2008 (4) TMI 4 - SC - Income Tax

Issues Involved:
1. Necessity of a pre-decisional hearing before directing a special audit under Section 142(2A) of the Income Tax Act, 1961.
2. Civil consequences of an order under Section 142(2A).
3. Prospective application of the clarified legal position.

Detailed Analysis:

1. Necessity of a Pre-Decisional Hearing:
The core issue before the court was whether the principles of natural justice require that an assessee be given a pre-decisional hearing before an order for special audit under Section 142(2A) of the Income Tax Act, 1961 is passed. The court noted that the decision in Rajesh Kumar & Ors. Vs. Deputy Commissioner of Income Tax & Ors. had held that such a hearing was necessary. The court reaffirmed this position, emphasizing that the principles of natural justice are implicit in Section 142(2A) and that an order for special audit entails civil consequences, thus necessitating a pre-decisional hearing. The court stated, "The exercise of power under Section 142(2A) of the Act leads to serious civil consequences and, therefore, even in the absence of express provision for affording an opportunity of pre-decisional hearing to an assessee... the requirement of observance of principles of natural justice is to be read into the said provision."

2. Civil Consequences of an Order Under Section 142(2A):
The court examined whether an order under Section 142(2A) entails civil consequences. It was argued that such an order affects the assessee due to the pecuniary burden and the inconvenience caused by the special audit. The court agreed, noting that "special audit has an altogether different connotation and implications from the audit under Section 44AB." The court further elaborated that special audit involves more than just verification of accounts; it includes submission of explanations and clarifications, making it akin to an investigation. Thus, the court concluded that an order under Section 142(2A) does entail civil consequences, which necessitates compliance with the principles of natural justice.

3. Prospective Application of the Clarified Legal Position:
Given the flux in the law and the divergence of opinions among various High Courts, the court decided that its clarification of the legal position should apply prospectively. The court stated, "we hold that the law on the subject, clarified by us, will apply prospectively and it will not be open to the appellants to urge before the Appellate Authority that the extended period of limitation... was not available to the Assessing Officer because of an invalid order under Section 142(2A) of the Act." This decision was made to avoid prejudicing the interests of the revenue and to provide clarity on the application of the law going forward.

Conclusion:
The court allowed the appeals to the extent that the impugned orders dated 14th March 2006, requiring the appellants to have their accounts audited, were vitiated by the failure to observe the principle of audi alteram partem. However, it held that the clarified legal position would apply prospectively, allowing the appellants to question the correctness of the material gathered based on the audit report but not the extended period of limitation. The parties were left to bear their own costs.