Form 10B audit reporting plays a central role in the compliance framework for charitable and religious institutions registered under section 12A(b) of the Income-tax Act, 1961. This audit requirement is not just a statutory formality; it is a comprehensive exercise to verify whether the books of account are properly maintained, the financial statements are in agreement with those books, and the activities of the institution are in accordance with applicable provisions of law.
The auditor’s report serves as an assurance to the tax authorities that the trust or institution has operated within its approved charitable or religious objectives, without diverting income to purposes or persons that would result in a loss of exemption under the law. The report also identifies any discrepancies, deviations, or non-compliance in the form of observations, qualifications, or disclaimers.
For many auditors, Form 10B is not just an annual compliance task; it is a highly structured engagement requiring professional skepticism, sound judgment, and clear documentation of findings. Understanding the underlying statutory framework is essential to performing this task effectively.
Scope and Purpose of the Audit
The primary objectives of a Form 10B audit can be grouped into three broad categories. First, ensuring that proper books of account have been maintained in accordance with the requirements of Rule 17AA of the Income-tax Rules, 1962. Second, verifying that the financial statements are in agreement with these books. Third, confirming that the particulars furnished in the form are true and correct to the best of the auditor’s knowledge.
While the Income-tax Act prescribes the format and clauses of Form 10B, the quality of the auditor’s work depends on professional application of auditing standards, including those applicable to special purpose reports. Each clause in Form 10B corresponds to specific reporting requirements, such as the application of income, transactions with specified persons, and compliance with other laws.
Observations, Qualifications, and Disclaimers
Form 10B provides space for the auditor to record observations and qualifications relating to each clause of the annexure. These remarks are more than just formalities; they provide context, limitations, and the auditor’s viewpoint on issues where the facts may not be entirely clear-cut.
An observation is typically a neutral statement describing a factual situation, such as reliance on management representations for certain information. A qualification is used when there is a disagreement or a limitation in scope that affects the auditor’s conclusion. A disclaimer is used when the auditor is unable to obtain sufficient appropriate evidence to form an opinion on a particular matter.
Differences of opinion with the assessee should be reported with clarity, indicating the specific clause to which the observation or qualification applies. This ensures that the tax authorities can assess the implications in the right context.
Linking Statutory Compliance to Transparency
One of the central purposes of Form 10B audit reporting is to enhance transparency in the operations of charitable and religious institutions. Transparency is achieved by making key disclosures about income application, related party transactions, and compliance with statutory provisions.
From an auditor’s perspective, transparency is not simply about reporting figures; it involves explaining how those figures were derived, the nature of any limitations encountered during the audit, and any relevant circumstances that could affect interpretation. This level of disclosure helps maintain the credibility of the institution and protects the auditor from any allegation of insufficient diligence.
Reporting Details of Persons under Section 13(3)
Definition of Specified Persons
A critical component of Form 10B audit reporting is the disclosure of details relating to persons specified under section 13(3) of the Income-tax Act. These include the author or founder of the trust, persons who have made substantial contributions, members of the author or founder’s Hindu Undivided Family, trustees or managers of the institution, relatives of any of these persons, and concerns in which such persons have substantial interest.
The term substantial contribution is defined as a contribution exceeding fifty thousand rupees up to the end of the relevant financial year. This definition is cumulative, meaning contributions in prior years are considered in determining whether the threshold has been crossed.
Practical Challenges in Identification
Identifying specified persons is not always straightforward. Contributions may be routed through different channels, such as family members or related concerns, making it difficult to establish connections without detailed scrutiny. Additionally, trusts often rely on voluntary declarations by contributors, which may not always be complete or accurate.
Auditors must adopt procedures to detect potential specified persons beyond those explicitly disclosed by management. This could involve cross-referencing contribution records with trustee details, reviewing related party disclosures in the financial statements, and performing analytical procedures on donor data.
CBDT Circulars and Auditor Reliance
Circular No. 143, dated 20 August 1974, provides that the auditor may rely on a list of specified persons furnished by the management. While this circular gives some operational relief, it does not absolve the auditor from exercising reasonable diligence. The list must be consistent with the records maintained by the institution.
Circular No. 17/2023, dated 9 October 2023, further clarifies that the auditor must report all persons contributing more than fifty thousand rupees during the year, and include details of relatives and related concerns if such information is available. It also reinforces the requirement to maintain records as per Rule 17AA.
Rule 17AA Requirements
Rule 17AA of the Income-tax Rules, 1962, requires institutions to maintain specified records in respect of specified persons. These include the name, address, Permanent Account Number, Aadhaar number, and nature of the relationship or interest with the institution. These records form the basis for the auditor’s reporting under Clause 41 of Form 10B or Clause 28 of Form 10BB.
Auditors must examine these records for completeness and consistency. Any gaps or inconsistencies should be reported as observations, and reliance on management’s representation should be clearly documented in the working papers.
Handling Incomplete Information
In practice, auditors often encounter situations where certain details, such as Aadhaar numbers or addresses of specified persons, are unavailable. In such cases, it is essential to disclose the limitation in the audit report. A suitable disclaimer would state that the information is based on the records provided by management in accordance with the relevant CBDT circulars and as maintained under Rule 17AA.
Sample Disclaimer for Section 13(3) Reporting
A typical disclaimer in this context could read as follows: The list of specified persons under section 13(3) of the Income-tax Act, 1961, is based on management’s submission in terms of CBDT Circular No. 143 dated 20 August 1974 and CBDT Circular No. 17/2023 dated 9 October 2023, and as maintained in the format prescribed under Rule 17AA of the Income-tax Rules, 1962.
This type of statement protects the auditor from undue responsibility for information that is inherently dependent on the completeness of management’s records.
Case Study: Common Errors in Identifying Specified Persons
Consider a charitable trust that receives a donation of seventy thousand rupees from an individual during the year. On the surface, the donor does not appear to be connected to the trust. However, upon further review, it is discovered that the donor is the spouse of a trustee. Under section 13(3), the donor is a specified person due to the relationship with the trustee, and the contribution should have been reported accordingly.
Another common oversight occurs when contributions are received through a company in which a trustee holds substantial interest. Such contributions are often misclassified as unrelated, leading to under-reporting in the Form 10B annexure.
These errors highlight the importance of going beyond surface-level review and applying analytical procedures and related party checks to donor records.
Best Practices for Verification
Auditors can adopt several best practices to improve accuracy in identifying specified persons:
- Comprehensive Donor Database Review – Extract a list of all donors exceeding fifty thousand rupees in cumulative contributions and cross-check with trustee and founder family details.
- Review of Related Party Transactions – Compare donor lists with related party disclosures in the financial statements and board minutes.
- Management Representation Letter – Obtain a formal declaration from management that the list of specified persons is complete and accurate.
- Independent Checks – Where feasible, verify PAN details through publicly available databases or government portals.
- Periodic Updating – Encourage the institution to update its records throughout the year rather than only at audit time, reducing the risk of omissions.
These practices not only enhance audit quality but also strengthen the institution’s own governance framework.
Introduction to Benefit Reporting under Section 13(2)
When a charitable or religious institution applies any part of its income directly or indirectly for the benefit of specified persons, it triggers serious tax consequences. Such application is prohibited under section 13(2) of the Income-tax Act, 1961, and its occurrence leads to loss of exemption under section 11 or section 12. In addition, section 115BBI imposes tax on the violating income at a special rate, while section 271AAE prescribes penalties. The recipient may also be taxed under section 56(2)(x) for the benefit received.
From the auditor’s perspective, assessing whether such benefits exist involves more than reviewing payment vouchers. It requires an understanding of relationships, related entities, the substance of transactions, and the applicability of exceptions under the law.
Identifying Direct and Indirect Benefits
Direct Benefits
Direct benefits are relatively straightforward. These include payments made to specified persons for goods or services not related to the trust’s charitable objects, excessive remuneration, or direct transfers of assets. For example, paying a trustee a consultancy fee for services unrelated to the trust’s activities constitutes a direct benefit.
Indirect Benefits
Indirect benefits are more complex and can include transactions that on the surface appear to be at arm’s length. For instance, selling trust property to a company in which a specified person has substantial interest at a price below market value results in an indirect benefit. Providing free use of trust-owned facilities to relatives of a trustee without a legitimate charitable purpose also qualifies as an indirect benefit.
Practical Challenges
Many benefits are embedded in operational activities, making them harder to identify. For example, awarding a supply contract to a vendor who is a close relative of a trustee may be justifiable if competitively priced, but without proper documentation and market comparisons, it can raise concerns under section 13(2).
Auditors should perform procedures such as vendor background checks, comparison of rates with market prices, and review of agreements to assess whether any transaction constitutes an undue benefit.
Rule 17AA Record-Keeping Requirements
Rule 17AA requires that charitable institutions maintain detailed records of all transactions with specified persons, including the nature, purpose, amount, and terms. These records form the basis for the auditor’s review under the benefit reporting clauses of Form 10B.
Inadequate record-keeping makes it difficult to conclude on compliance, and in such cases, the auditor may need to include a disclaimer indicating the limitations in verifying whether benefits were provided.
Sample Disclaimer for Benefit Reporting
A practical disclaimer could state that based on the audit conducted in accordance with applicable auditing standards for special purpose reports and the records maintained under Rule 17AA, no unreasonable payments to specified persons under section 13(2) were noted. This communicates the auditor’s reliance on the available records while affirming the absence of identified violations.
Reporting Specified Violations
Overview of Specified Violations
Clauses 43 of Form 10B and 30 of Form 10BB require auditors to report specified violations as defined in Explanation 2 to the fifteenth provision to section 10(23C) and the Explanation to section 12AB(4). These violations include:
- Applying income for purposes other than charitable or religious objects.
- Earning business income not incidental to the objectives.
- Failing to maintain separate books of account for incidental business.
- Applying income for private religious purposes.
- Applying income for the benefit of a particular religious community or caste.
- Carrying on activities that are not genuine or that breach registration conditions.
- Non-compliance with other applicable laws, where there is a final and undisputed order holding so.
Application for Non-Charitable Objects
This violation occurs when trust funds are used for activities unrelated to its approved charitable purposes. For example, using funds to finance a private investment venture or personal expenses of trustees falls squarely into this category.
Auditors need to match expenditures against the trust’s stated objectives in its registration documents. Supporting evidence, such as board resolutions, invoices, and agreements, should be reviewed to ensure alignment.
Business Income Not Incidental to Objectives
Trusts may engage in business activities, but these must be incidental to their objectives, and separate books must be maintained. For example, a school operating a canteen primarily for students may be incidental, but running a commercial catering service for the general public is not.
Auditors must assess both the nature of the activity and the intent. If the business activity is a standalone commercial operation, it will be treated as non-incidental, potentially triggering this violation.
Absence of Separate Books for Incidental Business
Even when a business is incidental, the trust must maintain separate books for that activity. Failure to do so constitutes a violation in itself, regardless of whether the activity is compliant in other respects.
Private Religious Application
Applying income to activities benefiting a specific religious denomination without corresponding public charitable benefit can cause exemption loss. For example, using funds solely for the upkeep of a private place of worship not open to the public would be treated as a violation.
Application for the Benefit of a Particular Community or Caste
Section 13(1)(b) disallows exemption if a trust is created for the benefit of any particular religious community or caste, except for scheduled castes, scheduled tribes, backward classes, or women and children. Auditors must carefully review the object clause and the actual activities to detect such exclusivity.
Non-Genuine Activities or Breach of Registration Conditions
This category includes cases where the trust’s operations deviate materially from its stated charitable objects or violate the conditions under which registration was granted. Such situations often arise when funds are diverted to unrelated projects or when mandatory filings are not made.
Non-Compliance with Other Laws
Clause (g) violations occur when there is a final, undisputed order by a competent authority holding that the trust has violated other applicable laws. Auditors are not expected to interpret the law themselves but must obtain management representation and review relevant orders to ensure accuracy in reporting.
Sample Disclaimer for Specified Violations
A disclaimer could state that during the audit conducted in accordance with applicable auditing standards for special purpose reports, no specified violation as defined in the Explanation to section 12AB(4) was noted. This provides assurance while limiting the auditor’s responsibility to the scope of work performed.
Compliance with Other Laws and Reliance on Representations
For violations under clause (g), the auditor’s work is guided by standards such as SA 250 and SA 501. This includes obtaining management representation regarding compliance with other laws and reviewing any final orders from competent authorities. Where no such orders exist, the auditor should state this fact in the report.
Case Study: Detecting a Specified Violation
Consider a trust running an educational institution that also operates a commercial bookshop selling stationery and general books to the public. While the school-related sales might be incidental, the broader commercial sales may not be. If separate books are not maintained for the shop, the trust is in violation even if the income is applied for educational purposes.
Another example is a trust using its funds to support a private religious function attended only by members of a specific family. This application of income would fall under private religious purposes, resulting in loss of exemption.
Risk-Based Audit Approach to Violation Detection
Given the potentially broad scope of violations, a risk-based approach is often effective. This involves:
- Identifying high-risk areas such as large or unusual expenditures, related party transactions, and new business ventures.
- Testing transactions in these areas for compliance with the trust’s objects and legal requirements.
- Reviewing minutes of meetings to detect any approvals for non-core activities.
- Following up on complaints, whistleblower reports, or media coverage that might indicate violations.
Role of Documentation
Thorough documentation is essential to support the auditor’s conclusions on benefits and violations. This includes maintaining copies of contracts, invoices, correspondence, and management representations. Documentation not only aids in forming a conclusion but also protects the auditor in case of future disputes.
Interaction with Management and Trustees
Auditors should have regular discussions with management and trustees during the audit to clarify the nature of certain transactions, confirm relationships, and assess the intent behind activities. Misunderstandings or incomplete information can lead to incorrect reporting, so open communication is key.
Introduction to Application of Income Reporting
The reporting of application of income in Form 10B is central to the audit of charitable and religious institutions. It serves to establish whether the trust or institution has applied its income in accordance with sections 11 or 10(23C) of the Income-tax Act, 1961. Application includes both revenue expenditure and eligible capital expenditure incurred for charitable or religious purposes within India, unless otherwise permitted by the law.
From an auditor’s perspective, verifying application of income involves reviewing accounting records, bank statements, and relevant agreements or invoices, while also ensuring that amounts classified as application are legally allowable and consistent with the institution’s stated objectives.
Preparation Basis for Income and Expenditure Account
Income and Expenditure Prepared as per Income-tax Act
When the trust prepares its Income and Expenditure Account in line with the provisions of the Income-tax Act, the application figures are directly aligned with statutory requirements. These accounts will segregate allowable and disallowable expenditures, identify capital outlays eligible for application treatment, and make necessary adjustments for accruals or prepayments.
In such cases, the auditor can certify that the figures reported are drawn from the records maintained in accordance with the Act. This provides a high degree of reliability and reduces the scope for post-assessment disputes.
Income and Expenditure Prepared on a General Purpose Basis
Where the accounts are prepared on a general accounting framework, the application figures may not align precisely with tax provisions. For example, depreciation may be included as an expense, whereas for tax purposes, the cost of acquiring a fixed asset may be treated as application in the year of purchase.
In these situations, auditors need to derive application figures from the balance sheet and supporting documents, making necessary tax adjustments. They should clearly state the basis of computation in their report to avoid misinterpretation by tax authorities.
Verifying Eligible Application
Auditors should test a representative sample of transactions to confirm that:
- The expenditure relates to the approved charitable or religious objects.
- Payments were made through permissible banking channels as required under section 11(5) read with relevant rules.
- Capital expenditure meets the criteria for application as per prevailing judicial precedents and circulars.
- No part of the income was applied outside India without prior approval from the competent authority.
Maintenance of Books of Account
Requirements under Rule 17AA
Rule 17AA of the Income-tax Rules, 1962 mandates that institutions maintain books of account and other documents such as ledgers, cash books, vouchers, and records of income and application. The rule also prescribes that records should be maintained in such a manner that particulars of income, application, accumulation, and investment are readily available.
Auditors must evaluate whether the institution has complied substantially with these requirements. Partial compliance, such as maintaining ledgers but without adequate supporting vouchers, may still result in adverse reporting depending on materiality.
Practical Audit Considerations
In practice, many smaller institutions may use basic accounting software or manual records. The auditor must assess whether the format and content of these records meet the minimum standards prescribed by the law. If deficiencies are material, the auditor should qualify the report accordingly.
Sample Reporting Language
An auditor may state that the requirements for books of account and related documents under Rule 17AA have been substantially complied with, as disclosed in Clause 14 of Form 10B. This confirms compliance while indicating that the assessment is based on the available evidence.
Non-Filing of ITR and Audit Report Timelines
Impact of Filing Deadlines
Section 13(10) and the twenty-second provision to section 10(23C) contain provisions that can deny exemption if the return of income or audit report is not filed within the prescribed due date. However, when the audit report is signed before the income-tax return filing deadline, the auditor cannot definitively comment on the applicability of these provisions.
Practical Reporting Approach
A common approach is for the auditor to state that as on the date of the audit report, the deadline for filing the return has not expired, and therefore no comment is being offered on the applicability of the above provisions. This protects the auditor from making a premature assertion.
ICAI Guidance Note – Suggested Observations and Disclaimers
Management and Auditor Responsibilities
The Guidance Note issued by the Institute of Chartered Accountants recommends that auditors reword the standard SA 700 responsibility paragraphs to fit the context of Form 10B reporting. These should be included in the observation fields to make it clear that management is responsible for preparing the financial statements and maintaining adequate records, while the auditor’s role is to express an opinion based on the audit.
Verification of Payment Modes
One area where disclaimers are often necessary is the verification of whether all receipts and payments were made through prescribed modes. In some cases, the evidence for certain small transactions may not be available, making full verification impractical.
A suggested disclaimer is that it is not possible to verify whether all payments and receipts were made through prescribed modes, as the necessary evidence is not available with the assessee. This alerts the reader to a limitation in audit scope without implying misconduct.
Verification of Loans and Deposits
The auditor may also be unable to fully verify whether all loans, deposits, and specified sums were accepted only through permitted banking channels. In such cases, a disclaimer stating the absence of necessary evidence will ensure transparent reporting.
Special Considerations for Application Computation
Accrual vs. Cash Basis
Institutions may follow either the accrual or cash basis of accounting, but for tax purposes, application is generally recognized on a cash basis unless otherwise provided. The auditor must reconcile differences between the accounting method and the tax reporting requirement.
Treatment of Depreciation
Judicial precedents have held that depreciation can be claimed as an application of income even if the cost of the asset has been treated as application in an earlier year, subject to certain conditions. The auditor should confirm that the treatment adopted by the assessee is consistent with the latest legal position.
Repayment of Loans
Repayment of a loan taken for acquiring a capital asset used for charitable purposes is generally treated as application of income. The auditor should verify loan agreements and ensure that the original loan proceeds were utilized for eligible purposes.
Importance of Reconciliations
Auditors should perform reconciliations between the amounts reported in Form 10B and the books of account. This includes reconciling income reported in the Income and Expenditure Account with that shown in the return of income, as well as reconciling application figures with supporting documentation. Discrepancies should be investigated and either resolved or reported as qualifications.
Management Representation
Management representation is an integral part of the audit process for Form 10B. Given that auditors rely on information provided by the management, it is essential to obtain written confirmations on matters such as:
- Completeness of the list of specified persons.
- Accuracy of the application of income figures.
- Compliance with provisions of the Income-tax Act and other applicable laws.
These representations should be dated and signed by authorized persons and kept on record as audit evidence.
Case Examples of Application Reporting Issues
Misclassification of Capital Expenditure
An institution may classify the purchase of a fixed asset as a revenue expense, leading to double counting in application. The auditor must ensure proper classification and avoid overstatement of application.
Non-Allowable Expenditures
Expenses such as penalties, fines, or donations to other institutions without proper documentation may be claimed as application. The auditor should disallow these in computing applications for reporting purposes.
Foreign Remittances without Approval
Applying income outside India without prior approval is not permitted. If such remittances are detected, they should be reported as violations and excluded from eligible application.
Communication with Those Charged with Governance
The auditor should communicate significant audit findings to the trustees or governing body, including any non-compliance, deficiencies in internal control, or material adjustments proposed. This communication can be formalized in a management letter separate from the audit report.
Conclusion
Form 10B audit reporting plays a pivotal role in safeguarding the transparency, accountability, and legal compliance of charitable and religious institutions. By thoroughly examining the application of income, the maintenance of books of account, transactions with specified persons, and adherence to statutory provisions under the Income-tax Act, auditors not only fulfill a statutory duty but also contribute to strengthening governance in the non-profit sector.
A well-prepared audit report, supported by clear observations, appropriate qualifications, and justified disclaimers, ensures that all relevant stakeholders, including trustees, regulators, and tax authorities, have a true and fair view of the institution’s compliance status. The process requires auditors to exercise professional skepticism, maintain detailed documentation, and apply the relevant provisions of sections 11, 12, 13(3), 10(23C), and Rule 17AA diligently.
Equally important is the role of management in providing complete and accurate records, maintaining prescribed books, and complying with procedural requirements, such as filing the audit report and return within the due dates. The synergy between the institution’s governance framework and the auditor’s independent verification helps minimize the risk of regulatory violations, penalties, and reputational damage.
Ultimately, Form 10B audit reporting is not just a compliance formality; it is an exercise in reinforcing trust in the functioning of charitable and religious organizations. When conducted with care, consistency, and adherence to the law, it enhances the institution’s credibility and ensures that its resources are directed toward the intended public benefit.