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Certain areas under EA-2000 Audit - A boon in disguise for unorganized manufacturing sector

SEPTEMBER 05, 2011

By Arun Jain, Superintendent of Central Excise, Ahmedabad

THE audits under EA-2000 (hereinafter referred to as the “audits”) protocol although started on an experimental basis in the year 2000 gained prominence over the years and have become one of the most emphatic wings of any Excise Commissionerate. As of now, the audit alone contributes significant revenue in a most silent manner. EA-2000 manifests the spirits of the department i.e. trade friendly regime, in as much as incorporation of declaration of Section 11A(2B) of CEA, 1944 by the assessee, post audit, speaks it all. Working papers which form an inherent part of the audit emanates the process of interaction of the trade with the department throughout the process of audit. The audit working is so designed that revenue areas detected by the auditors are being carried throughout the hierarchy of the departmental officers, in such a manner that at every stage, the issue is being addressed in the most legal manner. Auditors at site verify the records maintained by the assessee and primarily opine on the contentious (revenue) issues which further involve the senior officers and attain finality only after the say of the Chairperson (Commissioner) during the most important process called Monitoring Committee meetings, held periodically in the Commissionerate.

It is a fact that Central Excise/Service Tax audit was, till the year 2000, at the nadir of the priority areas of any management. It was only after the inception of the EA-2000, that the auditors started looking into the financial statements of the assessees, which ultimately drew the attention of the senior management, once the revenue objections were culled out. EA-2000 precisely encompasses the study of financial statements, which during the inception, started with the study of Sales and gradually with the passage of time, the Expenditures, Assets, Liabilities, Directors' Notes, Contingent Liabilities and the Auditors Notes drew the attention of the auditors and to utter surprise, susceptible revenue areas were culled out from the said areas.

What does present day Excise Audit envisages that would be of scope of interest for the trade as well as the department. Lets us visit some of those areas.

Value Addition: Value addition is interpreted in many a terms, but Excise audit specifically spells it as the difference between the value of all the inputs (raw materials, services availed) and the price at which the product is sold. It would be pertinent to mention that value addition serves as an important tool for any assessee in terms of managing the cost of the goods vis-ŕ-vis the profits in as much as Excise audit keeps a tab on the Cenvat Credit availments through such an exercise.

Rule 3 of CCR, 2004 primarily relates to the physical receipt of the goods rather than payments to the suppliers in as much as the Board has even clarified vide Circular No. 877/15/2008-CX., dated 17-11-2008 that the duty payments and not the price reduction, post sales, by the suppliers stands basis for availment of Cenvat Credit. Similarly, the said area is also identified under Sl. No. 22 of the 3 CD return (filed under Section 44AB of the Income Tax Act, 1961). When the Income Tax asks for the Modvat Credits availed in the previous year, the data has to be coming from Excise Records, where both the physical as well as monetary receipt of the goods/credits has been authenticated by the assessee. The reconciliation of both IT Returns and the Excise returns (ER-1) has been found to be susceptible leading to the revenue objection and burden of proof lies on the head of the assessee, as both the returns (ER-1 and 3CD return) are statutory in nature. The reason for this discrepancy is that the assessee takes the support of the financial statements (purchase ledgers) in case of IT return and RG 23 A Part II in case of Excise Returns.

In nutshell, the value addition should be consistent in terms of growth and any abnormality over the financial years becomes the subject of Interest both for the Department and primarily the assessee, which hitherto went unheeded by the latter. Only when the disparity in terms of the abnormal increase/decrease is pointed out, the assessee starts reviewing the records. Nevertheless, it surely reveals an audit objection, reasons stand supra.

PLA/Cenvat Ratio: The value addition tantamount to the duty payment structure of any assessee. If the inputs and the outputs enjoy the same duty brackets, it is clear that the PLA to Cenvat Duty ratio should be consistent with the Value additions also. However, if the assessee enjoys exempted clearances under some or the other notifications than the value additions with certain deductions (clearance on non payment of duties) squarely holds good.

Walkthrough of the systems: It is a known fact that International Organisation of Standards (ISO) is widely coveted amongst the Indian industries and thus the certification appears to be inherent with every known name. The same adds to the market credibility of an assessee, although, a significant cost is attached with it. Inspite of the fact that the assessee possessing ISO standards, EA-2000 strictly proposes walkthrough of the systems of purchase, sales and manufacturing processes adopted by the assessee, and in spite of the ISO standards existing in the system, results into ‘n' number of revenue objections. Hence walkthrough appears to be a landmark area under EA-2000. The walkthrough has been effectively preached under Audit Manual equally emphasized in today's audit process. The said exercise has proved a measure of redressal to the inherent problems (and invisible) in the systems.

a)  Purchase walkthrough: For any manufacturing activity “Purchase” of inputs triggers manufacture of the desired output. For availment of Cenvat Credit the physical receipts of inputs is followed by the availment of Cenvat Credit and vice-versa under the Cenvat Credit Rules is debarred. Hence, for any assessee, the integration of the systems related to both physical receipts and the financial accounting has to be emphatically monitored. Again, especially in an unorganized sector i.e. small scale units, it is observed that the Accounts and the Excise department deals the same issue separately. The accounting department keeps in view the P & L Accounts and for different reasons either books the expenditures at the time of receipt of the bills (of the supplier) or at the time of receipt of the goods leading to a (probable) disparity detected at the time of reconciliation of Cenvat Credit availed (in Excise returns) with the Cenvat (Credit) computed on the Purchase value, at the time of audits. Hence the role of the Stores (controlling the inputs inventory) in any manufacturing unit is of vital importance. It has been observed that most of the assessees prefer to keep the earlier prescribed RG23 A Part I for the accounting of the physical receipt of the goods, as the assessees still believe that same is well understood by the departmental officers and minimises the fuss. In this case, when the physical receipt of the goods is questioned, they always fall short of the evidences i.e. the Lorry receipts (accompanied with the goods) or unmaintained Material/Goods Requisition Note (being the internal record). The latter is well prescribed under ISO standards which if maintained gives the entire history of the purchases linking both the accounting aspect as well as details of logistics involved in the receipts. Similarly process of issuance of the Inputs from Stores to manufacturing (production floor) is also not scrupulously followed in such industries inasmuch as the issuances dates and the quantity is being shown as issued under the RG 23 A Part I (maintained in majority of the cases). Here Rule 9 of the CCR, 2004, mandates maintenance of such records, wherein alone details maintained under RG23A Part I in the above form would not suffice. In such a case, veracity of the Raw material consumed to the Total sales in any financial year gives a dubious picture. Leave alone the Excise deptt., the management is also deprived of the true picture about the value addition in any financial year. By encompassing the above controls in the system, many of the (perennial) audit objections, viz., i) Maintenance of the accounts of the Inputs used both in the exempted and the dutiable goods (Rule 6 of the CCR, 2004), ii) Goods received for reconditioning/repairing/refining (Rule 16 of the CER, 2002), iii) Inputs (especially the Imported goods) sent back on account of being defective, short receipts etc., sold as such (Rule 3 of the CCR, 2004), iv) Non receipt of the goods received by EOU (Re-warehousing under Chapter X procedures), v) removal and receipt of the intermediates for job work (under Rule 4(5)(a) of CCR, 2004, removal of partially processed inputs (under Rule 4(6) of the CCR, 2004), etc can be ruled out.

b)  Sales walkthrough: Again small scale units continue to work and behave as the retail outlets, thus belittling the concept of (being a) manufacturer. The majority of the assessees still continue to maintain one Daily stock account viz., RG-1 record (prescribed earlier but now done away under Circular No. 536/32/2000-CX., dated 30-6-2000, however Rule 10 of the CER remains), which is still unscrupulously maintained. It is seen that only when the goods are intended to be removed then only the same are entered into RG-1 as duly produced and cleared. Hence the activity of the production and clearances remain synchronic. Untill then the goods on the production floor continue to remain in the form of Work In Process. The Purchase orders (placed by the customers) triggers the process of sales. The same may be in the form of contractual agreement or in the form of telephonic orders, which later converts in the form of written agreement, if accepted. The contracts broadly speaks about i) the nature of the product, which may be a combination of both standardized and customized alongwith the value of the product, ii) Taxation part involved, iii) Time concept (JIT nowadays), iv) mode of payment, v) Inclusion of various other cost elements such as Freight, Insurance, returnable packing material etc. Again the assessee fails to co-relate the said sales contracts with the existing laws. As a result, the short payment of duties on account of the escalation clause (price rise seen in case of Metal inputs) with reference to the cost of the goods, valuation in case of supplies to the related units, amortization of the cost of Free supply of the Moulds, patterns, Dies in case of the engineering goods (both envisaged under Central Excise Valuation (Determination of Price of Excisable Goods) Rules, 2000) and similarly duty debits (prescribed under Rule 6 of the CCR, 2004) on exempted clearances under different Notifications.

Although, the above controls may sound expensive or time consuming but surely form a part of discipline which in a way promotes the health and growth of any assessee. The above observations under EA-2000 would be a tip of an iceberg, but it would be pertinent to mention that Excise audit is an event, through which the assessee can resolve the wide gamut of legal issues in the most amicable manner. The more they cooperate and participate; the better would be diagnosis of the underlying problems (by the Department).

(The author's views are personal)

Sub: Benefit of 11A2B not extended in most cases of audit

Benefits of 11A(2B) are not extended by the departmental officers even if the assessee pays the duty during the course of audit. Invariably, in most cases, Mumbai-III/V Commissionerates issues show cause notice for imposition of penalty under Section 11AC. Most cases departmental officers cites that unless audit officer had pointed out, the assessee would have got unintended/illegal benefit, hence though assessee has paid, he ought to be penalised to the maximum (penalty equal to duty). Instructions given in Board's Circular No. 768/01/2004-CX
January 5, 2004 are blatantly flouted by officers.

Voluntary compliance should be encouraged by acquainting the assessees about the provisions of Section 11A (2B) of the Central Excise Act (waiver of Show Cause Notice in cases where voluntary payment is made) and in the case of short payment etc. pointed out by Audit or detected during Audit/scrutiny of Returns in terms of the Sec. 11A (2B) of the Act, as amended.

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