1) General guidance
Navin Jain (NJ):
Replies to auditor’s queries should be submitted within deadlines.
Avoid taking too many adjournments.
If you recognise the tax officer is not convinced on a particular tax position, encourage him to make a file noting or issue a show cause notice so written submissions can be filed on that issue for consideration. In some cases, even if he is convinced on a debatable tax position, it is always preferable to submit a written reply to avoid the reopening of a tax assessment by a tax officer in future.
If you find any mistake in computation or tax position during the course of tax audit, it is advisable to voluntarily disclose this by filing a letter with the tax officer. If the tax officer raises that query, it may result in initiation of penalty proceedings. Suo moto compliance can result in a strong case against the levy of a penalty.
Jitendra Grover (JG) (pictured below right): The tax audit consequence will be as good as the quality of information submitted to the tax authority. From this viewpoint, it is important to do good preparation before and during the tax audit and taxpayers must try to continuously improve the quality of information and discussion with the tax authority throughout the audit process.
2) Understand focus areas
NJ: At audit, the tax auditor’s main focus is on issues relating to:
Tax holiday / income considered exempt;
Transfer pricing;
Withholding tax deduction on foreign currency payments;
Industry specific issues;
Contingent vs. ascertained liability for claiming expense;
Claim of expenses incurred to earn exempt income;
Tax impact of M&A transactions; and
Any share buyback or repatriation of cash to parent company without any tax liability in India.
JG: In relation to transfer pricing, taxpayers should closely analyse any structural change or major investment in the relevant financial year and get the transfer pricing documentation in-order for discussion.
It is also vital to review all recharges to and from group companies, consider the reasoning for each one of them and how each of them is linked to the group’s transfer pricing policy and business.
3) Proactive review of the financial statements
NJ: Taxpayers should review the balance sheet, profit and loss account and notes to accounts before the sign off of financial statements to proactively identify the key disclosures and accounting treatment that could impact the tax positions already taken or to be finalised.
Proactive review helps produce robust documentation and in building a case in support of tax positions that can be challenged during tax audit.
For example, in case there is a change in accounting policy that results in lower taxable income, taxpayers can proactively ensure that audit committee papers or minutes of such meetings reflect the business reasons for such a change and how the change is in compliance with accounting standards.
4) Comprehensive documentation in respect of key /related transactions
NJ: Identifying key/related-party transactions, outstanding balances and associated documentation – including invoices, agreements and benchmarking – when preparing your tax return plays a very important role at the time of tax audit.
For example, management recharges from the parent company is a huge area of dispute and one can avoid such a dispute by incorporating need, benefit and evidence for such management services in the documentation.
Comprehensive documentation is the key for a smooth transfer pricing audit.
5) Prepare Basis of Preparation (BOP) of tax return that captures all the tax positions and reasons for adopting them
NJ: I would recommended preparing an internal document that lists all the tax positions taken and the basis of the positions such as whether it is an internal position or as advised by advisers.
If the tax position is taken by the internal team, taxpayers should clearly document the judicial decision or other rationale for taking the position. This document is extremely helpful to the team that will be representing the company during the tax audit.
If judicial decisions in favour of a tax position taken have been overruled and settled by for example, the Supreme Court in favour of the Revenue, taxpayers should proactively deposit tax together with interest before the issue is raised in a tax audit.
6) TDS certificates and credit in OLTAS
NJ: As per withholding tax provisions, tax is withheld on the receipts of a company. The tax withheld is claimed as credit against actual tax liability in the tax returns.
The tax office will not give credit for tax withheld if the same is not appearing in OLTAS (report generated online as per records of tax office prepared on the basis of withholding tax returns filed by the persons that have withheld tax).
At the time of filing a return, taxpayers should ensure that tax withheld for which credit is claimed in the tax return matches with the OLTAS report, and where there is a discrepancy, proactive communication is required with the persons that have withheld tax to ensure correction.
This will help avoiding unnecessary administrative inconvenience during the tax audit stage.
7) Analyse the tax audit order for last year’s audit and replies submitted.
NJ (left): There is always a time lag between filing of tax returns and a tax audit.
The tax audit has to be completed three to four years from the end of the financial year for which the tax return is subject to audit.
Information the tax office may request should be compiled at the time of tax return preparation on the basis of last year’s audit experience. Practically, compiling this information at the time requested by the tax office is a challenge due to time constraints, ERP system limitations and changes in internal tax teams.
Analysing the previous year’s tax order and noting the basis on which disallowances were made will help in preparing the reply for the present year’s tax audit and framing the audit strategy.
8) Know the business and ERP system
NJ: Understanding the business, accounting and ERP system is very helpful when appearing before the tax officer during audits.
During a tax hearing, if the tax office is requesting some information or details that cannot be given due to ERP system limitations, one can proactively discuss and explain the difficulties to the tax officer.
If the tax officer has already documented and the taxpayer has agreed to give information during the hearing, it will be very embarrassing to tell him in the next hearing that information cannot be given.
9) Know your rights
NJ:Taxpayers should be aware of a tax officer’s powers and responsibilities. If the tax officer is not allowing adjournment or the opportunity to file legal submissions, reliance on the statutory provisions that require him to do so becomes a very powerful tool.
10) Behavioural aspects
NJ: Be polite, prompt and professional as it will get you so much further. Taxpayers should ensure they are on time, well organised and take the audit seriously. However, they should not be fearful. Be confident and represent assertively on the tax positions challenged by the tax office.
