The Interplay between Income Tax Returns (ITR) and Goods and Services Tax (GST)

The Indian taxation landscape has undergone significant changes in recent years, particularly with the introduction of the Goods and Services Tax (GST) in 2017. This new system has created a complex dynamic between Income Tax Returns (ITR) and GST, making it essential for businesses and taxpayers to understand the interplay between these two mechanisms to ensure compliance and accurate financial reporting.

Reconciliation of Turnover between GST Returns and Income Tax Returns: Comparing Chalk and Cheese

 Background

Businesses must reconcile the turnover reported in their GST returns (GSTR-1 and GSTR-3B) with the turnover reported in their Income Tax Returns (ITR). On September 29, 2020, the Central Board of Direct Taxes (CBDT) announced that the Principal Director General of Income-tax (Systems) or the Director-General of Income-tax (Systems) would upload information related to GST returns into the Annual Information Statement (AIS). Consequently, details of an assessee’s monthly turnover as per Form GSTR-3B now appear in the AIS/TIS.

Since the inception of the GST Act, dealer registration has been PAN-based, establishing a clear linkage between Income Tax and GST details. Starting from the Assessment Year 2018-19, Income Tax Returns have included fields for GST turnover and GST registration numbers.

Key Differences in Turnover Concepts

Financial statements prepared under Generally Accepted Accounting Principles (GAAP) adhere to a distinct set of rules, while the Goods and Services Tax (GST) framework employs different criteria for determining “turnover.” The GST turnover, as reported in Form GSTR-3B, is reflected in the Annual Information Statement (AIS) and Tax Information Statement (TIS).

Branch Transfer:

Given that GST registration is state-specific, each branch of an entity is treated as a separate entity. Consequently, inter-branch transfers are classified as outward supplies for the supplying branch and inward supplies for the receiving branch. This classification results in the inclusion of branch transfers in the GST turnover, potentially inflating the reported turnover compared to financial statements.

Real Estate Sector:

In the real estate sector, services such as construction or works contracts typically qualify as continuous supply of services under Section 2(33) of the Central Goods and Services Tax (CGST) Act. The invoicing rules for continuous supply of services are:

If due dates are ascertainable from the contract (e.g., milestones), the invoice must be raised on or before the due date of payment.

If due dates are not ascertainable from the contract, the invoice must be raised before or at the time of receiving payment.

If payment is linked to the completion of an event, the invoice must be issued on or before the event’s completion date.

However, financial statements prepared under the percentage completion method cannot be directly compared with the turnover reported in GST returns.

Financial Credit Notes:

As per Section 34(2) of the CGST Act, 2017, credit notes can only be issued within 30th October following the end of the financial year, or the date of filing the annual return, whichever is earlier. Even though these credit notes may be recorded in the financial statements prepared under GAAP, they cannot be adjusted against the GST turnover if they are issued after the stipulated time period. This creates a difference between the turnover reported in the ITR, which is based on the financial statements, and the GST turnover reported in the GST returns.

Supply to Distinct/Related Person without Consideration:

Schedule I of the CGST Act, 2017 stipulates that supply to related or distinct persons, even if made without consideration, is deemed to be a supply and is therefore subject to GST. The valuation of such supplies is governed by the Valuation Rules provided in the CGST Rules, 2017. According to these rules, the value of these supplies must be determined based on the open market value, the value of similar supplies, or the cost of supply plus a certain percentage of profit.

Since such supplies are considered taxable under the CGST Act, their value must be included in the GST return. This inclusion ensures compliance with GST provisions, where all taxable supplies, irrespective of consideration, are accounted for in the returns. However, the treatment of these supplies in the books of account presents a different scenario. As these supplies are made without consideration, they are not recorded as revenue in the financial statements. Consequently, their value is not included in the turnover while preparing the financials as per GAAP, resulting in a discrepancy between GST turnover and the turnover in the Return of Income.

Sale of Fixed Assets/Capital Goods:

GST is applicable on the sale of fixed assets/capital goods, as the GST Act is a transaction-based tax. The value of the sale of fixed assets/capital goods must be included in the GST turnover, as it is considered a taxable supply under GST. However, in the financial statements prepared as per GAAP, the sale value of fixed assets is not recorded as part of the turnover. Instead, it is presented in the Fixed Asset Schedule. This creates a difference between the GST turnover and the turnover reported in the financial statements, as the sale of fixed assets is included in the GST turnover but not the financial turnover. The GST law treats the sale of fixed assets as a taxable supply, while GAAP considers it a capital transaction that is not part of the regular business turnover. This divergence leads to discrepancies between the GST turnover and the financial turnover.

Discounts:

Under GST laws, the valuation of supplies is guided by the Valuation Rules, which determine the taxable values that become part of the GST turnover. Discounts are one example where the GST treatment differs from the accounting treatment:

1. Discounts given before or at the time of supply can be deducted from the transaction value for the purpose of calculating GST, provided they are recorded in the invoice.
2. Post-sale discounts can also be deducted from the transaction value if:
3. The terms of the discount were agreed upon before or at the time of supply
4. The discount can be linked to specific invoices.
5. The recipient has reversed the proportionate input tax credit claimed earlier.

However, if post-sale discounts are provided without any prior agreement, they cannot be deducted from the GST turnover, even though the discounted amount is recorded as revenue in the financial statements prepared as per GAAP.

This difference in treatment of post-sale discounts between GST and accounting standards leads to an additional reconciliation item between the GST turnover and the turnover reported in the financial statements.

In summary, while discounts reduce the revenue recognized in the books of account, their impact on the GST turnover depends on whether they were agreed upon before or after the supply was made. This creates a reconciling item between the GST turnover and the turnover as per the financial statements.

Conclusion:

Although the aforementioned transactions do not represent an exhaustive list, the complexities detailed above necessitate meticulous reconciliation to ensure accurate reporting and compliance with both GST and income tax regulations. These differences underscore the importance of careful analysis and documentation, as attempting to compare such disparate data without proper context can lead to misleading conclusions. Hence, professionals must approach these reconciliations with diligence to bridge the gap between GST and financial accounting standards effectively.

Concept of Inward Supplies

Input Tax Credit (ITC) and Expense Reporting

Clause 44 of the Tax Audit Report (Form 3CD) necessitates a detailed breakdown of the total expenditure incurred during the fiscal year. This expenditure must be categorized based on its association with entities registered under the Goods and Services Tax (GST), entities operating under the Composition Scheme, and other registered entities.

1. Total Expenditure Incurred During the Year

Clause 44 requires reporting of the total amount of expenditure incurred during the previous year, including both revenue and capital expenditures.

However, expenses that are not in the nature of expenditure, such as depreciation, provision for expenses, etc. should not be included in the total expenditure reported.

Expenditures related to activities or transactions covered under Schedule III of the CGST Act, which are treated neither as supply of goods nor supply of services, also need not be reported under this clause. Examples include employee salaries and certain inter-state stock transfers.

2. Expenditure Related to GST-Registered Entities

Columns 3 to 6 require segregation of the total expenditure based on the GST registration status of the supplier:

Column 3: Expenditure relating to goods or services that are exempt from GST

Column 4: Expenditure relating to entities under the GST Composition Scheme

Column 5: Expenditure relating to other GST-registered entities

Column 6: Total expenditure relating to all GST-registered entities (sum of Columns 3, 4 and 5)

3. Expenditure Related to Non-Registered Entities

Column 7 requires reporting of the expenditure relating to entities not registered under GST.

The key challenge in Clause 44 reporting is accurately segregating the expenditures based on the GST registration status of the suppliers. This information may not always be readily available, posing a significant difficulty for businesses. Clause 44 aims to provide the tax department with detailed data on a taxpayer’s expenditure patterns, which can be used for cross-verification and compliance purposes.

Currently, Table 14 of GSTR-9C has not been mandated, but it is anticipated that a similar requirement will be introduced in the future. The government is continually striving to enhance the efficiency and effectiveness of the tax system, and reconciling financial information is a crucial component of this process.

When the reconciliation of GSTR-9C and Clause 44 becomes mandatory, businesses will need to ensure that a proper reconciliation statement is prepared. In cases where there are discrepancies, businesses must provide appropriate reasoning in response to scrutiny notices issued for such differences.

Reconciling Inward Supply Data from AIS/TIS

The Income Tax Department has started reporting inward supply data of taxpayers in the Annual Information Statement (AIS) and Taxpayer Information Summary (TIS). This data is based on the GSTR-2B of the taxpayer. However, reconciling this information with the purchases shown in the Audited Financial Statements or Income Tax Returns (ITRs) can be challenging due to several reasons:

1. The party level sales (aggregated at PAN level) as reported in GSTR-1 of the seller is reported.
2. During the aggregation, inter-branch purchases are excluded.
3. Purchases from unregistered parties, as well as purchases outside the purview of GST like petrol and liquor, are not captured in the AIS/TIS data
4. As per GST laws, taxpayers can rectify their GST returns for the previous financial year until November of the current financial year. However, ITRs in cases where Tax Audit is applicable must be filed by October. This time lag can create complications while reconciling the data.

To address these reconciliation challenges, taxpayers and their auditors should:

1. Maintain detailed records of all purchases, including those from unregistered parties and outside the GST net.
2. Perform regular reconciliations between the AIS/TIS data, GST returns, and financial records.

Conclusion In conclusion, the implementation of Clause 44 in the Tax Audit Report (Form 3CD) and the reconciliation of inward supply data from the AIS/TIS emphasize the need for businesses to maintain rigorous financial documentation and accurate expenditure classification. Ensuring precise segregation of expenses based on GST registration status and conducting regular reconciliations between AIS/TIS data, GST returns, and financial statements are essential for compliance.