PREPARING FOR SERVICE TAX AUDIT

[Dr. Sanjiv Agarwal]

Scope of Service Tax Audit

The scope of Service Tax audit covers all services which are subject to levy of Service Tax and the selection of assessees and auditing of those assessees who have been selected for auditing will be subject to the guidelines and procedures prescribed in Service Tax audit manual. (Circular No. 775/8/2004-CX dated 17-2-2004)

The audit shall cover all areas of accounts and revenue as per proforma which will have summary of audit reports, summary of audit result, working papers on preliminary review, systems information, organization chart, tax accounting, service information, evaluation of internal controls, general accounting, revenue system, analysis, audit plan, Service Tax trend and reconciliations.

The Service Tax audit covers the following documents, statements or activities -

1. Manner of preparation of business records
2. Financial statements
3. Accounting of Service Tax transactions
4. List of major clients, volume of business and services provided
5. Identification of other revenues
6. Scrutiny of modified or cancelled bill, credit notes, excess or short payment, etc.
7. Legal non-compliances relating to Service Tax
8. Physical inspection of premises

(i)    Scrutiny of high value transactions

(j)    Evaluation of internal checks and controls

While doing the audit, care should be taken to ascertain whether any part of the service charges have been shifted in the expense account thereby suppressing the value of taxable service. At times checking of bank account with expenses and receipts is also important. Any liability accrued for import of services should be examined as also the exchange rate fluctuations.

A company may be liable to service tax with respect to services provided by a foreign branch to its Indian head office. Such services may not be reported as turnover in the financial statements. Auditors should obtain a list of foreign branches and branch accounts and try to scrutinize the same so as to ascertain the value of taxable services.

A good service tax audit approach would include the following –

• Overall knowledge of the service provider's business, accounting systems, returns and other reports filed, history of past assessments, litigation, etc.
• Obtaining the trial balance and getting used to the chart of accounts.
• Understanding the accounting system of the service provider.
• Touring the premises of the service provider including godowns, warehouses, depots, branches, units etc.
• Evaluating the internal control system of the service provider.
• In case of multi-locational units, trial balance should be obtained unit-wise.
• Understanding the various records maintained by the service provider.

Reconciliations for Audit

Reconciliation may be defined as a 'calculation that demonstrates how one figure (such as a balance) is derived from another'. A reconciliation statement serves the purpose of ensuring compatibility and consistency of figures and balances generated and reported by an enterprise. For example, a bank reconciliation statement ensures that the bank balance as per the entity's books are tallied with the bank balance as per the bank's books and if there are any discrepancies they are for genuine legitimate reasons. Thus, 'reconciliation' ensures a consistency in reporting.

The service tax returns and assessment is based on the records of the assessee such as invoice, sales register etc. In order to ensure a full and complete compliance and impart uniformity in assessments the returns may be 'compared' with the financial statements and accounts of the enterprise during the course of the assessment. Audited financial statements would also give sanctity to the figures. From a service tax perspective, reconciliation statements could serve a useful tool to compare the figures reported in the financial statements and in the service tax returns.

Reconciliation of value declared in returns and value as per books is important in view of the following -

• As per rule 6 of the Service Tax Rules, 1994 service tax becomes payable only on receipt of the consideration thereof. However, as per accrual principles of accounting income is recognized as soon as it becomes due. This may give rise to differences between value of services entered in the books and the value offered in the returns.
• Service tax is payable on receipt of advance consideration. However, such advances are not recognized as income in the current year. This may also give rise to difference.
• Service tax is leviable on reimbursements. If the assessee has not taken into consideration the reimbursements while computing the value of services, differences may arise.
• As per new taxation of services provided from outside India rules a branch of a company situated outside India and the company are treated as separate permanent establishments.

Therefore, the services rendered by the branch to the company is also liable to service tax. However, the value of such services will not be recorded as income in the books of the branch.

Certain reconciliation statements that could be generated from the financial statements and records are -

• Reconciliation of value of taxable services provided - charged and collected with financial statements. The reconciliation starts with the turnover as per accounts to arrive at the turnover on which service tax is paid.
• Reconciliation of service tax paid on overseas payments with financial statements.
• Reconciliation of service tax paid on freight with financial statements.
• A reconciliation statement similar to above can be prepared for service tax payments made in other cases where reverse charge mechanism is applicable viz., insurance commission paid to insurance agents by General Insurance and Life Insurance companies, brokerage paid to Mutual Fund Distributors by Asset Management Companies or Mutual Fund, sponsorship services availed by body corporates and firms.

Input credit balances can be checked from the financial statements as follows -

• The Cenvat credit balance unutilized at the end of the year as per the service tax returns should tally with the amount shown under the head current assets in the balance sheet.
• Details of Cenvat credit may be solicited.

There are several statements which can be examined to ensure compatibility and consistency in the reporting of figures in the service tax returns. Some of the documents which may be examined are as follows: -

• Financial statements i.e., balance sheet and profit and loss account;
• Tax audit report - Form No. 3CD attached alongwith the income tax return;
• VAT returns;
• TDS returns under the Income Tax Act, 1961;
• Records - sales register, input credit register, etc.

The VAT returns may be scrutinized to ensure that the value of services which attract both service tax and VAT are consistently reported.

Before commencing the Service Tax audit, the Department generally seeks the following information/documents etc for perusal or asks for the concerned books of accounts to be kept ready for their verification -

• Copy of registration certificate or centralized registration, as the case may be
• List of branches/offices
• List of records and books maintained by the assessee
• Copy of list of records as submitted by the assessee to the department
• Copies of Service Tax returns for past period (3 to 5 years or since last audit)
• Copies of annual report comprising balance sheet, profit and loss account, director's report & auditor's report.
• Copy of trial balance
• Copies of internal audit reports, if any
• Copy of tax audit report, if applicable
• Copy of cost auditor's report
• Particulars of registration with other Government departments/regulators
• Copies of income tax returns
• Copies of VAT returns
• List of general ledger accounts
• List of suppliers, vendors, customers, capital goods suppliers etc.
• Details of joint ventures, collaborations, franchisees, depots etc.
• A note on accounting system and billing procedure alongwith accounting policies followed.
• List of show cause notices and pending adjudications
• List of pending appeals/stay orders
• Details of refund/rebate filed and their status
• Details about valuation of services, exemptions and abatements availed.
• Details of Service Tax calculation and payment
• Details of Cenvat Credit account, opening balance, availed, utilized and balance
• Copy of bank account statement
• Certain reconciliations/data sheets.

Thus, it may be desirable for Service Tax assessees to prepare themselves for Service Tax audit so that they are able to handle audit queries effectively and face audit smoothly.