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"I am proud that I pay my taxes." This is what the government wants us all to say, and, in fact, is what all of us ought to say. But that's not how it works here.
First, in a country of a billion people, only a minuscule number need to pay taxes and file income tax returns. And the money so collected contributes to building roads, dams, airports and the like. That's good reason to pay tax, isn't it? But not everyone contributes to nation building; several people prefer to evade paying taxes.
Now, it is natural to expect that these tax evaders will be caught and punished, and that the honest taxpayers will be thanked for their services. No, that's not what happens.
What happens is that the tax evaders generally are allowed to go scot-free, while the taxpayer who goes to the trouble of paying and filing returns is rewarded with a scrutiny of his returns. But whoever said the world was fair? All we can do is figure out how best one can deal with such a scrutiny.
The basics: First, what is a scrutiny? Under the Income Tax Act, if an income tax officer is of the opinion that you have concealed any income in your return or you have filed any inaccurate particulars in your return, he can take up your return for scrutiny.
The income tax officer can serve the scrutiny notice within one year from the end of the month in which you have filed your return. So, if you had filed your return of income for the year ended March 31, 2005, on July 24, 2005, you may get a notice any time on or before July 31, 2006. The time limit relates to the serving of the notice by the Income Tax Department and not the issue of the notice.
The notice itself comes in a fixed format, with the taxpayer's name, address, permanent account number (PAN) and the year for which it has been issued, as well as the date and time when the taxpayer should appear before the income-tax officer. The good news (if you can call this good) is that the taxpayer need not appear personally before the officer and can authorise a representative to plead his case.
Generally, chartered accountants or other tax practitioners appear on behalf of taxpayers. If you plan to send an authorised representative, you must issue a valid power of attorney in his favour.
If Tax Man Comes Calling:
The objective of the tax officer is to find out whether the taxpayer has shown his correct income in the return or not. To this end, he will examine the expenses claimed in the return to ensure that they are genuine and not bogus or fictitious. So, if you ever face a tax scrutiny, be prepared to receive inquiries that question your income as well as your expenses claimed as deduction.
The officer's job: One method of evading tax is to simply not show an income in the tax return. For instance, you may have received interest on bank fixed deposits and deposited that amount in your bank account, but choose not to show that interest in your tax return. Another way of concealing income is to accept the income in cash and not route it into the official system at all.
This is the most common method.
The IT officer, therefore, has to be sharp enough to spot the evasion in the first place. Having done so and called for a scrutiny, he will ask for a summary of all your bank accounts and copies of the bank pass book/statement(s). From this, it would be very easy for him to spot the various credits in the account and cross check them with your tax return to verify whether you have shown the income in your return or not.
Apart from this, the officer will also ask for details of your family members who live with you, as well as details of all withdrawals made by you during the year under scrutiny for personal and household expenses and also ask you to submit a list of all the assets owned by you and members in your family. This information will help the officer figure out if you have a regular supply of black money.
Generally, those with black money tend to use this cash for daily expenses and the drawings from the bank account for household and personal use would be very small.
Based on the size of the family and an estimate of cost of living in your city, the officer would be justified in guessing how much money a family like yours would spend every month for personal needs. He will then compare how much money you have actually drawn for this purpose and how much money you ought to have drawn. If there is a shortfall, then the most logical conclusion will be that you have a supply of black money.
Withdrawal pangs: In fact, the Central Board of Direct Taxes recently issued a circular to its officers instructing them that if an individual taxpayer has shown withdrawals of less than Rs 50,000 per annum, then his return of income would be picked up for scrutiny.
So, if you're used to flashing your credit card at every place from petrol bunks to five-star hotels, make sure that the payment for the expenses charged on the card(s) is through your regular bank account and not through a secret account. A reasonably intelligent IT officer will ask you for details of all 12 months credit card statements and also ask how you paid for the same. If the entries for the payments do not figure in your bank summary, beware.
The officer is also likely to ask you for details of any loans given to relatives and friends. He will also ask for loan confirmations from the borrowers, along with their respective PANs.
If he finds from your bank statements that you have not taken any interest on these loans, he will assume that you have taken the interest in cash. The onus is on you to prove that the loans were genuinely interest free. Also, in the interest of a simple life, make sure you don't give interest-free loans when you've already borrowed money and are repaying that with interest.
Assume you borrowed Rs 10 lakh (Rs 1 million) at 15 per cent interest from a bank and give your wife or brother Rs 9 lakh (Rs 900,000) as an interest-free loan to buy shares. If you have claimed the interest on the bank loan as an expense against any of your incomes, there is every likelihood that the IT officer will disallow interest to the extent of 15 per cent of Rs 9 lakh on the ground that you have given an interest-free loan out of interest bearing funds.
You may have been hugely lucky and hit the jackpot on a TV game show. Remember that your IT officer is very likely watching this same show, and is more than likely to send you a notice asking how the prize money has been shown in your return. And, no matter what the show organisers may say, such cash prizes are not tax-free at all.
Then there's the sensitive matter of perks. You may get a large cheque from your employer towards reimbursement of medical expenses or travel allowances.
The IT officer will total up the amounts that you have received from your employer and crosscheck that figure with your salary certificate. If the two figures don't match, you will have to be able to explain why. If you have claimed some of these receipts to be reimbursements and therefore exempt, you need to be able to prove that you have made these payments in the first place.
Bottomline: These are just a few examples of what kind of questions you may face during a scrutiny. There may be other, more probing questions asked, depending on the IT officer. Remember, it's easier for the tax department to recover tax from an existing taxpayer than it is to unearth tax evaders.
And finally, you may want to know what happens after the scrutiny. The assessment order and the taxpayer's file goes to the office of the concerned commissioner of income-tax or additional commissioner who holds charge over your income tax officer and the papers are reviewed there.
After this review, the file then goes to the office of the Internal Audit Department of the Income-Tax Department and gets rechecked by them. What happens after this is that the strong arm of the law comes into play, and it's best to draw a veil over this.
The author is a member of the Bombay Chartered Accountants' Society (www.bcasonline.org).