Case Study - The Customs Act, 1962

QUESTION

Dalmia & Associates, a practicing CA firm, submitted its application to ICAI for carrying out the bank audit for nationalized banks. After following the designated procedures and approvals required for appointment of bank auditors, the firm was appointed as branch auditor of Eastern Bank of India, a public sector bank headquartered in Kolkata.

The audit offered was for branch located in Kolkata for year ending as on 31st March, 2022. Before commencing the audit, the teammates of the firm decided to first understand the nature of activities carried out at the bank branch. Besides the core business of bank of accepting deposits and sanctioning advances, newer banking products are being periodically introduced.

The teammates discussed about the basics of the core business of the bank and the products offered at the branch to have the complete knowledge of the same. They studied the financial implications of all the products offered at the branch along with the types of facilities provided to borrowers and the Standard Operating Procedures (SOP) followed. The teammates acquainted themselves with the basic understanding of the core banking solution (CBS) used by the bank and understood the authority levels. Based on the features of the products offered, the teammates also need to draw up a suitable audit plan to verify the transactions of the activities being provided by the Bank.

They also carried out the risk assessment based on clear understanding of the business profile of the Bank. They assessed the resource requirements for audit to be completed within the stipulated timeline. Based on the volume and nature of transactions executed at branch, staff were deployed. The leader of the audit team updated his teammates with banking law and regulations and RBI Guidelines.

The audit firm sent detailed requirement letter seeking information from branch management so that necessary information is received during the planning stage and accordingly proper audit plans could be prepared. The audit firm also called for previous year's inspection and other important reports so that beforehand they are aware of the past key issues.

They also look at the previous period's report of the previous statutory auditors and its compliance status. To gain an understanding of the issues at the branch, they also went through the previous year's LFAR. Finally, the detailed audit was started on time with proper planning and during the course of audit, following were observed by engagement team of Dalmia & Associates conducting audit of Kolkata branch of Eastern Bank of India: 

(i) As per instructions of Head office, there exists a system in the bank for obtaining reports on stock audits in respect of borrowers sanctioned fund-based facilities exceeding ₹ 5.00 crores. It was noted that one borrower was having overdraft facility amounting to ₹ 2.75 crore, term loan of ₹ 1.00 crore, packing credit facility of ₹ 0.75 crore, inland letter of credit facility of ₹ 0.35 crore and foreign bill purchased facility of ₹ 0.40 crore. The stock audit of said borrower was not carried out during the year.

(ii) It was also observed during the course of audit that advances of branch stood at ₹ 350.00 crore as on 31st March 2022. Out of advances of ₹ 350.00 crore, advances pertaining to foreign exchange portfolio stood at ₹ 200.00 crore. Due to high foreign exchange portfolio, auditors have assessed many potential risk areas which might lead to perpetuation of fraud. However, upon applying extensive audit procedures as required by Standards on Auditing, the auditors have not found any instance of fraud during the course of audit.

(iii) During the course of audit, it was observed that branch is dealing with many exporters who are enjoying credit facilities from branch. Some of the exporters are exporting to Nepal whereas others are exporting to Bangladesh due to proximity of both countries to Kolkata.

(iv) During the course of audit, it was also observed that one company had an amount of ₹ 25.00 crore stuck up with one of its overseas clients based in US to whom it had exported goods last year as apparent from the financial statements of the company. The company had availed duty drawback in respect of such export in accordance with the Customs Act and its rules. The turnover of company for financial year 2020-21 was Rs.₹ 30.00 crores. It has prompted auditors to undertake detailed checking of all credit facilities enjoyed by the company.

(v) It was further observed that M/s Poriborton Industries is enjoying credit facilities to the tune of ₹ 20.00 crore consisting of cash credit limit and outstanding balance as on 31.03.2022 is ₹ 19.98 crore. It is also observed that there is inadequate drawing power on the basis of latest available stock statement for the month of February, 2022. The borrower was having adequate drawing power in previous months of the year.

(vi) It was also observed by the engagement team members that there have been instances of "quick mortality" in some of cash credit accounts.

Please answer below mentioned questions on the basis of above details;

1. What shall be the consequences for the company in respect of amount of ₹ 25.00 crore stuck up with one of its clients in an export trade for which duty draw back had been availed under Customs laws?

2. The auditors want to change asset classification from "Standard" to "Sub-Standard" for M/s Poriborton Industries. Discuss.

3. Discuss what is understood by "quick mortality" and also list out reporting requirements in respect of such accounts in LFAR to be submitted by the auditor. What could be probable significance of such reporting?

ANSWERS

1. It is given in situation that company has not been able to realize ₹ 25.00 crore stuck up with overseas client based in US. Under Rule 18 of Customs and Central Excise Duties Drawback Rules, 2017, where duty drawback has been paid to an exporter but the sale proceeds in respect of such goods have not been realised within period allowed under the FEMA, 1999, including any extension of such period, such draw back shall be recovered from such exporter. Further in terms of Section 75A of Customs Act, 1962, interest at rate fixed under section 28AA shall also be recoverable along with duty drawback amount.

The amount of interest shall have to be paid for the period beginning from the payment of duty drawback to the claimant till the date of recovery of such amount.

2. As per RBI master circular relating to prudential norms on income recognition, asset classification and provisioning related to advances, the classification of an asset as NPA should be based on record of recovery. Bank should not classify an advance account as NPA merely due to existence of some deficiencies which are temporary in nature such as non-availability of drawing power based on latest available stock statement, balance exceeding limit temporarily, non-renewal of limits on due dates etc. In the case of M/s Poriborton Industries, drawing power is inadequate on basis of stock statement of February 2022 only. Hence, it is nature of temporary deficiencies. Hence, proposed action of auditors is not in line with above norms.

3. "Quick mortality" means that credit facilities sanctioned to a borrower have become nonperforming within a short period time from date of its first sanction. Such accounts where facility became non-performing within 12 months from date of first sanction are to be specifically reported in LFAR under "credit appraisal". The account number, account name and balances as at year end in respect of such accounts have to be reported. Its significance lies in the fact that it helps in highlighting and understanding serious short comings in credit appraisal. It means that credit appraisal may not have been carried out diligently leading to quick slippage of sanctioned credit facility to non-performing asset.

DISCLAIMER: The case law presented here is only for sharing knowledge and information with readers. The views are personal. In case of necessity do consult with professionals for better understanding and clarity on subject matter.

Reference: https://resource.cdn.icai.org/63181bos51123p6f.pdf

DUTY DRAWBACK SCHEME

The duty drawback scheme has been notified for a large number of export products by the Government after an assessment of the average incidence of Customs, Central Excise duties, Service Tax and Transaction Cost suffered by the export products.
Duty Drawback Scheme aims to provide the refund/ recoupment of custom and excise duties paid on inputs or raw materials and service tax paid on the input services used in the manufacture of export goods.

THE CUSTOMS ACT, 1962

The Duty Drawback provisions are described under Section 74 and Section 75 under the Customs Act, 1962. This Act laid down the various restrictions and conditions to claim drawback of duties under certain situations.

• SECTION 74: As per section 74, if the re-exports of imported goods, which are identified quickly and within two years from the date of payment of duty on the importation. Then an exporter is eligible to claim 98% of the duty paid by him as drawback under section 74.
• SECTION 75: As per section 75, if the export of goods manufactured or processed out of imported material with value addition, then a drawback should be allowed of duties of customs chargeable on any imported materials of a class or description. If sale proceeds not received within the stipulated period, a drawback is to be reversed or adjusted. Duty Drawback under section 75 can be claimed either as a fixed percentage depending upon the value of goods exported.

GOODS ELIGIBLE FOR DRAWBACK

The following are the eligible goods for the duty drawback.

• To export goods imported into India
• To export goods imported into India after having been taken for use
• To export goods manufactured/produced out of imported material
• To export goods manufactured/produced out of indigenous material
• To export goods manufactured /produced out of imported or and indigenous materials.

ELIGIBILITY CRITERIA

The below following are the minimum criteria to claim for processing drawback claim.

• Any individual must be the legal owner of the goods at the time the goods are exported.
• You must have paid customs duty on imported goods.
• Duty drawback is available on most goods on which customs duty was paid on importation and which has been exported.

DUTY DRAWBACK RATES

The rates are specified for the drawback of which import duty with the fixed percentage shall be allowed in respect of used goods after their importation and which have been out of customs control.

SECTION 28AA OF THE CUSTOMS ACT, 1962- INTEREST ON DELAYED PAYMENT OF DUTY

Subject to the provisions contained in section 28AB where a person, chargeable with the duty determined under sub-section (2) of section 28, fails to pay such duty within three months from the date of such determination, he shall pay, in addition to the duty, interest at such rate not below ten percent and not exceeding thirty percent per annum, as is for the time being fixed by the Board, on such duty from the date immediately after the expiry of the said period of three months till the date of payment of such duty:

Provided that where a person chargeable with duty determined under sub-section (2) of section 28 before the date on which the Finance Bill, 1995 receives the assent of the President, fails to pay such duty within three months from such date, then, such person shall be liable to pay interest under this section from the date immediately after three months from such date, till the date of payment of such duty.

Explanation 1: Where the duty determined to be payable is reduced by the Commissioner (Appeals), Appellate Tribunal or, as the case may be, the court, the date of such determination shall be the date on which an amount of duty is first determined to be payable.

Explanation 2: Where the duty determined to be payable is increased or further increased by the Commissioner (Appeals), Appellate Tribunal or, as the case may be, the court, the date of such determination shall be, - (a) for the amount of duty first determined to be payable, the date on which the duty is so determined;

(b) for the amount of increased duty, the date of order by which the increased amount of duty is first determined to be payable;

(c) for the amount of further increase of duty, the date of order on which the duty is so further increased.

SECTION 75 A OF THE CUSTOMS ACT, 1962

Interest on drawback.

(1) Where any drawback payable to a claimant under section 74 or section 75 is not paid within a period of one month from the date of filing a claim for payment of such drawback, there shall be paid to that claimant in addition to the amount of drawback, interest at the rate fixed under section 27A from the date after the expiry of the said period of one month till the date of payment of such drawback:

Where any drawback has been paid to the claimant erroneously or it becomes otherwise recoverable under this Act or the rules made thereunder, the claimant shall, within a period of two months from the date of demand, pay in addition to the said amount of drawback, interest at the rate fixed under section 28AB and the amount of interest shall be calculated for the period beginning from the date of payment of such drawback to the claimant till the date of recovery of such drawback.