Accounts Notes: Service Tax on Audit

Attention is invited to Board's Circular No. 19/13/96 dt.21/11/1996 wherein instructions were issued for auditing of assesses providing services relating to telephones, insurance and stock broking. The following instructions are issued in partial modification of the said instructions.

Since service tax has been in operation for over 7 years now, departmental officers as well as the service providers have by now become familiar with the rules and procedures relating to service tax administration. It has therefore been decided by the Board to extend the coverage of service tax audit to other services also on a selective basis.

An Expert Group (EV -07) has already been constituted under the CIDA Project to go into this aspect in details and suggest audit procedures for every service, keeping in mind the specific nature and peculiarity of each service. Once this study is completed it is proposed to bring out a comprehensive Service Tax Audit Manual on the lines of. the manual issued for Central Excise Audit. Till then, the following guidelines are prescribed for immediately initiating audit of selected service, tax assessees .

Only those assesses will be taken up for audit who are registered in the Metropolitan cities of New Delhi, Mumbai, Chennai and Kolkata and whose names are given in Annexure - I.

In respect of Stock-broking, Telephones and non-life Insurance, audit will continue to be done as per norms indicated in Board's Circular of 21/11/96 and selection of assessees by the Commissioners. In respect of these three services the Audit will, obviously, not be confined to metropolitan cities only.

The Audit of assesses listed in Annexure -I should be confined to the accounts for the years 1999-2000 onwards only. In respect of services which have been brought under the tax net in July, 2001, the Audit period will be July 2001 till the date of Audit. The Audit of each selected assessee should be completed in not more than 10 working days.

The audit would be conducted as per proforma Annexure - II (enclosed). This proforma is based on the EA-2000 Audit being carried out on the Central Excise side.

Efforts should be made to have the Audit done by teams of officers who are already familiar with EA-2000 Audit. Before proceeding with the Audit the teams should familiarize themselves properly with the law and procedures relating to Service Tax. The teams should ensure that during the course of Audit there is minimum hindrance in the normal working of the assessee.

Attempt should be made to conduct as many such audits during the remaining months of the current financial year so that short levies detected, if any, can be realized during this year itself.

Gathering and Documenting Systems Information

Interview & organisational information

(a) Person (s) Interviewed and Title:- [Name of the persons who have

been interviewed and their statements in brief]

(b) Organisational Information:- [Identify the Head Office/ registered office or regional/ branch offices of the taxpayer, location of its operations and location of its accounting records. Also the offices who are billing services]

(c) Organisational Type and Ownership:- [Confirm organisation,whether proprietorship, partnership or a Pvt Ltd or Ltd company]

(d) Organisation Chart:- [Obtain the organisation chart or describe the organisation structure if chart is unavailable. Note responsibilities of key personnel and any recent changes, particularly in personnel involved in tax accounting.]
Financial and Tax Accounting Information

(a) Business Records:- [Obtain audited financial statements, trial balance and chart of accounts. In case of audited statements, note name of the chartered accountants and review any notes to the financial statements.]

(b) Consolidated Internal Financial Statements:- [If unit is a division of a company, check if internal financial statements are prepared for the unit being audited before consolidation with other related units. Obtain a copy of last two reports.]

(c) Business Activities:- [Identify all business activities - commercial and non-commercial. For each activity & services indicate annual volume in Rupees. Attach additional working paper if necessary.]

(d) Tax Accounting:- [Describe how the tax payer accounts for service taxes, indicating registers/ledgers used]

(e) Tax Accounting - special situations:- [Clarify how service tax is accounted for in special situations such as service provided to related units, bills cancelled/revised, excess/ short payment of taxes.

Identify special registers or accounts maintained for such transactions.]
Service Information

(a) Pattern:- [List major clients, services provided and indicate annual volume in Rupees. Attach additional working paper, if necessary.]

(b) Service - special situations:- [Identify any special situations such as service to related unit.]

(c) Other Revenue:- [ not connected with any notified service]; [Identify other revenues as reported in the financial statements.]

(d) Miscellaneous:- [Identify any other issue that becomes known during the interview stage. Note other items, such as in-house magazines.]

3. Tour of the Premises:- [Tour the premises accompanied with appropriate personnel. Observe operations to confirm information received to date and to note areas that may be vulnerable to non-compliance. Ask about the number of workers in the organisation and if any shift work is done. This may not be needed, in case of majority of services generally]
Evaluation of the Internal Controls

General/ Tax Accounting

(a) System Review:- [Review and describe Service (Revenue) and tax Accounting and any other service tax related systems. Summarise the flow of information, procedures used for recording transactions and indicate person responsible for various functions.]

(b) Controls that impact taxes:- [Identify and describe any internal controls within these systems that have an impact on accounting for service tax. Check if there have been any system or personnel changes in key areas. If yes, review the change over period with care.]

(c) Walkthrough - Service System:- [Perform a walkthrough of the Service/ Revenue System. Trace a sample of transactions (all types). Amend systems descriptions to match findings in the 'walkthrough.]

(d) Walkthrough - Other system(s):- [Perform a walkthrough of any other system (e.g. Journal Entries & other adjustments etc.). Trace a sample of transactions, of all types from source documents through to the service tax account. Amend systems descriptions to match findings in the walkthrough.]

(e) Walkthrough - Service Tax Return:- [Perform a walkthrough of the process of compiling a tax return for one quarter/ six months, tracing from tax return amounts through to their sources. Amend systems descriptions to match findings in the walkthrough.]

(f) Postings to the General Ledger:- [Test postings from the books of original entry, i.e. Service and other journals, to the General Ledger. Verify that taxes are correctly recorded.]

(g) Taxes in GL:- [Verify mathematical accuracy of taxes by performing test adds on the GL and Journals. Note that even if the records are computerised, the test add should be done to detect programming "bugs".]

(i) High Value Transactions in GL and in Journals:- [Review GL, General Journal and journals for high value transactions related to Taxes. Consider tracing these to the source documents.]
Service/Revenue System

(a) Providing Services:- [Review key controls that prevent or detect the providing of services that are not invoiced. (Can service be provided without recording them?)]

(b) Recording of invoices:- [Review key controls that prevent or detect supply of services that are invoiced but not recorded. (Can services be invoiced but the invoice not recorded in the system?).These may include pre-numbered invoices, authorisation to cancel an invoice etc. etc.).]

(c) Recording of Cash transactions:- [ Review key controls that ensure that all cash revenues are recorded. (How does a unit make sure all cash transactions are recorded and deposited in the bank?) The controls may include pre-numbered cash transaction invoices, daily reconciliation of cash invoices, separation of taxes etc. etc.]

(d) Types of services:- [Review key controls that prevent or detect the mis-classification of services for exemption.]

(e) Credits for returns:- [Review key contro is that ensure adjustments are made to taxes payable for all credits issues for amendment of invoices.]

(f) Other:- [Review any other key internal controls within the Service/Revenue system on, which you can rely.]

(G) Other internal controls:- [Review other key controls that prevent or detect under-valuation of service tax.]

(H) Conclusions:
Analysis, Audit Plan & Assessments
Risk Loss Analysis (Reasonableness Tests)

service tax:- [Prepare the risk loss analysis, covering a period of one year or a minimum of one return, for service tax and provide your conclusions as to the significance of the potential revenue loss. Indicate possible problems and therefor the audit steps that might be indicated]

[Nb - a sample risk loss analysis format is given as Per annexure -'a']

6. Trend Analysis:- [Perform appropriate trend analysis to check the overall reasonableness and consistency of data provided by a taxpayer. Identify potential problem areas and audit steps required verifications of tax implications.]

Auditors should verify the invoices/Bills issued for audit period and the same should be compared with present invoices being issued to ascertain the rates being charged for past and present. Similarly, expenses incurred (including Capital Investment) as compared to income should also be examined.

7. Audit Plan:- [The audit plan must be based on information gathered so far before starting the audit and must be specific.]

Trend Analysis:- [perform appropriate trend analysis to check the overal reasonableness and consistency of data provided by a taxpayer. Identify potential problem areas and audit steps required verifications of tax implications].

auditors should verify the invoices/Bills issued for audit period and the same should be compared with present invoices being issued to ascertain the rates being charged for past and present. Similarly, expenses incurred (including Capital Investments) as compared to income should also be examined

Audit Plan:- [The audit plan must be based on information gathered so far before starting the audit and must be specific.]

SI.No.

Area

Period

Selection Criteria

Verification

Comments

Allotted to Shri(insp)

(i)

(ii)

(iii)

(iv)

(v)

(vi)

1. Registration - (i) whether registration done as per Board's Circular No 35/3/2001 CX dt 27/8/2001,

(ii) since it is not transferable, whether the registration is in the name of the person who actually engaged in the providing of services.

2.(i)Whether the tax is paid in the designated bank under proper TR-6 Chllan and the Tax-return is filed in time, (ii) whether amended return being filed after Noti. No. 10/2001-ST dt 9/10/2001,(iii) if the tax is paid after due date whether the interest at the proper rate is paid or not, (vi) and whether taxpayer has claimed any abatement from tax on account of amount not collected from the clients.

3.(i) In case of provisional assessment whether the taxpayer has applied for it giving cogent reasons, (ii) whether the AC/DC has given his express approval for it; (iii) whether a statement in the form of ST -3A giving details of service tax deposited or liable is filed along with tax return, and (iv) whether assessment is in the process of finalisation.

4. Tax paid amount - (i) whether the tax paid is proper under the law i.e. on gross amount, not on the net amount - (ii) whether it has not been undervalued by not included other incidental charges, and (iii) whether it has been reported by the RO to the AC/ DC who has to pass an order in this regard.

5. Whether excess service tax paid has been correctly adjusted periodically on pro-rata basis.

6. Penalty or Interest recovered whether it is properly calculated.

7. Exemption - Whether it is correctly availed

8. Verification of taxable service from other records/returns whether the taxable service has been cross verified from other records/ returns (i.e. such returns which are filed with government or financial institutions) maintained by the taxpayer.

8. Verificatlon:- [Carry out verification as planned. Note W/P Ref. in the last column of audit plan above. Where audit plan had to be altered, provide suitable comments].

9. Summary of Audit findings and assessment:--- [Once the verification, as per the audit plan, is complete, all of the assessments must be rolled up for presentation to and discussions with the supervisor and the assessee.] (The results must be presented in a logical manner and should be cross-indexed so that it would be easy to follow both by the assessee and Departmental officers).

10. Assesses agreement/ disagreement with the reassessment:- [Make a note of the date and name of person (s) present when the results of the audit as to the significance of the potential revenue loss. Indicate possible problems and therefore the audit steps that might be indicated.]

B. Reconciliation of Service Tax paid as per Return with that shown in Financial Account

Tax reported in Return i.e. 't' should invariably be first reconciled with the amount of tax paid in the financial accounts. For this purpose, the relevant account heads where service tax transactions are recorded should first be identified and then a reconciliation be first made between Service Tax paid as per Return

vis a visService Tax paid as shown in financial accounts. Depending upon the accounting policy being followed, whether service tax collected from customers and service tax paid to the Government are accounted separately or combined, the auditor must first ascertain the accounting system. If both the above accounts are clubbed then, a detailed extract of the combined account must be scrutinized and then tabulated so as to make meaningful comparison. If the two transactions are accounted for separately, then the two acc'ounts should first be reconciled and then compared with the tax return.

C.Auditor should also look towards the Income vs Expenses incurred (including capital investment), whether there is any possibility of suppressing the income liable for service tax. Auditor should also weigh the changes in the current charges for billing service (with the charges for billing service during audit period as per record). Any large variation in such charges without any reasonable basis is an indicator for suppression of income and therefore service tax.
Cir.No. 742/58/2003-CX

Date 3/9/2003

Sub:- Service Tax Audit Manual - Regarding.

I am directed to say that as you are aware that taxation of services was started in July, 1994 in a limited way with three services and since then the scope has been extended considerably. At present, 58 services are subjected to levy of Service Tax. The revenue from Service Tax sector has also been growing appreciably over the time. The audit of selected services (telephones, non-life insurance and stock brokers) was started in the year 1996. Subsequently, the same was extended in 2002 to cover certain selected service providers in four metropolitan cities.

2.Taking into account the peculiarities of service tax law, book keeping practices of service providers and the experiences gained during the course of auditing of selected service tax categories, it is felt necessary to prepare a comprehensive Service Tax Audit Manual following internationally recognized audit methodology to provide guidelines to the departmental officers to facilitate auditing of Service Tax-payers and to ensure uniformity. Accordingly, DirectorGeneral (Audit) has prepared and issued a comprehensive Service Tax Audit Manual. The Manual is for use of the departmental officers, which may be Carefully studied. The suggestions to improve the Audit Manual and the difficulties experienced if any, may be brought to the notice of Director-General of Audit.

3. The salient features of the Audit Manual are:

Legal provisions for levy and collection of service tax are indicated in one place.

Principles of auditing of Service tax-payers based on modern methodology are enumerated.

Guidelines are provided for selection of tax-payers for auditing based on risk assessment technique.

Detailed guidelines are provided for preparation of audit plan before the commencement of the actual audit.

Various techniques of auditing such as 'walk through', ABC Analysis,Revenue Risk Analysis and Trend Analysis are explained.

Specific guidelines are provided for conduct, preparation, reporting and follow up of audit.

Formats for collection and compilation of data on service providers and maintenance of Master Files have been prescribed.

Check list for service tax auditing has been provided.

Detailed profiles for three major services namely, telephone, non-lifeinsurance and stock brokers are made as part of the

Manual for effective audit.

The Service Tax Audit Manual meets one of the most critical requirements of service tax administration. Considering the fact that the administration of service tax is fundamentally following the principle of believing inbona fidesof the tax-payer and trust is reposed on voluntary compliance, it is expected that the Audit Manual shall be able to provide valuable guidelines.
Cir.No. 775/8/2004-CX

Date 17/2/2004

Sub:- Audit of Service Tax Assessees - Regarding.

Attention is invited to Board's Circular No. 19/13/96, dated 21/11/96 wherein instructions were issued relating to visit of Central Excise officers to the premises of the assessees for conducting audit of services relating to telephones, insurance and stock brokers. Subsequently, the coverage of Service Tax Audit was extended to other services also on a selective basis vide Circular No. 38/1/2002-CX., dated 7/2/2002.

A comprehensive Service Tax Audit Manual has been issued vide Circular No. 742/58/2003-CX., dated 3/9/2003 which,inter alia,provides detailed guidelines 'of audit of Service Tax assessees.

Board has examined the proposal of extending the scope of Service Tax Audit and it has been decided to extend the scope to all services which are subject to levy of service tax. Needless to mention that selection of assessees and auditing of those assessees who have been selected for auditing will be subject to the guidelines and procedures prescribed in the said Service Tax Audit Manual.