Central Excise Audits – Practical Perspective for Assessees

[CA.Ankit Gulgulia]

Central Excise Audits have always been considered as grinding and comprehensive for the assesses because of nature of duty and complicated legal structure. The clearances, manufacture records, cenvat, job work, returns, stock, valuation, registers and other all sought of records is a clear indication of the depth required to ensure a smooth and hassle free audit is taken by the assessee.

In this write-up, our intent is to discuss on the length & breadths of the excise audit with a practical blend. The following shall be few aspects out of the major avenues in which this article can be sub-visited.

a)       Frequency of Audits

b)       Governing Legal Provisions

c)       Discussion on Departmental Manual

d)      Common parts of Standard Audit Notice

e)       Most common areas of Audit

1. Standard Audit Programme – Department Manual
2. Classification of Major Inputs & Outputs
3. Availment of Exemption based on classification
4. Documentation & Records
5. Job Work Procedures
6. Cenvat Procedures
7. Export Procedures
8. Valuation Procedures
9. Reconciliation Procedures
10. Other Miscellaneous Procedures

f)        Ratios / Trends are Key

g)       Role of Pre-Audit is Essential

h)      Conclusion

Let’s now discuss these at length.

a)       Frequency of Audits

As per EA-2000 norms of Central Excise Audits, the following shall be the audit frequency.

Amount of annual total duty (Cash + Cenvat) paid by the assessee	Frequency of Audit
Above 3 Crores	Once in every year
Between 1 Cr – 3 Cr	Once in two years
Between 50 Lacs and 1 Crores	Once in Five years
Less than 50 Lacs	10% of units every year

b)      Governing Legal Provisions

(i)   As per section 11A (5) – Show Cause Notice Provisions,

Where, during the course of any audit, investigation or verification, it is found that any duty has not been levied or paid or has been short-levied or short-paid or erroneously refunded for the reason mentioned in clause (a) or clause (b) or clause (c) or clause (d) or clause (e) of sub-section (4) but the details relating to the transactions are available in the specified record, then in such cases, the Central Excise Officer shall within a period of five years from the relevant date, serve a notice on the person chargeable with the duty requiring him to show cause why he should not pay the amount specified in the notice along with interest under section 11AA and penalty equivalent to fifty per cent of such duty.

(ii)       Special Audit provisions under 14A & 14AA

If at any stage of enquiry, investigation or any other proceedings before him, any Central Excise Officer not below the rank of an Assistant Commissioner of Central Excise or Deputy Commissioner of Central Excise, having regard to the nature and complexity of the case and the interest of revenue, is of the opinion that the value has not been correctly declared or determined by a manufacturer or any person, he may, with the previous approval of the Chief Commissioner of Central Excise, direct such manufacturer or such person to get the accounts of his factory, office, depots, distributors or any other place, as may be specified by the said Central Excise Officer, audited by a cost accountant or chartered accountant, nominated by the Chief Commissioner of Central Excise in this behalf. {Section 14A of Central Excise Act,1944}

If the Commissioner of Central Excise has reason to believe that the credit of duty availed of or utilised under the rules made under this Act by a manufacturer of any excisable goods—

(a) ...

(b) ..

he may direct such manufacturer to get the accounts of his factory, office, depot, distributor or any other place, as may be specified by him, audited by a cost accountant or chartered accountant nominated by him.  {Section 14AA of Central Excise Act,1944}

(iii)     Power of Auditors / Departmental officers to verify records

Every assessee, and first stage and second stage dealer shall, on demand make available to the officer empowered under sub-rule (1) or the audit party deputed by the Commissioner or the Comptroller and Auditor- General of India, or a cost accountant or chartered accountant nominated under section 14 A or section 14 AA of the Act the records as specified under Rule 22 of Central Excise Rules, 2002. {Rule 22 of Central Excise Rules , 2002}

c)       Discussion on departmental manual – Few Important Abstracts

1. a.       Major ingredients of assessment

                     i.      Classification and rate of duty

                      ii.    Valuation

                      iii.   Quantity Removed

                      iv.   Cenvat Credit

1. Procedure of Excise Audit 2000

The steps in brief are mentioned below. It is important that the auditor records all of the steps, in Working Papers, as he goes along.

                   i.      Selection of Assessee

                   ii.      Preliminary or Desk Review.

                   iii.      Gathering Information about the Assessee and the Systems followed by him.

                   iv.      Evaluation of the Internal Controls.

                            1.  Walk-through

                             2. ABC Analysis

                    v.      Revenue Risk analysis.

                    vi.      Trend analysis.

                    vii.      Developing the Audit Plan.

                    viii.      Tour of the Premises/Plant

                    ix.      Verification

                     x.      Summarising Audit Findings.

                    xi.      Informing the Divisional Deputy/Assistant Commissioner of major audit points.

                    xii.      Reviewing results with the Assessee.

                    xiii.      Compliance of Audit objections.

                    xiv.      Future Compliance.

                    xv.      Reporting.

                    xvi.      Audit Follow up:

d)      Common parts of standard show cause notice.

1. a.       Part – A – “The Internal Audit Party headed by Shri ..... will take up the audit of the accounts/records of your unit on any day after 15 working days of the issue of this letter. It is requested that the following documents for the last five year or the period not taken up for audit already. which ever is applicable, may be furnished immediately to this office.”

1. b.       Part – B – Documents most commonly seeked.

             i.      Copies of Balance Sheet alongwith Schedules and Profit & Loss account alongwith Annexures and notes to the accounts, Trial Balance and Annual Financial Statement.

             ii.      Annual returns submitted to the Registrar of Companies, Sales Tax, Income Tax Returns along with Annexures (Form 3 CD).

             iii.      Director's reports

             iv.      Returns if any submitted to Banks/Financial Institutions.

             v.      Cost Audit, Tax Audit and Internal Audit Reports, wherever applicable.

             vi.      Date of last audit;

             vii.      Copy of Central Excise Registration;

             viii.      List of commodities manufactured with process of manufacture/dealt in specifically detailed out format

             ix.      Statement showing production, clearance, value & duty paid through PLA & Cenvat for the last five year or the period not taken up for audit already. may be enclosed. Cenvat availed on inputs, Capital goods and input services may also be given in a separate chart (The Statement should tally with ER-I).

             x.      List of records maintained as required to be submitted to RO as per sub Rule (2) of Rule 22 of the Central Excise Rules, 2002

             xi.      Copies of ER-4, ER-5, ER-6 & ER-7 return.

             xii.      PLA & Cenvat Account Details

1. c.        Part- C – Voluntary compliance of Audit Objections - For voluntary compliance of the Audit objections raised by the Audit parties, there exists a provision under Section 11A (2B) of the Central Excise Act wherein only applicable excise duty and interest can be paid on the spot and a letter seeking waiver of penalty/show cause notice can be given by the assessee thus leading to better compliance and less litigations
2. d.       Part D: - Annexure for detailed mix of records required.

e) Most common areas of audit

1) Standard Audit Programme - Different steps in auditing are -

• Preparatory or preliminary review: In this phase the audit party gathers as much relevant information as possible about the assessee and its operations in the office. The details to be gathered are, reason for selection, result of last audit, profile of the assessee giving details of ownership, goods manufactured etc. private records, special procedures, revenue realised, details of anti-evasion action if any, income tax returns, sales tax returns, annual reports, Cost audit reports, changes in law during the audit period, classification and price declaration, etc.
• Gathering and documenting the systems information: This phase starts as soon as the party reaches the unit. The party gathers and documents systems information by interviewing key personnel and tries to understand the organisational pattern, obtains annual reports and reports submitted to other departments/institutions, studies tax accounting systems. The auditors also find out about trading activity, captive consumption, exports, purchase procedure and policy, imports, job work, ISO reports and other revenues.
• Tour of the premises/plant: This is a very important element of the audit programme. The audit party gets an opportunity to physically verify many facts as understood during the first two phases and clarify doubts in this phase. The tour should cover all areas and should be thorough.
• Evaluation of internal controls: An understanding of the organisational chart of the unit, review of accounts and general ledger and a general systems review enables the auditor to understand and study the impact of various subsystems that have an impact on indirect tax revenue. The evaluation of internal controls involves study of tax accounting, revenue accounting and expenditure accounting. ‘Walkthrough’ method can be a very effective tool in evaluation of internal control.
• Risk loss analysis (Reasonableness test): Based on the studies made in the earlier steps, the audit party has to analyse and work out what would be the risk to revenue because of deficiencies of accounting system and what would be reasonable. The analysis will be used for development of Audit plan.
• Trends analysis: Study of trends in revenue, modvat availment, profit, prices and quantum of the items manufactured over a period will help the audit party in identifying areas which are to be looked into.
• Development of Audit plan: After completing all the steps detailed above, the auditors develop an audit plan in a narrative or list format which will be consistent with the complexity of the audit.
• Verification in accordance with the plan: The Audit Programme has detailed guidelines for verification of each and every aspect of the audit work and auditors are expected to use the guidelines and other techniques effectively to achieve best results.
• Preparation of audit findings: After completion of the audit, audit findings are to be prepared. Every finding should be substantiated with adequate evidence in the relevant Working Papers.
• Review of results with the assessee: Findings with Working Papers to substantiate the findings especially relating to short levies are to be handed over to the assessee and reviewed. Wherever the assessee agrees with the findings, he may be persuaded to pay the amount and pay the correct duty in future. Where the findings relate to procedural deficiencies, an undertaking will be sought from the assessee about future compliance.
• Review with the Range officer/Divisional Asstt. Commissioner: The audit party should also have a discussion with the concerned RO/AC before preparing the final Audit report. This will ensure greater accuracy in the report.
• Finalisation of Report: The final report will contain the details of findings of the audit party along-with results of review with the assessee and the Range Officer/Divisional Asstt. Commissioner.

2)       Classification of Major Inputs & Outputs

1. Classification under central excise is an avenue of extreme significance. The rate of duty, the benefits of tariff and based notifications are all dependent on the classification of such item.
2. It is imperative for the assessee to ensure that proper list of items manufactured and raw material purchased is well documented along with its relevant classification tariff heads
3. "Interpretative Rules" of CETA, 1985 must be adhered to strictly.
4. Necessary judgements clarifying the classification of the product is also an essential classification procedure.

3)       Availment of Exemption based on classification

1. If any exemption is available to any commodity, the same may be ascertained and the applicable rate of duty should be determined. If such exemption is subject to certain conditions, it shall be necessary to follow those conditions.
2. Necessary judgements clarifying the compliance of the conditions are also an essential exemption procedure.

4)       Documentation & Records

1. Invoice

                                                               i.      Removals only on invoice (Refer Rule 11)

                                                             ii.      Ensure Proper format & Serial number

                                                           iii.      Authorisations / Authentications

                                                           iv.      Number books / Intimations

                                                             v.      Computerised Invoices

                                                           vi.      Cancellation of invoice procedures

                                                         vii.      Supplementary Invoice procedures                                                           

1. b.       Private records as detailed in Rule 22

                        i.      Records shall mean all the records prepared or maintained by the assessee for accounting of transactions in regard to receipt, purchase, manufacture, storage, sales or delivery of the goods including inputs and capital goods. All accounts, agreements, invoice, price-list, return, statement or any other source document ,whether in writing or in any other form shall be treated as records. Source documents are those documents which form the basis of accounting of transactions and include sales invoice, purchase invoice, journal voucher, delivery challan and debit or credit note.

1. c.        Statutory records

                         i.      Income tax returns, ROC returns, Sales tax returns.

1. d.       Excise registers (including cenvat registers)
2. e.       Excise returns – ER-1 to ER-8 (as applicable) , PLA & other details.
3. f.        Computerised records – Audit trail justifications

5)       Job Work Procedures

1. Ensuring proper job work procedures
2. Job Work registers
3. Inter-unit job work procedures
4. Reversals under Cenvat Credit Rules,2004
5. Proper implementation of challan system is also essential

6)       Cenvat Procedures

1. Cenvat should be availed as per definitions of Rule 2 of Cenvat Credit Rules, 2004 strictly in regard to capital goods, input services and inputs and supplemented with rule 9 and rule 6 of CCR,2004.
2. Proper reversals under Rule 3(5) / (5A) / (5B) and complementing invoice and challan procedures
3. Rule 6 compliance for manufacture of dutiable and exempt goods simultaneously (or services where applicable)
4. Where the input service is distributed the same shall be as per 7A of CCR, 2004.
5. Compliance of other cenvat procedures as applicable.

7)       Export Procedures

1. The conditions and procedure relating to export without payment of following type of duties are contained in Notification Nos. 42/2001-Central Excise (N.T.) to 45/2001-Central Excise (N.T.), all dated 26th June, 2001 issued under rule 19 of the Central Excise Rules, 2002
2. The conditions and procedure relating to export under claim of rebate are contained in Notification 19/2004-Central Excise (N.T.) dated 6th September 2004 and notification No. 20/2004-C.E. (N.T.) dated the 6th September, 2004 issued under rule 18 of the Central Excise Rules, 2002
3. Refund of any duty of excise is governed by Section 11B of the Central Excise Act, 1944. By definition, refund includes rebate of duty paid on goods exported out of India or on materials used in the manufacture of goods exported out of India.
4. Proper presentation of refund claims and concerned limitation periods
5. ARE-1/ ARE-3, CT-3/1, CT-3 registers, LUT’s , Shipping bills and other documents to be properly maintained.

8)       Valuation Procedures

1. Valuation as per Section 4 / 4A & Section 3 (whichever applicable)
2. Proper costing sheets of the products to be documented
3. Valuation procedures and rules to be complied with strictly
4. Refer  2012 (8) TMI 791 - SUPREME COURT – Fiat India Landmark judgement

9)       Reconciliation Procedures

1. Reconciliation of stock and raw material
2. Consumption and production reconciliation
3. Sales as per excise and sales tax reconciliations
4. Cenvat reconciliations
5. Other reconciliations as per affairs of the company

10)   Other Miscellaneous Procedures

1. Compliance of Warehousing procedures
2. Compliance of SSI procedures
3. Compliance of testing , re-testing and others procedures.
4. Procedural correspondences required with department

f)        Ratios / Trends are key

1. This include analysis of important ratios for last three years having implication under Central Excise such as Cenvat Credit availed / Total Duty payable, Cenvat Credit / PLA a/c, Exempted / Excisable turnover, Electricity Units consumed / Finished goods manufactured etc. The main intention here is to notice unusual trends.

g)       Role of Pre-Audit is Essential

1. It is imperative that the Auditee/manufacturer conducts a pre-audit to the actual audit to ensure that all the issues are identified. The procedural non compliance shall be corrected while any duty/interest if identified shall be paid duly.

h)       Conclusion

Excise audit requires a precise and careful handling by the assessee companies. Also as practically seen in several cases the audit objections are normally made the part of show cause notice in toto by the department unless a strong and technically sound reply is filed by the assessee. Hence the same even gains more significance.  For voluntary compliance of the Audit objections raised by the Audit parties, the provisions of Section 11A(2B) can be adhered to.

   About the Author:

CA Ankit Gulgulia

Author is Practicing Chartered Accountant in New Delhi/NCR and specialising in Indirect Taxes, Corporate Laws and Transfer Pricing. He can be reached at [email protected] / +91-9811653975

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