Safeguard to be Taken by Tax Auditor in Certifying Various Clauses of Form 3CD of Companies

Section 271J of the Income-tax Act, 1961 deals with the imposition of penalties on providing inaccurate information in reports or certificates. According to this section, if during any proceedings under the Income-tax Act, 1961, the Assessing Officer or Commissioner (Appeals) discovers that an accountant has furnished incorrect information in any report or certificate submitted under the Income-tax Act or related rules, they have the authority to instruct the said accountant to pay a penalty of ten thousand rupees for each such report or certificate. Consequently, if incorrect information is included in a tax audit report as per section 44AB or any other report/certificate under the Act or Rules, the tax auditor could face a penalty of Rs. 10,000 for each such report/certificate.

Ensuring accurate details in Form No. 3CD is crucial for the tax auditor to prevent penalties under section 271J. The following story outlines the comprehensive measures that a tax auditor of a company should undertake when completing, validating, and cross-verifying information provided in relation to different clauses 20 and 21 of Form 3CD:

Clause 20(b): Details of contributions received from employees for various funds as referred to in section 36 (1) (va)

• Cross-check with the CARO report issued by the statutory auditor to ascertain what statutory employee welfare fund laws like PF/ESIC are applicable to the company.
• Ensure that reporting under clause 20(b) covers employee contributions to all such employee welfare funds deducted by the company assessee from the salary of its employees.
• If the CARO report mentions that there were delays by company in remitting employees contributions under PF and ESIC and reporting in clause 20(b) covers delays only in remitting PF dues, the tax auditor may be found guilty of furnishing incorrect particulars in tax audit report and penalty of Rs. 10,000 may be imposed on him by AO/CIT(A)/JCIT(A).

Clause 21(a): Please furnish the details of amounts debited to the profit and loss account, being in the nature of capital, personal, advertisement expenditure, etc.

First item of Clause 21(a): Details of amounts of capital expenditure debited to the Profit and Loss Account

• To determine whether expenditure is capital or revenue, the tax auditor should have regard to ICDSs – ICDS-V, ICDS-VII & ICDS-IX.
• Where a matter is not covered by ICDS, one can rely on case laws. If the matter is not covered by case laws, the matter should be decided having regard to the generally accepted accounting principles i.e. accounting standards.
• One should keep in view reconciliations between accounting treatment and ICDS prepared for clause 13(e).
• There may be items of expenditure that are required to be capitalized by ICDS-V, Tangible Fixed Assets, but charged off to P&L A/c to comply with (AS) 10/Ind AS 16. These also need to be reported under this clause.
• Suitable note may be given in clause (3) of Form 3CA that

“out of the capital expenditure reported in clause 21(a), amount of `Rs.………. is reported as adjustments required under ICDS V against clause 13(e)”.

This note should be given in clause (3) of Form No. 3CA itself and not in notes attached to Form No. 3CA.

• If the capital expenditure is the amount of interest covered by the proviso to section 36(1)(iii), the same should be reported against clause 21(i) and not clause 21(a).

Second item of Clause 21(a): Details of amounts of personal expenses debited to the profit and loss account

• Tax auditor should check the “Basis for modified opinion” paragraph in the statutory auditor’s report (“Independent Auditors’ Report on Standalone Financial Statements”) for any modification by the statutory auditor as regards personal expenses charged to revenue.
• Also, check the “Report on other legal or regulatory requirements” section of the statutory auditor’s report to ascertain whether any remarks made by the auditor on personal expenses charged to revenue as required by section 143(1) (b) of the Companies Act, 2013.
• Where the CARO report discloses the diversion of term loans for personal purposes of promoters, the tax auditor can consider reporting interest on such diverted funds debited to the profit and loss account as personal expenses under clause 21(b).
• If the statutory auditor’s report does not mention any case of personal expenses charged to P&L, then the tax auditor can rely on the statutory auditor’s report and report ‘NIL‘ against this clause.
• Tax auditor should give a note in clause (3) of Form No. 3CA that he has relied on the statutory auditor’s report for reporting on this clause. This note should be given in clause (3) of Form No. 3CA itself and not in notes attached to Form No. 3CA.

Third item of Clause 21(a): Details of amounts debited to profit and loss account in respect of expenditure incurred by an assessee on advertisement in any souvenir, brochure, tract, pamphlet, or the like published by any political party.

• Section 37(2B) disallows expenditure incurred by an assessee on advertisement in any souvenir, brochure, tract, pamphlet or the like published by any political party.
• Such expenditure is required to be reported against the third item of clause 21(a) in the tabular format if the same has been debited to the profit and loss account.
• In view of the Explanation of section 80GGB of the Act, a view can be taken that such expenditure is deductible under section 80GGB if such expenditure complies with section 80GGB of the Act and section 182 of Companies Act, 2013. This is based on judicial rulings allowing deduction under section 80G of Corporate Social Responsibility spending liable to be disallowed under Explanation 2 to section 37(1). [See Sling Media (P) Ltd v Dy. CIT [2022] 135 taxmann.com 164 (Bangalore-Trib.); FNF India Ltd v ACIT [2021] 133 taxmann.com 251 (Bang.-Trib); JMS Mining (P) Ltd v Pr. CIT (Kol.-Trib)]
• If the conditions of section 80GGB of the Act and section 182 of the Companies Act, 2013 are satisfied and the company has not opted for taxation under section 115BA or section 115BAA or section 115BAB, the tax auditor may report this expenditure as deductible under Chapter VI-A under Clause 33 of Form No. 3CD. In such a case, he should give a suitable note in clause (3) of Form 3CA referring to the third item in clause 21(a) and Clause 33 indicating the judicial rulings relied on by him. This note should be given in clause (3) of Form No. 3CA itself and not in notes attached to Form No. 3CA.

Fourth item of Clause 21(a): Expenditure incurred at clubs being entrance fees and subscriptions

• While reporting club expenses, expenditure incurred at clubs being entrance fees and subscriptions [4th item of Clause 21(a)] should not be clubbed with expenditure incurred at clubs being cost for club services and facilities used [5th item of Clause 21(a)] and reported together under 4th item of clause 21(a).
• The two expenses [(i) entrance fees and subscriptions and (ii) cost for club services and facilities used] are to be separately reported as per the requirement of the prescribed format under Clause 21(a).
• Payments in respect of both employees as well as directors should be reported under this clause in the case of companies.
• The tax auditor only needs to verify and furnish data regarding club expenditure against Clause 21(a). There is no need to opine on the allowability of expenditure as a deduction.
• If any portion of expenditure incurred on clubs is of a personal nature, the same should be shown separately under clause 21(a) as personal expenses.
• In Legacy Global Projects (P.) Ltd. v. Assistant Director of Income-tax [2022] 144 taxmann.com 4 (Bangalore – Trib.), it was held that mere disclosure of club fees in clause 21(a) of the Tax Audit Report does not per se render them liable to be disallowed u/s 37(1).
• Where the Assessing Officer while issuing intimation under section 143(1)(a) made adjustment on account of disallowance of payment made to the club, since the auditor had given details of payment made to various clubs during the year under consideration which were in nature of the subscription and had nowhere pointed that expenditure was disallowable, in such a situation, no adjustment with respect to disallowance payment made to the club could have been made by Assessing Officer in intimation issued under section 143(1) [Ansal Housing Ltd. v. Deputy Commissioner of Income-tax [2023] 153 taxmann.com 102 (Delhi – Trib.)]
• As can be seen in Legacy Global Projects and Ansal Housing cases, unnecessary litigation arises from club expenses reported in tax audit reports. To avoid inconvenience to clients, tax auditors may consider giving a note in clause (3) of Form 3CA stating

“We express no opinion on allowability or otherwise of club expenses reported in the 4th item of clause 21 of Form No. 3CD since we are not required to express any such opinion. The statutory auditors of the Company-assessee, in their “Independent Auditors’ Report on Standalone Financial Statements”, dated…., have not reported any club expenses debited to the profit and loss account as being of a personal nature. Relying on the said Report of statutory auditors, we report that none of the club expenses debited to the profit and loss account are of a personal nature.”

This note should be given in clause (3) of Form No. 3CA itself and not in notes attached to Form No. 3CA.

• If statutory auditors have reported any of the club expenses debited to P& L to be of a personal nature, the tax auditor may consider giving a note in the clause stating “The statutory auditors have reported in their “Independent Auditors’ Report on Standalone Financial Statements”, dated…., that a sum of Rs…..debited to profit and loss account under the head club expenses are expenses of a personal nature. Based on the said report, out of club expenses of Rs…… debited to the profit and loss account, we have reported under the 2nd item of clause 21 of Form No.3CD that a sum of Rs……. are expenses of a personal nature. As for the remaining club expenses of Rs…… debited to the profit and loss account, we have reported the same under clause 21 under the 4th item “Expenditure incurred at clubs being entrance fees and subscriptions” without expressing any opinion on their allowability or otherwise since we are not required to express any such opinion.” This note should be given in clause (3) of Form No. 3CA itself and not in notes attached to Form No. 3CA.

Fifth item of Clause 21(a): Expenditure incurred at clubs being cost for club services and facilities used

See remarks under the Fourth item of Clause 21(a) above

Sixth item of Clause 21(a): Expenditure by way of penalty or fine for violation of any law for the time being force

• Late filing fee paid @ Rs 200 per day for late filing of TDS return is late filing fee. It is neither penalty nor fine. Therefore, the same should not be reported under 6th item to clause 21(a).
• Compounding fee is not fine or penalty and should not be reported against the 6th item to clause 21(a). Same is “Expenditure incurred for any purpose which is an offence or which is prohibited by law” and is to be reported against the 8th item of clause 21(a).
• The tax auditor’s opinion is not required on allowability or otherwise of the amount of penalty or fine for violation of law which has been debited to profit and loss account.
• The tax auditor is only required to report the details of such items as have been charged to the profit and loss account.
• Separate reporting is required of penalty or fine for violation of any law for the time being in force debited to P&L [as the 6th item of clause 21(a)], and any other penalty or fine debited to P&L [as 7th item of clause 21(a)].
• Both types of penalties and fines are distinct and should not be clubbed together and reported either against the 6th item or the 7th item.
• This clause [Clause 21(a), 6th item] covers only penalty or fine for violation of law and not the payment for contractual breach or liquidated damages. Penalty for contractual breach is covered by the 7th item of Clause 21(a).
• Obtain the user credentials from Auditee Company to all government websites like GST, Income-Tax e-filing, MCA, etc.
• Verify the electronic cash ledger of the GST portal for payment of any fine or penalty under GST law.
• Verify TDS returns/Traces portal/Form 26AS for payment of any fine or penalty under the Income-Tax Act.
• Verify the CARO report regarding statutory dues to ascertain whether any fine or penalty has been paid.
• If the Assessee-Company does not give user credentials, the auditor should try to follow alternate procedures to verify fines/penalties for infractions of law. If he is unable to get evidence by alternate procedures, he should consider giving a suitable disclaimer in clause (3) of Form No. 3CA. This disclaimer note should be given in clause (3) of Form No. 3CA itself and not in notes attached to Form No. 3CA.
• The distinction between the amount paid which is prohibited by law and the amount paid which is compensatory in nature under the relevant statute, is relevant. In Mahalakshmi Sugar Mills Co. Ltd. v. CIT [1980] 123 ITR 429 and CIT v Hyderabad Allwyn Metal Works Ltd. [1988] 172 ITR 113 (SC), it was held that when an amount paid by the assessee could be regarded as compensatory (reparatory) in character then it would be allowable u/s 37(1) and if it were penal in nature it was not allowable.
• Study the order imposing a penalty or fine. Study the facts of the case. Study the legal provisions. Then, determine whether the amount paid is a fine or penalty for an infraction of law, or late filing fee, or compensatory in character.
• Where the tax auditor is satisfied that the amount in question is compensatory in character, he should document all relevant facts, and case laws relied upon by him and exercise professional judgment in his working papers.
• The nomenclature given to the payment under the relevant law should be ignored.
• The scheme of the relevant law should be examined to ascertain whether the impost is penal or compensatory in character. If the impost is found to be of a composite nature, that is, partly of a compensatory nature and partly of a penal nature, the impost will have to be bifurcated into penal and compensatory components based on appropriate criteria and only the penal component will have to be reported in the 6th item of clause 21(a).
• If the impost paid is purely penal, the entire amount will have to be reported by the tax auditor. If it is purely compensatory, there is no need to report it. [Prakash Cotton Mills (P.) Ltd. v. CIT [1993] 201 ITR 684 (SC), Swadeshi Cotton Mills [1998] 233 ITR 199, CIT v. Ahmedabad Cotton Mfg. Co. Ltd. [1993] 205 ITR 163 (SC)] [Paras 33.23 to 33.25 and 33.28 of the Guidance Note]
• In the case of Malwa Vanaspati & Chemical Co. v. CIT [1997] 225 ITR 383 (SC), it was held that where the assessee is required to pay an amount comprising both the elements of compensation and penalty, the compensation is allowable as business expenditure, but not the penalty.
• The tax auditor may not be an expert in deciding the nature of payment as to whether it is prohibited by law or not and may not be aware of the intricacies of all the laws of the land. He can rely on the expert opinion.

Seventh item of Clause 21(a): Expenditure by way of any other penalty or fine not covered above

• Late filing fee paid @ Rs 200 per day for late filing of TDS return is late filing fee. It is neither penalty nor fine. Therefore, the same should not be reported under 7th item to clause 21(a).
• Separate reporting is required of penalty or fine for violation of any law for the time being in force debited to P&L [as the 6th item of clause 21(a)], and any other penalty or fine debited to P&L [as 7th item of clause 21(a)].
• Both types of penalties and fines are distinct and should not be clubbed together and reported either against the 6th item or the 7th item.

Eighth item of Clause 21(a): Expenditure incurred for any purpose which is an offence or which is prohibited by law:

• The expression “Expenditure incurred for any purpose which is an offence or which is prohibited by law” is defined in Explanation 3 below Section 37(1) of the Act.
• In terms of Explanation 3, the following expenditures are to be reported under the eighth item to clause 21(a):

(i) any expenditure incurred for any purpose which is an offence under, or which is prohibited by, any law for the time being in force, in India or outside India; or

(ii) any expenditure incurred to provide any benefit or perquisite, in whatever form, to a person, whether or not carrying on a business or exercising a profession, and acceptance of such benefit or perquisite by such person is in violation of any law or rule or regulation or guideline, as the case may be, for the time being in force, governing the conduct of such person; or (e.g. Pharma companies giving away freebies to doctors acceptance of which is barred for doctors under Code of Ethics of Medical Council)

(iii) any expenditure incurred to compound an offence under any law for the time being in force, in India or outside India.

Clause 21(b) (i) Amounts inadmissible under section 40(a): as payment to non-resident referred to in sub-clause (i)

Payments to non-residents referred to in sub-clause (i) are interest, royalty and fee for technical services or any other sum chargeable under the Income-tax Act, 1961 (other than salary) is paid/payable outside India to any person or to non-resident/foreign company in India on which Tax is deductible at source under Chapter XVII-B and

A. Such tax has not been deducted; or

B. After deduction, such tax has not been paid on or before the due date specified in section 139(1) i.e. due date of filing the income-tax return. [If TDS deducted is deposited on or before the due date of filing ITR in any subsequent year, deduction will be allowed in that subsequent year]

In case of default in (A)/(B) above, 100% of the amount is liable to be disallowed under section 40(a) (i).

The following points may be noted:

• The word “amounts inadmissible” means amounts in respect of which deduction is claimed by debit to P&L or by making a claim in ITR and such claim is inadmissible. Tax audit u/s 44AB is an audit of accounts and not an audit of ITR. Therefore, amounts debited to P&L that are inadmissible u/s 40(a) (i) on account of TDS defaults are required to be reported under clause 21(b) (i).
• Tax audit report is required to be e-filed on or before 30th September of the relevant assessment year. However, the assessee has time till 31st October (ITR due date) to deposit the TDS deducted and avoid disallowance u/s 40(a) (i).
• Therefore, the tax auditor must give a note in clause (3) of Form No. 3CA that the status of the non-deposit of TDS deducted in clause 21(b) (i) (B) is as of the date of signing the tax audit report. This note should be given in clause (3) of Form No. 3CA itself and not in notes attached to Form No. 3CA.
• Sub-Rule (3) of Rule 6G provides that the assessee may obtain a revised tax audit report from CA and furnish the same before the end of the relevant assessment year if he has made payments covered by section 43B or section 40(a) after e-filing of tax audit report but on or before 31st October.
• Both defaults in (A) and (B) above are to be reported separately under clause 21(b) (i) (A) and under clause 21(b) (i) (B) respectively.
• Defaults are to be reported individually payee-wise. Reporting consolidated sum in respect of which TDS is not deducted and consolidated TDS not deducted, is not sufficient compliance with Clause 21(b) (i).
• Details regarding TDS defaults in respect of payments to non-resident payees are required to be reported in clause 21(b) (i) while TDS defaults in respect of payments to resident payees are required to be reported in clause 21(b) (ii).
• Date of crediting provision in books should be reported. ICAI has observed that in some cases tax auditors reported dummy dates instead of actual dates.
• In case of default in deducting TDS, the second proviso to section 201(1) provides that the deductor shall not be deemed to be in default if he produces a certificate in Form 26A from a CA that

(a) the payee has furnished return of income;

(b) has taken into account the sum for computing income in such return; and

(c) has paid the tax due on the income declared by him in such return.

• If the tax auditor has relied on certificates from CAs in Form 26A, he should state the fact of such reliance by way of a note in Clause (3) of Form 3CA. This note should be given in clause (3) of Form No. 3CA itself and not in notes attached to Form No. 3CA.
• Cross-check data reported here with data reported under clause 34 of Form No. 3CD.
• Cross-check data reported here with defaults in depositing statutory dues reported by the statutory auditor in the CARO report.

Clause 21(b) (ii) Amounts inadmissible under section 40(a): as payment to non-resident referred to in sub-clause (ia).

Section 40(a) (ia) disallows 30% of any sum payable to a resident on which TDS is deductible but not deducted or after deduction not paid on or before ITR due date.

If TDS deducted is deposited on or before the due date of filing ITR in any subsequent year, deduction will be allowed in that subsequent year.

There are two kinds of defaults involved:

A. Such tax has not been deducted; or

B. After deduction, such tax has not been paid on or before the due date specified in section 139(1) i.e. due date of filing the income-tax return. [If TDS deducted is deposited on or before the due date of filing ITR in any subsequent year, deduction will be allowed in that subsequent year]

The following points may be noted:

• The word “amounts inadmissible” means amounts in respect of which deduction is claimed by debit to P&L or by making a claim in ITR and such claim is inadmissible. Tax audit u/s 44AB is an audit of accounts and not an audit of ITR. Therefore, amounts debited to P&L that are inadmissible u/s 40(a) (ia) on account of TDS defaults in respect of payments to residents are required to be reported under clause 21(b) (ii).
• Tax audit report is required to be e-filed on or before 30th September of the relevant assessment year. However, the assessee has time till 31st October (ITR due date) to deposit TDS deducted and avoid disallowance u/s 40(a) (ia).
• Therefore, the tax auditor must give a note in clause (3) of Form CA that the status of the non-deposit of TDS deducted in clause 21(b) (ii) (B) is as of the date of signing the tax audit report. This note should be given in clause (3) of Form No. 3CA itself and not in notes attached to Form No. 3CA.
• Sub-Rule (3) of Rule 6G provides that the assessee may obtain a revised tax audit report from CA and furnish the same before the end of the relevant assessment year if he has made payments covered by section 43B or section 40(a) after e-filing of tax audit report but on or before 31st October.
• Both defaults in (A) and (B) above are to be reported separately under clause 21(b) (ii) (A) and under clause 21(b) (ii) (B) respectively.
• Defaults are to be reported individually payee-wise. Reporting consolidated sum in respect of which TDS is not deducted and consolidated TDS not deducted, is not sufficient compliance with Clause 21(b) (ii).
• Details regarding TDS defaults in respect of payments to resident payees are required to be reported in clause 21(b) (ii) while TDS defaults in respect of payments to non-resident payees are required to be reported in clause 21(b) (i). Interchanging clauses for reporting is not permissible as TDS defaults in respect of non-resident payments attract 100% disallowance of the sum paid while TDS defaults in respect of residents attract 30% disallowance in respect of sums paid.
• Date of crediting provision in books should be reported. ICAI has observed that in some cases tax auditors reported dummy dates instead of actual dates.
• In case of default in deducting TDS, the second proviso to section 201(1) provides that the deductor shall not be deemed to be in default if he produces a certificate in Form 26A from a CA that

(a) the payee has furnished return of income;

(b) has taken into account the sum for computing income in such return; and

(c) has paid the tax due on the income declared by him in such return.

• If the tax auditor has relied on certificates from CAs in Form 26A, he should state the fact of such reliance in Clause (3) of Form 3CA. This note should be given in clause (3) of Form No. 3CA itself and not in notes attached to Form No. 3CA.
• Cross-check data reported here with data reported under clause 34 of Form No. 3CD.
• Cross-check data reported here with defaults in depositing statutory dues reported by the statutory auditor in the CARO report.
• Check the applicability of provisions of section 206AB of The Income Tax Act, 1961 using the compliance portal available in the taxpayer’s login on the income tax portal.
• If provisions of section 206AB are applicable, check whether tax is deducted at a higher rate.

Clause 21(b): Consideration paid or payable to non-resident for specified services on which equalization levy is deductible but not deducted [Clause (ib) of section 40(a)]

• This item is not there in notified Form 3CD but is there in the e-filing utility.
• Tax auditors should report amounts covered by section 40(a) (ib) in e-filing utility.

Clause 21(d): Disallowance under section 40A (3)/Deemed income under section 40A (3A)

According to Section 40A (3), no deduction shall be allowed in respect of any expenditure incurred by an assessee if:

(1) A payment or aggregate of payments is made in respect of such expenditure;

(2) Such payment or aggregate of payments is NOT made by any permissible mode of payment. That is, payment or payments are made by non-permissible modes of payment. Permissible modes of payment are

a. account payee cheque drawn on a bank or

b. account payee bank draft, or

c. use of electronic clearing system through a bank account or

d. through such other electronic mode as may be prescribed;

Other prescribed electronic modes for making payment are:

• Credit Card
• Debit Card
• Net Banking
• RTGS
• NEFT
• IMPS
• BHIM
• UPI
• Aadhaar Pay.

(3) Such payment or aggregate of payments made to a person in a day exceeds Rs. 10,000 [exceeds Rs. 35,000 in case of payments made to transporters]; and

(4) Such payments or aggregate payments do not fall under any of the exceptions in Rule 6DD

Section 40A(3A) provides that where an allowance has been made in the assessment for any year in respect of any liability incurred by the assessee for any expenditure and subsequently during any previous year (hereinafter referred to as subsequent year) the assessee makes payment in respect thereof which satisfied conditions (1) to (4) above, the payment so made shall be deemed to be the profits and gains of business or profession and accordingly chargeable to income-tax as income of the subsequent year.

The following points are important:

• Where payment is made by a cheque or DD, the auditor has no means to verify whether the cheque or DD was an account payee cheque/DD or not. In such a case, the tax auditor needs to obtain a certificate from the assessee and rely on the same.
• Where the tax auditor relies on a certificate from the assessee as above, the fact of such reliance needs to be stated in clause (3) of Form No. 3CA. The observation made in this regard needs to be reported in clause (3) of Form No. 3CA and not in the notes attached to Form No. 3CA.
• Certain audit tools [Computer Assisted Audit Techniques (CAATs)] are available to find out such payments otherwise than in permissible modes exceeding the limit of Rs. 10,000 expeditiously and accurately. Tax auditors may employ these tools if data is voluminous.
• Cash payments below Rs. 10,000 cannot be ignored if they pertain to the same event or transaction and part of cash payments aggregating up to Rs.2,00,000 or more [sub-clauses (bc) and (bd) of clause 31 of Form No. 3CD]