1.81     Query

Provision for Taxation

The company’s Income-tax assessments are at times made on income much higher than that returned by them due to disallowance made by the Income-tax department while completing the assessment. As a result thereof the tax demanded is in excess of the admitted tax liability and the excess is genuinely contested in the relevant appeals filled by the companies. Sometimes such orders in respect of the periods prior to the Balance Sheet are received after the balance sheet date but before the completion of the audit. The guidelines for the accounting treatment of such liability are given in paragraphs 9.10 of Character 9 in the Statement on Auditing Practices as under: -

“The relevant orders received up to the time of audit in respect of income-tax proceedings should be examined and short provisions noticed should be made good. If there is a tax liability for which no provision is made in the accounts the auditor should qualify his report in this respect even if the company’s reserves are adequate to cover the liability.  If, for any valid reason, the company disputes its liability in regard to demands raised and does not desire to provide for them, a suitable note should be inserted on the accounts specifying, where material and practicable, the amount in dispute. In this connection, reference should be made to the Institute’s Note on ‘Provisions for Taxation’.

(NOTE: A reference to the Institute’s note on provision for taxation would show that it deals with the liability for tax only for the year under audit.)

 It would be observed from the above guidelines that all orders received up to the time of audit are to be considered. However, in respect of the disputed liability only a suitable note is required to be inserted in the accounts. In this connection the following queries arise: -

(1)Whether the note regarding the disputed tax liability would be of an ‘explanatory’ nature or ‘qualificatory’ nature or should it be included under the head ‘Contingent Liabilities’?

(2)Whether any distinction is to be made between the disputed tax liability which had arisen before the balance sheet date and the disputed tax liability which had arisen after the balance sheet date but before the completion of the audit?

In paragraph 9.11 in chapter 9 of the Statement on Auditing Practices it has been stated that ‘the auditor should similarly pay attention to the provision for sales-tax liability and excise duty liability, if any.  In regard to the Income–tax liabilities certain further queries have been raised as above.  It would be appreciated if it can be clarified that the clarification given to the aforesaid queries would also be applicable to such liabilities.

                                                          Opinion                                                  October 19, 1981

The opinion of the Committee on the queries raised is as follows:

(1) The note regarding the disputed tax liability can be explanatory in nature if the Auditor is satisfied about the validity of the reasons of the company for contesting the liability. If, however, the Auditor is not satisfied about the validity of the company’s contention in this regard, and the company has not made good the shortfall in the provision, then pursuant to paragraph 9.10 of the Statement on Auditing Practices, it will be his duty to qualify the audit report.

(2)In the opinion of the Committee no distinction should be made between the disputed tax liability which had arisen before the balance sheet date and that which has arisen after, but before completion of the audit, as paragraph 9.10 of the Statement on Auditing Practice covers within its scope relevant orders received upto the time of audit.  Moreover, under several reported judgements, it is now well settled law that the liability to income-tax arises, at the latest, by the close of the accounting year, regardless of the date of quantification of the amount of tax, and also regardless of the date for payment of the Income-tax.

(3)In the opinion of the Committee, generally the same considerations as have been spelt out in (1) and (2) above, should apply to the disputed liabilities for sales tax and excise duty as well, since sales tax and excise duty do not call for any special consideration in this regard. However, as the law relating to the point of time at which liability to sales tax and for excise duty arises, is not necessarily the same as that relating to Income-tax, this factor should be borne in mind in dealing with each case on its own merits.

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