POSITION UNDER INCOME TAX ACT OF BENEFICIARY OF HAWALA DEALER WITH SPECIAL

REFERENCE TO SEC 48(5) OF MVAT ACT, 2002

.... CA Dharmen Shah

Much hype is created among general public due to List being regularly updated by MVAT Department
relating to Suspicious Dealers. The last updated List of 1277 Suspicious Dealers who has issued false
bills without delivery of goods is displayed on Website of Government of Maharashtra – VAT
Department since July-12.

The Main Issue remains –

(A) What will be the role of Auditor in the course of Audit if they come across Purchases from
suspicious Dealers?
(B) What will be the Position of Bonafide Dealers who have purchased from Such Suspicious
Dealers under Income Tax?

RESPONSIBILITY OF AUDITOR :-

The Primary responsibility of Auditor is to certify as to reliability of the books of accounts and other
records are properly maintained, with the assertion that Profit & Loss Account and Balance sheet
give a true and fair view of state of Affairs of the Assessee.

Clause (xxi) of Paragraph 4 of the Companies (Auditor’s Report) Order, 2003 further requires the
auditor to specifically report “whether any fraud on or by the entity has been noticed or reported
during the year; if yes, the nature and amount involved is to be indicated”

Extracts from Revised Standards on Auditing:-

Para 11 of SA 200 (Revised) : Overall Objectives of the Independent Auditor and the Conduct of an
Audit in Accordance with Standards on Auditing states ‘In conducting an audit of financial statements, the
overall objectives of the auditor are (a) To obtain reasonable assurance about whether the financial statements
as a whole are free from material misstatement, whether due to fraud or error, thereby enabling the auditor to
express an opinion on whether the financial statements are prepared, in all material respects, in accordance with
an applicable financial reporting framework’

Extracts from SA 240 (Revised): The Auditor’s Responsibilities Relating To Fraud In An Audit Of
Financial Statements:
Para A5:- identifies Fraud to include ‘Causing an entity to pay for goods and services not received (for example,
payments to fictitious vendors, kickbacks paid by vendors to the entity’s purchasing agents in return for inflating
prices, payments to fictitious employees).’

Para A18:- Professional skepticism includes being alert to, for example:
♦ Audit evidence that contradicts other audit evidence obtained.
♦ Information that brings into question the reliability of documents and responses to inquiries to be used as audit
evidence.
♦ Conditions that may indicate possible fraud.
♦ Circumstances that suggest the need for audit procedures in addition to those required by the SAs.

Para A21 :- The auditor may accept records and documents as genuine unless the auditor has reason to
believe the contrary. Nevertheless, the auditor is required to consider the reliability of information to be used as
audit evidence. In cases of doubt about the reliability of information or indications of possible fraud (for example,
if conditions identified during the audit cause the auditor to believe that a document may not be authentic or that
terms in a document may have been falsified), the SAs require that the auditor investigate further and determine
what modifications or additions to audit procedures are necessary to resolve the matter.

Thus, Such Frauds are already known and expected to be known to Auditors and hence he is
expected to exercise Professional Skepticism while using the information available publically
relating to Suspicious Dealers on Vat Website.

Following cases are required to be examined regarding such Dealers

1. Some Dealers have actually issued 100% false sales invoices without delivery of goods.
2. Certain dealers have partly issued false sales invoice without delivery of goods and partly
Genuine Sales to his Customers.
3. Certain Dealers have actually made genuine Sales to other Dealers but have not deposited
taxes into the government Treasury.

So there are cases where in a Dealer has made genuine purchases but still his set-off may have
been dis-allowed.

Question is Whether all dealers are considered as Suspicious Dealers as per Website list are Hawala
Dealers?

The Maharashtra Vat Department has displayed Suspicious Dealers list on website saying List of Suspicious
Dealers and not HAWALA DEALERS. Further, A Disclaimer has been put in to say if any dealer whose name is
published has any grievances should contact DC Office Vigilance, Mazgaon. Further, In course of updating list by
Vat Department 2 dealers has been removed from Suspicious dealers till July,12. Thus, Solely based on
Suspicious Dealer List one cannot claim any purchase to be bill purchase and qualify the Audit Report.

What will be the plight of Customers who have purchased from such dealers and claimed set-off on
such purchases?

The plight of Bonafide dealers who have made genuine purchases from above dealers are denied of set-off by
issuing Notice in Form 603 u/s 64 of MVAT Act, 2002 with reference to Sec 48(5).

Extract from Sec 48(5) reads as under ‘For removal of doubts it is hereby declared that, in no case the amount of
set-off or refund on any purchase of goods shall exceed the amount of tax in respect of the same goods ,
actually paid, if any under this act or any earlier law into Government Treasury.’
It means that Set-off or refund shall be allowed to Purchasing Dealer to the extent his corresponding Selling
Dealer has deposited taxes in respect of such sales affected to him in to the Government Treasury.

As Per Para 51 of Judgement of Hon’ble High court in case of M/s. Mahalaxmi Cotton Ginning Pressing and Oil
Industries, Kolhapur ITC claim should not be allowed if the purchases are not genuine. However, it should not
prevent dealers from adopting such remedies as are available under law.

Intention of Maharashtra Vat Department in disallowing Input Tax Credit as per Circular 8T of 2012:-

Extract from Cir 8T of 2012 was issued after Judgement of Hon’ble High court in case of M/s. Mahalaxmi Cotton
Ginning Pressing and oil Industries, Kolhapur on 21.06.2012 states that :-
1. No Input tax credit claim shall be allowed unless the corresponding tax is paid by the selling dealer into
the government treasury.
2. In case of mis-match in sales and purchases in electronic matching, then to the extent of unmatched
amount ITC will be disallowed.
3. ITC claim shall not be allowed if the purchases are effected from hawala dealer and even though such
hawala dealer has paid taxes partially or fully as these are not genuine transactions.
Thus, the intention of the Vat Department is to dis-allow set-off on those transactions :-
(a) which are not genuine transactions
(b) Genuine Purchases made from Selling Dealer but he has not paid taxes.

In above situations, It is for Auditor to analyse that Taxes paid by Dealer in respond to Notice from Vat Authority
during the year is in respect of such purchases falls under which category (a) or (b).

To examine whether a Purchase Transaction is genuine any of the following audit procedures may be adopted:-
1. Auditor may inquire with Management and also evaluate internal controls relating to purchases cycle.
2. Auditor may consider verifying Purchase Invoice, Delivery Challan/ Transporters Copy, Mode of
Payment to such Vendor.
3. If Stock Register is maintained, Auditor may consider verifying whether such goods are reflected as
Purchase in such Stock Register.
4. If Stock Register is maintained, Auditor may consider verifying the consumption of such Raw material in
course of manufacturing activity or Sold/ issued to whom in course of business.
5. If such purchase forms part of Inventory, Then Auditor can be present at Inventory physical counting.
6. The Auditor may also resort to method of obtaining External Confirmations Procedures as per SA 505
(Revised).
7. The Auditor should also consider to obtain a Representation from Management with respect to such
Purchases.

If after performing above Audit procedures, Auditor is of opinion that the Purchases made are genuine then he
should not consider placing an emphasis or qualifying the Audit Report as there is no intention of fraud.

Case I : - Dealer has received notice in Form 603 during the F.Y. 2011-12 issued u/s 64 of MVAT Act, 2002
directing them to pay Vat along with Interest u/s 30(2) and 30(4) pertaining to Dealers from whom they have
made purchases during the Year 2005-06 to 2010-11. What should be remarks of Auditor in respect of Such
Notice? Whether such expense qualifies as Prior Period Expense ?

As Per AS-5 “Prior period items” are income or expenses which arise in the current year as a result of
errors or omissions in the preparation of the financial statements of one or more prior periods.
Since the above liability is not due to any error or omission the same cannot be treated as prior period
expense for the purpose of Clause (b) of Pt. 22 of Tax Audit Report.

Since the liability to pay has arised in Current Year and paid, the same should be allowed u/s 43B of Income Tax
Act, 1961.

Qualification with respect to such cases should be done after verifying whether purchases are genuine by
adopting methods available to Auditor.

Case 2 :- If in course of Audit for F.Y. 2011-12, Auditor comes across Purchases made by his client from
Suspicious Dealer.

If after performing Audit procedures, Auditor is of opinion that the Purchases made are not genuine then he
should consider placing an emphasis or qualify the Audit Report.
POSITION OF BONAFIDE PURCHASERS WHO HAVE PARTLY AFFECTED HAWALA PURCHASES:-

Presently it is observed that Income Tax authorities have started using the information pertaining to suspicious
dealers. The Position is explained by citing following Case:-

As observed in the case of M/s. Sanket Steel Traders V/s. ITO Ward 5(1), Vadodara ITA No. 2937/AHD/2008,
Some important points are as below:-

View taken by Assessing Officer and ITAT:-

In above case, the assessee was a trader. In course of Investigation, It was found that Purchases made from
certain parties were found to be bogus and Assessing Officer disallowed Total Value of Such Purchases and at
the same time added back payment made to such Purchasers as Unexplained Payments.

Further, ITAT confirmed that ‘Once the Purchases are proved Bogus, Total Value of Such Purchases is to be dis-
allowed and at the same time Payment made to such Purchasers should be added back to Income as
Unexplained Payments since such Dealers did not have any actual business transactions with the assessee.’

Further While Adding Back the Bogus Purchases to GP, the same cannot exceed Sales. Hence a reasonable
benefit is required to be determined by A.O. Thus, he cannot blindly add back Purchases.

Onus to prove Genuine Purchases:-

The Assessee in this case did not take any efforts to produce the seller and claimed that it is not his responsibility
to produce Seller.
However, To Contrary ITAT held that It is settled law that Onus is on Assessee to establish the genuineness of
the Purchase.

Whether Quantitative Details, Stock Register, Delievery challan, Weigh Bridge Copy, Octroi Receipt,
Transporter Copy can be used to prove Genuine Purchases by the Assessee:-
In the above case, The assesse had maintained complete quantitative Details of the goods claimed to have been
purchased. Further, Goods purchased from such suspicious Dealers had been included in closing Stock/ Sales.
He had also produced Weigh bridge Copy, Octroi Receipt and other documents in an effort to prove Genuine
Purchases.
ITAT Held that, Considering material produced It is observed that The Assessee has affected genuine
purchases but not from the Supplier mentioned in the Invoices but from some other Dealers may be without bills.
Therefore, purchase rate as mentioned in the alleged sales bill cannot be accepted. Any person indulging in the
practice of purchasing goods from the grey market and obtaining bogus bills of some other parties, would do so
for getting some benefit. But what would be the magnitude of the benefit would depend upon facts of each case.

Benefit which has been computed by ITAT depends on case to case. In the above case, Benefit was computed
@ 12.5%. In case of Vijay Proteins 55 TTJ (Ahd) 76 it was decided @ 30%, In case of Kulubi steel it was decided
@ 12.5%. In case of ITO Vs. Sun Steel 92 TTJ (Ahd) 1126Addition was made to the extent of 50%. Recently, In
case of Avishkar Processing Mills ITA No. 145, 146 & 147/Ahd/2009 of 10 th February 2012, the benefit was
decided to the extent of 25%.

Whether Payment made by Cheque through Bank can be treated as Unexplained Payment :-

ITAT had held Once the Purchases are proved Bogus, Total Value of Such Purchases is to be dis-allowed and
at the same time Payment made to such Purchasers should be added back to Income as Unexplained Payments
since such Dealers did not have any actual business transactions with the Assessee.

Thus, It is established that If Purchases are proved bogus, Payment made by Bank can be treated as
unexplained payment.
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