Non-Banking Financial Companies (NBFCs), by nature of their complex and large-scale operations, require strong financial controls and strict adherence to regulations. One of the key mechanisms to ensure this is through tax audit services for NBFCs.
This guide will help you understand NBFC tax audits in India. We’ll explore everything you need to know, from the purpose to the process of tax audits. We also share with you the most common audit findings we at PKC Management Consulting have encountered in our 35+ years as a trusted audit firm.
Why do NBFCs need Tax Audit Services?
There are two main categories of reasons that make tax audit services for NBFCs essential:
Regulatory Framework & Laws
The following set of laws and regulations make it necessary for NBFCs to undergo tax audits:
- RBI Regulations: The Reserve Bank of India (RBI) sets regulations for NBFCs, and tax audits are often mandatory for NBFCs above a certain size.
- Income Tax Act, 1961: This act lays out the general framework for tax audits, applicable to all entities (including NBFCs) that exceed the mentioned thresholds of turnover or income.
- The Companies (Indian Accounting Standards) Rules, 2016: They require NBFCs to prepare their financial statements in accordance with the specified Schedule III, with some modifications allowed based on the relevant regulator’s requirements.
- The Institute of Chartered Accountants of India (ICAI): They issue guidance notes to assist auditors in conducting tax audits of NBFCs.
Expertise Access & Risk Management
Apart from regulatory compliance, the other reasons that make tax audits essential for NBFCs are:
- Identifying Tax Liabilities & Opportunities: Professional tax auditors can identify potential tax liabilities hidden in your accounts and uncover tax deductions you might be missing.
- Minimizing Risk: Tax audits help ensure your tax filings are accurate and compliant. This reduces the risk of penalties and legal disputes with tax authorities.
- Enhancing Credibility & Trust: A clean tax audit report enhances an NBFC’s credibility. It signals to stakeholders that the company is financially sound and compliant.
- Facilitating Efficient Financial Planning: Tax audits provide valuable insights into the financial health of an NBFC. By identifying areas of inefficiency, auditors can offer recommendations for improvement.
Tax Audit Process for NBFCs followed by Top Service Providers Like PKC Management Consulting
A tax audit for an NBFC in India follows a well-defined process that includes the following steps:
Appointment of a Qualified Chartered Accountant (CA)
The NBFC selects a qualified CA or an experienced CA firm like PKC Management Consulting to conduct the tax audit. We recommend getting proposals from multiple service providers with experience in NBFC tax matters.
Collection & Verification of Financial Documents
The appointed auditor gathers relevant financial records, tax filings, and supporting documents from the NBFC including:
- Balance Sheet, Profit & Loss statements, Cash flow statements
- Tax challans and returns for previous years
- Loan agreements, investment documents, bad debt provisions
- Internal control documents related to taxation
The CA reviews and verifies the authenticity and completeness of the provided documents.
Examination of Income & Expenditure Accounts
Next is the examination the NBFC’s income and expenditure accounts to ensure accuracy and adherence to accounting standards. These involve:
- Scrutinizing records for income from various sources (interest income, fees, etc.)
- Verifying the legitimacy of expenses and their proper classification.
- Reviewing tax implications of specific transactions and ensuring proper accounting treatment.
Verification & Compliance With Relevant Provisions
Next, they verify whether the NBFC has complied with all relevant tax laws and regulations. This may involve:
- Examining the timely filing of tax returns and payment of taxes.
- Assessing compliance with specific tax provisions applicable to NBFCs (e.g., bad debt provisions, income recognition).
- Identifying any potential discrepancies.
- Ensuring adherence to relevant laws like Income Tax Act, RBI guidelines, and GST regulations.
- Verifiying the correct calculation and timely payment of statutory dues, such as taxes, provident fund, and other regulatory fees.
Preparation and Submission of the Tax Audit Report (Form 3CA/3CB and 3CD)
Based on the audit procedures, the auditor drafts a comprehensive tax audit report. The report comprises of the following:
- Findings of the audit regarding income, expenses, taxes, and compliance.
- Any adjustments or corrections identified during the audit process.
- Recommendations for future tax planning and improved internal controls.
The finalized report is submitted to the NBFC’s management and relevant authorities as per regulations.
Common Tax Audit Findings in Case of NBFCs
Tax audit services for NBFCs often reveal a variety of issues and discrepancies. Understanding these can help you find the areas of improvement:
Income Recognition Errors
At PKC Management Consulting, we’ve found that NBFCs sometimes fail to recognize income accurately, especially interest income on non-performing assets (NPAs). This can lead to discrepancies between reported income and actual earnings, affecting tax calculations and financial statements.
Improper Expense Classification:
Expenses are sometimes misclassified, either as capital or revenue expenses, leading to incorrect tax deductions. Proper classification is important to ensure accurate computation of taxable income and compliance with tax regulations.
Wrong Treatment of Bad Debts:
NBFCs deal with a large volume of loans, and bad debt provisions are important. Audits may identify inconsistencies in identifying and provisioning for bad debts, leading to potential under or over-provisioning, impacting taxable income.
Issues with Loan and Advance Accounting
Audits also sometimes find errors in the accounting of loans and advances. This may include incorrect interest calculations or improper classification of loan accounts leading to serious discrepancies in financial statements.
Unclaimed Deductions and Exemptions:
NBFCs are eligible for various tax deductions and exemptions. Auditors at PKC Management Consulting, have often discovered instances where the NBFC missed out on claiming legitimate deductions or exemptions, increasing their tax burden.
Non-Compliance with Specific NBFC Tax Provisions:
The Income Tax Act may have specific provisions for NBFCs regarding specific transactions or activities (e.g., treatment of securitization transactions). Audits identify instances where NBFCs haven’t followed these provisions, resulting in tax liabilities.
Contact PKC For a Smooth Tax Audit for your NBFC!
Frequently Asked Questions
What is a tax audit for an NBFC?
A tax audit for an NBFC is a thorough examination of its financial records and tax filings by a qualified CA. The purpose of the audit is to verify the accuracy of income and deductions reported, ensuring compliance with all relevant tax laws and regulations.
What are the benefits of using professional tax audit services for NBFCs?
Professional tax auditors offer expertise in handling complex NBFC tax regulations. They can identify potential tax liabilities and opportunities, minimize risks of penalties, and ensure timely filing of tax returns.
What are some key things to look for in a tax audit service provider for NBFCs?
Experience in handling NBFC tax audits, in-depth knowledge of relevant regulations, and a strong understanding of the NBFC industry and its specific tax challenges are crucial aspects to consider.
How often do NBFCs need to undergo tax audits?
The frequency of tax audits depends on the specific category and size of the NBFC. The RBI and Income Tax Act guidelines dictate the frequency for each category.
Does tax treatment differ for different types of NBFCs?
There can be slight variations in tax treatment depending on the NBFC type like microfinance, housing finance, etc. Specific tax provisions or incentives might apply to certain categories.
