. The western economic model driven on equity culture, where liability is not a major component of financing as against equity. In this backdrop, classifying a long term loan as current due to a default is correct and appropriate from their perspective but that may not appropriate in our business and funding model. The reclassification may impact the current ratio of companies severely and 8
CA R.G. Rajan
corporates who require liquidity to survive will be shown their balance sheet by the lending institutions with a lecture on how they are funded in excess of their requirements for current needs. The catastrophic effect of these will be small and tiny corporates will be hit hard and they may go out of business, resulting in large scale unemployment and possible social unrest. The incontrovertible fact is the income tax department is one of the biggest litigant in the world. The revised schedule requires a company to classify foreign exchange gain under other income. In substance a foreign exchange gain is the higher price realization and foreign exchange is the lower realization in a sale transaction. If one is required to classify the gain under other income, implying it does not arise from your operation, as per the financial statements, the income department can use this against the assesse to deny benefits of export incentives or other incentives. Let us now analyze how this impact in transfer p r i c i n g a s s e s s m e n ts . Th e m a i n c ri te ri a of selection of a comparative company in a TP assessment is the companies selected should be broadly comparable. One of the key criteria used in broad comparison is the comparison of the products produced which was earlier disclosed as quantitative details in the annual report. The revised schedule VI removed the requirement of disclosing quantitative disclosures with the result these information will no longer be available in a public domain. Income tax department will use the powers u/s 133 to extract the information and will use it selectively, where assessees will be left in lurch. The revised schedule VI talks of corresponding figures (comparatives) should be presented by all companies except in the case of companies which are newly incorporated. The term corresponding and comparatives have a completely different meaning to an accountant and to have coined as if to mean the same is inexplicable. A reading of revised schedule VI gives a feeling it was drafted by a team of experts on diverse field of Ind AS standards, current accounting standards, company law etc., but who never met each other. In fine, it is an exercise that could become a disaster for small corporates and virtually of no use to bigger ones. AUDITOR • September 2012
Guidance Note of ICAI on the Revised Schedule VI When the revision in Schedule VI requirements of Companies Act 1956 was carried out, the main purpose attributed for such revision was to align the provisions of Schedule VI to the requirements of IND AS which have already been notified to converge with IFRS. The notable revisions in this regard are the categorization of all assets and liabilities as current/ non-current and long term/short term. The main focus of IFRS which is the genesis of IND AS is to make the Accounting Standards principle based rather than rule based. This means, it will enable the accounting of transactions to be done in accordance with the underlying nature of the transaction rather than in a prescriptive manner. However, if one looks at the provisions of revised schedule VI as well as the prescriptions in the guidance note issued by ICAI on the disclosure of items as per revised Schedule VI, it appears that it is more of rule based rather than principle based. Some of the instances are listed below: 1. Disclosure of advances for capital expenditure vide paragraph 8.7.3 of the Guidance Note Both in revised schedule VI and in this paragraph of guidance note, it is prescribed that capital advances should not be classified as short term or current even those advances will be settled by completion of the concerned capital expenditure within 365 days. The reason attributed for this pronouncement is that these advances are meant for procurement of fixed assets, which are non-current assets, and hence they should be disclosed only as long term advances and not as current assets. The above prescription seems to be at variance from the broad principle laid down that all items of assets which are expected to be squared up or realized within 365 days have to be classified as current assets. Even if it is a capital advance, if it is adjustable within 12 months, it should have been included in the short term advances and only those capital advances which were expected to be squared up beyond 365 days should have been classified as long term advances. It clearly shows that Schedule VI is more of rule based and not of principle based. 2. Disclosure of bank deposits Bank deposits are required to be disclosed under the head “cash and cash equivalents” which again will form part of current assets. But the question arises as to how to handle bank deposits with more than 12 month maturity period left as on year end date. In this regard, the revised Schedule VI clearly says that such deposits also should be disclosed only under the head “cash and cash equivalents”. But the same should be disclosed separately as an item. The above disclosure requirement again violates the principle of classification of the assets as current and non-current based on the maturity profile. Further, while dealing with this item in paragraph 8.8.4, the
AUDITOR • September 2012
CA N.S. Srinivasan
guidance note travels beyond the requirement of the statute and says that the non-current portion of all the bank balances “including the deposits” will have to be classified under the head “other non-current assets” with separate disclosure to that effect. While one can argue on the correctness or otherwise of the statutory requirements as well as the requirements imposed through the guidance note, this is highlighted as another instance of prescription based disclosure rather than principle based disclosure. 3. Disclosure of income tax provision and pre-paid taxes and also the accounting of tax provision Neither in the revised Schedule VI format nor in the guidance note thereon, there is any reference to the presentation for the provision for income tax as well as pre-paid taxes. As per the earlier Schedule VI format, the pre-paid taxes like TDS, advance tax etc., used to be disclosed under “loans and advances” while the income tax provision used to be disclosed under the provisions in the liability side and both will be netted off. Hence the question arises whether the income tax provision as well as the pre-paid taxes are long term or short term in nature. As far as the income tax provision for year ended 31.3.2012 is concerned, there cannot be any room for doubt that it is only a short term provision, since the same will have to be discharged by way of selfassessment before 365 days. Of course, even if one wants to take advantage of the provisions of section 139(4) of Income Tax Act 1961 which enables belated filing of return of income till the end of the assessment year, the liability is required to be settled by way of self-assessment tax within 365 days. As far as the income tax provision and pre-paid taxes figures of earlier years are concerned, strictly speaking, neither they are in the nature of asset nor the provision is in the nature of liability in as much as the liability has already been extinguished through the prepayment of taxes. Of course, there will be a situation where the pre-paid taxes exceed the income tax liability provided which is reflected in the form of refunds claim in the return of income of earlier years. In such a situation, the amount of refund so claimed (namely the difference between the pre-paid taxes and income tax provision) has to be disclosed only as long term advance due to the fact that our tax authorities take their own sweet time to release the refund. There also, if by Gods Grace, the assessee had obtained the refund before the finalisation of the accounts, there is justification to classify it as “other current asset” under the head “short term advances”. There could be a situation where the company has deliberately kept some portion of the tax liability not paid (which according to me is absolutely impossible due to the present scheme of e-filing of return of income which compels the tax liability as per the return of income to be paid till the last pie). Still, (continued on next page)
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there could be a situation where based on the return of income filed for earlier years, a tax demand has been raised which has been provided in the accounts but not paid. Such tax liability should definitely be classified only as short term provision since as per law, any demand raised by income tax department will have to be discharged within 35 days unless the same is disputed and its recovery is stayed by the Assessing Officer or higher authorities. In a situation where there is neither refund due nor any tax liability payable, according to me, both the items of pre-paid taxes and provisions for tax liability kept un-reversed in the books of accounts are neither assets nor liabilities. They are mere accounting figures which are retained for the purpose of trail so that as and when any intimation is received from the income tax department, corresponding reversal entries could be passed. Now the question arises how to present these items in the balance sheet. The answer to this question would depend on the expectation regarding the action from the income tax department. In the normal course, unless and until a person receives at least intimation from the income tax department, anything could be presumed and there is no finality. This is more so when any notice under section 143(2) is received or time limit for its issue has not expired. For instance, if one looks at the picture as on 31.3.2011 in the context of finalizing the accounts for the year ended 31.3.2012, if those accounts were finalized before 30.9.2012, the time limit for issue of notice under section 143(2) has not yet expired. Therefore, there is no finality to the figures retained in the books of accounts for that year ended 31.3.2011 and since as on that date i.e. 31.3.2011, the time limit available to the department to rake up the matter extends beyond 12 months, the figures for that year will have to be disclosed only as long term items. On the other hand for the figures pertaining to the 31.3.2010 where the time limit for issue of notice under section 143(2) has already expired, the company can safely reverse the figures since as per the present scheme of assessment, unless any reopening notice is received, the acknowledgement for filing of return of income itself is deemed to be an intimation. On the other hand, if a notice under section 143(2) has been received for that year, definitely, the figures for that year should also be classified as long term items. Apart from the disclosure of the balance sheet items as discussed above, the next issue is the presentation of the tax provision, especially the interest component of the tax provision. Such interest would include interest payable under various sections of Income Tax Act 1961 like 234A, 234B, 234C, 201(1A), 220 and so on. In the guidance note, it is simply stated in paragraph 9.8.1.3 that interest on short fall in payment of advance tax is in the nature of finance cost and hence should be disclosed as such and it should not be clubbed with current tax expenditure. There is absolutely no discussion in this paragraph as to how
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they come to the conclusion that it is in the nature of interest on borrowing. If a company is already having huge borrowings and is facing liquidity crisis and used tax liability amount to meet their business commitment, then one can understand the aforesaid pronouncement of the guidance note. If a company is not having any borrowings at all and only due to wrong or difficulty in estimation of their profits which results in payment of interest under section 234A, B or C, it is difficult to understand how to treat it as finance cost. Similarly, where interest under section 234A is also attracted, may be for an earlier year, due to delay in filing of the return of income, then the company will be paying interest under section 234A, and 234B concurrently for the same period. Even 234A interest is held to be in compensatory in nature by court decisions. If that be so, vide paragraph 9.8.1.4, that will also have to be disclosed only as finance cost. It is surprising to note that the guidance note has totally not considered the decision of the Guwahati High Court in the case of Assam Forest Products (P) Ltd vs- CIT 180 ITR 478 rendered under section 40(a)(ii) of Income Tax Act 1961 to the effect that interest under sections 139, 215 and 217 (which are the predecessors of interest under sections 234A, 234B and 234C) are to be reckoned as accretions to the tax liability and hence they cannot be allowed as deduction under that clause. In the aforesaid paragraphs of the guidance note there is also no discussion on what is the true meaning of the term “current tax” as contemplated in revised Schedule VI. They have only reproduced the definition of that term in AS22 vide paragraph 9.8.1.1. In that definition, it is only stated that it means the amount of income tax determined to be payable in respect of the taxable income for a period. If one goes by the schematic computation of tax liability in ITR-6, the interest under section 234A, B and C are also included as part of the tax liability and only thereafter the abatement for pre-paid taxes is allowed to arrive at the balance tax liability payable for the period by way of self-assessment. Therefore, if one strictly applies this presentation as contained in ITR-6 which is the part of Income Tax Rules, the interest payable under section 2324A, B and C should be treated as part of “current tax” as defined in AS22. But the guidance note is silent on this aspect as well. Similarly, the guidance note is totally silent on how to present or disclose in the P&L statement and balance sheet the interest liability payable under other sections of the Income Tax act like 201(1)(A), 220 etc., Without discussing all these aspects in an elaborate manner, both the revised Schedule VI requirements as well as guidance note there on simply give prescriptions on the presentation/ disclosure of the various items in the financial statements. Hence, it appears that neither the revised Schedule VI nor the guidance note thereon are following the so called principle based approach, but they are still clinging on to the rule based approach in the matter of disclosure.
AUDITOR • September 2012
Review Engagements aka Limited Review Before we can catch our breath, pat our backs on the statutory and tax audits completed on time there is the next challenge of review engagements looming in front of many of us. We shall now try and understand the nuances of such engagements: Review Engagements are governed by Standards on Review Engagements(SRE) 2400 and 2410. SRE 2400 provides guidance when the review of financial information is undertaken by a professional who is not the auditor of an entity and SRE 2410 relates to review by an auditor for their own audit client. Though the essence would be the same the procedures and reporting would differ since an auditor of an entity is expected to have a better understanding of the client, the environment in which they operate and the control framework as compared to a review by another professional, not being the auditor. T h i s c o n c e p t o f Re v i e w s a l t h o u g h t o b e performed in brief is fairly complex and can be far more intensive on the mind than an audit where we have the benefit of time and detailed audit procedures that provide comfort to the auditor. The scope is limited for review engagements as compared to audit and that is the reason no opinion is expressed. Under a review engagement the auditor has to express a conclusion whether, anything has come to his knowledge that the financial information is not prepared, in all material respects, in accordance with an applicable financial reporting framework. Applicable financial reporting framework would be as per the Accounting Standards notified under
CA Veda
the Companies (Accounting Standards) Rules, 2006. In case the review is for a subsidiary of a foreign company (for consolidated financial statements) then the review may also be performed under the reporting framework applicable in the country of the holding company. The report should clearly indicate the relevant reporting framework under which the review has been carried out. Review Procedures Review engagements largely involve inquiry and analytical procedures. So it is time to sharpen your questioning skills and refresh your memory on open ended, close ended questions and what not. Review engagements provide the perfect platform andtime for the auditor to obtain a better understanding of the client's business and the challenges during the period. This will also help in defining a strategy and planning the year end audit. Inquiries should not be restricted to the accounts and finance division and should be covering all the major departments sales and marketing, production, inventory management, treasury etc. Based on my experience, I would broadly think that there are two main procedures for review engagements and let us face it; this is all we would have time for. * Inquiry with Management / Personnel * Analytical procedures(including budget vs actual) These procedures will help us to identify potential risk areas to focus on in the course of the review. Some illustrations are as under:
Review Procedure
Scenario
Inference (What should you watch out for?)
Enquiry with stores personnel on inventory levels in an automobile company
Parts of a particular model are not moving at all and he is in a fix
Model obsolescence requiring provision
Enquiry with sales team and stores personnel.
Sales Team: Sales as planned if not better. Stores personnel: Inventory pile up and pressure to reduce stock levels particularly in the last month of the
Potential cut off issues when there is a
Enquiry with plant maintenance
AUDITOR • September 2012
spike in the debtors balance with no big change in the closing inventory as compared to the previous period period under review. Period under review has been quite Potential delay in capitalisation when busy with significant capacity depreciation increase is not expansion in the initial months. proportionate to expected charge 11
(continued from the previous page)
Reasonableness test for depreciation
Another important analysis which helps in understanding the trend during the period under review is the comparison with the budgets/ business plans. However this can be effective only if the budgeting process is robust. The auditor needs to understand how frequently the budgets are revised, what is the basis for the plan, how the budget is discussed and deliberated by the management, how does the management analyse the variations etc.
Inventories
Further, current and deferred taxes have to be ascertained considering the year's projected performance and the related proportion to the current period results instead of assessing the review period on a standalone basis.A quick referenceto the key review procedures is as under and can be used as a checklist as well
Comparison of actual inventory holding period with budgets and also prior period actuals.
Review of inventory aging for adequacy of stock provision Sundry Debtors
Review of debtors aging for adequacy of provisioning
Analysis of age composition in relation to normal credit period
Enquiry on restatement of forex debtors Cash and Bank
Review of bank reconciliation statements for old or un-reconciled balances
Direct bank confirmations atleast for significant balances Review of the board and committee minutes General
(best practice is to have this reviewed by a senior audit team member as they can appreciate the interdependencies and the related financial implications)
Current liabilities and provisions
Review of creditor days in relation to budget and prior period actuals
Scanning analytics of the grouping schedules Attritions and inductions of senior to analyse significant variations management personnel and significant changes in organisation structure Review of adequacy of closing provisions based on the known fixed costs, industry New business, product lines or discontinuance specific costs and subsequent payment thereof, operating locations opened / closed, scrutiny basis and documentation
Update understanding on the client internal Profit and Loss account controls with respect to changes Information on the industry trend (this helps Comparison with budgets/business plans and in the analytical review of the major analysing the significant variations components). Review of significant new contracts during Disaggregated revenue analytics (wherever the period possible) Follow up on audit discussion points from the Gross margin analysis and variation analysis year end or the previous interim review for other expenses Re v i e w o f i n t e r n a l a u d i t a n d o t h e r Last but not the least let us also not forget the management audit reports importance of management representations for Loan Funds the review engagements. This has to be tailor Reasonableness of interest charge vis-à-vis made according to the client and also the loan funds movement developments during the period under review. Review whether all associated costs for a new What we think, or what we know, or what we borrowing has been recognised (i.e.) believe is, in the end, of little consequence. commitment charges, processing fee etc. The only consequence is what we do. Fixed Assets Quality is never an accident. It is always the Scanning of fixed assets register to identify result of intelligent effort. - John Ruskin ineligible capitalisations 12
AUDITOR • September 2012
Recent Judicial Decisions Reported
P.M. Veeramani, FCA
Statute: Income Tax Act – Sec.10(23C)(vi a) – Pharmacy will not deny exemption Decision in favour of : Assessee Title : Baun Foundation Trust vs CCIT Citation: 73 DTR 45 Bench: Bombay HC Application for approval under section 10(23C)(via) could not be rejected on ground of running a chemist shop in the hospital, more so when the income earned therefrom was used for pruposes of hospital Statute: Income Tax Act – Sec.12 A – TDS does not indicate commercial activity Decision in favour of : Assessee Title : Heart Care Management vs DIT Citation: 52 SOT 277 Bench: ITAT Delhi No adverse inference could be drawn for holding conference in a five star hotel . Conducting of conference was authorized by the objects of the trust. Merely because donors being pharmaceuticals companies and they deducted TDS on donations, it would not convert donation into a commercial receipt on basis of presumptive inference and registration cannot be denied on these grounds Statute: Income Tax Act – Sec. 17(2)(iv) – Tax paid by employer Title : CIT vs Hidechito Shiga Citation: 345 ITR 269
Decision in favour of : Assessee Bench: Delhi HC
The tax borne and paid by the employer is covered by section 17(2)(iv) as a perquisite and therefore, has to be excluded from salary while computing the perquisite value of rent free accommodation in accordance with amended Rule 3 of IT Rules, 1962 Statute: Income Tax Act – Section 40(a)(i) – No TDS on reimbursement of exp Decision in favour of : Assessee Title : Bayer Material Science Private Ltd vs ADIT Citation: 17 ITR Trib 275 Bench: ITAT Mumbai Where the payment is towards reimbursement of expenses, there cannot be any element of income in such payment in the hands of the payee. Once the element of income is missing, TDS is not applicable. Statute: Income Tax Act – Sec 41(1) – Reversal of balance in inter branch accts Title : Punjab National Bank vs ACIT Citation: 17 ITR Trib 462
Decision in favour of : Assessee Bench: ITAT Delhi
Amount transferred from inter branch transaction blocked accounts to reserves through profit and loss account , after permission by Reserve Bank of India , which was subject to conditions, is not an income . The department has not brought any material to show that the sum in question was once allowed as a deduction in the computation of income. When the primary requirement was absent, the question of bringing the sum to tax under section 41(1) was not legally permissible. Statute: Income Tax Act – Sec 43B(f) – arbitrary and unsustainable Decision in favour of : Assessee Title : CIT vs Hindustan Latex Ltd Citation: 74 DTR 212 Bench: Kerala HC Payment of premia to LIC for policy under Group Leave Encashment Scheme is not covered by 43B(f) and it is deductible under 37(1); even otherwise, 43B(f) is arbitrary and unsustainable. Statute: Income Tax Act – Sec 80(IA) – conversion of HDPE bags is manufacture Decision in favour of : Assessee Title : Jhaveri Coaters Private Ltd vs ACIT Citation: 74 DTR 145 Bench: Gujarat HC Process undertaken by assessee brings about a structural change in semi finished HDPE bags and brings into existence laminated HDPE bags which are put to entirely different kind of use and hence it amounted to manufacture and entitled to relief Statute: Income Tax Act – Sec 80(IA) – preparation of voter ID cards is manufacture Decision in favour of : Assessee Title : CIT vs Haryana State Electronics Devpt. Corpn. Ltd Citation: 71 DTR 322 Bench: P & H HC Preparation of voter photo identity cards is engaging in manufacture or production of article or things and hence an industrial undertaking eligible for deduction u/s 80IA. Manufacture of identity cards cannot be described as photography apparatus and goods within the meaning of Entry 10 of Schedule XI. Statute: Income Tax Act – Sec 90 – Education Cess not applicable for DTAA Decision in favour of : Assessee Title : DIC Asia Pacific Pte Ltd vs ADIT (IT) Citation: 74 DTR Trib 140 Bench: ITAT Kolkatta In view of specific provisions of Article 2 of the Indo Singapore DTAA and in view of the fact that education cess introduced by Finance Act 2004 is essentially of the same nature as surcharge, the scope of article 2 extends to education cess and therefore, the same cannot be levied in respect of tax liability at fixed rates specified under DTAA.
(continued on next page)
AUDITOR • September 2012
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Statute: Income Tax Act – Section 153 A – search assessment to be based on seized docs Title : All Cargo Global Logistics Ltd vs DCIT Citation: 74 DTR SB 89
Decision in favour of : Assessee Bench: ITAT Mumbai SB
In addition to the income that has already been assessed, the assessment under 153A will be made on the basis of incriminating material found in the course of search but not produced in the course of original assessment and undisclosed income or property discovered during search; A container freight station is an inland port as it carries out functions of warehousing , customs clearance and transportation of goods from location to the seaport and vice versa by rail or by trucks and there its income is eligible for deduction under 80IA(4). Statute: Income Tax Act – Section 154 – Carry forward of loss not considered by CPC Title : Ambala Central Co-operative Bank Ltd vs ITO Citation: 52 SOT 233
Decision in favour of : Assessee Bench: ITAT Chandigarh
Assessee e-filed return claiming set off carry forward. Set off not considered in electronic processing and demand was raised. Assessee preferred rectification petition which was rejected by AO. Loss already determined in earlier years as per copies of return filed and hence AO directed to verify the figures on record and allow set off. Statute: Income Tax Act – Section 143(2) – Asst invalid if no notice is issued Title : V.R.Sreekumar vs ITO Citation: 74 DTR Trib 210 TM
Decision in favour of : Assessee Bench: ITAT Cochin
If the assessee has intimated that the original return may be treated as one filed in response to notice under section 148, the AO is duty bound to issue notice under 143(2); in the absence of such notice , assessment under section 143(3) r/w s 147 was invalid Statute: Income Tax Act – Section 158 BB – Undisclosed expenditure allowable Title : CIT vs P.D.Abraham Citation: 74 DTR 34
Decision in favour of : Assessee Bench: Kerala HC
When the department relies on the seized records for estimating undisclosed income, there is no reason why expenditure stated there should be disbelieved merely because that payments were not made through cheques or demand drafts. Hence, expenditure not recorded in regular books of accounts should be deducted while arriving at undisclosed income.
B.B. Naidu Study Circle Meeting 19th October 2012 at 6.00 p.m Topic :
Family Run Businesses in India
As auditors or finance managers in India, we would have come across many ‘family-run' businesses small and medium size to large conglomerates. Many of the famous South Indian business houses are still largely family-run (and also family-owned....). Mr. Tilak Shankar, an IIM-A Management Consultant will lead the discussions on the Current Trends, Risks, Challenges, Needs of Family Run Businesses. It will be a good opportunity for us to focus our thoughts on this topic to increase our strategic view on one of the foremost business models in South India. This will help us to 'deliver better' on our professional commitments in such scenarios. Mr. Tilak Shankar, CEO of Management Solutions, has carried out more than 300 consulting assignments- to a wide range of clients in India. He has assisted clients in top management recruitment positions. Studies include corporate strategy, new project evaluation, HR consulting, process consulting, assistance in Joint ventures. His expertise is Healthcare management consulting, family-owned business consulting, corporate strategy, new project appraisals, joint ventures, human resource consulting, to name a few. We request participation in large numbers as a free exchange of views will enhance the utility of such meetings. As members of SOA, please encourage participation by your personal presence and ensure your member colleagues / friends also attend. 14
AUDITOR • September 2012
80 th year celebration - moments to cherish
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