How long to maintain tax records?

The tax season is past us, and a common question put forth by most of our clients is "How long do I need to maintain copies of my tax return and affiliated records?"

In most cases, taxpayers need to keep copies of their tax returns, and all return-related substantiating documents until the period of limitation for the returns runs out. The period of limitations is the time within which the tax return can be amended to claim credits or refunds, or for the IRS to assess additional tax liabilities.

The table below lists the period of keeping records for different scenarios

Additional tax owed	3 years
Does not report Income	6 years
Credit or refund after filing return	3 years from date of filing / 2 years from payment of tax whichever is later
Claim for loss from worthless securities or bad debt	7 years

A general suggestion is to maintain all employment tax records for at least 4 years after the date that the tax becomes due or is paid, whichever is later.

Keep records of all stock and fund purchases, and year-end statements on reinvested dividends and capital-gains distributions.

When claiming depreciation, amortization, or depletion deductions, keep related records for as long as the underlying property is owned. That includes deeds, titles and cost basis records.

Hang on to receipts for major home improvements for at least three years after sale of house property. They may come in handy if one wants to show potential buyers how much has been spent to upgrade the property, and certain home-improvement expenses can be used to lower any tax bill on home-sale profits.

Discard ATM receipts and bank-deposit slips as soon as they match up with the monthly statements. Pay stubs can also be similarly trashed on receipt of the W-2 for the year.

Any year that one makes a nondeductible contribution to a traditional IRA, he / she must file Form 8606 to document those contributions. Then all of those 8606 forms must be held on to until all the money from the IRA is withdrawn, so one won't end up overpaying the tax bill when retirement comes calling.

Although it is recommended that tax returns are maintained for at least six years, the taxpayer can at least have a digital archive as it can provide clues about income and investments and other tax information that might come in handy in the distant future.

The standard IRS recommendation is for paper documents to be cross-cut shredded to effect 5/16 inch-wide or smaller strips, or completely burned. In case of magnetic media, a combination of overwriting and Degaussing, followed by incinerating, shredding, pulverizing, disintegrating or grinding is usually recommended.

To save space, one can scan the records and have them stored electronically. The IRS has accepted scanned receipts since 1997. One just needs to ensure that the scanned or electronic receipts reflect the paper records accurately. The ability to index, store, preserve, retrieve, and reproduce the records must be complete.

For any queries on this article please e-mail info@gkmtax.com for our tax experts or like many of our clients, we can prepare your tax returns for you.

US Healthcare changes - 2012 ruling

On June 28, the Supreme Court upheld the constitutionality of the Patient Protection and Affordable Care Act of 2010.Numerous tax changes are included in the law. Some have already gone into effect and others are scheduled to kick in over the next several years.
This chart briefly summarizes some of the most important tax changes, organized by the year when they are effective. The Supreme Court's decision means the following changes will stay in effect or will continue to go into effect as scheduled (unless Congress or the IRS takes additional action).
 

	CHANGES THAT TOOK EFFECT BEFORE 2010
Tax Change	Description	Effective Date/ Tax Code or Law Section/ IRS Guidance
Exclusion for Certain Forgiven Student Loans	A retroactive federal income tax exclusion for student loan amounts paid off or forgiven under certain state loan repayment/ forgiveness programs intended to increase the presence of healthcare professionals in underserved areas.	Amounts received or forgiven in tax years after 2008. IRC Section 108(f)(4)
Therapeutic Discovery Projects	A retroactive tax credit for qualified investments in therapeutic discovery projects, as defined in the law. Only available to taxpayers with 250 or fewer employees.	Eligible expenses paid or incurred in 2009 and 2010 ($1 billion limit on total credits allowed). IRC Section 48D
	CHANGES THAT TOOK EFFECT IN 2010
New Health Insurance Tax Credit for Small Employers (Including Not-for-Profit Organizations)	Qualifying small employers can claim a credit to cover up to 35 percent of the cost of providing health insurance to employees.    Qualifying small employers that are tax-exempt non-profits can claim credits to cover up to 25 percent of employee health insurance costs. A qualifying small employer is one that: has no more than 24 full-time-equivalent (FTE) workers; pays an average FTE wage of less than $50,000; and has a qualifying healthcare arrangement in place.     A qualifying arrangement requires employers to: pay at least 50 percent of the cost of each enrolled employee's coverage and pay the same percentage for all employees (even those with more-expensive family coverage or self-plus-one coverage).	Tax years beginning in 2010 to 2013. The credit can be claimed for eligible costs incurred in tax years beginning in 2010 before the healthcare law was enacted. IRC Sections 45R, and IRS Notice 2010-44 For more information from the IRS: Small Business Healthcare Tax Credit: Frequently Asked Questions.
Healthcare- Related Tax Breaks Granted to Adult Children	Effective for plan years beginning after September 22, 2010, health plans that cover dependent children mustcontinue to cover adult children until they turn 26.     In conjunction, employer-provided health coverage for an employee's adult child is now treated as a tax-free fringe benefit as long as the child hasn't reached age 27 by the end of the year. It doesn't matter if the adult child is the employee's dependent or not.     The IRS stated that tax-free treatment also applies to reimbursements from an employer-provided cafeteria plan, healthcare flexible spending account (FSA) plan, or health reimbursement arrangement (HRA) to cover an under-age 27 adult child's qualified medical expenses.     If you're self-employed and pay your own health coverage, the cost of covering an adult child is eligible for the above-the-line deduction for self-employed health premiums, as long as the adult child hasn't reached age 27 by year end (regardless of whether the child is a dependent).     There is a discrepancy between the age-26 coverage requirement and the age-27 tax breaks.	Effective in 2010 IRC Sections 105(b) and 162(l) IRS Notice 2010-38
Liberalized Adoption Tax Breaks	Increased the annual cap on tax-free employer adoption assistance payments by $1,000 through 2012.     Similarly, the healthcare legislation increased the maximum annual adoption credit by $1,000 through 2012.     Also, for 2010 through 2012, the adoption credit is refundable so it can be collected in full even if you don't owe federal income tax.	Tax years beginning in 2010 through 2012. IRC Sections 36C and 137
New Rules for Not-for-Profit Hospitals	Established new rules for hospitals to qualify for tax-exempt nonprofit status.	Tax years after March 23, 2010. IRC Sections 501(r) and 6033(b)
No More Tax Credit for "Black Liquor"	Disallowed the cellulosic biofuel producer credit for so-called black liquor fuels.	Fuels sold or used after 2009. IRC Section 40(b)(6)(E)
New Loss Ratio Rule for Health Organizations	Required a medical loss ratio of at least 85 percent for health organizations to qualify for certain insurance company tax breaks.	Tax years after 2009. IRC Section 833
New Tanning Excise Tax	Imposed a 10 percent excise tax on indoor tanning services.	Services after June 30, 2010. IRC Section 5000B
Economic Substance Doctrine is Codified	The legislation provided a place in the tax code for the economic substance doctrine. It is deemed to exist only if the transaction in question: changes the taxpayer's economic position in a meaningful way without regard to tax consequences and is entered into for a substantial non-tax purpose. A 20 percent penalty can be assessed on tax underpayments attributable to transactions that are disallowed because they lack of economic substance. The penalty rises to 40 percent for "undisclosed economic substance transactions." Other penalties may also apply.	For transactions entered into after March 30, 2010 and tax underpayments, understatements, refunds, and credits attributable to transactions entered into after that date. IRC Sections 7701(o), 6662(i), and 6676(c)
	CHANGES THAT TOOK EFFECT IN 2011
No More Tax-Free Reimbursements for Non-Prescription Drugs	If you participate in an employer-sponsored healthcare FSA or HRA or have your own health savings account (HSA) or medical savings account (MSA), former rules allowed you to take tax-free withdrawals to pay for non-prescription drugs like pain and allergy relief medications. Starting in 2011, this tax-favored treatment is only available for prescription drugs, insulin, and doctor-prescribed over-the-counter medications.	For expenses incurred in tax years beginning after 2010. IRC Sections 106(f), 220(d), and 223(d)
Stiffer Penalty on Nonqualified HSA and MSA Withdrawals	If you take money out of your HSA or MSA for any reason other than to cover qualified medical expenses, the former rules allowed you to usually owe federal income tax plus a 10 percent penalty tax, or a 15 percent penalty tax for an MSA. The healthcare law increased the penalty tax rate to 20 percent for nonqualified withdrawals.	Withdrawals in tax years beginning after 2010. IRC Secs. 220(f) and 223(f)
New Simple Cafeteria Plans for Small Employers	Established a new, simpler Section 125 cafeteria benefit plan for employers with 100 or fewer employees. These plans are deemed to automatically satisfy all applicable cafeteria benefit plan nondiscrimination rules if they satisfy certain minimum standards for eligibility, participation, and contributions.	Tax years beginning after 2010. IRC Section 125(j)
New Tax on Drug Companies	Imposed a new nondeductible fee on manufacturers and importers of branded prescription drugs. Each targeted company must pay an allocable portion of the total annual fee. The fee is apportioned among targeted companies based on each company's share of sales in the preceding year.	Calendar year 2011. Section 9008 of the Patient Protection Act
	CHANGES THAT TAKE EFFECT IN 2012
Employers Must Report Healthcare Costs to Employees	Requires employers to report to employees on their annual W-2 forms the value of employer-provided health insurance coverage (not including salary-reduction amounts contributed to healthcare flexible spending accounts).     The reporting requirement is informational only. It does not affect whether coverage is excludable from gross income under the tax code and does not affect the amount includable in income or the amount reported in any other box on Form W-2. It also does not cause otherwise excludable employer-provided healthcare coverage to become taxable.     "The purpose of the reporting is to provide useful and comparable consumer information to employees" on the cost of their coverage, according to the IRS.	Originally scheduled to begin in 2011, this provision was delayed until the 2012 calendar year on annual W-2 forms, which must generally be issued to employees by January 31, 2013. (IRS Notice 2012-9) IRC Section 6051(a)(14)
New Tax on Health Insurance Policies	Health insurers and sponsors of applicable self-insured health plans have to pay an annual fee of $2 per covered life ($1 per life for affected policy or plan years that end by September 30, 2013).	Policy years ending after September 30, 2012. IRC Sections 4375, 4376, and 4377
	CHANGES TAKING EFFECT IN 2013
Additional 0.9 percent Medicare Tax on Salaries and Self-Employment Income Earned by Higher Income Taxpayers	Right now, the Medicare tax on salary and/or self-employment (SE) income is 2.9 percent (1.45 percent is withheld from employee paychecks, and the other half is paid by the employer. Self-employed people pay the whole 2.9 percent).     Starting in 2013, an extra .9 percent Medicare tax will be charged on: Salary and/or SE income above $200,000 for an unmarried individual; Combined salary and/or SE income above $250,000 for a married joint-filing couple; and Salary and/or SE income above $125,000 for those who use married filing separate status.    These thresholds will not be adjusted for inflation. For self-employed people, the additional .9 percent Medicare tax hit will come in the form of a higher SE tax bill. However, the additional .9 percent will not qualify for the above-the-line deduction for 50 percent of SE tax. (The additional .9 percent Medicare tax must be taken into account for estimated tax purposes.)	Tax years beginning after 2012. IRC Sections 164(f), 1401(b), 3101(b), 3102, and 6654
Additional 3.8 percent Medicare Tax on Net Investment Income Collected by High Income Folks and Trusts	Right now, the maximum federal tax rate on long-term capital gains and dividends is 15 percent. In 2013, the top rate is scheduled to go up to 20 percent as the "Bush tax cuts" expire. Starting in 2013, all or part of the net investment income, including long-term capital gains and dividends, collected by high-income folks can get hit with a 3.8 percent "Medicare contribution tax." Therefore, the top federal rate on long-term gains and dividends for 2013 and beyond will be 23.8 percent (unless Congress acts to extend the 15 percent rate).    The additional 3.8 percent Medicare tax won't apply unless modified adjusted gross income (MAGI) exceeds: $200,000 for an unmarried individual; $250,000 for married joint-filers; or $125,000 for married filing separately. These thresholds won't be adjusted for inflation.     The additional 3.8 percent Medicare tax will apply to the lesser of: net investment income or the amount of MAGI in excess of the applicable threshold.     Net investment income includes interest, dividends, royalties, annuities, rents, gross income from passive business activities, gross income from trading in financial instruments or commodities, and net gain from property held for investment (but not for business purposes) reduced by deductions allocable to such income.     The additional Medicare tax must be taken into account for estimated tax payment purposes.     For a trust, the extra 3.8 percent Medicare tax will apply to the lesser of: undistributed net investment income or the AGI in excess of the threshold for the top trust federal tax bracket.	Tax years beginning after 2012. IRC Sections 1411 and 6654
New $2,500 Cap on Healthcare FSA Contributions	Right now, there's no tax-law limit on salary-reduction contributions to an employer healthcare FSA (although many plans impose their own annual limits). Starting in 2013, the maximum annual FSA contribution by an employee will be capped at $2,500. After that, the cap will be indexed for inflation.	Tax years beginning after 2012. (IRS Notice 2012-40) IRC Section 125(i)
Higher Threshold for Itemized Medical Expense Deductions	You can now claim an itemized deduction for medical expenses paid for you, your spouse, and dependents, to the extent the expenses exceed 7.5 percent of AGI. Starting in 2013, the hurdle is raised to 10 percent of AGI. But if you or your spouse is age 65 or older at year end, the new 10 percent-of-AGI threshold will not take effect until 2017. The medical deduction threshold for AMT purposes remains at 10 percent of AGI.	Tax years after 2012 (2016 if taxpayer or spouse is 65 or older at year end). IRC Section 213(a) and (f)
No More Deductions for Retiree Drug Plan Subsidies	Employers that sponsor qualified retiree prescription drug plans are entitled to collect tax-free federal subsidies for a portion of the cost. Employers are currently allowed to deduct the full cost of retiree drug plans without any reduction for the tax-free federal subsidies. In effect, deductions are allowed for amounts that are actually paid by the government. The healthcare law reduces deductions by the amount of tax-free federal subsidies.	Tax years beginning after 2012. IRC Section 139A
New Excise Tax on Medical Device Manufacturers	Manufacturers have to pay a 2.3 percent excise tax on taxable sales of medical devices for humans. However, devices retailed to the general public will be exempt. The tax will not apply to eyeglasses, contact lenses, hearing aids, etc.	Sales after 2012. IRC Section 4191
New Deductible Compensation Limit for Health Insurers	Affected health insurance providers face a $500,000 per-person deduction limit on compensation paid to "applicable individuals," which can include officers, employees, directors, and certain other service providers such as consultants.	Tax years beginning after 2012. IRC Section 162(m)(6)(A)
	CHANGES TAKING EFFECT IN 2014
New Penalties on Individuals without "Adequate" Coverage	In general, U.S. citizens and legal residents will be required to pay penalties if they don't obtain "adequate" health insurance coverage.     The tentative penalty will equal the greater of: the applicable percentage of household income above the threshold that requires filing a federal income tax return; or the applicable dollar amount times the number of uninsured individuals in the household. The applicable income percentage is 1 percent for 2014, 2 percent for 2015, and 2.5 percent for 2016 and beyond.     The applicable dollar amount is $95 for 2014, $325 for 2015, and $695 for 2016. After that, the $695 amount will be adjusted for inflation. For under-age-18 household members, the applicable dollar amounts will be 50 percent of the aforementioned amounts.     The final penalty amount for each household will be limited to 300 percent of the applicable dollar amount. For example, the maximum 2016 penalty will be $2,085 (3 times $695). However, if the national average cost of "bronze coverage" (a new term of art) for the household is less, the maximum penalty will be limited to the cost of bronze coverage.     If an affected individual is uninsured for only part of the year, the penalty will be calculated monthly using pro-rated annual figures.	Tax years beginning in 2014. IRC Section 5000A
New Penalties on Employers	Employers with at least 50 full-time employees that do not provide them with affordable health coverage that meets certain minimum standards will be charged a penalty if even one full-time employee purchases his own government-subsidized coverage through a state-run exchange.     Government-subsidized coverage means coverage for which a federal cost-sharing subsidy (explained below) is available.     The penalty will be $167 per month ($2,000 per year) for each employee who is not provided with "adequate" coverage for that month (even if a particular employee purchases subsidized coverage from a state-run exchange). However, no penalty is charged for the first 30 employees.     An employer can still owe penalties even when employees are offered the opportunity to enroll in a plan that provides minimum essential coverage, but one or more employees choose to instead buy subsidized coverage through a state-run exchange. In this case, the penalty is $250 per month for each applicable employee, but the total penalty cannot exceed the penalty that would be charged for outright failure to offer "adequate" coverage.     Employers cannot deduct these penalties as a business expense.	Coverage months beginning in 2014. IRC Section 4980H
New "Cost-Sharing Subsidies" for Eligible Individuals	Government paid "cost-sharing subsidies" will be provided to help individuals ineligible for Medicaid, employer-provided coverage, or other "adequate" coverage. This has been explained as a low-income benefit, but you can be eligible with income up to 400 percent of the federal poverty level.     The cost-sharing subsidy is sometimes called a "premium assistance tax credit," because the enabling language is found in the tax code. In most cases, however, the subsidy will be paid directly to the insurer. If that doesn't happen, the subsidy amount can be claimed as a refundable tax credit on the eligible individual's federal tax return.	Tax years beginning in 2014. IRC Section 36B
More Generous Health Insurance Tax Credit for Small Employers	As explained in the 2010 changes, qualifying small employers can claim a new tax credit to help cover the cost of providing employee health coverage. For 2010-2013, the maximum credit percentage is 35 or 25 percent for tax-exempt employers. Starting in 2014, the maximum credit percentage increases to 50 or 35 percent for tax-exempt employers. However, employers must purchase qualifying health coverage from state-run insurance exchanges to be eligible for the higher credit percentages. Also, the FTE wage caps for credit qualification and calculation purchases are indexed for inflation, starting in 2014.	Tax years beginning in 2014. IRC Section 45R and Section 1421 of the healthcare legislation.
Some Employers Must Give Employees "Free Choice Vouchers"	An affected employer must give a "free choice voucher" to any eligible employee who chooses to buy his or her own coverage instead of participating in the company plan. The voucher amount equals what the employer would have contributed on behalf of the employee if he or she participated. As long as the employee spends at least the amount of the voucher on qualified health coverage, the voucher is tax-free to the employee. However, an employee who takes advantage of the voucher is ineligible to receive any cost-sharing subsidy for buying coverage from a state-run exchange.	Calendar year 2014. Section 10108 of the healthcare legislation.
New Excise Tax on Health Insurance Providers	A new fee is imposed on health insurance providers. Each targeted company must pay an allocable portion of the total annual fee, which is $8 billion for 2014. The fee is apportioned among targeted companies based on each company's share of applicable net premiums.	Calendar year 2014. Section 9010 of the Patient Protection Act.
	CHANGE TAKING EFFECT IN 2018
New Excise Tax on "Cadillac Health Plans"	Health insurance companies that service the group market and administrators of employer-sponsored health plans will get socked with a 40 percent excise tax on premiums that exceed the applicable threshold of $10,200 for self-only coverage or $27,500 for family coverage. For retired individuals and plans that cover employees in high-risk professions, the thresholds will be $11,850 and $30,950, respectively. These thresholds may be increased to reflect higher-than-expected inflation in health premiums. Plans sold in the individual market will be exempt, except for coverage that is eligible for the above-the-line deduction for self-employed health premiums.	Tax years beginning in 2018. IRC Section 4980I

Deadline to report Foreign Account Holdings

The deadline (June 30, 2012) for certain taxpayers to report accounts they hold in foreign banks and other financial institutions has gone by .

By June 30, 2012, citizens and residents of the United States, as well as domestic partnerships, corporations, estates and trusts, must generally file Form TD F 90-22.1 Report of Foreign Bank and Financial Accounts (FBAR) if:

An "Issue of Fundamental Fairness"  In a speech in April, IRS Commissioner Douglas H. Shulman said, "We view offshore tax evasion asan issue of fundamental fairness. Wealthy people who unlawfully hide their money offshore aren't paying the taxes they owe, while schoolteachers, firefighters and other ordinary citizens who play by the rules are forced to pick up the slack." Over the past four years, Shulman explained, the IRS has "significantly increased" the resources and focus on offshore tax evasion. The IRS has also given taxpayers a chance to come forward voluntarily and avoid criminal charges. Through the end of 2011, the IRS has had approximately 33,000 voluntary disclosures from individuals who came in under several special programs started in 2009. To date, these individuals have paid back taxes and penalties amounting to more than $4.4 billion. "We are now mining the information we have received to date and have launched our next wave of investigations on banks, bankers, intermediaries and taxpayers," Shulman said.

1. They have a direct or indirect financial interest in, or signature authority over, one or more accounts in a foreign country. This includes bank accounts, brokerage accounts, mutual funds, trusts or other types of foreign financial accounts.

2. The total value of the accounts exceeds $10,000 at any time during the calendar year.

Taxpayers also may be subject to FBAR compliance if they file an information return related to: certain foreign corporations (Form 5471); foreign partnerships (Form 8865); foreign disregarded entities (Form 8858); or transactions with foreign trusts and receipt of certain foreign gifts (Form 3520).
Some individuals are exempt.
Exceptions to the Reporting RequirementThere are FBAR filing exceptions for the following United States persons or foreign financial accounts:

• Certain foreign financial accounts jointly owned by spouses;
• United States persons included in a consolidated FBAR;
• Correspondent/nostro accounts;
• Foreign financial accounts owned by a governmental entity;
• Foreign financial accounts owned by an international financial institution;
• IRA owners and beneficiaries;
• Participants in and beneficiaries of tax-qualified retirement plans; and
• Certain individuals with signature authority over, but no financial interest in, a foreign financial account.

To determine eligibility for an exception, consult with your tax adviser.
Take the FBAR requirement seriously. Several legislative changes, as well as a clarification of the IRS's interpretation of the "willful standard," have led to increased enforcement and stiffer penalties for noncompliance of foreign account reporting requirements.

The IRS states that the form "is a tool to help the United States government identify persons who may be using foreign financial accounts to circumvent United States law. Investigators use FBARs to help identify or trace funds used for illicit purposes or to identify unreported income maintained or generated abroad."

Failing to file an FBAR can result in the following penalties:

• A civil penalty of as much as $10,000 if the failure was not willful. This penalty may be waived if income from the account was properly reported on the income tax return and there was reasonable cause for not reporting it.
• A civil penalty equal to the greater of 50 percent of the account, or $100,000, if the failure to report was willful.
• Criminal penalties and time in prison.

Consult with your tax adviser if you have an interest in, or authority over, a foreign account. Your tax adviser can ensure you meet the reporting requirements and remain in compliance with the law.

Filing an amended return

What triggers an amended return?  When your client forgets to submit information or when in the midst of the tax season crunch the return has just been processed by your firm but has not provided maximum tax benefit to client.  In addition any of the following can trigger an amended return:
       Reporting additional income on your 1040
      Receipt of a revised K-1 from a trust, estate, S-Corporation or partnership
      Reporting additional withholding from a  1099 or W-2
      Claiming additional dependents
      Removal of dependents previously claimed
      Change in personal exemptions
      Claiming additional tax credits
      Non-inclusion of deducible expenses

 A Form 1040X alongwith corrected Form 1040 with the necessary schedules should be filed. An amended return is processed in about 7-12 weeks by the IRS. 
 For an amended return:
 a. If a refund is due the amendment should be filed within three years from the filing date when the original return was due or two years from date of payment of tax whichever is later.
 b. For calculation errors or missing attachments an amendment is not required.
 c. Filing status can be changed from 'married filing separate' to 'joint', or 'qualifying widow(er)' to 'head of household' status. However change in status from 'married filing joint' to 'married filing separate' is not allowed after the actual due date for your original return has passed. (April 15)
 d. You cannot pick and choose your corrections on an amended return – if you do file an amended return, file after correcting all errors, including those that get you refunds and those that increase your tax liability.
 e. For claiming an additional refund, wait to receive the original refund before filing Form 1040X. Check from original refund can be 
f.  If amending more than one tax return, prepare separate Form 1040Xs for each return, and have them mailed out in separate envelopes too. Even if the original return has been electronically filed, you can amend it only on paper.
g. Usually, the IRS has about three years to audit a tax return. The three-year special statute of limitations does not apply for an amended return. Work on the assumption that every return is examined – an amended return is even more likely to be examined.
Finally a detailed covering letter emphasizing the changes made in the amendment gets the return processed quickly. 

For any queries on this article please e mail info@gkmtax.com for our tax experts or like many of our clients, we can prepare your tax returns for you.

IT Filing due date is now 31st August 2012!

In view of difficulties faced by taxpayers in filing Income tax Returns CBDT has extended last date for filing of Return for Companies and persons not subject to tax Audit for the A.Y. 2012-13 to 31st August 2012 from existing 31st July 2012.

Why is your e-filing faulty?

Defective Returns

Currently CPC is unable to process over 2 lakhs returns which have been classified as defective under  CPC’s business rules. Assessees are requested to avoid errors mentioned below which are among the top reasons for the return to be classified as defective:

1.   ITR 4 – The assessee has not filled Part A P&L or Balance Sheet or both and  gross receipts as per and has entered a positive value in Schedule BP serial no1. This is the single largest reason for returns being classified as defective

2.   ITR 4 – P&L “Sales/Gross receipts of business or profession” is greater than 60 lakhs and AUDIT INFORMATION not completely filled.

3.   ITR 4S – has been filed but presumptive income u/s 44AD is less than 8% of Gross Receipt or Sales  turnover u/s 44AE is less than Rs5000 p.m. per vehicle in case of heavy vehicles or`less than 4500 p.m. per vehicle in case of other vehicles.

4.   ITR 4S – has been filled but Code mentioned under Nature of Business is 601 or 602 or 603 or 604 which are incorrect codes.

5.   ITR 1- Tax Deducted as per Schedule TDS 1 is greater than GTI (Gross Total Income)

6.   ITR 1- Tax Deducted as per Schedule TDS 2 is greater than GTI (Gross Total Income)

7.   Depreciation claimed in Point 42 of Part A – P&L but Schedule DPM /DOA not filled.

8.   Mainly ITR 4- Deduction claimed under Chapter VIA under sections 80IA, 80IB,80IC, 80G but the relevant Schedules not filled

9.   All ITR forms – Brought Forward Loss has been claimed at Point 9 of Part B TI but Schedule CFL (Carried Forward Loss) has not been filled.

10. All ITR forms – No Income details or tax computation has been provided in ITR but details regarding taxes paid have been filled and filed.

11. ITR 6 – Corporate assessee has filed ITR 6 but audit information is incomplete

12. ITR 4 & 5 – In audit information 44AB Flag is Y but Part A P&L and or Part A BS not filled.

13. ITR 4- Part A P&L and Part A BS not filled but entire tax is claimed refund which is more than Rs25,000.

14. ITR 1- 4 – Gender Mismatch – The Gender provided in the return does not match with that appearing in the PAN database.

Business Line : Features / Mentor : Withholding tax issues for corporates

Business Line : Features / Mentor : Withholding tax issues for corporates

A private limited company based in the UK, specialising in staffing solutions, set up shop in India a couple of years ago as more and more UK companies started outsourcing IT, customer service and other related jobs to India.

The company helps UK and Indian concerns hire and administer staff in India wherein all expenses incurred are reimbursed by the companies and earns a 3 per cent margin on its gross billings as management fees.

TWO MAJOR CHALLENGES

As a subsidiary set up in India, the company is, of course, subject to all tax deduction at source rules here. It hires computer professionals and gets reimbursed for the salary payment along with a management fee of 3 per cent which is typically a function of a staffing company. The company faces two major challenges — the first being blockage of working capital in the form of Tax deducted at Source (TDS) and the second being higher deduction of TDS by a few of its customers.

To use a simple arithmetic example, a gross monthly billing of Rs 100 lakh towards salary reimbursement would result in a management fee of Rs 3 lakh.

However, this would invite tax deduction at 2 per cent under sec 194 C of the Income Tax Act amounting to Rs 2,24,720. How? Well, tax is calculated on gross billing so Rs 100 lakh plus service tax @ 12.36 per cent would result in a gross bill of Rs 112,36,000 and hence a TDS of Rs 2,24,720.

Let us assume that the net profit of the company is 10 per cent of the management fees, which works out to Rs 30,000.

The TDS deduction on the gross is Rs 2,24,720. This is an anomaly where the tax withheld is more than the income earned by virtue of the application of tax deduction rules. Of course, at the time of assessment, the anomaly resolves itself as any excess tax deducted/paid is refunded but meanwhile substantial working capital gets locked up and the financial costs decide the viability of the business.

There are remedies in the form of a request for lower or no deduction of tax — this would require a certificate from the Income Tax department. However, obtaining such a certificate is a procedural and a time-consuming hassle, not to mention the costs involved.

The second challenge that it faces is the rate of deduction that a few of its customers insist upon. As the company is considered to be a professional consulting firm, customers insist on TDS under Sec 194-J at the rate of 10 per cent of gross billings for professional services.

Generally for contracts, TDS is applicable at 2 per cent of gross billings under Sec 194 C whereas some of the customers insist on deduction at 10 per cent under sec 194 J. As customer is king, the company does not have an option other than accepting the business with higher deduction of tax. A refusal would cause it to lose the client all together.

In the process of taxing gross billings, the concept of equity is lost. Companies which deal in low margin services such as temp staffing always face a crunch in working capital and high deduction of tax at source only serves to accentuate the problem.

Equity would be better served if tax were deducted on the 3 per cent margin, which is the income portion of the deductee. The logic is that the taxpayer needs to have taxes withheld on the profit or revenue element but withholding on gross billing defeats the purpose and further erodes an already low margin.

Another fact we must analyse is that if these employees were directly on a client company's payroll, tax would be deducted on their salaries based on slabs but what happens in temp staffing situations is that tax is deducted on the staffing company's gross billing (which includes a reimbursement for money paid to staff) and the staffing company further deducts tax on the salaries paid to the temp staff. Thus the same income gets taxed twice albeit in different hands.

CHECKS AND BALANCES

To compare this with international situations, withholding is generally limited to only salary income in many developed countries.

In the US, in fact, independent contractors are responsible for their own taxes. Payers only issue a 1099 Miscellaneous with a copy to the IRS to inform them of the amounts paid to an independent contractor.

The contractor, of course, must account for all the 1099s received while calculating and filing his taxes. This system of checks and balances ensures that income does not escape the tax net. Also, in cases where the IRS suspects that a taxpayer is not declaring passive income such as interest and dividends, they instruct the concerned payers to withhold tax and then pay out the interest/dividend.

All this, of course, is possible thanks to the sophisticated system of checks and balances built in over a period of many years.

India too needs to look at such systems to serve the purpose of equity and justice in taxation. Low margin businesses, especially in the services sector, thrive on availability of working capital and strict costing rules.

Subjecting them to heavy taxation even for a short period of time is not just and will only serve to drive them out of the market unless these businesses have deep pockets to pump in working capital or parent companies that can support and fund the crunch.

Another option that could be considered to resolve this is the introduction of a system of abetment wherein the cost or reimbursement portion of the gross billing is excluded and tax is withheld only on the balance.

One is supposed to pay one's taxes with a smile – it would be nice indeed if cash wasn't a compulsory additional requirement! Jokes aside, taxes are never a pleasure even when the application of rules is just. The pain is worse when a literal application of rules blocks the day-to-day funding of a business. Cash, after all, is the lifeline of every business.

(The author is a Coimbatore-based chartered accountant and can be reached at karthi@gkmtax.com)