Integrated audit system

In my previous article under the title audit under income, sales tax and corporate laws, I had stressed the need for the Central Board of Revenue (CBR) and the Securities Exchange Commission of Pakistan (SEC) to work closely to devise an integrated system of audit of the accounts of the corporate sector.
In this respect the press report is encouraging that the chairmen of SEC and CBR in their meeting have agreed to work in close co-ordination in the interest of the growth of a vibrant and efficient corporate sector. Further that both of them have agreed that the existing framework for taxpayers should be rationalised.
It is a positive approach in view of the globalisation which is well talked about subject today. Economic globalisation constitutes integration of national economy into international economy through trade etc.
Similarly in this scenario we should now consider the integration of audits conducted under different three statutes viz corporate, income tax and sales tax laws into statutory audit conducted under the Companies Ordinance 1984 (CO).
The major issues, therefore, to be pondered by the said two agencies is how integrate the audit system conducted under the existing three statutes viz, (i) the Companies Ordinance, 1984, (ii) the Income Tax Ordinance, 2001, (iii) the Sales Tax Act, 1990, which keep engaged the taxpayers throughout the year in conducting the audit by one after the other auditors. The objective of such integration should be to save the taxpayers from the hassle of taxation system.
The taxpayer, under the existing system has to pass through the worst type of crisis linked with the existing taxation system which consequently fuels a wide range of corruption. In order to find ways to integrate the existing audit systems a cursory review of the provisions in respect of maintenance of books of accounts and audit thereof in the respective aforesaid statues would be helpful.
THE INCOME TAX ORDINANCE/RULES, 2001/2002 (ORDINANCE): The Ordinance under section 174 requires every taxpayer to maintain such accounts, documents and records as may be prescribed. In case he fails to comply with maintaining the prescribed books etc, the Commissioner is empowered to disallow or reduce the taxpayers claim in respect of expenses or receipts in the return of income.
The Rules 28-32 of the Income Tax Rules, 2002 (Rules) prescribes the minimum level of books of accounts, documents and record of accounts required to be maintained by a taxpayer with respect to all money received, expended, sales, purchases, assets and liabilities.
These requirements are similar to S.230 of the CO which provides mandatory requirement for the maintenance of books etc by a company. Further Rules 32(2) requires a company to maintain the books of accounts etc in accordance with the International and Financial Reporting Standards as well as under the Companies Ordinance, 1984.
Further section 20(1) of the Ordinance allows the deduction of any expenditure claimed by the taxpayer in his return provided it is incurred by him exclusively for the business. Moreover section 21 of the Ordinance specifies certain expenses deduction which will not be allowed in computing the income of the taxpayer.
It includes any expenditure paid under a single head of account in aggregate exceeding Rs 50,000 and in case of salary payment if it exceeds Rs 10,000 which is paid otherwise than through crossed cheque.
Further section 111 of the Ordinance also disallows, any amount credited in the taxpayer's accounts or any investment made or any expenditure incurred, nature/sources of which is not explainable by the taxpayer, excluding foreign exchange remittance made through bank, as deduction but such transaction is treated as income of the taxpayers for the purpose of taxability thereon.
The taxation officer while finalisation the assessment of a taxpayer requires assurance that the taxpayer has complied with the above provisions of the Ordinance in computing his taxable income declared in his return and has paid the tax properly thereon.
He does not find assurance on certain aforesaid points from the audited accounts. Therefore he goes through the verification process of the books of accounts, vouchers and related documents to satisfy himself that the taxpayer has complied with the said provisions of the Ordinance.
Moreover section 177 of the Ordinance provides for selection for audit the cases of the taxpayers by the Commissioner. In such cases thorough scrutiny of the accounts of the taxpayers is conducted by the auditor of the income tax department or by a firm of chartered accountant appointed by the CBR.
SALES TAX ACT 1990 (ACT): The books of accounts of the registered persons are also subject to audit by the auditors, senior auditors of the department as well as by the Special Auditors appointed by the CBR under section 132A of the Act from the firms of chartered accountants. The auditors conduct the audit or verification with respect of the records, tax invoices and monthly returns furnished by the registered persons properly maintained as required under section 22 of the Act, and reflected correctly the taxable supplies, input and output tax claimed and net amount of the tax properly paid.
It will be observed that the audit assignment is also entrusted under section 32A of the Act to the firms of chartered accountants who also act as auditors of their clients under the CO, who already have verified the aforesaid records during the course of statutory audit of a company but the audited accounts and reports thereon do not make any specific reference thereof.
If this aspect of the issue is reviewed by the SEC and an opinion or reference thereon be expressed in the audited accounts, it would be a source of relief to the taxpayers and the sales tax collectors too.
THE COMPANIES ORDINANCE, 1984 (CO): Section 230 of CO provides mandatory requirement for maintenance of books of account etc with respect of money received, expended, sales, purchases, assets and liabilities. Similar requirements are provided under section 32 of the Income Tax Rules, 2002.
The CO makes the company's management prepare and present a balance sheet and profit and loss account in confirmative with the approved International Accounting Standards and the requirement of the CO.
The CO further requires every company to get its accounts audited by a firm of chartered accountants who audits the accounts of a company in accordance with the provisions of the CO and also with the International Auditing Standards which requires it to obtain reasonable assurance to ensure that the accounts presented to him are free of any material misstatement.
For this purpose an auditor examines the accounts with evidences supporting the amounts and disclosures made in the accounts and after due verification he expresses his opinion in the form of a report under section 35A of CO on the prescribes issues which are also of vital importance for assessing officers in the assessment of a company.
These issues inter alia include that (i) proper books of accounts as required under the CO have been kept, (ii) the balance sheet and profit and loss accounts are in agreement with the books of accounts. (iii) the expenditures incurred during the year were for the purpose of the company's business, (iv) further that the business conducted, investment made and expenditure incurred during the year were in accordance with the object of the company.
These observations of an auditor carry significant weight and meet the requirement of the assessing tax officer, despite the fact that he generally requires the taxpayer to produce books of accounts, documents and details of each income and expenditure, shown in the audited accounts and declared in the return of income by him.
However, there are certain areas which do not fall within the scope of an audit, hence these areas are not reported in the auditors' report. Though some of them are taken care of during the audit with a view to meet the requirement of the CO and IAS but these matters are not reported in the accounts.
INTERNATIONAL ACCOUNTING STANDARDS (IAS): The CO makes it mandatory for an auditor to follow the specified IAS in carrying out the audit of a company. The auditors are required by ISA-220 to implement the policies and procedure designed to ensure that the audit is conducted in accordance with the international audit standards. Further the IAS-230 requires the auditors for documentation and prepare working papers of the audit conducted by them to provide evidence to support their audit opinions expressed by them in their report.
The Institute of Chartered Accountants of Pakistan has made it mandatory for the auditors to review their working papers under their quality control review programme.
Though the directors and the management of a company are primarily responsible for the prevention of fraud and error, but the auditors are also made responsible by IAS-240 to consider the risk of material misstatement in the financial statements resulting from an error. The auditors are further required to comply with the IAS-250 to consider the non-compliance, if any of the related laws and regulations and their material effect on the financial statements.
It will be observed from the various international standards mentioned above that the function of the auditor is tightened up all around. There is no escape to avoid any responsibility in discharging their duties and provides complete assurance for reliability of their audited accounts.
AUDITOR'S REPORT: The CO has ensured the auditors report to be an authenticated and free from false and misleading statement providing criminal charges under the CO against such auditors. It has made an auditor liable to punishment with imprisonment for a term which may extend to one year and a fine upto Rs 100,000 in case the auditors report is made or any document of the company is signed by him is not in accordance with the requirements of sections 157, 255 or 257 of the CO or is made with the intent of profit which is a false or incorrect in any material.
ASSESSING TAX OFFICER'S APPROACH (ATO): It will be observed from the above discussions that the CO has taken due care and has imposed checks and balances to ensure the authenticity of the audited accounts and auditors report thereon; despite it the ATO generally places little reliance on the audited accounts duly certified by the company's statutory auditors. Though the learned Income Tax Appellate Tribunal has given its verdict in a case reported 1998 PTD 860 that rejecting the book version duly audited by a company of Chartered Accountants was against the sprit of section 32A of the Income Tax Ordinance, 1979.
Further it has held that the method of accounting adopted by the assessee could not be questioned being duly certified by a renowned company of chartered accountants.
The staple mother treatment given by an ATO to they accounts may appear sound if the following factors are taken into account:
Although in the auditors report they expressed their opinion on the issues relating to proper books of accounts, the expenditures incurred for the purpose of business etc but still there are certain provisions as specified under section 21 of the Ordinance in respect of deduction not allowed and the expenditures are disallowed under section 111 of the Ordinance the answer of which is not found in the said accounts. For instance the expenditure which is not admissible for deduction in computing the income from business as specified under the aforesaid sections on which the assessing tax officer is required to be satisfied as to whether these provisions of the Ordinance were complied with by the taxpayers. There may be similar other issues too.
The point to be emphasised is that they conducted by the auditors under the CO is extensive enough, still its scope is required to be extended little more to cover the requirements of the Ordinance and Sales Tax Act, 1990, so as to make it a document acceptable to all stack holders; it will give relief to the taxpayers and the management of the company may concentrate more to their business which ultimately will enhance their profitability and will generate more revenue to the exchequer.
TAXPAYERS IRRITANTS: The taxpayers are to maintain the books of accounts as required under the CO, the Ordinance and Act. Further he gets the accounts audited by a firm of chartered accountants in compliance with the CO. Based on the said accounts they file the return of income declaring the income disclosed in the audited accounts, yet the said accounts are not accepted by the ATO.
Although the Ordinance treats the return of income filed by a taxpayer as an assessment, if it is taken to be complete. In case his return is found incomplete he is required to furnish information requisitioned by a Commissioner. Further the Commissioner or any other officers authorised in this behalf by the CIT or CBR is empowered under section 176 to call for any information from the taxpayer. Besides it, the taxpayer is subject to audit under section 177, if his case is selected by the Commissioner for audit.
In all the above cases the information usually called for, more or less are the same.
Recently the CBR has revised the form of return of income which requires the taxpayers to furnish certain information's which are not available in the audited accounts. The advocates and income tax practitioners complain that the chartered accountants may collect these information's during the process of audit of a company; but they may face difficulty to furnish these information with the return of income of their clients, because the audited accounts do not make disclosure of the information required by the tax authorities. As a result of this lack of co-ordination between the said regulators, CBR and SEC, defeat the objective of simplification of taxation system for which the CBR is making efforts.
The simplification can only be achieved through integration of accounting and audit systems existing under the said statutes.
In the circumstances the taxpayer is aggrieved after a details statutory audits under CO and the auditors opinion expressed on his accounts free from qualification, the assessing officers do not rely on it and he is subject to audit time and again.
From the above discussion it will be noted that there are similarities and dissimilarities in the said three statutes in respect of maintenance of books of accounts, records etc and conducting of audit thereof; which are summed up as under:
The position of similarities in the said three statutes in respect of audit are as under:
All the said three statutes provide for the books of accounts in respect of money received and expended, sales, purchases, assets and liabilities.
The auditors report expresses opinion in respect of (i) proper books of accounts as required under the CO have been kept, (ii) the balance sheet and profit and loss accounts are in agreement with the books of accounts (iii) the expenditures during the year were for the purpose of the company's business (iv) the business conducted, investments made and expenditure incurred during the year were in accordance with the object of the company.
The auditors opinion on these issues are directly concerned with the assessment of income declared by a taxpayer in his return. The ATO may, therefore, be made to rely mandatarily on the audited accounts as the auditors opinion on these issues meet the requirement of section 20 of the Ordinance.
The points of dissimilarities found in the above said three statutes are as under:
The expenditure disallowed as specified in section 21 and section 111 which are not covered in the audited accounts nor in the auditors reports.
The provision of sections 22-31 of the Ordinance have also relevance in considering the modalities to make the audited accounts acceptable by the tax authorities.
The required information for the purpose of sales tax also need consideration.
RECOMMENDATIONS: Although the aforesaid areas are covered during the process of statutory audits but the need is to documents them and reference of opinion thereon is required to be made in the audited accounts. It also entails to expand the scope of the statutory audit under CO to cover the aforesaid areas to meet the requirements of the tax collectors, both income tax and sales tax.
In order to cater to the need of the accounting information by the tax authorities both, income tax and sales tax, the Schedule four and five to the CO may be revised which have recently been revised by the SEC to bring them in line with the international accounting standards.
As agreed by the Chairman of the CBR and SEC to work in close co-ordination to rationalise the existing framework of the convenience of the taxpayers, accordingly a task force be constituted comprising the members from income tax, sales tax authorities, tax bars, ICMA and ICAP. The reference to the task force may be to review and examine the present system of sales tax, income tax and corporate laws in respect of maintenance of books of accounts on the consolidation, presentation the/accounting information and which centre on the need of the said statutes. Further to examine the legal, regulatory and other related issues involved there with recommendation plan thereof.
The concept of integrated audit system may be opposed on the grounds that (i) the approach and objective of the audit under different statutes are different, (ii) the scope of audit will have to be extended to cover the areas which may not be in conformity with the international audit standards, (iii) audit may become expensive and such other arguments will be offered against it.
But as agreed between the two chairmen of the said regulators viz CBR and SEC the objective of tax policy clearly be defined, but I would emphasis that it should be redefined, to achieve common objectives of both the said regulators to encourage corporalisation, investment and overall interest of Pakistan. This is the time of complex possibility and we believe the best approach is to embrace that reality.
The benefits to accrue of the integrated system of audit would be (i) it will save the taxpayers from hassle of taxation system; (ii) it will reduce the cost of collection of revenue through downsizing in the taxation department and efficiency of tax officers would be enhanced, retaining honest and qualified staff and last but not least it would minimise new taxes on the public which are normally imposed to meet the lucrative expenses of the government officials.