Chapter 9 Audit of Income Tax

Transcription

1 Chapter 9 Audit of Income Tax Index Topics Pages Introduction to Income Tax Audit Approach to Income Taxes Appendix 1 - Examples of Income Tax Assessments 9.6 Example 1 - Assessment of Personal Income Tax Example 2 - Computation of Taxes on Income from Business Example 3 - Computation of Taxes on Income from Agriculture Example 4 - Computation of Income Tax from House 9.13 Property Appendix 2 - Key Questions Checklist - Income Tax (1) 9.14 Key Questions Checklist - Income Tax (2) 9.15 Key Questions Checklist - Income Tax (3) 9.16 Appendix 3 - Schedule of Main Documents & Records /8/ Chapter- 9 Audit of Income Tax

2 Introduction to Income Tax Chapter 9 - Audit of Income Tax 1. The primary income tax legislation is the Income Tax Ordinance, 1984 (the Ordinance) and the Income Tax Rules, In addition income tax rates, exemptions and rules are amended in Finance Acts passed by Parliament. Rules and SROs also give guidance on income tax matters. 2. Each income tax assessee is required to be registered with the National Board of Revenue and obtain a Taxpayer s Identification Number (TIN No.) 3. The main elements of income as defined in the Ordinance for tax purposes are: any income, profits or gains from whatever source derived, chargeable to income tax under any provision of the Ordinance under any head specified in Section 20; any loss of such income, profits or gains; the profits and gains of any insurance association carried on by mutual insurance associations; any sum deemed to be income, or any income arising or received, or deemed to accrue or arise or be received in Bangladesh under any provision of the Ordinance. 4. The main heads of income mentioned in Section 20 of the Ordinance are: salaries; interest on securities; income from house property; agricultural income; income from business or profession; capital gains; and income from other sources. 5. The Wealth Tax Act, 1963 has been repealed by the Finance Act, A taxpayer is now required to pay a 10% of income tax payable, if the net value of his assets excluding the cost of his own residential house and his liabilities and expenses exceeds Tk 10,00,000.00, but does not exceed Tk 30,00, A taxpayer is required to pay 15% of income tax payable, if the net value of his assets excluding the cost of his own residential house and his liabilities and expenses exceeds Tk 30,00, Auditors derive their authority for the audit of income tax from article 128 of the Constitution of the People s Republic of Bangladesh. Auditors shall be obliged to maintain confidentiality of all tax particulars in the same way as tax officials. 31/8/ Chapter- 9 Audit of Income Tax

3 7. A taxpayer may be allowed various deductions, exclusions, exemptions and allowances from the above income. The net figure of income is then subject to tax at the rates prevailing at the time. Examples of the assessment of taxes on different types of income are shown in Appendix The following different tax stages and possible risks of loss of income tax to the Government merit consideration: Assessment Have all taxpayers/transactions been identified? Has all income liable to income tax been declared? Is there adequate supporting evidence on file? Is gross income calculated correctly? Are the deductions allowable in accordance with regulations? Is the total income assessable correctly calculated? Have the correct tax rates been used? Are any investment tax credits deductible? Is the final tax liability correctly calculated? Are discretionary adjustments clearly shown and authorised? Collection Has the income tax liability been recorded correctly in accounts? Has the full amount been collected? Has it been banked promptly? Allocation Have the income tax receipts been correctly classified? Are income tax receipts correctly shown in Government Accounts? Arrears/Overpayments Do tax files/records clearly show any arrears? Is prompt and effective action taken on arrears? Do tax files/records clearly show any overpayments? Are overpayments refunded promptly to the correct taxpayer? 31/8/ Chapter- 9 Audit of Income Tax

4 Write Offs Has any tax been written off? Was the write off authorised? 9. Revenue auditors should consider these questions when reviewing internal controls and procedures at visits of selected tax offices. A summary checklist for this purpose is shown in Appendix 2. 31/8/ Chapter- 9 Audit of Income Tax

5 Audit Approach to Income Taxes 10. The audit approach taken at local income tax offices will usually follow a top down approach as follows: review management arrangements, any significant changes in tax procedures, systems and tax rates in the past year (see Chapter 8); review data available on trends in income tax in the zone or circle being audited (see Chapter 8); seek explanations for any significant variances and consider whether adequate; review the application of system, procedures and values for assessing, collecting and accounting for income tax (see Appendix 2); carry out substantive tests of the rules, systems and procedures as needed, based on checklist (Appendix 2); and report findings to the appropriate authorities. 11. For the main risk areas, noted in paragraph 8 above, there are a number of controls which should be in operation. The list is not exhaustive but does cover the main risk areas. Revenue auditors should review and test these controls when they carry out their systems and substantive tests at a tax office. 12. The main records for audit are noted in Appendix The main risk(s) and possible control(s) on income tax is listed below: Main Risk(s) Assessment 1. Taxpayers/transactions liable to pay income tax have not been identified. 2. Identified taxpayers/transactions have been incorrectly assessed resulting in under/over payment of income tax. Possible Control (s) 1. Good investigation procedures, comparison with previous tax years, good registration procedures including taxpayers identification numbers, receipt of income tax returns/self assessment returns properly pursued and recorded. 2. Adequate training of tax officials, adequate audit files and supporting evidence, good supervision and review procedures, adequate checking/verification of income liable to income tax, correct tax rules, procedures and tax rates applied. 31/8/ Chapter- 9 Audit of Income Tax

6 Collection 3. Tax assessed as due is not recorded correctly in tax records. 4. Tax assessed as due is not paid or banked promptly. Allocation 5. Tax revenues are incorrectly classified and recorded in accounts. Refunds 6. Refunds of income tax are not made or made incorrectly - wrong amount or to wrong person. Write Offs 7. Income tax due is written off incorrectly or prematurely. 3. Adequate reconciliation and checking procedures in the tax office. Independent review of taxpayers ledger cards. Evidence of payment as per tax files. 4. Good procedures to pursue arrears or nonpayment promptly, reports of long-standing arrears sent to higher authority for action, independent review of banking, arrears. 5. Independent checking of classification of revenues. 6. Refunds are verified independently prior to payment. Taxpayers records are checked independently to ensure that refunds payable are paid. 7. Write offs must be authorised independently by higher authority. 31/8/ Chapter- 9 Audit of Income Tax

7 Appendix 1 Examples of Income Tax Assessments Example 1 : Assessment of Personal Income Tax Mr. XYZ is a salaried person in receipt of a monthly pay of Tk 75, He also receives a medical allowance of Tk per month. He also receives house rent allowances to the extent of Tk 10, per month. He is also given a conveyance allowance of Tk 1, per month (no transport for office pick-up and drop). He has invested Tk 3,00, in approved government securities during the financial year He has certified that he actually spent Tk 20, during the year as medical expenses. Compute the income tax payable by him for the assessment year Computation of Income Tax Name of Tax Payer - Mr. XYZ Financial Year/Accounting Year Assessment Year ) Gross Income: Salary Tk 75, X 12 Tk 9,00, House Rent Allowance Tk 10, X 12 Tk 1,20, Medical Allowance Tk 5, X 12 Tk 60, Conveyance Allowance Tk 1, X 12 Tk 18, (No transport for office pick and drop) Gross Income Tk 10,98, ) Taxable Income i) Salary Tk 75, X 12 Tk 9,00, ii) House Rent Allowance Tk 1,20, Less 50% of Basic Salary or Tk 10, per month whichever is less. Tk 60, Tk 60, iii) Medical Allowance Tk 60, Less Exemption Tk 20, Tk 40, (actually spent and certified) iv) Conveyance Allowance (No conveyance provided by the employer) Tk 18, Less Exemption (Rule 33.C of Income Tax Rules, 1984) Tk 5, Tk 13, Total Income assessable for tax Tk 10,13, /8/ Chapter- 9 Audit of Income Tax

8 3) Tax Liability Up to Tk 75, Next Tk Tk 5, Next Tk 1,25,000.00@18% Tk 22, Balance Tk Tk 1,90, Tk 2,18, Less Investment Tax 15% of 20% of total taxable income of Tk 10,13, or 15% of Tk 1,50, whichever is less. Tk 22, Total Income tax liability Tk 1,95, (Note: Investment allowance permissible is 20% of total taxable income, subject to a maximum of Tk 1,50,000.00). Advance Income Tax paid per month = Tk 10, Advance Income Tax paid during the year Tk 10, x 12 = Tk 1,20, Balance tax payable Tk 1,95, Tk 1,20,000 = Tk 75, /8/ Chapter- 9 Audit of Income Tax

9 Example 2 : Computation of Taxes on Income from Business ABC Company Ltd., a publicly traded company, is engaged in the manufacture and sale of cotton textiles. For the accounting year , the company's account shows a net profit of Tk 20,00, During the year the company recovered a bad debt of Tk 20, but the recovery of this bad debt has not been credited to the Profit & Loss Account for The company had no dividend income during the year. During ' the company also sold an old machine for Tk 40, The original cost of the machine was Tk 80, and the written down value of the machine was Tk 20, This was not reflected in the accounts of the company. During the year the company received an insurance claim of Tk 2,80, in respect of a building which was used for the business of the company and damaged during the year. The original cost of the building was Tk 3,00, and its written down value Tk 2,50, The scrap value realized for the building was Tk 10, During the year a scientific equipment which was used for scientific research which facilitated extension of business of the company was disposed of at a price of Tk 15, When the equipment was procured at a cost of Tk 1,40, the entire cost was allowed as a deduction from the income of the company. This sale proceed was not credited to P&L A/C. The company also exports garments. During the year the company transferred its export quota to another company. An export value to the extent of Tk 45, was prescribed by the Export Promotion Bureau as the company's business income. This was kept outside the accounts of the company. During the year the company paid Tk 1,20, as rent for a building which is used as part of its premises. This was debited to P&L A/C. The company also paid during the year an amount of Tk 12, for repairs to its hired premises. The company undertook to bear the cost of such repair. This was debited to P&L A/C. The company paid Tk 47, as interests for capital borrowed for the purpose of the business. This was not debited to P&L A/C. Cost of current repairs to buildings, machinery, plant and furniture used for the purpose of business debited to P&L A/C amounted to Tk 75, Depreciation debited to P&L A/C is in excess of admissible allowance by Tk 11, An expenditure of Tk 9, on account of hospital established for treatment of the company's employees, their families and their dependants was not charged to P&L A/C. 31/8/ Chapter- 9 Audit of Income Tax

10 Capital expenditure of Tk 1,00, for the extension of an educational institution established for the benefit of the company's employees, their families and dependants was debited to P&L A/C. The educational institution charges for its services. The Chairman of the company incurred a personal expenditure of Tk 47, during his visit abroad as a member of a trade delegation sponsored by the government, and the amount was debited to P&L A/C. Annual membership fee of Tk 5, was paid to the Bangladesh Textile Mills Owners Association. This was not charged to P&L A/C. An expenditure of Tk 60, was laid out for the purchase of a new machine. The company's net profit includes a sum of Tk 10,00, on account of export. Compute ABC Company's income tax liability for the assessment year Computation of Income Tax Liability Name of Tax Payer - ABC Company Ltd. Financial Year Assessment Year Gross Income (net profit) as per Manufacturing, Trading and Profit & Loss Account) Tk 20,00, Add: Bad debt recovered, but not credited to Profit & Loss Account Income from sale of old machine (Tk 40, Tk 20,000.00) Income on account of insurance claim for the damaged building: Tk 20, Tk 20, i) Original Cost Tk 3,00, ii) Written down value Tk 2,50, Less scrap value Tk 10, iii) Difference Tk 2,40, iv) Insurance claim received Tk 2,80, v) Excess of (iv) over (iii) treated as the Tk 40, company s income from business Sale-proceed of scientific equipment Tk 15, Income from transfer of export quota of Tk 45, garments Write-back of depreciation in excess of admissible depreciation Tk 11, /8/ Chapter- 9 Audit of Income Tax

11 Write-back of capital expenditure for extension of educational institution of educational institution erroneously debited to P/L A/C. (No deduction for capital expenditure for the educational institution is permissible as the educational institution charges for its services.) Write-back of Chairman s personal expenditure during his visit abroad as a member of a trade delegation sponsored by the government as this is not admissible as a charge on the company s earnings. This cannot be allowed as a deduction. This is written back. Deduct: Expenditure for charitable hospital not charged to P/L A/C. Interest on borrowed capital not debited to P/L A/C. Annual membership fee paid to the Bangladesh Textile Mills Owners Association not charged to P/L A/C. Tk 1,00, Tk 47, Tk 22,98, Tk 9, Tk 47, Tk 5, Cost of purchase of new machine worth Tk 60, is not admissible as a deduction as this is a capital expenditure. 50% of export income (Tk 10,00,000.00) is admissible as a deduction. Tk 5,00, Cost of current repairs amounting Tk 75, to buildings, machinery, plant and furniture used for the purpose of business was already charged to P/L A/C. No need to allow it as a deduction again. Total Deduction Tk 5,61, Adjusted Total Income (Taxable Income) = (Tk 22,98, Tk 5,61,000.00) = Tk 17,37, Income Tax Liability Total Income (Taxable Income) Tk 17,37, Tax 35% Tk 6,07, Total Tax Liability Tk 6,07, /8/ Chapter- 9 Audit of Income Tax

12 Example 3 : Computation of Taxes on Income from Agriculture Mr. MLH is a self-employed farmer who earns all his income from his agricultural land. During the financial year his gross income from crops amounted to Tk 5,00, He maintains no account of his income and expenditure. He paid Tk 5, on account of land development tax and rent during the period. He also paid Tk 1, as local tax, rate and cess during the period. He also incurred the following cost of production during the period. a) Expenses for cultivating the land Tk 4,00, b) Cartage for marketing the produce Tk 50, c) Repairs and maintenance of agricultural Tk 10, implements and machinery d) Premium for crop insurance Tk 5, e) Expenses for maintenance of irrigation Tk 3, works f) He maintains pucca irrigation channel worth Tk 50,000.00, Kutcha irrigation channel worth Tk 25, and tractor worth Tk 1,00, g) Interest on borrowed capital used for Tk 10, improvement of land h) Write-off on account of net loss on sale of Tk 12, machinery exclusively used for agricultural purpose. i) Interest on mortgage and other capital Tk 10, charges for purposes of improvement of the land j) Cost of packaging Tk 12, Compute Mr. MLH s income tax liability for the assessment year Computation of Income Tax Liability Gross Income Tk 5,00, Less Land Development Tax and Rent Tk 5, Tk 4,95, Less Local Tax, Rate and Cess Tk 1, Tk 4,94, Deduct Cost of Production: i) Expenses for cultivating the land Tk 4,00, ii) Cost of packaging Tk 12, iii) Cartage for marketing the produce Tk 50, iv) Repairs and maintenance of agricultural Tk 10, implements and machinery. Tk 4,72, /8/ Chapter- 9 Audit of Income Tax

13 Since he does not maintain accounts of his income and expenditure, deduction on account of cost of production is limited to 60% of the market value of the produce (Tk 5,00,000.00) i.e. Tk 3,00, and balance cost of production amounting to Tk 1,72, is not admissible as deduction. Less Tk 3,00, Tk 1,94, i) Premium for crop insurance Tk 5, ii) Expenses for maintenance of irrigation Tk 3, works iii) Interest on borrowed capital used for Tk 10, improvement of land iv) Interest on mortgage and other capital Tk 10, charges exclusively used for agricultural purposes. v) Write off on account of net loss on sale of Tk 12, machinery exclusively used for agricultural purposes. vi) Depreciation: a) Pucca Irrigation of book Tk 7, value 50, b) Kutcha Irrigation of book Tk 5, value 25, c) of book value 1,00, Tk 18, Total Depreciation Tk, 30, Tk 70, Total Income (Tk 1,94, Tk 70,500.00) = Tk 1,23, Income Tax Liability for the assessment year : On first Tk 40, (Vide Sixth Schedule, Part A, 00 Paragraph 29) On next Tk Tk 5, On next Tk Tk 6, Tk 11, Advance tax paid per month = Tk Balance tax payable (Tk 11,030.00) - (Tk x 12) = Tk 11, Tk 3, = Tk 7, /8/ Chapter- 9 Audit of Income Tax

14 Example 4 : Computation of Income Tax from House Property Mr. MNZ is the owner of a residential building. He has let out the building for a monthly rent of Tk 50, He pays Tk annually to the government as land development tax. He has constructed the building with borrowed capital for which he pays monthly interest of Tk 15, According to his statement, he incurs an annual expenditure of Tk 2,50, on account of maintenance and provision of basic services. The building was completed on and let out from Compute his income tax liability for the assessment year (F.Y ) Computation of Income Tax Payable: Gross Income from house property Tk 50, X 12 Tk 6,00, Deductions: Land Development Tax Tk Interest on borrowed capital Tk 1,80, Tk 15, X 12 Cost of annual maintenance (evidences not permissible as deduction, i.e. 25% of Tk 2,50, Tk 62, Total Deductions: Tk 2,43, Total Income (Taxable Income) Tk 3,57, Income Tax Liability On first Tk 1,00, On next Tk Tk 5, On next Tk Tk 27, On Balance Tk Tk 14, Tk 46, Income Tax Payable = Tk 46, /8/ Chapter- 9 Audit of Income Tax

15 Appendix 2 Key Questions Checklist - Income Tax (1) Audit Objective Key Questions/Tests Yes No W/P Assessment 1. Regulations and procedures adequately provide for the proper assessment of income tax and those regulations work in practice. 1.1 Are there adequate regulations in place to ensure that all persons, transactions or events liable for income tax are duly identified? 1.2 Do these procedures work in practice on income taxes? 1.3 Are there adequate regulations and procedures to ensure that persons, transactions or events identified as liable for income tax are properly assessed? 1.4 Do they work in practice? Collection 2. Regulations and procedures adequately provide for the collection of sums assessed and the regulations and procedures operate in practice. 2.1 Are there adequate regulations and procedures to ensure that all sums assessed as due are correctly recorded? 2.2 Are these procedures working? 2.3 Are the procedures and regulations adequate to ensure that income recorded as due is collected without undue delay? 2.4 Is income tax collected without undue delay? 31/8/ Chapter- 9 Audit of Income Tax

16 Key Questions Checklist - Income Tax (2) Audit Objective Key Questions/Tests Yes No W/P Banking 3. Regulations and procedures adequately cover the prompt banking of sums due. 3.1 Are the procedures and regulations adequate to ensure that income tax due is banked promptly? 3.2 Do these procedures work? Allocation 4. Regulations and procedures adequately provide for sums collected to be allocated to the appropriate code of account. 4.1 Are there adequate procedures to ensure that: All sums received are promptly and correctly recorded? Only valid receipts are recorded? Records of tax paid are reconciled with amounts banked? All receipts are coded correctly? All recorded receipts are properly shown in the account? 4.2 Are these procedures working? Arrears 5. Procedures for following up arrears of income tax are adequate. 5.1 Are there adequate procedures to ensure that tax unpaid or underpaid is pursued promptly? 5.2 Are these procedures working? 31/8/ Chapter- 9 Audit of Income Tax

17 Key Questions Checklist - Income Tax (3) Audit Objective Key Questions/Tests Yes No W/P Write Offs 6. Procedures for writing off unpaid income taxes are sound and adequate. 6.1 Are there adequate procedures to ensure that write offs or remissions of income tax are appropriate and properly sanctioned? 6.2 Are they working in practice? Refunds 7. All procedures for refunding income tax are adequate. 7.1 Are there adequate regulations and procedures to ensure that: Repayments are properly assessed? Only valid repayments are made? Repayments are made to the proper recipient and for the correct amount? All valid repayments are properly coded and recorded? Repayments are properly shown in the account? 7.2 Do they work in practice? 31/8/ Chapter- 9 Audit of Income Tax

18 Schedule of Main Documents & Records Appendix 3 1. Income Tax assessment files, including tax returns, statements, etc. (IR 24) 2. Statements of assets, liabilities and expenses (IR 25) 3. Register of Taxpayers 4. Register of Outstanding Taxes 5. Taxpayers Ledgers 6. Tax Computation Sheets (IT 30) 7. Daily Collection Register 8. Monthly Tax Assessment Register 9. Applications for Refund of Tax (IR 36) 10. Depreciation Allowance Detail (IR 41) 11. Appeal Forms 31/8/ Chapter- 9 Audit of Income Tax