Key Guidelines for Finalizing Accounts: Income Tax & GST Compliance

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Finalizing the books of account is a pivotal process for businesses, aimed at ensuring their financial statements accurately reflect the company’s financial status in compliance with the Companies Act, GST, and Income Tax provisions. While traditionally performed at the fiscal year-end, adopting a routine check, such as monthly or quarterly, significantly aids in maintaining compliance and financial integrity. This detailed guide explores vital considerations for businesses before finalizing their financial records, focusing on adherence to Goods and Services Tax (GST) and Income Tax regulations.

Finalizing the books of account is a pivotal process for businesses, aimed at ensuring their financial statements accurately reflect the company's financial status in compliance with the Companies Act, GST, and Income Tax provisions. While traditionally performed at the fiscal year-end, adopting a routine check, such as monthly or quarterly, significantly aids in maintaining compliance and financial integrity. This detailed guide explores vital considerations for businesses before finalizing their financial records, focusing on adherence to Goods and Services Tax (GST) and Income Tax regulations.

Goods & Service Tax (GST) Considerations before finalization of Books of Account

1. GST Returns and Amendments: As per section 39 of the CGST Act, 2017, businesses must file monthly or quarterly returns (GSTR-1, GSTR-3B) within the prescribed deadlines. Errors identified in returns for the previous fiscal year can be amended in the annual return (GSTR-9) or via amendments in subsequent monthly returns, ensuring compliance with section 37 (Amendments to details of outward supplies).

2. Reconciliation and Compliance: Section 42 of the CGST Act mandates the reconciliation of sales and purchases with the records maintained by the GST authorities. This reconciliation ensures that the output tax liability and input tax credit (ITC) align with the records, preventing potential mismatches and facilitating accurate tax payments.

3. Comply with ITC Restrictions Under CGST Act Section 17(5): Businesses must rigorously adhere to the stipulations of Section 17(5) of the CGST Act, ensuring that Input Tax Credit (ITC) is not wrongfully claimed on restricted commodities. If an ITC claim breaches these guidelines, it is imperative to rectify such claims by reversing the credit, additionally incurring an interest charge of 18% per annum.

4. Adjust Asset Cost for Depreciation Post-ITC Claim: When claiming Input Tax Credit on capital assets, it's crucial to adjust the asset's cost basis for depreciation calculations in accordance with tax regulations. For instance, if a capital asset is acquired for Rs 1,00,000, inclusive of GST amounting to Rs 18,000, and ITC is utilized for this GST amount, the asset's adjusted cost for the purpose of calculating depreciation under the Income Tax laws would then be Rs 82,000. This adjusted figure should be used as the basis for depreciation computations, ensuring accurate reflection of the asset's cost post-ITC claim and aligning with fiscal compliance standards.

5. Supplier Compliance and ITC Eligibility: The eligibility to claim ITC is contingent upon the supplier's compliance with filing their returns, specifically GSTR-1, which reflects in the recipient's GSTR-2A and GSTR-2B, as per Rule 36(4) of the CGST Rules, 2017. This rule emphasizes the necessity of matching the input tax credit claimed with the details furnished by the suppliers.

6. Monitor GST Portal for Notices and Ensure Timely Responses: It is crucial for businesses to diligently monitor the GST portal for any notices issued by the GST Department. Receiving a notice indicates that the department requires clarification or additional information regarding your GST filings or transactions. In such instances, it is paramount to craft and submit a comprehensive response by the specified deadline. Timely and accurate responses to these notices not only demonstrate compliance but also help in avoiding potential penalties or legal complications. Regularly checking the GST portal and adhering to response deadlines ensures smooth compliance with GST regulations, maintaining the integrity of your business's tax affairs. This proactive approach aids in preemptively addressing issues, fostering a transparent and compliant tax management process.

7. Monitoring Turnover for GSTR-9 and 9C: Businesses with an annual turnover exceeding Rs 2 crore are mandated to file GSTR-9, and those with a turnover exceeding Rs 5 crore are required to file GSTR-9C, as stipulated by the CGST Rules. It is crucial to monitor sales turnover closely to comply with these filing requirements.

Key Guidelines for Finalizing Accounts

8. Adhere to the 180-Day Payment Rule for ITC Claims Under Section 16(2) of CGST Act: Under the stipulations of Section 16(2) of the CGST Act, it's imperative for businesses to ensure that payments to suppliers are completed within 180 days from the date of the invoice. This is particularly crucial for those who have claimed Input Tax Credit (ITC) based on the GSTR-2B filings. Should the payment not be made within this timeframe, the previously claimed ITC must be reversed, incurring an additional interest charge at the rate of 18% per annum. This reversal and interest charge must be reported in the GSTR-3B of the tax period immediately following the lapse of the 180-day period.

9. Ensure Timely Filing of Letter of Undertaking (LUT) for GST-Free Exports: Businesses engaged in exporting goods or services outside India are required to file a Letter of Undertaking (LUT) to avail the benefit of exporting without the payment of GST. As per the GST regulations, this LUT should be filed annually, on or before the 31st of March at the beginning of the financial year. The LUT allows exporters to seamlessly conduct international transactions without the burden of GST, facilitating a smoother flow of exports.

Filing the LUT within the stipulated timeframe is crucial for maintaining compliance with GST laws and ensuring that your business can continue to enjoy the benefits associated with GST-free exports. Late submissions may result in the necessity to pay GST on exports and then claim refunds, which could affect cash flow and operational efficiency.

10. GST Implications on the Sale of Capital Assets with Previously Claimed ITC: When a business sells capital assets during the financial year on which Input Tax Credit (ITC) was claimed at the time of purchase, GST must be applied to the sale of these assets. This ensures the correct tax treatment of capital assets, aligning with GST norms that govern the sale of goods and services within the framework. The requirement to charge GST at the point of sale serves to adjust the tax benefits previously availed through ITC, ensuring the tax credits correlate accurately with the asset's lifecycle within the business.

11. Input Tax Credit Eligibility Under Reverse Charge Mechanism (RCM): Under the Reverse Charge Mechanism (RCM), the liability to pay GST shifts from the supplier to the recipient of goods or services. In scenarios where RCM is applicable, businesses are allowed to claim ITC only after the GST under RCM has been paid. This stipulation ensures that tax credits are only availed once the tax liability has been fulfilled, maintaining the integrity of the tax credit system.

Income Tax Considerations before finalization of Books of Account

1. Preparation of Comparative Books of Accounts: It is essential for businesses to prepare comparative books of accounts annually, aligning with best practices and compliance requirements. For instance, when finalizing accounts for the financial year (FY) 2023-24, it is advisable to concurrently prepare the accounts for FY 2022-23. This comparative analysis is not only mandatory in scenarios where an audit is applicable but also serves as a critical tool for external entities such as customers, shareholders, and financial institutions to assess the company's financial health and performance over time. Such practice enhances transparency and provides valuable insights into the company's operational effectiveness and financial stability.

2. Adjustment of Personal Expenses in Profit and Loss Account: When compiling the profit and loss (P&L) account, it's crucial to identify and adjust for personal expenses, as these are not permissible deductions under the Income Tax Act. Any personal expenses recorded must be added back to the net profit to accurately calculate taxable income. This adjustment ensures the P&L account reflects only those transactions pertinent to the business operations, thereby aligning the reported profit with the tax obligations stipulated by the Income Tax laws.

3. Compliance with Tax Deducted at Source (TDS) Regulations: Businesses must diligently ensure that TDS on applicable payments is correctly deducted and remitted to the authorities within the prescribed deadlines. Furthermore, it's imperative to reconcile TDS receivables with Form 26AS and the Annual Information Statement (AIS) to verify that all deductions and credits are accurately reflected and accounted for. This practice not only ensures compliance with tax regulations but also aids in the accurate computation of tax liabilities and receivables.

4. Filing of Statement of Financial Transactions (SFT): In scenarios where the Statement of Financial Transactions (SFT) is applicable, businesses are required to file it by the 31st of May following the financial year in question. The SFT filing is crucial for disclosing specific transactions to the tax authorities, as mandated under the Income Tax Act. Timely and accurate submission of the SFT supports the government's efforts in preventing tax evasion and ensures that businesses remain compliant with their reporting obligations.

5. Optimal Structuring of Interest and Remuneration in Partnership Firms for Income Tax Compliance: Partnership firms navigating through the complexities of financial management must adhere to the Income Tax Act's stipulations regarding interest on capital and remuneration paid to partners. These provisions are designed to ensure that the distributions made to partners are within reasonable limits, thus aligning with tax efficiency and compliance.

a. Interest on Capital to Partners: The Income Tax Act permits partnership firms to pay interest on the capital contributed by partners, capped at a maximum rate of 12% annually. This interest is deductible as a business expense before arriving at the book profit, provided the payment is stipulated in the partnership deed and does not exceed the prescribed rate. Adhering to this limit is crucial for tax planning, as it ensures the firm can reduce its taxable income through legitimate expenses, thereby optimizing its tax liabilities.

b. Remuneration to Partners: Regarding remuneration paid to partners, including salaries, bonuses, or commissions, the Income Tax Act outlines specific thresholds based on the firm's book profit:

    • For the first Rs. 3 lakh of book profit, remuneration can be the higher of Rs 1,50,000 or 90% of the book profit.
    • For any book profit beyond Rs. 3 lakh, the remuneration is capped at 60% of the book profit.

These guidelines ensure that remuneration to partners is linked directly to the firm's profitability, promoting equitable distribution of profits and aligning partner remuneration with the firm's financial performance. It's essential for partnership firms to meticulously calculate these distributions to comply with tax regulations and avoid any disallowances that could arise from exceeding these limits.

6. Accurate Calculation of Depreciation: Businesses must calculate depreciation strictly according to Section 32 of the Income Tax Act, utilizing the Written Down Value (WDV) method and adhering to the rates specified within the Act. This ensures that depreciation claimed on assets accurately reflects their usage and wear over time, aligning with statutory guidelines to optimize tax benefits legally.

7. Compliance with Section 43B and the MSME Act: Adherence to the latest amendments in Section 43B concerning payments to creditors is critical. Payments to MSME creditors must be settled within 45 days of the agreed date, or within 15 days if no specific date is mentioned, as mandated by Section 15 of the MSME Act. Failure to comply results in the disallowance of such expenses, underscoring the importance of timely payments to maintain tax compliance and support business liquidity.

8. Restrictions on Cash Transactions for Asset Purchases: The Income Tax Act restricts the allowance of expenses for cash payments exceeding Rs. 10,000 made in a single day for the purchase of an asset. This measure aims to encourage traceable transactions and ensures that the actual cost of the asset, for depreciation purposes, excludes any amount paid in cash over this limit.

9. Timely Payment of Advance Tax: Ensuring that advance tax payments are made by the due dates is essential for avoiding interest and penalties. Advance tax payments, based on estimated tax liability, help in managing cash flow more efficiently and prevent lump-sum payments at the end of the fiscal year.

10. Bank Reconciliation for Financial Accuracy: Regular preparation of bank reconciliation statements is vital for verifying the accuracy of financial transactions recorded in the books. This reconciliation between the cash book and the bank passbook detects discrepancies early, ensuring financial statements reflect the true financial position of the business.

11. Treatment of Bad Debts: The Income Tax Act specifies that provisions for bad debts cannot be claimed for the purpose of computing taxable profits. However, actual bad debts written off, which meet certain conditions, can be deducted, highlighting the need for careful consideration and documentation of irrecoverable amounts.

12. Ensuring Compliance with Cash Transaction Limits Under Section 269ST of the Income Tax Act: It is crucial for businesses and individuals to adhere strictly to the cash transaction limits set by Section 269ST of the Income Tax Act. This section prohibits accepting cash of Rs 2 lakh or more in a single day from a single person for any transaction. The objective behind this regulation is to curb the flow of unaccounted money and encourage a transparent financial ecosystem.

Violating this limit has serious repercussions. As per Section 271DA, if a transaction exceeds this threshold, the penalty imposed is equal to the amount received. For instance, accepting Rs 2,50,000 in cash from one person in a single day would trigger a penalty of Rs 2,50,000. This stringent measure underscores the importance of monitoring and managing cash transactions meticulously to avoid such punitive financial consequences.

13. Mandatory Tax Audit Thresholds: For businesses and professionals, crossing the turnover threshold of Rs 1 Crore for businesses or Rs 50 lakh for professionals triggers the requirement for a compulsory tax audit under Section 44AB. Monitoring sales turnover and gross receipts meticulously is crucial for identifying the need for a tax audit, ensuring compliance, and facilitating accurate tax reporting.

Conclusion: Finalizing books of account is a comprehensive process that requires a nuanced understanding of GST and Income Tax laws. By adhering to the specific legal provisions and ensuring meticulous compliance, businesses can effectively navigate the complexities of financial reporting and taxation. This adherence not only safeguards against potential legal and financial repercussions but also significantly contributes to the transparent and accurate presentation of the financial health of the business.