Clause 21(h) of the Form No.3CD is as under:
Clause 21(h) – Amount of deduction inadmissible in terms of section 14A in respect of the expenditure incurred in relation to income which does not form part of the total income;
As we all aware that, Section 14A of the Income-tax Act read with Rule 8D of Income-tax Rules which provide for disallowance of expenditure incurred in relation to income which does not form part of the total income, had been subject matter of a number of controversies. Hence while disclosing this in Tax Audit, the Auditor as well as the assessee have to be doubly sure. Hence today I am writing this article stating some most important things related to disclosure of section 14A under tax audit report.
Before starting I would like you to glance through the extract of Section 14A and Rule 8D of the Income Tax Act, 1961:
Section 14A of Income Tax Act:
“Expenditure incurred in relation to income not includible in total income.
14A. (1) For the purposes of computing the total income under this Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act.
(2) The Assessing Officer shall determine the amount of expenditure incurred in relation to such income which does not form part of the total income under this Act in accordance with such method as may be prescribed, if the Assessing Officer, having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee in respect of such expenditure in relation to income which does not form part of the total income under this Act.
(3) The provisions of sub-section (2) shall also apply in relation to a case where an assessee claims that no expenditure has been incurred by him in relation to income which does not form part of the total income under this Act :
Provided that nothing contained in this section shall empower the Assessing Officer either to reassess under section 147 or pass an order enhancing the assessment or reducing a refund already made or otherwise increasing the liability of the assessee under section 154, for any assessment year beginning on or before the 1st day of April, 2001.”
Rule 8D of Income Tax Act
[Method for determining amount of expenditure in relation to income not includible in total income.
8D. (1) Where the Assessing Officer, having regard to the accounts of the assessee of a previous year, is not satisfied with—
|(a)||the correctness of the claim of expenditure made by the assessee; or|
|(b)||the claim made by the assessee that no expenditure has been incurred,|
in relation to income which does not form part of the total income under the Act for such previous year, he shall determine the amount of expenditure in relation to such income in accordance with the provisions of sub-rule (2).
[(2) The expenditure in relation to income which does not form part of the total income shall be the aggregate of following amounts, namely:—
|(i)||the amount of expenditure directly relating to income which does not form part of total income; and|
|(ii)||an amount equal to one per cent of the annual average of the monthly average of the opening and closing balances of the value of investment, income from which does not or shall not form part of total income :|
Provided that the amount referred to in clause (i) and clause (ii) shall not exceed the total expenditure claimed by the assessee.]”
The method prescribed under sub-rule (2) of Rule 8D is applicable when the Assessing Officer is not satisfied with the correctness of the claim of expenditure made by the assessee or with the claim made by the assessee that no expenditure has been incurred. Normally this situation would arise at the time of assessment i.e. after the tax audit has been completed and the return has been filed. Therefore, at the time of tax audit the tax auditor will have to verify the amount of inadmissible expenditure as determined by the assessee. The method under sub-rule (2) of Rule 8D is to be adopted by the Assessing Officer when he is not satisfied with the amount as determined by the assessee. Rule 8D does not mandate that the assessee should necessarily compute the disallowance as per the method prescribed under sub rule (2). Therefore, the assessee may or may not adopt the same.
It is primarily the responsibility of the assessee to furnish the details of amount of deduction inadmissible in terms of section 14A i.e. in respect of the expenditure incurred in relation to income, which does not form part of the total income. The tax auditor shall examine the details of amount of inadmissible expenditure as furnished by the assessee. While carrying out such examination the tax auditor is entitled to rely on the management representation. However, attention is invited to para 5 of Standard on Auditing -580, “Representation by Management” (earlier known as Auditing and Assurance Standard-11) which is as under:-
“During the course of an audit, management makes many representations to the auditor, either unsolicited or in response to specific enquires. When such representations relate to matters which are material to the financial information, the auditor should;
(a) seek corroborative audit evidence from sources inside or outside the entity;
(b) evaluate whether the representations made by management appear reasonable and consistent with other audit evidence obtained, including other representations; and
(c) consider whether the individuals making the representation can be expected to be well informed on the matter.”
The tax auditor will verify the amount of inadmissible expenditure as estimated by the assessee with reference to established principles of allocation of expenditure based on logical parameters like proportion of exempt and taxable income recorded, turnover, man hours spent to earn the relevant income etc. For allocation of interest between taxable and non-taxable income, the quantum of investment, the period and the rate of interest are generally the relevant factors to be considered. This requires proper estimates to be made by the assessee. The tax auditor is required to audit such estimates. Attention is invited to Standard on Auditing- 540 (earlier known as AAS-18)“ “Audit of Accounting Estimates”. In accordance with this Standard the auditor should adopt one or a combination of the following approaches in the audit of such accounting estimates:
– review and test the process used by the assessee to develop the estimate;
– use an independent estimate for comparison with that prepared by the assessee; or
– review subsequent events which confirm the estimate made.
An assessee may claim that no expenditure has been incurred by him in relation to income which does not form part of the total income under the Act. Even in such a case the provisions of section 14A will apply. Accordingly, the tax auditor is required to verify such contention of the assessee.
As stated before the method prescribed under sub rule (2) of Rule 8D is to be adopted by the Assessing Officer when he is not satisfied with the correctness of claim made by the assessee. As per clause (i) of sub-rule (2) the expenditure which is directly relatable to income which does not form part of total income is inadmissible expenditure. Besides such expenditure there may be expenditure such as interest, which is relatable to both taxable and non-taxable income which needs to be properly allocated while calculating the inadmissible amount. Interest which, can be directly attributable to any particular income or receipt chargeable to tax needs to be excluded while determining the inadmissible amount. Clause (ii) of sub-rule (2) of rule 8D deals with allocation of interest which, is not directly attributable to any particular income or receipt.
The broad principles may be kept in mind while verifying the amount of inadmissible expenditure. After verifying the amount of inadmissible expenditure, if the tax auditor:
(a) is in agreement with the assessee, he should report the amount with suitable disclosures of material assumptions, if any.
(b) is not in agreement with the assessee with regard to the amount of expenditure determined, he may give:
– A qualified opinion:
A qualified opinion can be given when the auditor is of the opinion that the effect of any disagreement with the assessee is not so material and pervasive as to require an adverse opinion or limitation on scope is not so material and pervasive as to require a disclaimer of opinion.
– An adverse opinion:
The auditor in rare circumstances may come across a situation where the impact of his disagreement about the computation of such inadmissible expenditure is so material and pervasive that it affects the overall opinion. In such a case the tax auditor may give an adverse opinion.
– The disclaimer of opinion:
When the assessee has neither provided the basis nor the supporting documents, for the claim of such inadmissible expenditure, then due to limitation on the scope of auditors work, the auditor can give disclaimer of opinion.”
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(Republished with Amendments by Team Taxguru)