Tax Audit | Detailed Analysis of Clause 20 and Clause 21 | As per the Guidance Note issued by the ICAI

Income-tax law requires the assessee to get his books of accounts audited in pursuance of the requirement under Section 44AB of The Income Tax Act, 1961. The Chartered Accountant conducting the tax audit is required to give his findings, observations, etc., in the form of an audit report at the e-filing portal of Income-tax in Form No. 3CA/3CB and 3CD. In this story, we would discuss the reporting requirement of clauses 20 and 21, which are contained in Part B of Form 3CD.

1. Clause 20

1.1 Any sum paid to an employee as bonus or commission for services rendered, where such sum was otherwise payable to him as profits or dividend. [Section 36(1)(ii)]

The assessee would be allowed a deduction in respect of a payment made to an employee in the nature of a bonus of commission only if such bonus or commission was available exclusively to such employee in relation to the services rendered by him. However, deduction shall not be allowed in the case of distribution of dividends indirectly in the name of bonus/commission.

The tax auditor is not required to express his opinion on the disallowability or otherwise of these payments.

The auditor should obtain a schedule giving details of the sum paid/payable to an employee as bonus/commission for services rendered and examine the same with the terms of the contract of those employees. In case, bonus/commission paid/payable is not in terms of employment agreement but is paid/payable as profits or dividend, report accordingly.

Also, an auditor needs to verify whether the payment has been made within the time limit prescribed under section 43B. The details of such payment need to be provided in clause 26 of Form 3CD.

1.2 Details of contributions received from employees for various funds as referred to in section 36(1)(va)

This clause permits deduction of the following if it is credited by  the assessee to the account of the employees in the relevant statutory fund on or before the due date. Here, due date is not the due date for filing income tax return but the date by which an assesse is required as employer to credit the employee’s contributions to the employee’s account in the relevant fund under any Act such as:

• Provident Fund (PF)
• Employees’ State Insurance (ESI)
• Superannuation fund
• Any Other Fund for the Welfare of Employees

Further, any grace period allowed under the relevant statute may be taken into consideration while determining the due date. Auditor responsibility is to scrutinize the liability account where contribution received from employees is recorded and compare this with actual contribution deposited. Details under this clause shall be provided in the manner below:

2. Clause 21

2.1 Please furnish the details of amounts debited to the profit and loss account, being in the nature of capital, personal, advertisement expenditure, etc.

2.2 Amounts inadmissible under section 40(a)

Guidance Note provides that where assessee has not deducted TDS and obtained a CA Certificate in Form No.26A to the effect that deductee/payee has declared the payment in his ITR and paid tax on the total income, including such payment and relies on the same so that non-deduction of TDS does not attract disallowance, tax auditor should verify the certificate in Form 26A and how it has been reflected in the statement of TDS filed vide Form 24Q/Form 26Q/Form 27Q.

1. Payment made to non-resident referred to in sub-clause (i)

(a) Details of payment made to non-resident on which tax is not deducted

In clause 21(b)(i)(A) auditor is required to check and report all the payments which are made to non-resident but TDS is not deducted on them. Under this clause, the auditor is required to give the following details for each such type of payment:

• date of payment
• amount of payment
• nature of payment
• name and address of the payee

(b) Details of payment made to non-resident on which tax has been deducted but has not been paid during the PY or in the subsequent year before the expiry of the time prescribed under section 200(1)

In clause 21(b)(i)(B) auditor is required to check and report all the payments which are made to non-resident on which TDS is deducted but the same is not deposited with the government. Under this clause, the auditor is required to give the following details for each such type of payment:

• date of payment
• amount of payment
• nature of payment
• name and address of the payee
• amount of tax deducted

Note: Under both the sub-clauses the entire payment made to a non-resident shall be disallowed.

2. Payment referred under section 40(a)(ia)

(a) Details of payment made to resident on which tax is not deducted

This sub-clause is applicable when any amount of payment is made to a resident on which tax is deductible but the same was not deducted, that amount would attract 30% of disallowance. Under this situation tax auditor has to report the following particulars:

• date of payment
• amount of payment
• nature of payment
• name and address of the payee

(b) Details of payment made to resident on which tax has been deducted but has not been paid on or before the due date specified under section 139(1)

This sub-clause is applicable when any amount of payment is made to a resident on which tax is was deducted but the same was not either fully or partially deposited to the government, that amount would attract 30% of disallowance. Under this situation tax auditor has to report the following particulars:

• date of payment
• amount of payment
• nature of payment
• name and address of the payer
• amount of tax deducted
• amount out of
• deposited, if any

Note: This clause is applicable to only those sums which are disclosed and are claimed as an expenditure.

3. Payment made under section 40(a)(ic)

Section 40(a)(ic) is talking about fringe benefits tax. This attracts to those payments which companies paid to their employees in lieu of benefits they offered in addition to the compensation paid. Now this section is not applicable. If any old dues are paid in the year under audit and debited in the books of account, the same must be reported.

4. Payment made under section 40(a)(iia)

This section is applicable to any sum paid on account of wealth tax. Now this section is not applicable.

5. Payment made under 40(a)(iib)

This section is applicable to any payment made by way of royalty, license fee, service fee, privilege fee, service charge, or any other fee or charge, which is levied exclusively on or which is appropriated, directly or indirectly, from a State Government undertaking by the State Government.

Any such royalty, license fee, service fee, privilege fee etc. should be reported.

6. Payment made under section 40(a)(iii)

This section is applicable to those payments which are chargeable to “salaries”, where it is payable to outside India or to a non-resident, and if, the tax was not deducted or paid therefrom. Under this situation tax auditor has to report the following particulars:

• date of payment
• amount of payment
• name and address of the payee

7. Payment made under section 40(a)(iv)

This section is applicable to any payments which are made towards provident fund or other fund established for the benefit of employees of the assesse unless the assessee has made effective arrangements to secure that tax shall be deducted from the fund which is chargeable to tax under the head “Salaries”.

The amount of payment as referred above is required to be reported under this clause.

8. Payment made under section 40(a)(v)

This section is applicable to those payments on which tax is actually paid by an employer under clause 10CC of section 10(“where an employee, being an individual generate income in the nature of a perquisite, provided for by way of other monetary payment, the tax on such income actually paid by his employer, at his own option, on behalf of employee”).

The amount of payment as referred above is required to be reported under this clause.

2.3 Amounts debited to profit and loss in respect of interest, salary, bonus, commission or remuneration inadmissible under section 40(b)/40(ba) and computation thereof

Under this, the tax auditor has to ensure that the inadmissible amount under section 40(b)/40(ba) and other such information is disclosed in respect of interest, salary paid to partner of partnership firm or LLP, or a member of (AOP) or (BOI). Further, ‘inadmissible’ inferred that the auditor has to examine the facts and conditions for allowance or disallowance and accordingly determine the prima facie inadmissibility of the deduction and also quantify the same. However, Salary, bonus, commission or remuneration, or interest are admissible only when the remuneration or interest is paid in accordance with partnership deed pertain to a period prior to the date of execution of partnership deed/LLP Agreement and shall not exceed the limits prescribed under section 40(b) in case of remuneration or not exceed the simple interest calculated at the rate of 12% in case of interest. Moreover, the remuneration is paid to working partners only.

Information required o be reported is the amount inadmissible as per section 40(b) or 40(ba) and not the total amount debited to the profit and loss account.

2.4 Disallowance/deemed income under section 40A(3)

Under this sub-clause, the tax auditor has to check and reports all those transactions on which payment is made by the assessee exceeding Rs.10,000/- to a single person in a single day (Rs.35,000 in case of assessee engaging in the plying, hiring or leasing goods carriages) other than by way of account payee cheque/draft which should include the list of payments exempted in terms of Rule 6DD with reasons. The auditor should also examine whether the conditions for the specific exemption granted under clauses of Rule 6DD are satisfied or not. If it does not satisfy the conditions mentioned under rule 6DD it should also be disclosed under this sub-clause.

This section is also applicable where the expenditure incurred in the earlier previous year but payment is made on the previous year, and if it exceeds the specified limit, it would be deemed to be the income of the current previous year and reported under this sub-clause.

Also, in cases where the payment is made through crossed cheque. In other words, the crossed

Under this, along with the nature of payment, name and PAN/Aadhar of the person is also to be disclosed in the manner mentioned below:

Note: In the case where an assessee did not possess any evidence, which verifies that the payment made was through account cheque or account payee draft, the same should also be reported.

2.5 Provision made for payment of gratuity not allowable under section 40A(7)

The provision made for gratuity is disallowed under section 40A(7) unless it is paid. This clause puts a liability on the auditor to report all these types of provisions. Moreover, the provision for payment to approved gratuity fund, shall not be disclosed under this clause because the same is reported under clause 26.

Guidance Note requires the tax auditor to verify whether a provision for gratuity has been made as provided in the trust deed. It also requires the tax auditor to verify whether the provision has been made as provided in the trust deed, rules and regulations governing such trust deed and PCIT/CIT Approval Order stipulations

2.6 Any payment made by employer to its employee not allowable under section 40A(9)

Under this sub-clause it is the duty of the auditor regrding the details of payments which are not allowable under section 40A(9) shall be disclosed.

Section 49 states that no deduction shall be allowed in respect of payment made by an employer towards the setting up or formation of, or as a contribution to, any fund, trust, company, AOP, BOI, a society registered under the Societies Registration Act, 1860, or other institution for any purpose, unless such payment is made for the purposes and to the extent provided by or under clause (iv) or clause (v) of section 36(1), or as required by or under any other law for the time being in force.

The requirements of Guidance Note in this regards are as follows:

(a) Tax Auditor shall maintain detailed working papers documenting the factual nature of such expenses incurred and debited to the Profit and Loss for the previous year under consideration, which are considered disallowable under section 40A(9) of the Income-tax Act, 1961.

(b) Tax Auditor should get the relevant content in such working papers duly confirmed by the assessee as a necessary safeguard.

(c) Tax Auditor should carefully examine the capacity of the assessee while making such contribution before reaching any conclusion on the allowability or disallowability of the contribution.

(d) If any such contribution is made by the assessee in a capacity other than that of an employer, then such contribution is not to be considered as disallowable u/s 40A(9) of the Income-tax Act, 1961 and is not to be reported in clause 21(f).

2.7 Particulars of any liability of a contingent nature

Under this sub-clause assessee is required to furnish particulars of any liability which is contingent in nature and debited to the profit and loss account. Thereafter auditor should scrutinize the accounts relating to Provisions/Outstanding Liabilities to ensure that they do not contain any provision for contingent Liabilities.

Further, the tax auditor may scrutinize the particular items of contingent liabilities disclosed in earlier years in order to determine whether or not any items have been provided in the books in the relevant previous year and if so, whether the liability continues to be contingent on nature.

2.8 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

Section 14A of the Income Tax Act, states that no deduction is allowed in respect all those expenditures incurred by the assessee towards the income that does not form part of total income of the assessee as per provisions of the Act.

This clause puts liability on the auditor to check and report the amount of expenditure incurred by an assessee in relation to an income that does not form part of the total income under the Income Tax Act.

The tax auditor should scrutinize the details of the amount of inadmissible expenditure as furnished by the assessee. While doing the same auditor has to rely on the management representation. Moreover, the auditor should also verify the amount of inadmissible expenditure estimated by the assessee with reference to established principles of allocation of expenditure based on some logical parameters.

In case where the Assessing Officer is not satisfied with the correctness of the claim, the computation shall be done in accordance with the method prescribed.

2.9 Amount inadmissible under the proviso to section 36(1)(iii)

Section 36(1)(iii) deals with the amount of the interest paid in respect of capital borrowed for the purposes of the business or profession shall be allowed as deduction under the Income Tax Act, 1961. However, in case where any interest is paid, in respect of those borrowings which are taken for acquisition of an asset for extension of existing business or profession, such interest shall not be allowed as deduction till the date asset was first put to use.

Further, while reporting under this sub-clause the tax auditor should refer to the Accounting Policy adopted by the assessee. He should examine whether the accounting policy of the assessee is in line with principles laid down in AS-16 or Ind AS 23.

Note

This document is prepared as per guidance note provided by ICAI

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Detailed Analysis of Clause 13 and Clause 14
Detailed Analysis of Clause 15 and Clause 16
Detailed Analysis of Clause 17 to Clause 19
Detailed Analysis of Clause 22 to Clause 25
Detailed Analysis of Clause 26 to Clause 29
Detailed Analysis of Clause 30 to Clause 30C
Detailed Analysis of Clause 31
Detailed Analysis of Clause 32 to Clause 34
Detailed analysis of Clause 35 to Clause 38
Detailed Analysis of Clause 39 to Clause 41
Detailed Analysis of Clause 42 and Clause 43