VAT AUDIT MANUAL

VAT audit manual Maharashtra STD October 2007

DISCLAIMER

1. This is a manual of procedure. It doesn't replace the Act, Rules or Notifications. 2. Any future amendment to the Act, Rules or Notifications may require changes in the procedures. The manual should be read accordingly. 3. Any Trade or Departmental Circular issued after the publication of this manual may modify the procedure. 4. The manual is intended for the internal use of the Department. Nothing from the manual should be quoted in any statutory order, notice or intimation to the dealers or other persons.

Copyright Notice: This manual is the property of the Sales Tax Department of Government of Maharashtra and may not be reproduced , copied, stored or sold or made use for any commercial purposes without the explicit written permission of The Commissioner of Sales Tax

VAT audit manual Maharashtra STD October 2007

CHAPTER 1 BACKGROUND TO VAT COMPLIANCE

Chapter 1.1 1.2 1.3 1.4 Description The scope of this manual The role of VAT audit Elements essential to a VAT compliance system Objectives of VAT audit Page Nos. 7 7 8 9 7 8 9 10

CHAPTER 2 - AUDITORS POWERS AND RESPONSIBILITIES

2.1 2.2 2.3 Auditors powers under the MVATA 2002 Overall Responsibilities Other functions and roles of various officials 11 11 12 11 12 15

CHAPTER 3 - CLASSIFICATION OF AUDITS

3.1 3.2 VAT audit classification Advisory visits 16 17 17 17

CHAPTER 4 - STRUCTURED APPROACH TO AUDIT

4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 General The structured approach to audit Audit organization and staffing Selection of audit visits Management of audit activity Allocation of time to audit cases Control of audit cases Targets 18 18 19 21 25 28 28 29 18 19 21 25 27 28 29 29

CHAPTER 5 - UNDERTAKING THE AUDIT

5.1 5.2 5.3 5.4 5.5 5.6 5.7 5.8 5.9 5.10 5.11 Introduction Notebooks Guidelines for keeping good notebooks Preparation for the audit visit Pre-visit checks Use of mark-up ratios Interviewing a dealer on an audit visit Structuring the interview Basic questions at the interview Use of audit cross-checking system Conducting VAT audit 5.11.1 Auditing of inputs
VAT audit manual Maharashtra STD October 2007

30 30 33 34 35 37 37 38 40 41 42 44

30 33 34 35 36 37 38 40 41 42 46

5.11.2 Auditing of outputs 5.11.3 Use of mark-up, cash reconciliation and cash flow tests 5.11.4 Examination of annual accounts 5.11.5 Accounts audited by accountants 5.11.6 Auditing of special focus areas 5.12 Potential VAT risks 5.12.1. Disaggregation 5.12.2. Absence of VAT dealer records 5.12.3. Failure to produce tax invoices 5.12.4. Failure to produce commercial evidence of exports/ inter-state trade 5.12.5. Failure of VAT dealer to attend appointment for audit 5.12.6. Failure to register for VAT 5.13 Closing the audit visit 5.13.1. Factors to be considered in closing the audit visit 5.13.2. Procedure for closing the audit visit Flow chart

44 44 45 45 46 46 46 47 47 48 49 49 49 49 50 53 52 49

CHAPTER 6 - REFUND AUDITS

6.1 Note 54 54

CHAPTER 7 - POST AUDIT CONTROLS

7.1 7.2 7.3 7.4 7.5 Introduction Action by the auditor Action by the next highest authority Control of audit activities Post Audit Learnings - Business Audit Bulletin 55 55 56 57 57 55 56 57 57 57

CHAPTER 8 - AUDIT CASES WHERE POTENTIAL FRAUD / EVASION IS SUSPECTED

8.1 8.2 8.3 8.4 8.5 Introduction The role of the auditor in fraud investigation. Identification of fraud by auditors Classification and Organization of Fraud Investigation Process for Communication with Investigation Wing 4 58 58 60 61 61 58 60 61 61 62

VAT audit manual Maharashtra STD October 2007

CHAPTER 9 - MANAGEMENT REPORTING

9.1 9.2 9.3 Introduction VAT work return Classification of VAT errors and evasions 63 63 63 63 63 64

CHAPTER 10
10 10.1 10.2 10.3 10.4 10.5 10.6 10.7

-REGISTERS FOR BUSINESS AUDIT SECTION

65 65 66 67 68 68 69 70 65 65 66 67 68 68 69 70

Introduction Control Register (bar 1.) Day Book of Business Audit and Assessment (bar 2) Cross Check Register (bar 3) File movement register (bar 4) Audit not undertaken register (bar-5) Criteria analysis register (bar 6) The description of the above Registers

CHAPTER 11
11.1 11.2 11.3

-THE INSPECTION OF RECORDS

71 71 71 71 71 71

Introduction Coverage Reporting and Compliance

CHAPTER 12
12.0

-COMMENT ON RECORD FILING

72 72

Comment

CHAPTER 13
13. Schedule

-UPDATING OF MANUAL
73 73

VAT audit manual Maharashtra STD October 2007

APPENDICES
APPENDIX A FORMS USED IN VAT AUDIT Form Audit 1 - VAT auditor weekly programme Form Audit 1.1-Dealers' Profile& Pre-visit Check Form Audit 1.2- Preliminary or Desk review Form Audit 2 - Confirmation of audit appointment Form audit 2.1 Authorisation by the JC Form audit 2.2 Duties and responsibilities of the dealer during the course of audit. Form Audit 3 - Urgent / routine cross-checking form Form Audit 4 - Notification of audits that are not undertaken Form Audit 5 - Summary of business activities and records Form Audit 5.9 Interim Audit visit Report Form Audit 6 - Audit visit report Form Audit 7 - Format of Audit Findings DELETED INPUTS CHECKLIST OUTPUTS CHECKLIST ANNUAL ACCOUNTS SPECIAL FOCUS AREAS ASSESSMENTS PROCEDURES (amndd) MONTHLY REPORT ON UNDER-DECLARATIONS STATEMENT OF SPECIFIC AND GENERAL AUDIT VISITS COMPLETED DELETED STATEMENT OF AUDIT ASSESSMENTS AND UNDERDECLARATIONS STATEMENT OF RECOVERIES PENDING WITH BUSINESS AUDIT LIST OF DEALERS FILING RETURNS / REVISED RETURNS STATEMENT TO BE SENT TO REFUND AUDIT BRANCH REFERRAL OF AUDIT CASES FOR INVESTIGATION ILLUSTRATIONS OF VAT EVASIONS THE ROLE OF INTERNAL AUDIT IN STD MARK-UP EXERCISES CASH RECONCILIATION EXERCISES CASH FLOW TESTS TRADE SECTOR NOTES PENALTY SHOW-CAUSE NOTICES LIST OF RELEVENT PROVISIONS OF ACT RULES, NOTIFICATIONS AND CIRCULARS BUSINESS AUDIT BULLETIN ABBREVATIONS 6

APPENDIX B APPENDIX C APPENDIX D APPENDIX E APPENDIX F APPENDIX G APPENDIX H APPENDIX H1 APPENDIX H2 APPENDIX H3 APPENDIX H4 APPENDIX H5 APPENDIX --H6 APPENDIX I APPENDIX J APPENDIX K APPENDIX L APPENDIX M APPENDIX N APPENDIX O APPENDIX - P APPENDIX - Q APPENDIX -R APPENDIX -S

VAT audit manual Maharashtra STD October 2007

CHAPTER 1

BACKGROUND TO VAT COMPLIANCE

1.1 The scope of this manual a) This manual is intended to assist the auditor to carry out an audit by providing a basic structure under which a VAT audit should be conducted. This will enable the auditor to identify areas where VAT legally due has been under-declared. b) The role of VAT audit and the VAT auditor are completely different to that of the internal audit department. There are some brief guidelines attached at Appendix K which set out an international best practice role for an internal audit department in a tax authority. 1.2 The role of VAT audit a) The objective of a VAT audit is to close the gap between the tax declared by VAT dealer and the tax legally due. Using a risk based audit selection system, the Sales Tax Department (STD) should be able to fulfill the dual purpose of maximizing revenue collection and ensuring voluntary compliance by providing a reasonable chance that defaulters will be identified and undeclared tax, interest and penalties are collected. b) The VAT audit is an integral part of a VAT compliance / self-assessment system. It is important to note that, the role of VAT Audit is to undertake business investigation at dealers place of business with prior intimation to the VAT dealer. The VAT auditor is not expected to exercise powers relating to enforcement, viz, search or seizure. However, wherever necessary, VAT auditor has to seek help of Investigation team so that the potential evidence is not destroyed. c) The aim of VAT audit is to encourage the highest possible level of voluntary compliance using a system of self-assessment. The VAT dealer calculates his own liability and makes his payment of the tax declared as due while the STD reviews the self-assessment subsequently by means of a VAT audit. d) A self-assessment system relies for its effectiveness on a number of integrated components: They are: VAT dealers maintaining proper books of account and records, if appropriate, as prescribed by the Law and or Rules An effective taxpayer education campaign so that VAT dealers are aware of their obligations. 7

VAT audit manual Maharashtra STD October 2007

 1.3

Simple, understandable and effective procedures and forms so that a VAT dealer who wants to comply can do so without undue cost Effective penalties for non-compliance which are enforced by the STD Simple and effective controls which reduce the scope for fraud Prompt and effective action against VAT dealers who have not filed VAT returns and / or who have not paid the tax declared or assessed.

Elements essential to a VAT compliance system a) Registration of VAT dealers This provides the basis for control of VAT dealers. It identifies those dealers who have an obligation to account for VAT and brings them under the control of the administration. Failure to register at the appropriate time is dealt with in the relevant provisions of the Maharashtra Value Added Tax Act 2002 (MVATA 2002). b) VAT return The VAT return is the most important form in VAT administration as it provides the basis for the audit of the VAT dealer and the means for collecting the tax. It is essential that the dealer is using the correct VAT return for his business and the filing of those VAT returns is strictly enforced and the tax declared is collected. Failure to take action in these areas renders VAT audits ineffective. c) Keeping books of account and records As VAT is levied by reference to the financial transactions of the business, books of account and records must be kept by dealers to enable STD to check and confirm that the registered dealers have complied with their legal obligations to maintain proper accounts. Dealers must retain their records for a minimum period of five years from the expiry of the year to which they relate, see Rule 68. d) Tax invoices The tax invoice is a crucial document in the operation and control of a VAT system. The tax invoice establishes the VAT liability of the seller of taxable goods and most importantly is also the authority for a buyer to claim a credit for the tax paid on inputs, without tax invoices effective compliance cannot be achieved. Tax invoices provide an audit trail for dealers involved in both the sale and purchase of taxable goods. The MVATA 2002 s. 86 defines the requirements and conditions related to the issue of tax invoices.

VAT audit manual Maharashtra STD October 2007

e) Access to books, records and documents For effective verification of VAT returns, STD auditors require access to the books and records of all dealers. Ordinarily, the VAT dealer is required to keep his accounts, registers and documents at the place or places of business specified in his registration certificate, unless agreed otherwise by the Commissioner. Further, in terms of the provisions of s. 64(1), VAT auditor may require the VAT dealer to make available any accounts, registers, documents or furnish any information relating to his business, as may be necessary for verification of VAT returns. If need be, VAT auditor can take copies or extracts of accounts, registers or documents as may be necessary. VAT auditors can also authenticate the accounts / records / documents evidencing the transactions by putting their signature so as to ensure that the records / evidence is not destroyed or altered. Details of accounts / records / documents authenticated should be recorded in the Note Book. Some VAT dealers will attempt to hide records, which may contain evidence of VAT evasion. In such a case, VAT auditor may consider seeking help of the Investigation team so that search can be carried out for detecting hidden records. The MVATA 2002 s.64 provides for powers of access to premises, seizure of records, and the power to copy and seize books, which can be used by appropriately empowered officials. Penalties are also specified for a failure to fulfill these obligations. 1.4 Objectives of VAT audit a) The overall aim is to check the correct amount of tax is collected and improve compliance by dealers. To achieve this objective, auditors should be required to: Confirm the dealer is correctly registered List the activities undertaken by the business Note the accounting records used by the dealer Ensure the records correctly reflect the business activities of the dealer Assess the level of risk posed by the dealer to the VAT regime and identify the appropriate counter measures Educate the dealer and give the dealer the opportunity to ask questions which the auditor either answers on the visit or seeks guidance at the office and provides the dealer with written advice. 9

VAT audit manual Maharashtra STD October 2007

Ensure that any unsatisfactory features discovered on an earlier visit have been corrected. Ensure that return and other statutory filings are timely done by dealers.

VAT audit manual Maharashtra STD October 2007

10

CHAPTER 2

AUDITORS POWERS, LEGAL PROVISIONS AND RESPONSIBILITIES

2.1 Powers under the MVATA 2002 relating to production and inspection of accounts and documents and search of premises: a) Section 64 of the MVATA 2002 empowers the Commissioner to enter business premises at all reasonable times to inspect accounts, registers and documents related to purchases, sales, delivery and stocks of goods. b) It further empowers the Commissioner to enter and search any place of business of any dealer or any other place where the Commissioner has reason to believe the dealer keeps, or is keeping, any accounts register or documents of his business or stocks of goods relating to his business. c) If the Commissioner has reason to believe any dealer has evaded or is attempting to evade any tax due from him, the Commissioner may seize such accounts, registers or documents from the dealer as may be necessary. d) Section 10 of the MVATA 2002 empowers the Commissioners to delegate such powers and perform such duties as necessary to Additional Commissioner, Joint Commissioner, senior Deputy Commissioners, Deputy Commissioners, Assistant Commissioners, Sales Tax Officers and other Officers and persons. e) VAT auditor will have powers as may be delegated by the Commissioner. Having regard to the recommendation that, Investigation function within a VAT system should be separate from VAT audit function; the Commissioner may decide not to delegate the powers to VAT auditors with regard to investigation, enforcement, search or seizure. However, wherever necessary, VAT auditor should seek help of Investigation team for carrying out effective and purpose oriented audit. Certain audit cases can also be referred for Investigation (Refer Appendix I for further information). f) Currently, the powers under section 64(3) and 63(4) aren't delegated to the officers other than the officers working in the Investigation Wing. g) The various sections rules and circulars which are mainly relevant to the Business Audit Sections working are compiled in Appendix Q. 2.2 Overall Responsibilities: a) Auditors authorized to conduct audit should adhere to the instructions contained in this manual.
VAT audit manual Maharashtra STD October 2007

11

b) The auditor should identify himself and show his authorization to the VAT dealer before commencing his audit. c) The auditor should be impartial and apply the law and Rules in a uniform manner. d) The auditor should ensure that any information obtained in the course of that audit relating to the VAT dealer is treated in strict confidence. e) The auditor should ensure that in the areas covered on the audit visit, tax has been properly accounted for, declared and discharged under the provisions of the MVATA 2002. f) The auditor should ensure that the VAT dealer is treated in a courteous manner and is provided with the opportunity to respond to queries raised by the auditor. g) The VAT dealer should be provided with a full and proper explanation of any under declaration of tax identified. h) Where there is a lack of cooperation, failure to provide information or any unusual circumstances, the auditor should consider about referring the case to Investigation Section. 2.3 a)

Responsibilities of various officials in the audit branch shall also include following functions and roles Additional Commissioner of Sales Tax VAT-3 To be Administrative head of the Business Audit branch in Mumbai. To be in-charge for compilation of DO of the State and Policy decisions on Business Audit. To cause to generate, allocate and distribute the cases for business audit Branch in Mumbai Division and mofussil areas. To Approve post-facto specific audits. To grant pre-Audit permission for Audit visits proposed by Auditors based on market information To Achieve VAT revenue target and target of number of audits in the Business audit Branch. To evaluate revenue risk criteria for audit and make necessary changes as per the results of criteria selected earlier. Approve the extension of time alloted to Deputy Commissioner for completion of each audit case. To communicate with Tax Intelligence Unit. To communicate with other branches of the Sales Tax Departments Joint Commissioner of Sales Tax, Business Audit Overall administration and control of Business Audit section. 12

b)

VAT audit manual Maharashtra STD October 2007

Supervision of all subordinate officers & staff.. Issue authorization letters to Deputy Commissioners for sending it to dealers advising therein that indicated official has been authorized to conduct audit in the dealers' case alloted to them. Inputs on pre-visit preparation, guidance & closure of cases allocated to the Deputy Commissioners. Follow up and achievement of VAT revenue target of the section. Authorization of specific audits based on information generated through audit with post-facto approval by Additional CST Vat 3 and if through local information, then with pre-visit approval of Additional CST Vat 3 in case of Mumbai. In case of matters related with mofussil, such approvals shall be given by Additional CST of respective geographical zones. Supervision of business audit programme. To ensure that all notified audit visits are completed and reported. Conduct quarterly staff meetings on risk areas and audit techniques. Quarterly select one case from those out of Deputy Commissioner having no under / over declaration for detailed scrutiny. Inspection and review of audit units. Approve the extension of time alloted to Asst.Commissioner / Sales Tax Officers for completion of audit. Evaluate Revenue risk criteria. Communicate with fraud investigation cell to maintain cohesion . To keep liaison with other branches. To maintain cohesion within the division. Special attendance to inexperienced staff or weak performers. Monitor and improve staff performance. Review of cases as per section 25. Any other work as directed by the superior. Deputy Commissioner of Sales Tax, Business Audit

c)

Receive letter from Joint Commissioner for being authorized for Audit and send it with confirmation letter to dealer. Issuing of authorization letters in the cases allocated to members of his audit unit. Receipt & allocation of cases to Assistant Commissioners (AC) and Sales Tax Officers (STO). Issuing of confirmation letters to the dealers in own cases. Inputs on pre-visit preparation, guidance & closure of cases allocated to AC, STO. Submit pre-visit preparation for audit to Joint Commissioner in own cases, outline strategy and get inputs in own cases. Conduct of audit in own cases. Preparation & submission of interim / final audit report to JC. Intimating the findings of audit to dealer. If the dealer doesn't not agree with the findings in stipulated time, issue Assessment notice & complete assessment. Educate the dealer wherever required. 13

VAT audit manual Maharashtra STD October 2007

Overall supervision of own audit unit. Consolidation & Submission of Demi-Official(DO) and other statements of the unit. Reaching the revenue and audit targets of self & the unit as a whole. Selection of specific audit cases based on information received and submission to JC. To segregate the papers to be sent to the central registry and to the local registry. Review audit results achieved and reasons for under- declarations of Audit unit. Quarterly select one case from those out of Assistant Commissioner and Sales tax Officer having no under / over declaration for detailed scrutiny. Any other work as directed by the superior Assistant Commissioner of Sales Tax, Business Audit

d)

Receive letter from Deputy Commissioner for being authorised for Audit. Issue confirmation letters for audit in cases allocated to him along with authorisation letter. Follow up of the audit cases after they are fixed, Submit pre-visit preparation of cases, outline strategy and take inputs from DC Conduct of audit in own cases Preparation & submission of interim / final audit report Intimating the findings of audit to dealer If dealer not agreeing with the findings, issue Assessment notice & complete assessment, Educate the dealer wherever required Submission of Demi-Official (DO) and other statement to the Deputy Commissioner. Revenue and audit target completion of self. To segregate the papers to be sent to the central registry and to the local registry. Any other work as directed by the superior e) Sales Tax Officer, Business Audit Receive letter from Deputy Commissioner for being authorised for Audit. Issue confirmation letters for audit in cases allocated to him along with authorization letter. VAT audit manual 14 Maharashtra STD October 2007

Follow up of the audit cases after they are fixed. Conduct of audit. Verification of books and audit of business. Preparation & submission of interim / final audit report. Advising the dealer to file revised returns. If dealer not agreeing with the findings, issue assessment notice & complete assessment. Educate the dealer wherever required.

Submission of Demi-Official (DO) statement to Deputy Commissioner. Revenue and audit target completion of self. To segregate the papers to be sent to the central registry and to the local registry. Any other work as directed by the superior Authority. f) g) Sales Tax Inspector, Business Audit Collection of information / Preparation of dealer profile Preparation of pre-visit report Getting the files and details from the division offices and other branches wherever available Follow up dealer for confirmation of audit scheduled date To serve the appointment letters / notices / orders if such are returned unserved. Help officer in verification of dealers details / record Read and correct the statements, letters prepared by clerks Put up and follow up cross check. See that the requisite check list of activities to be carried out at dealers POB are completed. Preparation of weekly audit program Rearrange the visits where they haven't taken place in first instance To give information to clerk for DO and other statements To follow up for payments where dealer agrees for revised returns To carry out audit as & when directed Any other work as directed by the superior Tax Assistant / Clerk, Business Audit

Can assist the auditor in capacity of tax assistant in the audit at dealers premises as and when required by his officer Preparation and certification of registers Receipt and entry of files in registers Getting the files and details from the wards / divisions or other branches Putting up of letters of allocation, confirmation Submission and forwarding of UOR Typing and putting up of letters and communications Put up Monthly statements VAT audit manual 15 Maharashtra STD October 2007

Preparation of proceedings for file movement. Taking relative entries of under declarations in prescribed registers Preparation and submission of monthly statements and other statements Custodian of files Any other work as directed by the superior

VAT audit manual Maharashtra STD October 2007

16

CHAPTER 3

CLASSIFICATION OF AUDIT
3.1.VAT audits can be divided into 3 main categories: a) General audit b) Refund audit c) Specific audit i. General audit: These audits form the majority of the audits to be completed by STD and the objective of general audits should be to provide broad audit coverage of all VAT dealers within 5 years with additional audits for larger, more complex VAT dealers and those with identified under-declaration risks. The selection of VAT dealers for general audit is defined later in this audit manual. ii. Refund audits: the guidelines for these audits are set out in a separate manual. The said manual be referred as and when necessary in cases of refund audit iii. Specific audit: Specific audits include:

audits resulting from the receipt of urgent references, see the section on crosschecking (these should take priority) late registrations cancellation of registration where large amounts of revenue are deemed to be at risk audits emanating from credible information regarding suspected major tax evasion from intelligence sources audits resulting from the receipt of routine references where the dealer is not registered for VAT, see the section on cross-checking later in this manual. audits resulting from existing audits, where the auditor is of view that there is possibility of tax risk, even if the dealer is registered. These cases shall be authorised by Joint Commissioner and need post audit approval of the Additional Commissioner of Sales Tax, VAT 3. In case of mofussil audit cases such approval shall be given by Joint Commissioner in charge with post facto approval of zonal Additional Commissioner

VAT audit manual Maharashtra STD October 2007

17

audits resulting out of market-related information from various sources received by any auditing official or by joint Commissioner. These Audit visits shall need pre-audit permission by Additional Commissioner of Sales Tax (VAT Adm 3) for Mumbai and Additional Commissioner of Sales Tax of respective zone for mofussil area.

3.2.Advisory visits

One of the objectives of VAT audit is to educate the dealer and give him an opportunity to ask questions which the auditor either answers on the visit or provide the dealer with written advice after seeking guidance at the office. These visits are not general audit visits, however, they should be incorporated as specific audits. Visits to the large dealers and dealers allocated to LTU should be completed to encourage compliance where significant revenue is likely to be involved.

VAT audit manual Maharashtra STD October 2007

18

CHAPTER 4

STRUCTURED APPROACH TO AUDIT

4.1.General: a) The level of audit activity and frequency of audit will be decided by the staff resources available related to the VAT registered dealer population. However, it will always be necessary to ensure that the available staff resources are deployed to achieve the twin objectives of maximizing both revenue collection and voluntary compliance by VAT dealers. b) The achievement of these objectives can produce a conflict, for the targeting of high risk dealers should maximize revenue collection, whereas broad audit coverage is necessary to achieve maximum voluntary compliance. A balance, therefore, has to be struck between the deployment of audit resources, both to collect revenue and to provide wide basic audit coverage. This is to be achieved by selecting cases pertaining to specific annual tax throughput as mentioned in para 4.6(a) and deploying the various categories of officers to cover these dealers based on the throughput. 4.2.The structured approach to audit: a) Work must be planned in such a way so that an audit takes full account of available information, assesses the action required and is carried out systematically. The auditor should routinely: plan the audit programme arrange the appointment with the dealer carry out the pre-visit / audit preparation perform a detailed and structured initial interview with the dealer record the information obtained from the dealer in the interview, and subsequently from the dealers records, in the auditor notebook assess the information and identify potential risks, these will help the auditor to decide the checks to be applied when carrying out the audit of the records examine business activities and records, and test and verify, where possible, the information found and where not possible, question the dealer for clarification record the checks made and any results in the auditor notebook
VAT audit manual Maharashtra STD October 2007

19

 conduct a final interview with the dealer, this should attempt to resolve any issues discovered during the audit and also highlight any discrepancies found issue an assessment for any under-declaration of VAT after following prescribed process, where the dealer has not been able to provide a satisfactory explanation and also notify the dealer of any over-declaration by advising him to file appropriate forms and returns , if not already filed. record the work performed in the auditor notebook and subsequent audit report b) A structured approach to the audit ensures that: For the auditor: time is spent effectively when examining the dealers records work is focused on areas of risk the auditor develops a professional approach to his work and from this uniform professional approach, STD develops its credibility with the dealer population the confidence of auditors is developed For the dealer: the audit is seen as an opportunity to develop a relationship with STD and enable him to meet his legal obligations is able to resolve any uncertainties regarding his VAT liabilities in a satisfactory manner there is a formal and transparent way of recording what has been undertaken on the audit and the dealer has a permanent record of any under-declarations and has the opportunity to challenge the auditors findings

4.3.Audit organization and staffing: a) VAT audits should be carried out in large taxpayer units (LTUs), Mumbai VAT office and divisional offices. b) It is recommended that the audit function within each office should have separate teams to deal with the following audits: Refund audit (Normally, Refund audits would be handled by Refund Audit Section) 20

VAT audit manual Maharashtra STD October 2007

General and Specific Audit

c) The allocation of staff numbers to each team should broadly follow the workload percentage set out in this manual. In other words, 80% for general, and 20% for specific audits. Refund Audit has its own separate allocation. d) The Additional Commissioner Of Sales Tax (VAT ADM3) should be directly responsible for overseeing the work of the VAT offices (Business Audit Branch) in Mumbai. He shall cause to generate the Audit cases through Mahavikas for the Business Audit Sections in Mumbai and in mofussil areas and for communicating the same. He shall be responsible for the compilation of Demi-official statements and the policy matters regarding Business Audit for the State. In case of Moffussil , the Joint Commissioner in charge of the VAT Administration shall be responsible for overseeing the Business Audit. He shall be also responsible for a giving sanctions for specific audits with post facto approval from zonal additional Commissioner. e) The Deputy commissioners, assistant commissioners and STOs should be supported by Sales Tax Inspectors (STIs) and there should be a number of clerical support staff who may also work as Tax Assistant. f) In section offices, the more complex VAT audits should be carried out by the DC with support from the AC and designated STOs or STIs' as may be appropriate. g) Audit of other large dealers should be carried out by the AC. h) The less complicated smaller VAT audits should be carried out by STOs. i) Composition audits and audits resulting from references where the selling dealer is not registered, should be carried out by STOs and STIs. Whereas, in case of specific audits having bearing on large scale revenue the same can be carried out by the DCs or ACs. j) In Mumbai VAT Business Audit section and mofussil offices, it is desirable that VAT dealers should be audited at least once during a five-year period with the larger dealers audited once a year. k) Due to the number of composition dealers, it may not be possible to adhere to the principle of receiving an audit every five years. Therefore, it may be necessary to select the higher risk composition dealers based on turnover, compliance and perceived risk. l) The average number of audits per month to be completed by each official of Business Audit are reported in para 4.8 below. These targets may however be changed from time to time depending upon actual results

VAT audit manual Maharashtra STD October 2007

21

m) The Mahavikas should generate and communicate the allocation of cases at least one month prior to the completion of earlier tranche of cases. This will facilitate the planning of audit visits after considering various issues like previsit checks, adjournment of visits on account of the unavailability of the dealer or the officer on a particular date due to any reason, issuance of confirmation letter, etc. Generation and allocation of cases through Mahavikas shall be facilitated by the office of Additional Commissioner of Sales Tax Vat Adm 3. 4.4.Selection of audit visits: a) In the initial years of the VAT : Till the time, the Mahavikas system is fully and completely operational and the audit criteria are evolved for generating general audit cases, the cases shall be selected from the database of the dealers by applying the criteria decided by a designated committee of CST, Additional CST Adm Vat 3, Joint Commissioners of Business Audit sections and any other members as may be nominated by CST. These criteria may be changed from time to time. The random selection shall also be a criteria for selection of audit. However, such cases are to be limited to maximum 20% of the total general audits. Apart from these i. Where significant credible information is received, including urgent references from other audits, concerning the possibility of evasion, an audit should be carried out at the earliest opportunity. These shall also include the specific audits mentioned in first para of (i) in part (b) below ii. Dealers, who have consistently failed to file VAT returns (other than composition dealers) and have been issued with ex-parte assessment(s), should receive an audit where it is considered there is a significant revenue risk. iii. The third category would be of those dealers which are selected by applying certain audit criteria as mentioned above.

b) Subsequent years of audit i. Specific audits These audits may include those which are generated by applying specific criteria or trade or area, or a dealer, or those audits which are undertaken in response to certain specific information generated through market or through audit visits of the auditors. The selection of specific audits can also be made manually by the head of the audit office. However the specific audit should not normally exceed 20 % of the available audit capacity.

VAT audit manual Maharashtra STD October 2007

22

The cases in which Investigation Branch has conducted visits, business audit should be taken compulsorily in such cases for the next 3 years . The cases may be selected by auditor for specific audit being the cases generated through any audit visit undertaken. The sanction of these specific Audits should be given by the concerned Joint Commissioner of Sales Tax with post-facto approval by the Additional CST (VAT-3) for Mumbai and of the Additional CST of respective Geographical zone for mofussil. The specific audit cases which are generated through market related intelligence the previsit approval is to be taken from the Additional CST VAT Adm 3 for Mumbai and from respective zonal Additional CST in case of mofussil

ii.

General audits The selection of general audits should be based on the criteria set out below. The highest number of points equates to a higher level of deemed risk and therefore priority for audit. 20 % of the general audit cases shall be generated through random selection method from the total list of Vat dealers, after excluding the cases already selected for audit for that particular year. After a particular criteria is applied and list is generated of general Audit, the results of the criteria should be tabulated in register named BAR 6. For cases selected through random selection the criteria shall be random selection. The criteria are not permanent, but can be changed from time to time after evaluating the results consolidated from BAR 6.

CRITERIA Level of tax throughput (input tax plus output tax) Above Rs. 10 lakhs in the last 12 months 60 points Between Rs. 3 lakhs and Rs. 10 lakhs in the last 12 months 40 points Between Rs. 1 lakh and Rs. 3 lakhs in the last 12 months 30 points Below Rs. 1 lakh in the last 12 months 20 points Compliance

VAT audit manual Maharashtra STD October 2007

23

o Dealers who have received an assessment for an under-declaration of tax on a VAT return where the amount exceeds Rs. 1 lakh or are marked POOR on an advisory visit 40 points o Dealers who have received an assessment for an under-declaration of tax on a VAT return where the amount is below Rs. 1 lakh 30 points Complexity of VAT dealer business o Dealer whose business involves international exports/ SEZ 20 points o Dealer who holds a certificate of entitlement under a package scheme of incentives 20 points o Dealer whose business involves: International importer Branches within the state of Maharashtra Inter-state Branch transfer and consignment sales Sales to other states Purchases from other states Works contracts Exempt goods Mark-up
o

1-3 activities 5 points 3-5 activities 7 points In excess of 5 activities 10 points

Where the mark-up is > 40% below the average for the activity/ commodity code 40 points Where the mark-up is between 20%-40% below the average for the activity/ commodity code 30 points Where the mark-up is 10%-20% below the average for the activity/ commodity code 20 points 24 2007

o
VAT audit manual Maharashtra STD October

Date of the last audit visit o More than 3 years 40 points o Between 1 year and 3 years 10 points o Below 1 year 0 points

Legal entity o Proprietor 20 points o Partnership 15 points o Private Ltd Co., 10 points o Public sector and Public Ltd Co. 7 points o Others 5 points o Government department 0 points

Criteria Level of tax throughput Compliance Complexity of VAT dealer business Mark-up Date of the last audit visit Legal entity Business Activity TOTAL c)

Maximum points 60 40 50 40 40 20 50 300

The cases which are not to be audited: In cases which are allotted to Business Audit section, but wherein the dealer has already submitted the form number 501, the Business Audit for that financial year is to be carried out by the refund audit section. The business Audit section should not carry out Audit of such case in that year. In cases where a dealer has been selected for business audit and during audit by Business audit section, the case results in refund to the dealer, the auditor in the business audit branch should complete the audit by applying all 25

VAT audit manual Maharashtra STD October 2007

checks enumerated in refund audit manual along with their business audit and after issuance of the audit findings or filing of 501 or revised returns in consonance with audit findings, the matter be referred to refund audit branch along with the final findings of Audit for subsequent action i.e. Grant of refund. The names of such dealers along with specified details are to be communicated every month through the office of the Joint CST to the Refund Audit branch in the prescribed H6 Format of statement The cases which are allotted to LTU are not to be audited by Business audit branch 4.5.Management of audit activity: a) The overall management of the VAT audit section is responsibility of the Additional Commissioner Sales Tax (VAT ADM-3). He will be responsible to the Commissioner of Sales Tax for the VAT audit plan and achieving the VAT audit revenue target. In the mofussil areas the Joint Commissioner VAT Administration shall be responsible for the overall management of the VAT in the respective Geographical Division. b) Additional Commissioner Sales Tax (VAT ADM-3) shall also be responsible for the policy matters related to Business Audit and generating the general audit cases for Mumbai as well as Mofussil areas c) For Mofussil divisions, the Mahavikas computer system will select a percentage of the audit workload in a selected time period.. This will be based on the number of VAT dealers, the audit staff availability and the need to audit all VAT dealers once in a five-year cycle. The dealers with the highest number of points will be selected for audit. d) There is ability for the Assistant Commissioner (AC) and Deputy Commissioner (DC) audit to manually select dealers files for audit based on local knowledge, intelligence or the need to audit for a specific audit, for example an urgent reference. This manual selection is only to be used with a view to auditing high-risk VAT dealers and for selecting specific audits. The Joint Commissioner (JC) audit should authorize these audits. However, the post-facto approval should be taken from Additional CST (VAT-ADM3) in such situations in Mumbai and that of respective Additional Commissioner of that particular division in cases of mofussil areas. However for audits of cases based on the market related information, such approval should be taken from the respective Additional Commissioner of Sales Tax prior to conduction of audit. e) Once the audit selection has been made, the audits must be completed unless the authority of DC or the JC, as the case may be, is obtained for non-completion of the audit, see Form Audit 4, Appendix A. In case of delay in completion of the audits para 4.6(e) and 4.7 (a) may be referred for extension procedure.

VAT audit manual Maharashtra STD October 2007

26

f) The JC audit is responsible for the management of VAT audits in his section and DC Audit is responsible for the management of VAT Audit in his Audit unit. g) The Joint CST as well as the Deputy CST should ensure that the authorization letters are issued to the auditors along with the list of the cases allotted to them through Mahavikas or otherwise. This shall ensure proper planning of audit program h) Auditors planning audit visits should complete Form Audit 1; see Appendix A, when making audit appointments on office days. The final program on Form Audit 1 should be passed to his immediate Superior not later than the last office day for the preceding week. The details of Form Audit 1 should be entered into the computer audit system before passing on to the next authority. In case of change in the audit program like changing the dealer to be visited for any reason, the same be intimated to the immediate superior before going for the changed visit. i) The draft job descriptions for the audit positions in STD are set out in the current draft of the proposed STD organizational chart and staffing allocations. j) The job descriptions indicate the functional role and managerial responsibility of each position within the audit function.(outlined in Chapter 2 of this Manual) k) The following management activities should be conducted: Joint Commissioner: 1. Ensure the audit programs are satisfactorily completed.
2. To maintain control register for the cases allocated to his section . 3. 4.

To review overall audit results achieved and the reasons of underdeclarations to focus the activity to maximize revenue collection. Conduct quarterly staff meetings to exchange views on risk areas and audit techniques. under-declaration / over-declaration for detailed scrutiny

5. Quarterly select one audit case of deputy Commissioner where there was no

6. Approve the extension of time alloted for audit cases allocated to Assistant Commissioners / Sales Tax Officers.

Deputy Commissioner 1. Ensure the audit program is satisfactorily completed

VAT audit manual Maharashtra STD October 2007

27

2. Review audit results achieved and the reasons for under-declarations to focus audit activity to maximize revenue collection. 3. Quarterly select one completed audit visit where no under-declaration/ overdeclaration was detected by ACs or STOs' for detailed scrutiny 4. Conduct quarterly staff meetings to exchange views on risk areas and audit techniques Assistant Commissioner 1. Ensure the audit program is satisfactorily completed Sales Tax Officer 1. Ensure the team audit program is completed

l) The following table depicts the structure and hierarchy for reporting, file allocation, closure of Audit and submission of Demi-official Reporting statements Files allocated by Reviews progress of audit and closes files of

Reports to Designation
Additional Commissioner VAT 3 Joint Commissioner Deputy Commissioner Assistant Commissioner Sales Tax Officer Sales Tax Inspector Clerks Commissioner of Sales Tax Addl. Commissioner VAT 3 Joint Commissioner Deputy Commissioner Deputy Commissioner Respective Officer Respective Officer

Submits D.O. To

Compiles D.O. Of

N.A.

N.A.

Commissioner of Sales Tax Additional Commissioner VAT 3 Joint Commissioner Deputy Commissioner Deputy Commissioner None None

State along with that of Mumbai Business Audit sections All Audit Units Audit Unit Own Own

N.A. Addl. Commissioner Deputy Commissioner Deputy Commissioner None None

Deputy Commissioner Assist. Comm. & STO None None

None None

None None

VAT audit manual Maharashtra STD October 2007

28

4.6.Allocation of time to audit cases a) When planning allocation of time for audits, the following time should be allowed for the audit of VAT dealers. VAT dealers with annual tax throughput (input tax + output tax) exceeding Rs.10 lakhs not exceeding 5 days. VAT dealers with tax annual throughput (input tax + output tax) between Rs.2 lakhs 10 lakhs not exceeding 3 days. VAT dealers with annual tax throughput (input tax + output tax) below Rs.2 lakhs not exceeding 2 days.

b) It is also to be seen that the allocated audit cases should be completed within a period of three months from the date of allocation. c) Tax throughput should be taken as the output tax declared on the VAT return together with the set-off (input tax) claimed on the VAT return. d) For the first 2 years, a monthly average of tax throughput should be used to establish this criterion. e) The time limits specified for audits in (a) and (b) above should not be exceeded. In matter of the cases allocated to the Sales tax officers and the Assistant commissioners the time limits specified can be exceeded with the written authority of the JC, when there is evidence that significant additional revenue is likely to be generated, or there is evidence of possible evasion or there is a valid reason for the delay in action. In case of the deputy Commissioners the time limits can be exceeded with the written authority of the JC under similar conditions mentioned above. The reasons for the delay may be recorded in AUDIT FORM 5.9 which is to be submitted to superior authority and the same can be used for seeking the permission for extension. f) The maximum time allocation should include preparation for the visit, time spent at the premises of the dealer and post-visit action excluding the assessments which may take longer time. g) Effective VAT audit is best achieved by the use of short, sharp, targeted visits which depend on thorough visit preparation to be effective. 4.7. Control of audit cases: a) It needs to be ensured that the Auditing officials complete their allocated physical quota of Audit Visits in the time stipulated under para 4.8, within three months of the communication of the allocated cases. Any case not completed in the audit
VAT audit manual Maharashtra STD October 2007

29

month should be carried forward in priority order to the next month or, alternatively reported with the reason for the inability to complete the audit. In case the delay is more than three months then the permission be sought by following the procedure set out in 4.6 (e) above. b) The allocation of audit cases should be recorded on a computerized listing with the date of allocation, the date of commencement of audit and the date of finalization. c) The authority of the JC or as the case may, of DC should be obtained on Form Audit 4, see Appendix A, before an audit case is accepted for non-completion. d) The JC or as the case may be DC should monitor the allocation, completion and standard of all audits. 4.8 Targets: The auditors are generally and on average, expected to complete following targets in the Audit Branch. These targets can be changed in future depending upon the actual results accomplished. a) Physical Targets: : : : 4 Audit visits per month. 8 Audit visits per month. 10 Audit visits per month.

Deputy Commissioners Assistant Commissioners Sales Tax Officer b) Financial Targets :

Currently, the Financial target based on the cost of the staff in the four business Audit Sections in Mumbai multiplied by the factor of 100, is set to Rs. 580 crores per annum for these Business Audit sections of Mumbai. This may be suitably divided amongst the sections and units to arrive at the unit wise targets. The targets for the Mofussil areas should likewise be decided. It has also been discussed and decided that as non filing of returns is also a type of evasion and the credit of payments made by such non filers who file returns after audit may be given to the auditor. The amount of tax, interest and penalty which is finally assessed by the Auditor by passing the Assessment order shall also qualify for the achievement of target. Similarly in matters where the cases have been referred to the enforcement branch, indicating therein the amount recoverable the same amount shall qualify for inclusion in the targets of the referring auditor.

VAT audit manual Maharashtra STD October 2007

30

CHAPTER 5

UNDERTAKING THE AUDIT

5.1. Introduction: a) The VAT audit is one of the most important links in the chain of the VAT administration. It is the opportunity to interact with the dealer and more importantly check the self-assessed VAT returns the dealer has submitted. b) If VAT audit is seen to be ineffective, dealer non-compliance by way of underreporting tax due will grow and tax evasion will become a major problem in revenue collection. c) This chapter defines in some detail the action to be taken to perform effective VAT audits. 5.2 Notebooks a) Notebooks are pivotal to the audit system. A suggested layout for an audit notebook is set out below with example text in italics: Front cover of notebook

VAT AUDIT NOTEBOOK

Auditor nameM Howard Notebook number 1... Date taken into use4 May 2005 Date taken out of use22 August 2005

VAT audit manual Maharashtra STD October 2007

31

Inside cover of notebook (Index) Date of visit Dealer name 4 May 2005 Gangadhar Ltd 5 May 2005 Kamal Ltd

Page number(s) 1-6 7-10

Main pages of notebook Page 1. Date: 1 May 2005 Dealer name: Gangadhar Ltd Dealer address: 12 Kemps Corner, Mumbai

VAT audit manual Maharashtra STD October 2007

32

b) Further recommended guidelines for keeping notebooks are set out below under guidelines for keeping good notebooks. c) Keeping good notebooks is an essential component of an effective VAT audit. If the auditor is to recollect what he has done at an audit, it is not sufficient to write up the notes at a later stage. This is a bad habit and should be discouraged. The distractions that occur at the office often mean that notes of a visit are not written until days after the visit. d) The recollection of facts and, in particular, figures, is substantially diminished after a few hours let alone a few days. Once this practice is adopted it soon becomes a routine and the process and purpose of good notes is lost. e) If dealers are not happy with an auditor taking notes it should be explained that the notes are part of the audit process and have to be written in order that the auditor recalls what was checked on a specific visit. f) There is a natural aversion by some dealers and they are uneasy about auditors taking notes. If all auditors make good notes at their visits then dealers will gradually become used to this process and soon take it for granted. g) The following points highlight some of the reasons why good notes are so important to the audit visit:

They provide an accurate recollection of events and facts It provides information, not only for the auditor, but for other people, including management and any subsequent investigation As outlined above, they can be the main evidence in starting a fraud investigation and can form part of the evidence that assists in successful penalties being levied against the dealer It provides a record of what was said between the dealer and the auditor in answer to the auditors questions It can assist in preventing allegations of wrong-doing or corruption when the auditor is in the habit of keeping good notes in a well organized notebook.

h) The importance of good notebooks should not be under-estimated. Many auditors could find themselves being asked about a visit they may have undertaken some months or years before. It becomes very embarrassing for an auditor if he has to admit that his notes are either non-existent or lacking in detail. i) The auditors notebook should be completely confidential and should not be shown or copied to the dealer. The only exception is the record of interview VAT audit manual 33 Maharashtra STD October 2007

which can be shown to the dealer in order to obtain his agreement that the recorded interviews, and his answers, are accurate. 5.3 Guidelines for keeping good notebooks a) Notebooks are only as good as the effort that is put into maintaining them. The process of note taking is important and needs the auditor to consider what he is asking and what answers are given in return. b) On an audit the auditor should prepare a series of fundamental questions that all dealers should be asked. The answers to these questions should be noted very clearly in order that there is no misunderstanding in the answers given. c) It is important before using any form of notebook that the following points are considered: The notebook is bound making it difficult for pages to become loose and drop out The pages should be individually numbered A list of basic questions should be stuck at the front of the book to act as an aide-memoir (see later) All entries in the book are to be made in ink

d) When the above points have been considered, the auditor should get into a routine when writing up his notebook at the dealers premises. The following points should be observed: Use the prepared basic questions as the start point for the interview and all other questions should come from these answers Start each visit with the dealers details, date, where the visit took place, the time it started and subsequently finished and who was interviewed Write all entries neatly as it may be some time until they are referred to, remember other people may need to read them

e) If auditors visit a dealer in teams of two, one auditor should ask the main questions and the other write the answers. This can be reversed on the next visit so both auditors get used to both asking and noting the questions/answers. The auditor taking the notes may also think of other questions once the interviewing auditor has finished.

VAT audit manual Maharashtra STD October 2007

34

f) Never, under any circumstances, remove pages from the notebook. If there are mistakes, leave them in the book and cross them out so the original error can be seen alongside the new answer or point. g) Record precisely what has been checked, nothing more and nothing less. It is often tempting to write details of things that have not been checked in detail. This should be avoided as it could be an important issue at a later stage and therefore embarrassing if the auditor is unable to give pertinent detail. h) Record any problems, in particular anything that appears fraudulent. This note could be important evidence at a later stage. i) Record transactions for cross-checking (this is discussed in detail later in the manual) j) Record the dealers replies to answers accurately 5.4 Preparation for the Audit Visit: a) The head of the divisional VAT office should pass the VAT dealer files selected for audit to the auditors so that visit preparation can commence. The information can also be accessed by the official on the mahavikas. b) When planning audit visits, account should be taken of the time allocation defined earlier in this manual and the visits planned within that time-scale. c) Audit visits should be carried out on 4/5 working days of the week and the other day(s) should be office days for the planning of audit visits, report writing, the resolution of queries and issue of assessments. d) Ideally, all audit staff should attend the office on the same day to allow for the discussion of the problems identified in the past week and to develop teamwork. However, the head of the audit division should hold regular staff meetings with all audit staff, at least once in a quarter, to identify audit problems, exchange ideas and plan future audits. e) In the case of general and audits resulting from urgent references, the auditor should contact the authorised person listed in the file and make an appointment for the audit visit. f) This appointment should be made at least one week in advance and the VAT dealer advised to have all the books, accounts and records available, and the appointment confirmed by posting or delivering Form Audit 2. The list of documents and the books the dealer should keep ready for the audit should also be sent with form Audit 2 ( see Appendix A). This form should be prepared in duplicate and the original sent to the dealer with a duplicate placed in the dealer file. The auditor should ensure that the authorization letter in form 2.1 issued by his superior authority and the duties and responsibilities in Audit form 2.2 is
VAT audit manual Maharashtra STD October 2007

35

sent along with the confirmation letter to the dealer. If any extra documents and statements are to be prepared by dealer, the same are to be be informed to the dealer g) The audit visit should normally be carried out at the dealers place of business. If it is conducted at any other notified premises, a visit must be made to the business premises to establish the credibility of the business and the nature of the activities undertaken. h) Before the visit, the VAT dealer file should be reviewed in detail, checked for outstanding references, copies of any VAT returns / Revised VAT returns and the revenue risk areas should be identified. A plan of the areas to be checked should be developed at this time. i) Each week, the auditor should prepare the computer Form Audit 1 in triplicate. Two copies should be passed to the immediate Superior, to be used to check the completion of audit reports and for onward communication to the Joint commissioners office. In case of Deputy commissioners the program shall be in duplicate, of which one copy will be forwarded to joint commissioners office. The auditor should retain the other copy for his own record- keeping purposes. In case the program of audit visit is changed due to non availability of the dealer or any other reasons, and some other dealer is to be visited then the same can be done under prior information to the immediate superior authority. Audit visits should not be made without the prior intimation to the immediate superior. 5.5 Pre visit checks a) It is essential the auditor considers the dealers business before he arrives for the audit. This will improve the confidence of the auditor when he establishes some knowledge of the business and the trade that he works within. b) In the same way that preparing basic questions gives a more professional image of the auditor, time spent looking at the overall credibility before the audit will help establish what the auditor needs to examine on his visit. c) For example, if the sales or purchases of the dealer have been fluctuating the auditor should try and establish the reason. It may be that the dealer has seasonal variations in his business, however, it could indicate that the VAT figures are being manipulated. d) It is also worth consulting colleagues who have visited similar businesses and establishing what the trends could be and what possible problems may be encountered on the audit. e) It is valuable to gather any information, that is legally available, from other Government departments before the visit, for example details of the dealers imports and exports, which will assist in establishing the credibility of the business.
VAT audit manual Maharashtra STD October 2007

36

f) General checks on the input to output ratio can be checked to other businesses in the same trade to see if they are credible. Whilst these do not prove underpayment or fraud they can give the auditor an indication of how the business is performing and whether or not it appears credible. g) The auditor should consider the risk areas associated with particular dealers and plan his visit accordingly. For example, a restaurant will receive large amounts of cash and the auditor should consider examining the cash controls at the visit. h) The auditor could consider looking at the business before his visit to establish what normally happens when an official of STD is not present. He can then establish if there are any differences on his visit. For example, are there more cash registers being used when he is not there, the amount of staff and the general level of trade can all assist in establishing an understanding of the business before the visit takes place. It can also uncover potential areas of under-declaration or fraud. i) When constructing an interview, in conjunction with the basic interview questions outlined later in this manual, the auditor should also consider supplementary questions that are specific to the type of business he is to visit. j) Before contacting the dealer establish what records should be available at the visit. If the dealer has not been asked for certain documents, he can blame the auditor for not specifying what was required. k) Form 704, where available, should be consulted and risk areas from this form considered. l) If it is not feasible to send a letter outlining what records should be made available, the auditor should make a list of what he needs in his notebook and use this as a reminder when he telephones the dealer to make an appointment. This will avoid any uncertainty over what was requested and the auditor then has a note to refer to at the visit. m) To assist the auditor prepare for the audit there are sector notes attached at Appendix O which highlight some higher risk trade sectors where international best practice VAT audit guidelines are set out. n) The standardized formats for the dealer profile and Pre-visit checks are provided in Form no.1.1 and Form no.1.2 respectively. These formats should be filled , risk areas identified and should be discussed with the immediate supervisory authority before conducting of Audit. This is expected to help in identification of the main risk areas.

VAT audit manual Maharashtra STD October 2007

37

5.6 Use of mark-up ratios: It is expected that in course of time the information about the mark up ratios of the various trades and industries shall be available on Mahavikas for comparing with the mark ups shown by the dealer. When such information is available a) Average mark-up ratios for the past twelve months period should be produced by the computer for each combined trade category / commodity code. In addition, the mark-up ratio for the particular return should also be available. b) The auditor should examine the data provided for the tax periods and identify any tax periods where there are wide variations from the normal pattern of mark-ups or where the mark-up for the tax period is in excess of 10% below the average for the particular category / commodity code. c) Mark-up ratios should be analysed carefully and only those related to specific activities and commodities have a value in selecting tax periods and risk areas for audit. For example: 5.7 A VAT dealer selling motor vehicles and spares would provide meaningful data from the ratio for comparison purpose A general store or a departmental store selling a wide variety of goods would not provide any reliable mark-up ratio data.

Interviewing a dealer on an audit visit a) The purpose of interviewing the dealer is to obtain information about his business and the accounting records. For this reason it is essential that the interview be conducted with the dealer and not a representative. b) In some large businesses this may not be practical, as the directors may have delegated responsibility for the accounts to another person. However, where practical the business owner should be interviewed to ascertain the workings of the business and if he does not keep the records, then the appropriate person should also be interviewed on this matter. c) If the person keeping the records is purely a bookkeeper, then it is important to establish who supplies the information that he writes into the records. d) This could be very important at a later stage if there is an allegation of fraud as the bookkeeper can only enter into the records the figures that have been supplied to him. e) Some examples of basic questions are set out later in this chapter and should be used for every audit. Supplementary questions will follow from these and can be tailored to the particular type of business that is being audited. f) It is important to ask basic questions as a matter of routine as dealers will become used to this and it also gives the auditor confidence in his interviewing

VAT audit manual Maharashtra STD October 2007

38

skills. An auditor who is prepared for his interview will appear more professional to the dealer and therefore command more respect. g) If the auditor presents his questioning in a random unstructured manner he will not only miss asking vital questions but furthermore, he will appear unprofessional in front of the dealer. h) The interview should be conducted in a relaxed manner. It is not an interrogation and if this is how it is presented to the dealer he will undoubtedly be guarded in his answers. A relaxed structured interview will encourage the dealer to discus his business and consequently produce the answers the auditor requires. i) The auditor should not, however, accept a vague answer to a specific question. If the dealer appears unsure of something, the question should be asked again in a different way. 5.8 Structuring the interview a) The interview with the VAT dealer should flow logically through the following headings: 1. Personal details of the interviewee and his business 2. Accounting structure 3. VAT knowledge 4. Knowledge of VAT obligations b) It is important not to ask the VAT dealer closed questions. If, for example, the auditor is trying to establish what bank accounts the dealer is using for the business, the following examples of questions would produce different answers: 1. How many bank accounts do you use for the business? 2. You have a bank account for the business? c) The first question is asking the VAT dealer to tell the auditor how many accounts he has for the business. In the second question, the auditor is telling the VAT dealer that he has a bank account for the business and he will probably say yes. d) The latter does not establish what the correct position is in relation to the business bank accounts. If the auditor subsequently finds other bank accounts, it might lead him to believe that the VAT dealer has been evasive with his answer.

VAT audit manual Maharashtra STD October 2007

39

e) This would be the case in the first example as the auditor has asked the correct question. The second example would leave the VAT dealer in the position that he could correctly say that the auditor never asked him how many bank accounts he used for the business. He has said that he has a bank account, but he has not been asked how many. f) The questions auditors should be asking should be structured to gain information. It is therefore better to begin the questions with an open style: Who Why When What Where Which How

g) Questions started in this way will encourage the VAT dealer to talk and the auditor will probably get answers to other questions when he gives his answers. h) Closed questions are usually answered with a yes or no and do not further the interview. i) If there are two auditors at the interview, the auditor writing the notes of the interview should listen carefully to the questions and answers and ensure that he records them correctly. j) It is important to show an interest in the VAT dealer and his business as this will also encourage him to talk about his business and any problems he has encountered. This, in turn, might indicate areas where the auditor could find under-declared tax if the dealer has not applied the VAT rules correctly k) Questioning should not be rushed as more can be gained by talking to the VAT dealer than looking at the records and not understanding how the business works. l) The accounts will only show the auditor what the VAT dealer wants him to see and what has been declared, any abnormalities will be highlighted from the interview.

VAT audit manual Maharashtra STD October 2007

40

m) The VAT dealer should also be allowed to ask questions and clarify things he does not understand. This will gain his confidence and ascertain if he has any problems with VAT as it applies to his business. A good interview will: 5.9 ESTABLISH THE NORMAL QUESTION THE ABNORMAL

Basic questions a) The following are examples of basic questions that should be used as a template for interviews with dealers: What are the VAT dealer contact details? What are his responsibilities in the business? Who is the accountant? What is the accounting system (in full)? What books and records are kept (in full)? Other records kept (for additional credibility checks) Who completes the records? What are the main business activities? What are the other business activities? What are the principal outputs? What are the principal inputs? Who are the main customers? Who are the main suppliers? Who puts the figures on the VAT returns? If not the VAT dealer, does that person receive the information from the dealer? Does he understand VAT as it applies to his business?

VAT audit manual Maharashtra STD October 2007

41

 5.10

Does the VAT dealer understand that all sales must be declared on the VAT return? Does the VAT dealer understand that all purchases must be genuine? Are all sales and purchases correctly declared on the VAT returns? Are all the VAT returns correct? Does he understand that it is an offence to render false VAT returns?

Use of audit cross-checking system: a) The checking of one VAT dealers input tax claim to the selling VAT dealers output tax is a vital control in VAT audit. Manipulation of tax invoices and false tax invoices are a major source of fraud and evasion. b) A cross-checking system should be used to counter this practice. This system provides that auditors can refer information from original input tax invoices for cross-checking at the VAT dealer issuing the invoice. For this it has now been decided that one cross-check section be created at Mumbai under Additional Commissioner of Sales Tax VAT-ADM3 to handle the cross checks from both the refund audit and Business audit sections in Mumbai. All the cross checks originating from Business Audit office should be referred to this cross check unit for further processing. The specific registers are to be maintained for keeping the track of the cross check memos issued (Register BAR-3) c) This will ensure that the tax being claimed as an input credit has been accounted for and paid by the seller. d) The information required should be recorded in the audit notebook, without the knowledge of the VAT dealer, in case the VAT dealers are in collusion to defraud the tax department. e) Form Audit 3, see Appendix A, should be completed in the VAT office and forwarded to the Cross check section. Output tax declared by the seller should be checked against the Form Audit 3 details in the course of a VAT audit. This form should be prepared in duplicate, the original sent to the cross check section and the duplicate filed in the dealer folder. f) There are two categories of referrals: i. URGENT Relating to suspected fraud or evasion or transactions involving an amount of tax in excess of Rs.1 lakh. These references require a response within 14 days 42

VAT audit manual Maharashtra STD October 2007

ii. ROUTINE A selection should be made: 1. Where the amount of tax exceeds Rs.25,000/- on one or more invoices and the auditor requires evidence that output tax has been properly accounted for by the seller in relation to the input tax. 2. Where purchases of a value exceeding Rs.25,000/- on one or more invoices or repeated purchases of a lesser value are identified and no VAT has been charged and the TIN of the dealer is not reflected on the invoice, a reference should be used to identify dealers who have an obligation to register for VAT. 3. In the case of the identification of a multiple number of transactions without VAT being charged by a particular seller or being inclusive of tax, all the transactions from that particular seller should be included on the reference. 4. These routine references require a response within a period of 120 working days ( as per cross check manual) from the date of receipt. The references should be checked in the course of general audits. Where references are outstanding after three years, a specific audit should be carried out. g) This system requires the creation of separate records in Business audit section as well as in cross check section to record the issue of references and the receipt of references. h) The records should be monitored on a weekly basis by JC of divisional office to ensure that the system is functioning effectively. i) The records should be used to ensure responses are received and that time limits are met. j) The system should be used selectively by auditors, but auditors should be encouraged to use routine references on a regular basis with a requirement to issue a minimum of 2 routine references on each audit visit. k) Closing of audit proceedings should not be kept pending till verification of all cross checks is completed. Instead, non-compliance should be closely followed up and consequential action, if any, should be initiated thereafter. 5.11 Conducting VAT audit: a) All VAT audits should start with the performance of basic checks, which are mandatory. These include:
VAT audit manual Maharashtra STD October 2007

43

Check that the VAT certificate is displayed Carry out an initial interview with the dealer. Check if there are any changes to the registration details Check the VAT registration particulars to ensure the details on the register are correct. Ensure the activity code and commodity code are correctly allocated. Complete or confirm and update the information required on the Form Audit 5, see Appendix A. Check the VAT returns filed since the last audit visit with reference to the dealers summary of input/output/net tax for each tax period. Record any changes in the VAT dealers business activities, accounting systems, VAT activities, imports, exports, tax-free and exempt sales, etc. Resolve with the dealer any outstanding matters e.g. late submission of returns / late payment/ matters left over from the previous visit/ correspondence. Make sufficient arithmetical checks on the records of sales and purchases until satisfied that they are accurately maintained. Unjustified excessive arithmetical checking is a waste of time Attempt to reconcile the records on the VAT returns filed with the dealers certified annual accounts, where a full year accounts have been finalised. Establish where a dealer has a legal obligation to have accounts audited by an accountant, that the time limits for producing these accounts have been met. Inspect the business premises / factory / warehouse etc to establish the equipment / capital goods in use and the outputs produced by the dealer.

b) On completion of the basic checks the auditor should proceed to audit inputs and outputs and supplementary checks. c) All auditing checks should be completed on the basis of test-checking and sampling techniques. Risk areas of over claims of input tax or under-declaration of output tax should have been identified prior to the visit. The test checks should commence in the risk areas by selecting a particular tax period. d) If the results are satisfactory, the auditor should move on to the next area for testing; if unsatisfactory, the checks should be extended to identify the full and
VAT audit manual Maharashtra STD October 2007

44

accurate extent of any tax under-declaration so that an assessment is soundly based, and will stand the test of review / appeal. e) If an over-declaration of tax is identified, it should be quantified if this can be accomplished without undue effort, otherwise the dealer should be advised, and told to calculate the over-payment and forward his / her calculations to the Auditor. The auditor should then conduct the audit ensuring therein that all the processes for the refund audit are also completed. Thereafter coming to conclusion that there is over declaration of taxes in that particular financial year, the auditor should issue prescribed letter of audit findings to the dealer by following the prescribed procedure advising him to file revised returns and form 501. In case the dealer files such revised return and applies in form 501 to refund audit branch, the copy of audit findings and revised return filed by the dealer should be sent to refund audit branch. The refund audit branch has already been advised to issue the refund on the basis of findings by the auditor without again going through the audit process. The later actions are to be carried out by Refund audit branch. 5.11.1 Auditing of inputs: a) Business purchases (inputs) provide the logical starting point for a VAT audit. Identification of the inputs to a business should provide the pointers to expected outputs. b) Appendix C provides a summary of the checks to be used when auditing input records and accounts. The sampling techniques described above should be used in applying these audit checks. c) The audit cross-reference system should be used to verify suspicious tax invoices, check on large input tax claims, and confirm that sellers of significant, quantities and value of goods without a charge of VAT are not liable for VAT registration. 5.11.2 Auditing of outputs: a) Appendix D provides a summary of the checks to be used when auditing output records and accounts. The sampling techniques described above should be applied in completing these audit checks. b) Checks should be completed on references received under the audit crossreference system set out above. 5.11.3 Use of mark-up, cash reconciliation and cash flow tests a) Where examination of the dealer records gives rise to suspicion that the output tax may be under-declared, the auditor should consider using the techniques set out in Appendices L-N
VAT audit manual Maharashtra STD October 2007

45

5.11.4 Examination of annual accounts: a) When reviewing the VAT dealer records, if applicable, the annual accounts should be consulted to establish whether there are areas in the VAT records which should receive more in-depth check. More guidance is set out in Appendix E. 5.11.5 Accounts audited by accountants a) The MVATA 2002 requires VAT dealers whose turnover exceeds Rs. 40 lakhs and those holding prescribed licenses to obtain a certificate on Form 704 from a chartered accountant. b) In Mumbai the furnishing of this form should be monitored in Returns branch along with their regular returns follow up. The list of the names of dealers whose audit reports in form 704 are received by returns branch should be prepared on computer along with the other details like TIN, the date of receipt, and year for which the audit is done (in form dd/mm/yy to dd/mm/yy). This list along with the forms received should then be forwarded to the Business Audit 1 and a receipt of the handover be obtained. Two new officers are expected to be appointed to scrutinise the findings given by the auditors in these audit reports. They are to propose actions on the findings. These findings can then be taken up by the committee of the joint commissioners and CST for audit criteria and a strategy for auditing these matters can be evolved. On the expiry of the last date of filing of 704, the returns branch shall cause to generate a defaulters list through MAHAVIKAS based on the comparison of the turnovers as returned by the dealer and available in Mahavikas. Resultant defaulting dealers shall be followed up for the filing of 704 received by the return Branch and action taken to enforce the filing of the form as set out in the law. These forms after the action of the scrutiny officers should then be stored date wise after entering the storage location against the name of the dealer in the list. c) In other offices the form should be accepted and filed in the VAT dealer folder. No follow up action should be taken with regard to non-filers from the business audit branch as this would divert valuable audit resources from their main function. d) This list of the 704 received should be available for viewing to the auditing officials. This will help official to access any form of any particular dealer. The form 704 of the dealer , if available should be given to the officer before audit if the dealer is chosen for audit. The forms should be scrutinized when preparing for a VAT audit visit, as part of the pre-audit preparation, and used to target risk areas for audit. e) On the audit visit Form 704 should be used as a method of verifying the accounts produced by the VAT dealer.

VAT audit manual Maharashtra STD October 2007

46

5.11.6 Auditing of special focus areas: a) There are areas of VAT upon which the auditor may require to focus, in particular: Works contracts Incentives Deduction of tax at source Entry tax Composition Set-off on stock held as on the appointed day Leasing.

b) These issues and the revenue risks they pose are examined in more detail in Appendix F. 5.12 Potential VAT risks: 5.12.1. Disaggregation: a) This is a particular risk in the context of business activities in India. If a business can be split into separate entities for particular aspects of the business the turnover for each part of the business can be maintained below the VAT registration threshold and the liability to VAT avoided. b) It is important that the following checks are applied to ensure disaggregation of a business is not used as a means to avoid accounting for and payment of VAT. c) Businesses with common owners, which claim to be separate entities for VAT registration purposes, should be checked in the following aspects. To satisfy the status as a separate business, these conditions must be met: Owners / responsible persons for each activity must be clearly defined. Separate bank accounts must be in use. Separate accounts for purchases and sales must be maintained for each business activity.

Separate stock for each business must be maintained and be clearly identifiable. VAT audit manual 47 Maharashtra STD October 2007

Separate stock records must exist for each business.

d) Where the above conditions are not fully met the business activities should be treated as a single entity and registration effected in accordance with the registration instructions. e) The sharing of business premises without clearly defined separate operational areas should not, in itself, preclude treatment as a separate business for VAT registration. f) Any VAT registration decision made in accordance with these instructions is appealable by the taxpayer. 5.12.2. Absence of VAT dealer records : a) This constitutes an offence under Section 74(3) (o) of the MVATA 2002 with a penalty of Rs.100 a day, on conviction, for continuing offenses. b) The auditor should calculate the output tax due from the best information available. Banking records or gross takings details should be used to calculate the tax due and only inputs for which a tax invoice can be produced should be allowed as creditable input tax. c) The auditor should not attempt to reconstruct the VAT dealers records, but should advise him of the tax calculated due on the information available. d) The VAT dealer should be advised that a second audit visit would be carried out on a specified date not more than 15 days after the date of audit. e) An assessment should be issued for the sum calculated if the records are not available on the second visit. If the VAT dealer produces the records on the second visit, the assessment should be recalculated based on the information produced if those records are found to be acceptable. f) A letter or show cause notice as the case may be, should be issued to the VAT dealer advising him that if the required records are not maintained or produced in future, he will render himself liable to prosecution. 5.12.3. Failure to produce tax invoices: a) Where input tax credit has been claimed in any return and the VAT dealer is unable to produce a tax invoice at the time of audit visit and even after communicating the audit result for non available Tax invoices, fails to file revised return thereby reducing the said input tax credits for which the tax invoices are not available,a show cause notice on Form 302 should be issued.

VAT audit manual Maharashtra STD October 2007

48

b) If, after 15 days, the dealer has not responded to Form 302 an assessment on Form 303 should be issued for the tax and interest after following due procedure. c) Where there are numerous such instances, consideration should be given to secure any evidence of potential evasion. 5.12.4 Failure to produce commercial evidence of export / inter-state trade: a) Where exemption has been claimed for the exportation of goods internationally or to another state, and the defined evidence including , customs and transport documents, order from foreign supplier, sale document and letters of credit are not available, the auditor should specify the documents required and allow the VAT dealer 15 days to produce them at the VAT office. A show cause notice on Form 302 should be issued. For C and H form declarations separate time frames have been provided which is mentioned below. b) If the documents are not produced, the sales for which exemption has been claimed should be classified at the appropriate rate, where the classification of the goods can be established, and tax calculated at that rate and Form 303 issued. c) In cases where the liability cannot be established, tax should be calculated at 12.5%. An assessment in Form 303 should be issued. d) Where there are numerous such instances, consideration should be given to secure any evidence of potential evasion. e) Wherever it is noticed that the dealer does not have the declarations for interstate sales and has not filed revised returns thereby accepting the liability for such sales or is not ready to file the revised returns, the assessments for raising the liabilities are to be carried out. f) It has been decided considering the legal provisions that, while assessing such cases the dealer is not to be granted any more time to produce pending declarations for the interstate sales transactions falling in the return periods between 1-4-2005 to 31-3-2006. g) It has also been decided considering the legal provisions that the dealer may be given time of one month, from the date of visit to the dealer, to produce the pending declarations supporting the interstate sales transactions falling under period 1-4-2006 to 31-3-2007. In case of failure of the dealer to produce the declarations in given time or filing of revised returns disclosing such liability, assessments are to be carried out and the dues to be raised.

VAT audit manual Maharashtra STD October 2007

49

5.12.5. Failure of VAT dealer to attend an appointment for a VAT audit: a) If a VAT dealer fails to keep an agreed appointment for a VAT audit without reasonable cause and the audit visit has to be aborted, this should be regarded as an offence under Section 74 of the MVATA 2002. b) The VAT dealer should be contacted and a fresh appointment made. For this reappointment letter should to issued in prescribed form. c) The VAT dealer should be given a written warning that a liability to prosecution has occurred under Section 74 of the MVATA 2002. d) If the VAT dealer fails to keep the second appointment, the facts should be brought to the notice of the Joint Commissioner or the Deputy Commissioner with a view to pursuing punitive action. e) Thereafter the auditor can visit the dealer without taking his prior appointment and may complete the audit on basis of the books and records available. 5.12.6. Failure to register for VAT Where routine references or intelligence indicate that a dealer may be liable for VAT registration, Investigation section should designate an STO / STI to carry out an inspection visit to verify the dealers turnover and establish if there is a liability for a VAT registration.

5.13

Closing the audit visit 5.13.1 Factors to be considered in closing the audit visit a) Suspicion of fraud Follow the procedures outlined later in this manual.

b) Tax under-declared, but no suspicion of fraud Tax under-declared (input tax over declaration or output tax underdeclaration) not exceeding Rs.500/- in total no action required. Tax under-declared exceeds Rs.500/- and full facts available. Discuss the discrepancies with the VAT dealer and attempt to obtain his agreement to the amount. Tax under-declared where full information or documentation is not available. Advise the VAT dealer of the amount of the assessment unless the information or documentation is produced by means of issue of Form 50

VAT audit manual Maharashtra STD October 2007

302. If the documents are not produced and the VAT dealer does not respond to Form 302, assess the tax and interest and issue Form 303 . See Appendix G. c) No discrepancies Advise dealer of the audit result and deal with any queries he may have. It should be confirmed to the VAT dealer that this does not signify his VAT accounts are accepted as accurate up to a certain date, but only that no discrepancies were found in the areas checked.

5.13.2. Procedure for closing the audit visit: a) As the audit progresses, the auditor should list all discrepancies as they are discovered for discussion with the VAT dealer at the end of the audit. If there appear to be major problems with the accounts, the issues may have to be discussed with the VAT dealer during the audit. b) At the end of the visit and before leaving the VAT dealers premises the auditor should review the work done against the original audit strategy. c) The objective should be to ensure that all points originally intended to be covered have been completed, to see if anything remains to be clarified and to identify whether anything new has emerged which has not been followed up. d) A review of the viability of the business should be made. This can be done on the basis of information gathered during the audit and, if available, the annual accounts of the business. e) The purpose of this review is to assess whether a going concern is likely to become bankrupt (sole proprietor) or go into liquidation (private or public incorporated company). There are two revenue concerns: At the time of any default, a large amount of tax is outstanding which, if prompt action is not taken to secure it, may be lost. Stock and assets of an insolvent business may be sold off without the appropriate tax being accounted for. For this reason a brief note should be made of stocks and assets held.

f) The auditor should discuss with the VAT dealer the whole range of his VAT activities. The auditor should draw attention to any lack of compliance, and offer advice to assist the VAT dealer. g) The auditor should attempt to close the visit in a constructive and positive manner. The auditor should leave the VAT dealer with a list of all discrepancies, and detailed explanations of the errors, which have been found.
VAT audit manual Maharashtra STD October 2007

51

h) It is good practice at the end of every audit to conduct a final interview with the VAT dealer. In all cases this will be a matter of courtesy on departure, however, it should be the time when any outstanding matters are discussed and finalised, for example: Uncertainties by the dealer about the operation of the tax system Remaining points for clarification Seeking rectification of aspects of accounting which are considered unsatisfactory from a revenue viewpoint Explaining the findings of the audit including the amount of additional tax payable by the dealer. The dealer should be informed that in case he is in agreement with the findings, he can discharge the additional tax liability by filing revised returns and paying the tax payable as per the said return. In case of disagreement on findings of audit, the dealer should be informed that an assessment will be issued by following the procedure as outlined in (m) below.

i) If there is a need to resolve any uncertainties at the VAT office, the auditor should summarize these before closing the visit, and be sure to contact the VAT dealer within 10 days to clarify the matter. j) Any findings given by the auditor should be confirmed by letter in prescribed format form audit 7, which should be copied to the dealer file and the issue recorded on Form Audit 5.9 at the time of final audit report, see Appendix A. k) This establishes a point in time that the dealer has been directed on a particular issue and future failure to comply could result in action being taken against him. l) The auditor should explain to the VAT dealer that any interest resulting from the discrepancies identified would be strictly in accordance with the MVATA 2002. m) Where the dealer is not in agreement with the audit findings, the auditor should explain the action that will follow, for example, a show cause notice on Form 302 will be issued within a week. The dealer will have 15 days to respond to Form 302, any representations will be taken into account and an assessment order Form 303 will be issued for the tax and interest. Before passing the assessment order the working of the taxes , its basis and copy of the draft order should be forwarded to the immediately superior authority for their information and perusal, at least 10 days before the passing of order. After passing of order Payment is required within a further 30 days. The recovery is to be followed by the auditor for the next 60 days for getting the dues paid. The dues recovered are to be duly entered in the registers prescribed and after 60 days the unVAT audit manual Maharashtra STD October 2007

52

recovered amount has to be transferred to the recovery Branch for further recovery action. n) The VAT dealer should be advised of his rights and obligations with respect to items in dispute. o) The flow chart set out below defines the procedures to be followed during an audit:

VAT audit manual Maharashtra STD October 2007

53

Flow chart setting out the normal procedures to be followed on audit visits:

VAT AUDIT
Arrive at dealers premises - introductions - Explain purpose of visit - Carry out interview of dealer/ basic checks

Retrieve records to be examined from dealer Arrange work area for access to records and contact person to assist Carry out additional checks where necessary Audit selected figures/return
Are there: - Discrepancies in the return - Deficiencies in system?

Select Additional Areas

No

Closure

Yes
List them Do they have revenue significance?

Yes

Yes
Is it possible fraud?

Discuss and resolve with VAT dealer

Document evidence

Closure

Closure

No Yes
Do I need to extend audit? No

No Discuss and resolve Yes Are there any contentious issues? No Obtain copies of source documents

Closure

VAT audit manual Maharashtra STD October 2007

54

CHAPTER 6

REFUND AUDITS
6.1 Note: A separate manual has been prescribed for Refund Audits. The case wherein the dealer has already filed application in form 501, the audit is to be conducted by the refund audit branch for whole of the year. The cases which are selected for business audit and as a result of audit it is found that the dealer stands to get a refund, that is the case results in over declaration, in such cases the auditor while carrying out the business audit shall also apply the procedure prescribed for the refund audit in refund audit manual for carrying out the refund audit and thereafter completing the procedure and coming to the conclusion in the matter should give such findings in audit form 7. The dealer may be advised to file the revised return and on such filing the dealer may file the prescribed form 501 with the refund audit authorities. The refund audit branch , however may give the refund on basis of the findings of the Auditor issued to dealer in form Audit form 7. The refund audit branch need not again carry out the Audit as prescribed in their manual. The auditor of business audit branches at end of each month should forward to his immediate superior authority a statement in form H6 stating their in the list of dealers ,their over-declarations, the date of findings in form 7, date of filing of revised return and a copy of findings in form 7 issued to the dealer. These statements should be consolidated at section level by the office of Joint commissioner and then forwarded to the office of the Joint Commissioner of Sales Tax Refund Audit Branch.

VAT audit manual Maharashtra STD October 2007

55

CHAPTER 7

POST AUDIT CONTROLS

7.1. Introduction: a) The essential elements of post audit action should be to: Update the summary of business activities and records on Form Audit 5, (see Appendix A) Complete the interim visit report in form Audit form 5.9, after each visit to the dealer and pass the file to immediate superior authority. Specifically note any amendments to the activity / commodity code and any changes to the business activities. In the case of Vat Assessments the instructions are set out in Appendix G. Issue form audit 7 to the dealer after due consultation with immediate superior authority. Note on Form Audit 6 the appropriate code for the under-declaration as set out in Appendix H. Prepare and issue Forms Audit 3. Pass the VAT dealer file for review by the immediate superior authority along with Final Visit report on Form Audit 6. If any potential assessment falls within the criteria for referral to the investigation section, see Appendix I, action should be taken as set out.

7.2.

Action by auditor a) In case of cases where an audit visit has been made and further visits are to be made to the same dealer at different dates before concluding the audit, the auditor should always file the interim visit report in form audit 5.9, prepare Forms Audit 3 from his notebook, not later than the first office day following the date of the visit. In the report the auditor should give outline of the happenings during the visit and identify core issues. For each such visit the second and then third interim report in the same form needs to be filed and submitted to the immediate supervising authority. If the audit visit is concluded , then complete visit report on Form Audit 6 has to be filed and Form Audit 5 is to be updated.

b) The auditor should review the work completed on the visit and ensure that all the appropriate action has been taken. VAT audit manual 56 Maharashtra STD October 2007

c) Any uncertainties should be resolved with the VAT dealer, and any issues not settled on the visit should be decided by reference to the immediate Supervising authority and any decisions notified to the VAT dealer within 10 days of the visit. Decisions should be recorded on Form Audit 6. d) Where an under-declaration or over declaration has been identified, the amount of tax must be calculated and the reasons defined. In such case of the amount of under declaration or over-declaration accepted by the auditor should be notified to the dealer in Audit form 7. In case where the dealer challenges the under declaration notified, the assessment is to be undertaken .The auditor should, in all cases wherein assessment order is to be passed in form 303, submit for information to his immediate supervisor, the file of the dealer along with working of taxes, and the draft of the proposed assessment order in form 303. These should be submitted at least ten days before the actual passing of the assessment order. e) The next higher authority should go through the show cause notice / assessment before the assessment notice or over declaration forms are issued by the auditor. f) The basis of all calculations should be provided on Form Audit 6. The explanation of any assessment or notice of under declaration should be provided to the dealer on the reverse of Forms 302 and 303. g) Areas of risk for follow up action on the next visit should be highlighted on Form Audit 6. 7.3. Action by the next highest authority: a) The immediate supervising authority should retain copies of all auditors weekly visiting work programmes (Form Audit 1). The Joint Commissioner shall retain the copies of all auditors visit programmes. b) Forms Audit 1 should be used as a control document to ensure that all notified audit visits are completed and reported. c) Checks should be carried out to ensure the visit was completed on the specified date and the length of the visit is appropriate. d) All visits resulting in the issue of an assessment / over-declaration (that is issuance of Forms 302, and 303) should be fully checked by the next highest authority (immediate supervising authority) including arithmetical checks. e) Discrepancies identified should be resolved with the auditor and Forms Audit 6 certified by the next highest level. f) All visit reports should be checked by the next highest authority. As defined earlier there should be detailed scrutiny of 1 visit report per quarter where no under / over-declaration has been identified.
VAT audit manual Maharashtra STD October 2007

57

g) The scrutiny should include but not be limited to: Comparison between Form Audit 6 with particular attention paid to the allocation of the appropriate activity / commodity code A check on the description of purchases and sales to establish that the correct liability has been declared Review the dealer file to ensure identified risks / cross-checks have been dealt with on the visit Check that appropriate action has been taken where discrepancies have been identified Check that findings given have been confirmed in writing and recorded in the dealer file

h) Special attention should be paid to reports from inexperienced staff or auditors whose work performance gives cause for concern. i) It is important all auditors ensure assessments are soundly based and calculations are accurate. 7.4. Control of audit activities a) The Additional Commissioner VAT ADM 3 is responsible for the overall management of VAT audit within the state. He should, with the co-operation of his management team, devise an audit program with twin objectives. Firstly, collecting maximum revenue through risk focused audits and secondly, achieving maximum voluntary compliance by broad based audit coverage. b) Performance of the VAT program should be monitored by a management information system (MIS), see Appendices H, H1, H3, H4, H5, H6 . 7.5 Post audit learnings-Business Audit Bulletin:It is desirable that the methods of tax evasion employed by the dealers should be known to the auditors. Therefore a system of Business Audit Bulletin is being implemented. It will showcase the specialist techniques deployed by the auditors while detecting under-declaration and peculiar modus operandi used by dealers to subvert the tax liability. Such cases shall be selected by the JCs while going through the reports submitted by DCs and by DCs while going through the cases submitted by ACs and STOs. The report submitting auditor should thereafter prepare a synopses of the case in an indicative format which is provided in Appendix R.

VAT audit manual Maharashtra STD October 2007

58

CHAPTER 8

AUDIT CASES WHERE POTENTIAL FRAUD/ EVASION IS SUSPECTED

8.1. Introduction: a) The investigation of fraud is a vital element in the administration of VAT. The purpose behind a VAT fraud investigation is to deter VAT dealers from knowingly making fraudulent VAT returns. b) A distinction is to be drawn between innocent errors made on VAT returns and false declarations made with the intent to defraud. c) If it cannot be proved that there was fraudulent intent on the part of the VAT dealer then the action to be taken is outside the scope of this chapter. d) The following cases should be regarded as an illustrative list of evidence of fraud. 8.2. Use of false tax invoices Alteration / amendment of tax invoices Tampering with/misuse of statutory forms such as way bills, C-forms etc Suppression of taxable turnovers/material information such as not disclosing place of business / godown False claim of exports False description and false classification of goods

The role of the auditor in fraud investigation a) The main role of the auditor is to visit dealers and audit their VAT returns. b) Auditors are, however, an important and integral part of the fraud investigation process. The three key elements of the auditors responsibilities are to: i. identify a potential fraud ii. quantify the fraud in order to give the investigators an idea of what revenue has possibly been evaded iii. contain the situation when at the dealers premises

VAT audit manual Maharashtra STD October 2007

59

c) Considering the fact that the VAT auditors may not be delegated all the powers to enable them carry out search, seizure etc. Being so, wherever necessary, VAT auditor has to work on fraud investigation cases in association with the Investigation team. The role of VAT auditor discussed hereinafter with regard to fraud investigation should be read accordingly. d) There are a few ways in which an auditor can deal with a potential fraud when it comes to deciding how to contain the situation. Before looking at these, it is important to consider what needs to be achieved when containing the potential fraud. e) The auditor may have identified a potential fraud and the quantification could be relatively straightforward. When it comes to containing the matter, the auditor is trying to preserve evidence of the commission of a possible offence without the dealer realising that he has been discovered. f) The auditor must make a decision based on whether or not the dealer has been alerted to the suspicions of the auditor. g) There is no real way of explaining if the dealer is aware, however, experience has shown that when faced with this problem the auditor will know by the dealers reaction. h) In the scenario where the auditor is suspicious that the dealer may be committing fraud and that the the tax amount involved may not exceed Rs.5 Lacs and the auditor deems it unnecessary to uplifting of the records (through investigation officers ) at that stage, in such cases, in order to demonstrate the identification and quantification of the suspected fraud at the office, the auditor can only rely on his notes in the absence of the dealer records. In such cases the auditor may also take extracts of the books or the copies of the documents and may get them authenticated by the dealer to be true. i) The importance of good notes were dealt with in an earlier section, however, in the context of fraud recognition, good notes are essential as potential evidence in case the original records are destroyed. j) If the dealer destroys the records because he fears the auditor has discovered the fraud, then the notes that the auditor makes of the transactions which supported the VAT return may be the only way of penalising the dealer for alleged fraud. k) It should also be remembered that the dealer will have submitted a VAT return and he should have records and invoices in order to substantiate what was written on the return.

VAT audit manual Maharashtra STD October 2007

60

l) If the auditor notes the suspicious transactions and the purchase and sales figures which made up the VAT return that is in question, this could be the evidence that helps prove a fraud has taken place. 8.3 Identification of fraud by auditors:

The purpose of VAT audit should be to identify discrepancies and deficiencies in the VAT dealers records and ensure that the full amount of VAT due has been recorded and paid on each return. Having identified an error, the auditor should attempt to establish whether it was innocently made, or made deliberately with the intention of reducing the tax to be paid. If the VAT dealer is unable to offer a reasonable explanation for any error, the auditor should attempt to gather any evidence to suggest an intention on behalf of the VAT dealer to defraud the STD of the VAT due. The auditor should approach this task by seeking to establish the VAT dealers normal operational and accounting methods and then seek an explanation for any variations from normal business procedures. Where the explanations offered are unconvincing, there must be a suspicion that a fraud could have been committed. When an auditor discovers a potential fraud or evasion the guidelines in Appendix I should be followed. In all other cases where there are grounds for suspecting fraud, the auditor should take possession of the relevant documents and any evidence, if this is practical and withdraw from the audit advising the VAT dealer that there is a need to look further at his records and check them back at the office. As noted above, no indication should be given that fraud is suspected, or that anything serious is wrong, so that the VAT dealer does not seek to destroy evidence while the case is being reviewed. The types of VAT fraud are too varied for a definitive list to be provided, but Appendix J details the more common types of fraud which have been detected in VAT systems. The appendix also specifies the counter measures that could be employed by administrators. The list is not exhaustive, and is for guidance only to create awareness of possible VAT frauds. There should be a list of VAT frauds (where an intention to defraud exists) and evasions (were an error is considered to be a mistake) completed & 61

VAT audit manual Maharashtra STD October 2007

regularly updated by each office. The central investigation unit should regularly disseminate information and trends concerning VAT frauds. 8.4 Classification and organisation of fraud investigation: a) The investigation of fraud makes significant demands upon staff resources and is rarely cost effective when compared to the collection of revenues, penalties and interest. b) The value of fraud investigation is to encourage and engender voluntary compliance by VAT dealers by providing a reasonable prospect that fraudulent VAT dealers will be detected, investigated and prosecuted in the courts, or subjected to financial penalties. c) To achieve this objective the aim is to gain maximum publicity for the successful conclusion of major fraud cases. d) Cases where fraudulent intent can be proved, but the revenue at risk is less than the guidelines in Appendix I should be dealt with by the VAT auditor and an assessment issued for the additional tax, penalty and interest due. e) Cases where fraudulent intent can be proved, and the revenue involved is within the guidelines set out in Appendix I and cases of deliberate manipulation, should be handed over to the investigation unit. f) The dealer file should be noted with a record of the fraud and the associated risks on Form 6. g) The JC should be consulted at an early stage of any potential investigation and in association with specialist investigation agencies, any evidence gathered by the auditors should be scrutinized to establish whether there is, prima-facie, a case for investigation Any investigation authorised should be undertaken by specialist investigators in line with the guidelines in Appendix I. h) All VAT auditors have a responsibility to detect and identify fraud and should receive audit training to achieve this objective. i) The investigation of VAT fraud requires special skills and in-depth training is normally to be undertaken in the regions by a specialist fraud investigation team.

8.5

Process for Communication with Investigation Wing: a) During the course of any audit, if the auditor is of the opinion that the search and seizure is required to be carried out , then the case may be handed over to

VAT audit manual Maharashtra STD October 2007

62

the Investigation. Further the control of the matter of investigation will shift to the Investigation Branch. b) In such cases where search and seizure is felt to be necessary, auditor should inform his concerned Joint Commissioner, who thereafter should contact the joint Commissioner of Sales tax of the Specified Investigation Wing. It ihas been decided that the first two Sections I and II of the Business Audit in Mumbai should contact Investigation Aand the next two sections III and IV should contact Investigation Bin such situations. In case of the Business Audit in Mofussil areas, the respective Mofussil Joint Commissioner of investigation wing may be informed , who'll thereafter depute the investigation officers for the further course of action. c) In cases where the audit has been initiated by the auditor, but the auditor as well as the concerned Joint Coomissioner are of opinion that the matter needs thorough investigation and that further evidence is needed to be collected , then the concerned may in consultaion with the Additional Commissioner of Sales tax VAT ADM 3 forward such case to Investigation section. Thereafter the investigation section shall deal with such cases. d) The Tax Intelligence Unit which is separetely established , will liasion with other Government departmental authorities or Agencies other than the Sales Tax Department for collection of tax related or fraud related intelligence. This will be the nodal agency for such task.

VAT audit manual Maharashtra STD October 2007

63

CHAPTER 9

MANAGEMENT REPORTING
9.1. Introduction: a) The compilation of an audit programme will depend on the number of registered VAT dealers and the risk associated with those VAT dealers. b) The programme will be risk-based, dependent on the need to enforce return filing, collect tax under-declared, monitor refund claims on a risk basis, and effectively control the largest VAT dealers. c) The development of an ongoing audit programme will be dependent on accurate and timely management information. d) Audit management information will perform the following functions: 9.2. Monitor the progress of audit activity (Statement H, H1,H3,H4,H5,H6) Record fraud and evasion trends to prevent revenue leakage and maximize collections. Monitor staff performance to improve the standard of audit activity Monitor the audit program to ensure broad coverage resulting in improved voluntary compliance Provide the basis for future audit planning.(Register BAR 6)

VAT work return: a) Examples of audit work reports and under-declaration classification are provided at Appendix H, H1-H3. This should provide the basis for the overall management of VAT audit. b) These reports should be generated by the computer on a monthly basis through Business Audit module of MAHAVIKAS system. Till the time the said business audit module on Mahavikas is in place, such statements can be generated on a spreadsheet on the standalone computers provided to the officials.

9.3.

Classification of VAT errors and evasions:

All VAT under-payments identified by auditors should be classified on a numeric basis to assist the management of fraud and evasion trends. A simple classification basis is provided at Appendix H. 64

VAT audit manual Maharashtra STD October 2007

The purpose of this classification of under-declaration trends should be to provide management with information, to enable resources to be targeted towards audit activity, which should maximize revenue collection, and encourage VAT dealer voluntary compliance. At the same time, the measure of the levels of under-declaration detected should provide some indication of the effectiveness of the level of voluntary compliance, and the effectiveness of audit action.

VAT audit manual Maharashtra STD October 2007

65

CHAPTER 10 REGISTERS FOR BUSINESS AUDIT BRANCH

Till the time the Mahavikas is fully developed and operational, the Business Audit module is implemented and is ready to generate all types of MIS, following registers are to be necessarily maintained. These are also to be entered on the standalone computers .

10.1 CONTROL REGISTER (BAR 1.)

SR.NO 1

DATE OF RECEIPT 2

SOURCE OF AUDIT 3

CODE OF J.C. 4

CONTROL REGISTER NUMBER 5

ALLOCATED TO (CODE OF AUDIT OFFICER) 6

NAME OF DEALER

R.C. NO

TIN

RESULT OF AUDIT (1- PERIOD OF No UNDER UNDERdeclaration, 2- DECLARATIO DECLARATIO Underdeclarat N/ N (in Rs) ion, 3OVERDECLA overdeclaratio RATION n) 10 10 A 11 TAX

DATE OF DATE OF RETURN/ UNDERUNDERDATE OF ISSUE OF REVISED DECLARATIO DECLARATIO A.O. FORM 302 RETURN N (in Rs) N (in Rs) (DD/MM/YY) (DD/MM/YY) FILED (DD/MM/YY) 12 13 14 15 16 INTEREST PENALTY

CODE OF ISSUES INVOLVED 17

DATE OF CLOSURE (DD/MM/YY) 18

REMARKS 19

VAT audit manual Maharashtra STD October 2007

66

10.2 DAY BOOK OF BUSINESS AUDIT AND ASSESSMENT (BAR 2)

SR NO.

PERIOD OF CONTROL DATE OF UNDERNAME OF REGISTER ASSESSME TIN/R.C.NO DECLARATIO THE DEALER NUMBER NT OREDER NS 2 3 4 5 6

GTO OF SALES AS PER RETURNS RS. 7

GTO OF SALES AS PER AUDIT RS 8

TAX PAID WITH RETURNS (RS.) MVAT 9

TAX PAID WITH RETURNS (RS.) CST 10

UNDERDECL UNDERDECL UNDERDECL INPUT TAX ARATION ( IN ARATION( IN ARATION( IN CLAIMED RS.) RS.) RS.) RS. 11 MVAT 12 INTEREST PENALTY under MVAT under MVAT 13 14

UNDERDECL UNDERDECL UNDERDECL DATE OF ARATION ( IN ARATION( IN ARATION( IN REVISED RS.) RS.) RS.) RETURN INTEREST PENALTY CST DD/MM/YY under CST under CST 15 16 17 18

REMARKS

19

VAT audit manual Maharashtra STD October 2007

67

10.3 cross check register (BAR 3)

Sr.No. 1

Outward No. 2

Control Register Number 3

Name & Name & Name & Designatio TIN No. of TIN No. of n of Audit the Dealer Vendor Officer 4 5 6

Nature of Amount of Transactio Transactio n n 7 8

Result of CrossCheck 9

Remarks 10

VAT audit manual Maharashtra STD October 2007

68

10.4 file movement register (BAR 4)

Sr. Date No. 1 2 Control Register Number 3 Name of the Dealer 4 Send To 5 Sign 6 Remarks 7

10.5 Audit not undertaken Register (BAR-5)

Sr. No . 1 Control Register Number 2 Reason for inability to undertake an audit 5

Name of the Dealer whose audit could not undertaken 3

TIN NO. 4

Permission Sought Alongwith Date 6

VAT audit manual Maharashtra STD October 2007

69

10.6 CRITERIA ANALYSIS REGISTER (BAR 6)

CONTROL SR CONTROL REGISTER NUMBER REGISTER NUMBER NUMBER

TOTAL NUMBER OF CASES CASES RISK PERTAINING INVOLVING CRITERA TO RISK UNDERNUMBER CRITERIA DECLARATIONS

FROM 1 2

TO 3 4 5 6

TOTAL AMOUNT OF UNDERSUCCESS RATE (IN OUTPUT RATE DECLARATIONS NUMBER OF CASE IN Rs/CASE DETECTED (IN PER 100 SELECTED) RS.)

VAT audit manual Maharashtra STD October 2007

70

10.7 The description of above registers. Control Register(BAR-1): All cases received for audit need to be necessarily included in this register. Control register is to be maintained as a core document at the Office Of Joint Commissioner of the concerned Business Audit section. This register is also to be maintained by each auditor to keep track of the cases alloted to him. This register at JC office is to be updated from time to time on basis of other statements. (quarterly or monthly ) Day Book Of Audit And Assessment(BAR-2) This register is to be maintained by each auditor to report the results of audit and assessments. This should be the source documents for the statements to be sent to Returns Branch,Refund Branch,Recovery Branch.

Cross Check register (BAR-3): This register is to be maintained by each auditor.The cross-checks in Form 3 are to be issued on the next day of audit visit. The cross checks issued should immediately be entered in register , thereafter re ,it is to be updated with the results of cross-check regularly. File Movement Register (BAR-4): This register is to be maintained by each auditor and its supervising authority. This should include the control number of file whereever applicable and even the UORs if they are sent in a file. Audit Not undertaken register (BAR-5) : This register is to be maintained by each auditor. As and when the eventuality of audit not undertaken takes place, it is to be recorded in this register. These are to be later on entered in the control register by the audit head as well as by the office of the JC Criteria Analysis Register (BAR-6) : This register is to be maintained by each auditor. The results of this register are to be considered for evaluating the results of the various Audit criteria to the supervising authority for the purposes of evaluating the given criterion by the designated authority as and when required. This evaluation should be done biannually.

VAT audit manual Maharashtra STD October 2007

71

CHAPTER 11 THE INSPECTION OF RECORDS

11.1 Introduction: It is advisable that all the prescribed registered are maintained and the processes are carried out. For this purpose the Joint Commissioner supervising each section shall conduct once in every year the inspection of all audit units under him and the Deputy Commissioner shall conduct inspection of his audit unit. 11.2 Coverage: The inspection shall cover following aspects,

the maintenance of the registers prescribed. The test check of the communications issued for communicating audit results to recovery or returns branch. The procedure for the maintenance of the audit file records. The pendency of the assessments and audits and the reasons therefore The work sheets of the Inspectors and of the tax audit assistants / clerks

11.3

Reporting and compliance The Inspecting Authority shall cause a report of such inspection be drafted outlining therein such discrepancies and shortcomings as may be observed or noticed during the inspection. These shortcomings or discrepancies need to be explained and a reply to be filed by the officer in-charge of inspected unit within a month of receipt of such report

VAT audit manual Maharashtra STD October 2007

72

Chapter 12. Comment on record filing system.

It is expected that the auditors shall develop the list of minimum documentation which need to be kept on record. The decision will also depend on the requirements for the purpose of the internal or STRA audit which shall be carried out in the cases where the assessments are to be carried out.

VAT audit manual Maharashtra STD October 2007

73

Chapter 13. Responsibility and date for updating the manual

The current manual is to be functional from 1st November 2007.

Any changes which are sought to be incorporated in the manual need to be discussed and submitted under the signature of at least four auditors, or under the signature of joint commissioner or higher authorities and may be forwarded to the team in charge of manual. These changes shall then be discussed and submitted in a joint meeting of the business audit sections and decided. The accepted changes may be submitted before the Authorities of the CST and core group and thereafter may be included in the audit manual in the next version.

The next audit manual version may include the processes which are felt to be needed for the effective functioning of officials and staff and such may be based on the experience and the actual issues experienced in the field. The next phase of the updating will be in March 2008.

VAT audit manual Maharashtra STD October 2007

74

VAT audit manual Maharashtra STD October 2007

75