Clause 26 deals with specific liabilities referred to in various sub-clauses of section 43B of the Income Tax Act. These liabilities include sums that the assessee is obligated to pay, such as taxes, duties, contributions, and other specified expenses. The clause requires the auditor to report the payment status of these liabilities according to whether they pre-existed on the first day of the previous year or were incurred during the previous year.
Section 43B and Actual Payment Basis
According to section 43B, specified expenses are deductible only based on actual payment, even if the assessee follows the mercantile system of accounting. This means that for the specified expenses, the timing of deduction is linked directly to the payment rather than the accrual of liability. If the liability was incurred during the previous year and payment is made on or before the due date for filing the income tax return under section 139(1), the deduction is allowed for that previous year.
Reporting Requirements for Pre-existing and Newly Incurred Liabilities
Clause 26 is divided into two major parts for reporting purposes. The first part concerns liabilities that pre-existed on the first day of the previous year but were not allowed as a deduction in any preceding year. The auditor must report the nature and amount of such liabilities and whether they were paid or unpaid during the previous year.
The second part concerns liabilities incurred during the previous year. The auditor must report whether these liabilities were paid on or before the due date for filing the return or remained unpaid. The details should include the nature of liability, the amount, and any remarks.
Types of Specified Expenses Covered Under Section 43B
Section 43B covers a variety of specified expenses that are allowed as deductions only when paid. These include:
- Any tax, duty, cess, or fee payable, including GST, customs duty, excise duty, or any other indirect tax, but excluding income tax.
- Contributions by the employer to recognized employee benefit funds such as provident fund, superannuation fund, and gratuity fund, provided payment is made before the due date of the respective fund or filing of the return.
- Bonus or commission payable to employees.
- Interest on loans from specified financial institutions like public financial institutions, state financial corporations, scheduled banks, and certain non-banking financial companies.
- Leave encashment provided by the employer.
- Sums payable to Indian Railways for the use of railway assets.
The auditor is required to distinguish payments made during the previous year that were allowed in earlier years from those disallowed. However, the auditor is not required to opine on the admissibility or inadmissibility of these expenses.
Accounting for GST Collected and Deferred Payments
If a company credits GST collected from customers to a separate account, treating it as a liability, this must be indicated in the financial statements by way of a note. The Guidance Note issued in 2023 clarifies the interpretation of “actual payment” under section 43B for tax audit reporting in clause 26.
Deferral of GST Under Incentive Schemes
The Guidance Note recognizes that under certain incentive schemes, GST may be regarded as paid by statutory legislation or notified schemes. In such cases, the tax auditor, after considering relevant facts, may treat deferred GST as discharged liability if supported by precedent from circulars or judicial rulings under previous sales tax regimes. For example, if a sales tax deferred under a state government scheme is treated as paid, then the same principle applies for GST in terms of actual payment under section 43B.
Judicial rulings have upheld that when sales tax is converted into a loan repayable in installments under notified schemes, this constitutes actual payment for deduction purposes. Therefore, such deferred amounts may be allowed as deductions in the year when conversion is permitted.
Bank Guarantees Are Not Actual Payments
Furnishing a bank guarantee for payment of any sum does not amount to actual payment under section 43B. The Supreme Court has clarified this point, emphasizing that a guarantee is only a security and does not discharge the liability to claim deductions.
Advance Deposits of Duty Qualify as Actual Payment
Advance deposits of duties such as excise duty qualify as actual payment under section 43B and hence qualify for deductions. Judicial decisions have supported that amounts deposited in excise personal ledger accounts or similar advance payments are entitled to deduction benefits under section 43B.
Statutory Dues Within the Scope of Section 43B
The Guidance Note further clarifies which statutory dues qualify under section 43B. For instance, royalty payments are considered a tax, and outstanding royalties on the balance sheet date are relevant for the section 43B deduction. Conversely, certain fees, such as bottling fees paid under excise law for acquiring exclusivrightsht,are not considered taxes and thus do not fall within section 43B.
In addition, certain charges like mandi tax, which is collected in exchange for services provided by market committees, have been judicially held not to be taxes, and therefore not within the ambit of section 43B.
Clause 27 Overview
Clause 27 relates to specific accounting treatments regarding Central Value Added Tax (CENVAT) credits and prior period income or expenditure entries in the profit and loss account. The auditor’s role includes verifying the accuracy and completeness of such items as per the books of account and returns filed by the assessee.
Central Value Added Tax Credits and Their Treatment
The auditor is required to obtain a detailed list of Central Value Added Tax credits carried forward from the previous year, as well as those availed of or utilized during the current year. This information must be verified against the CENVAT ledger and returns filed to ensure that the amounts correspond correctly.
If any discrepancies are found between the ledger and the returns, the auditor should check whether proper reconciliations have been prepared and documented. The auditor must ensure that the treatment of CENVAT credits in the profit and loss account is appropriate and reflects the actual utilization and carry forward of credits.
Input Tax Credit Under GST and Reporting Challenges
With the introduction of the Goods and Services Tax (GST), the reporting of Input Tax Credit (ITC) has raised some challenges. Although Form 3CD requires reporting of ITC, the current rules have not been amended to explicitly include the term Input Tax Credit. As a result, there is some uncertainty about the requirement to report GST ITC in the tax audit report.
The predominant view is that since the amendments necessary to the form have not yet been notified by the tax authorities, ITC under GST may not be required to be reported in Form 3CD at present. However, auditors should stay updated on any future clarifications or amendments to the audit reporting requirements concerning GST ITC.
Prior Period Income and Expenditure
Clause 27 also requires the auditor to report particulars of income or expenditure relating to prior periods that have been credited or debited to the profit and loss account during the previous year under audit. These items represent adjustments arising from past accounting periods but recognized in the current year.
It is important to note that income or expenditure crystallized in the current year but relating to prior periods should not be treated as prior period items for reporting under this clause. Similarly, sales or purchase returns during the year should not be classified as prior period income or expenditure.
Applicability of Prior Period Reporting
The requirement to report prior period items applies primarily to entities following the mercantile system of accounting. Under this system, income and expenses are recognized when accrued rather than when received or paid, necessitating the disclosure of adjustments related to earlier periods.
The auditor should obtain a detailed list of such prior period income or expenditure items, including the nature of the item, amount, the prior period to which it relates, and any remarks or explanations. This ensures transparency in financial reporting and helps identify unusual or non-recurring adjustments affecting the current year’s financial statements.
Format for Reporting Prior Period Items
For clarity and uniformity in reporting, the auditor should present prior period income and expenditure in a tabular format detailing the type of transaction, particulars, amount involved, the specific prior period year, and relevant remarks. This assists in providing a comprehensive view of all such adjustments and facilitates verification by tax authorities and stakeholders.
Clause 28 Overview
Clause 28 concerns whether the assessee received any property, specifically shares of a company that is not publicly listed, without consideration or for inadequate consideration, as referred to in section 56(2)(viia) of the Income Tax Act. This provision was applicable from June 1, 2010, to March 31, 2017, and hence is not relevant for assessments from the financial year 2017-18 (Assessment Year 2018-19) onwards. For such years, the auditor generally reports “No” under this clause.
Background on Section 56(2)(viia)
Section 56(2)(viia) was introduced to tax any property or shares received by an individual or Hindu Undivided Family without adequate consideration from closely held companies. The aim was to curb tax evasion through gifts or transfers of shares at undervalued prices. Since this section is no longer applicable for recent assessment years, this clause is included in the audit report mainly for historical reference or when applicable for earlier years.
Clause 29 Overview
Clause 29 deals with the receipt of consideration by a closely held company for the issue of shares where the consideration exceeds the fair market value (FMV) of the shares, as per section 56(2)(viib) of the Income Tax Act. The auditor must verify and report details of such transactions during the previous year.
Section 56(2)(viib) and Its Applicability
Section 56(2)(viib) applies to private limited companies that receive consideration for shares issued to resident persons exceeding the FMV. The excess consideration over FMV is treated as income under the head “Income from Other Sources” and is taxable accordingly. The FMV is generally determined by Rules 11U and 11UA of the Income Tax Rules or other acceptable valuation methods satisfactory to the Assessing Officer.
This provision does not apply to venture capital undertakings receiving consideration from venture capital companies or funds.
Auditor’s Responsibilities Under Clause 29
The auditor must ascertain whether the assessee is a closely held company and obtain a list of shares issued to resident persons along with the consideration received. The auditor should verify the details in the company’s books and documents to confirm if the consideration exceeds the FMV.
A valuation report from a merchant banker as per Rule 11UA(2)(b) should be obtained to substantiate the FMV. The auditor should also secure a management representation letter justifying the issue price. If the issue price is less than FMV, the auditor should select “No” in the relevant e-filing form.
Additionally, the company is required to file Form 61A under Rule 114E if aggregate consideration received from any person for acquiring shares exceeds Rs. 10 lakhs in a financial year. The auditor must verify that this filing is done and report compliance as required in the tax audit report.
Reporting Format for Clause 29
Details to be reported include the name of the person from whom consideration was received, PAN, Aadhaar number if available, number of shares issued, amount of consideration received, FMV of shares, and any remarks.
Clause 29A Income Chargeable Under Income from Other Sources
Clause 29A requires reporting of any amount included as income under the head “Income from Other Sources” as referred to in clause (ix) of subsection (2) of section 56. This primarily involves advances received on capital assets forfeited during the previous year.
Auditor’s Responsibility Regarding Forfeited Advances
The auditor should obtain a certificate from the assessee regarding all advances received on capital assets that were forfeited. Relevant agreements and forfeiture clauses must be reviewed to confirm the legitimacy of forfeiture. Balance confirmations from parties whose advances were forfeited should be secured.
A management representation should be obtained regarding receipt and forfeiture of advances. Mere notices of forfeiture that are disputed by other parties should not be treated as finalized forfeitures for reporting.
Tax Implications of Forfeited Advances
Section 56(2)(ix) provides that advance money forfeited by a seller due to the buyer’s non-compliance with agreement terms is taxable as income from other sources.
Clause 29B Income Chargeable Under Income from Other Sources as Gifts or Deemed Gifts
Clause 29B relates to income from other sources under clause (x) of subsection (2) of section 56, which covers gifts or deemed gifts received that are taxable.
Auditor’s Role in Verifying Gifts and Fair Market Value
The auditor should ensure that acquisitions of shares and securities reported here are through transfer, not fresh issue, and verify the fair market value of unquoted shares and securities per valuation rules. Where the fair market value exceeds the cost of acquisition by more than Rs. 50,000 in aggregate, details must be reported.
For immovable property, if the difference between the transaction value and stamp duty value exceeds Rs. 50,000, it should be reported. If the assessee intends to contest the valuation, the auditor should note the assessee’s stance and management representation in the audit report.
Section 56(2)(x) Provisions on Taxability of Gifts
Under this section, any sum of money received without consideration exceeding Rs. 50,000, any immovable property received without consideration or for inadequate consideration where the difference exceeds Rs. 50,000, and any movable property received without consideration exceeding Rs. 50,000 in fair market value, are taxable as income from other sources.
Exceptions to Taxability of Gifts
There are exceptions where such receipts are not taxable, including gifts received from close relatives such as spouse, siblings, ascendants, and descendants. Gifts on the occasion of marriage, by inheritance or will, from local authorities, charitable institutions registered under relevant sections, and specified trusts or funds, are also exempted.
Further Details on Clause 29 and Related Income under Section 56
Clause 29 encompasses not only the consideration received on the issue of shares exceeding their fair market value but also includes reporting requirements on other types of income chargeable under the head “Income from Other Sources” as outlined in clauses 29A and 29B. These provisions aim to capture various forms of deemed income arising from transactions involving capital assets, gifts, and advances.
Understanding Income Chargeable Under Clause 29A
Clause 29A deals with income chargeable under section 56(2)(ix), which primarily relates to advances received towards the transfer of a capital asset that have been forfeited due to non-compliance with the terms of the agreement. Such forfeited advances are treated as income from other sources.
From the auditor’s perspective, it is important to ensure that any such forfeiture has been properly recorded in the books of account. The auditor should verify the existence of agreements governing the forfeiture, review the specific clauses related to advance receipt and forfeiture, and obtain confirmations or representations from management and relevant parties.
The auditor must exercise professional judgment to distinguish between disputed forfeiture claims and actual finalized forfeitures. Mere notices or claims of forfeiture that are contested by the other party should not be treated as income unless duly settled.
Income Under Clause 29B: Gifts and Deemed Gifts Taxability
Clause 29B requires reporting of amounts chargeable to income under section 56(2)(x), which broadly deals with gifts or property received without adequate consideration. The auditor must focus on items recorded in the books of account that relate to such income from other sources.
The nature of income covered here includes monetary gifts exceeding Rs. 50,000 received without consideration, immovable property where the difference between transaction value and stamp duty value exceeds Rs. 50,000, and movable property with fair market value exceeding Rs. 50,000 received without consideration or for inadequate consideration.
The auditor should confirm the details of such receipts, ensuring that acquisitions of shares and securities are through transfers and not fresh issues. The fair market value of unquoted shares and securities must be verified according to prescribed valuation rules.
For immovable property, the auditor must note the transaction value, stamp duty value, and whether the assessee intends to contest the valuation. Management representations and detailed disclosures in the audit report are necessary to highlight such intentions.
Exemptions and Exceptions to Gift Taxability
Certain categories of recipients and types of gifts are exempt from tax under section 56(2)(x). Gifts received from close relatives, including spouse, siblings, and ascendants or descendants, are exempt. Gifts on the occasion of marriage, by inheritance or will, from local authorities, charitable institutions registered under specific sections of the Income Tax Act, and trusts or funds recognized under the Act are also exempt.
The auditor must verify the nature of the recipient and the source of the gift to ensure accurate reporting and to exclude exempt gifts from the taxable income disclosure.
Auditor’s General Responsibilities for Clause 29 Reporting
The auditor must obtain sufficient and appropriate audit evidence for all items reported under clause 29 and its sub-clauses. This includes verifying the existence and valuation of shares issued, advances forfeited, and gifts or other property received without consideration or for inadequate consideration.
The auditor should obtain management representations and supporting documents such as valuation reports from merchant bankers, agreements, confirmations, and reconciliations. Any deviations, disputes, or potential tax liabilities arising from these items should be documented in the audit report.
Compliance with Form 61A and Rule 114E
Clause 29 also entails verifying compliance with information reporting requirements under Rule 114E of the Income Tax Rules, which mandates the filing of Form 61A by companies receiving specified consideration for shares.
The auditor should check whether the company has filed Form 61A if the aggregate consideration received from any person exceeds Rs. 10 lakhs in a financial year. Details of such filings must be reported in the tax audit report as per clause 42(a) or 42(b).
Integration with Tax Audit and Financial Reporting
The information collected and reported under clauses 26 to 29 plays a critical role in ensuring transparency and compliance in tax audits. Accurate reporting of liabilities under section 43B, CENVAT credits, prior period items, and income from shares and gifts protects the interests of the tax authorities and supports the correct computation of taxable income.
Auditors must apply their expertise to assess the correctness and completeness of disclosures, considering complex valuation issues, statutory interpretations, and evolving judicial precedents.
Practical Challenges and Considerations for Auditors
Tax auditors face several practical challenges in reporting under clauses 26 to 29. The interplay of different tax laws, accounting standards, and judicial rulings requires a thorough understanding of applicable provisions.
Valuation of shares and securities, especially unquoted ones, can be complex and may require reliance on expert reports. For GST-related liabilities, auditors must keep abreast of amendments and guidance notes issued by tax authorities.
In case of disputes over forfeiture of advances or valuation of gifts, auditors must carefully evaluate management’s representations and supporting evidence to provide accurate audit findings.
Conclusion
Clauses 26 to 29 of the tax audit report require meticulous attention to detail and comprehensive verification by auditors. These clauses cover critical areas such as the timing of deduction of specified expenses under section 43B, the treatment of CENVAT and GST credits, recognition of prior period adjustments, and taxation of income arising from shares issued above fair market value, forfeited advances, and gifts or deemed gifts.
Adherence to these reporting requirements enhances the integrity of the tax audit process and supports the accurate assessment of tax liabilities. Auditors must remain vigilant, continuously update their knowledge on legislative changes and judicial pronouncements, and maintain detailed documentation to fulfill their responsibilities effectively.