SPECIAL AUDIT BEFORE ASSESSMENT UNDER INCOME TAX ACT PROVISONS

[Mr. M. GOVINDARAJAN]

The relevant statutory provisions governing the special audit are incorporated under Section 142 of the Income Tax Act which is titled as ‘enquiry before assessment’. Section 142 (2A), 142(2B), 142(2C), 142(2D) , 142 (3) and 142(3) are relevant in this behalf.

Section 142(2A) provides that if at any stage of the proceedings before him, the Assessing Officer, having regard to the nature and complexity of the accounts of the assessee and the interests of the revenue is of the opinion that it is necessary so to do, he may, with the previous approval of the Chief Commissioner of Commissioner, direct the assessee to get the accounts audited by an accountant as defined in the Explanation below sub section (2) of Section 288, nominated by the Chief Commissioner of Commissioner in this behalf and to furnish a report of such audit in the prescribed form duly signed and verified by such accountant and setting forth such particulars as may be prescribed and such other particulars as the Assessing Officer may require. The proviso to this sub section provides that the Assessing Officer shall not direct the assessee to get the accounts so audited unless the assessee has been given a reasonable opportunity of being heard.

Section 142 (2B) of the Act provides that the provisions of Section 142 (2A) shall have effect notwithstanding that the accounts of the assessee have been audited under any other law for the time being in force or otherwise.

Section 142 (2C) provides that every report under Section 142(2A) shall be furnished by the assessee to the Assessing Officer within such period as may be prescribed by the Assessing Officer. The proviso to this section provides that the Assessing Officer may, suo motu, or on an application made in this behalf by the assessee and for any good and sufficient reason, extend the said period by such further period or periods as he thinks fit; so, however that the aggregate of the period originally fixed and the period or periods so extended shall not, in any case, extend 180 days from the date on which the direction under Section 142(2A) is received by the assessee.

Section 142(2D) provides that the expenses of, and incidental to any audit under Section 142(2A) (including the remuneration of the accountant) shall be determined by the Chief Commissioner of Commissioner (which determination shall be final) and paid by the assessee and in default of such payment, shall be recoverable from the assessee in the manner provided in Chapter XVII-D for the recovery of arrears of tax. The proviso to this Section provides that where any directions for audit under Section 142(2A) is issued by the Assessing Officer on or after 01.06.2007 the expenses of, and incidental to, such audit (including the remuneration of the Accountant) shall be determined by the Chief Commissioner or Commissioner in accordance with such guidelines as may be prescribed, and the expenses so determined shall be paid by the Central Government.

Section 142(3) provides that the assessee shall, except where the assessment is made under Section 144 be given an opportunity of being heard in respect of any material gathered on the basis of any enquiry under Section 142(2) or any audit under Section 142(2A) and proposed to be utilized for the purpose of assessment.

Section 142(4) provides that the provisions of this section as they stood immediately before the amendment by the Direct Tax Laws (Amendment) Act, 1987 shall apply to and in relation to any assessment for the assessment year commencing on 01.04.1988, or any earlier assessment year and references in this section to other provisions of this Act shall be construed as references to those provisions as for the time being in force and applicable the relevant assessment year.

In ‘Sahara India (Firm) V. Commissioner of Income Tax’ – 2008 (4) TMI 4 - Supreme Court the Supreme Court held that a bare perusal of the provisions of Section 142(2A) would show that the opinion of the Assessing Officer that it is necessary to get the accounts of assessee audited by an accountant has to be formed only by having regard to-

• The nature and complexity of the accounts of the assessee; and
• The interests of the Revenue.

The word ‘and’ signifies conjunction and not disjunction.   In other words, the twin conditions of ‘nature of complexity of the accounts’ and ‘the interests of the Revenue’ are the prerequisites for exercise of power under Section 142(2A).

The word ‘complexity’ is not defined in the Act.   The High Court in ‘Swadesh Cotton Mills Co. Limited V. Commissioner of Income Tax’ – 1987 (3) TMI 20 - ALLAHABAD High Court held that the word ‘complexity’ is a nebulous word. Its dictionary meaning is – The State or quality of being intricate or complex or that is difficult to understand.   However, all that is difficult to understand should not be regarded as complex. What is complex to one may be simple to another. It depends upon one’s level of understanding or comprehension. Sometimes, what appears to be complex, on the face of it, may not be really so if one tries to understand it carefully.   Thus before dubbing the accounts to be complex or difficult to understand,-

• There has to be a genuine and honest attempt on the part of the Assessing Officer to understand accounts maintained by the assessee;
• Appreciate the entries made therein and in the event of any doubt, seek explanation from the assessee;

But the opinion required to be formed by the Assessing Officer for exercise of power under the said provision must be based on objective criteria and not on the base of subjective satisfaction. There is no gainsaying that recourse to the said provision cannot be had by the Assessing Officer merely to shift his responsibility of scrutinizing the accounts of an assessee and pass on the buck to the special auditor.   Similarly the requirement of previous approval of the Chief Commissioner of the Commissioner in terms of the said provision being an inbuilt protection against any arbitrary or unjust exercise of power by the Assessing Officer, casts a very heavy duty on the said high ranking authority to see to it that the requirement of the previous approval, envisaged to see to it that the requirement of the previous approval, envisaged in the section is not turned into an empty ritual. Needless to say that before granting approval, the Chief Commissioner or the Commissioner, as the case may be, must have before him the material on the basis whereof an opinion in this behalf has been formed by the Assessing officer.   The approval must reflect the application of mind to the facts of the case.

Whether it is required to give opportunity of being heard to the assessee in such cases? For this the Supreme Court in ‘Rajesh Kumar V. Deputy Commissioner of Income Tax’ –2006 (11) TMI 135 - SUPREME Court gave answer.   In this case the Supreme Court held that prejudice to the assessee is apparent on the fact of the said statutory provision.   It has been observed that on account of the special audit, the assessee has to undergo the process of further accounting despite the fact that the accounts have been audited by a qualified auditor in terms of Section 44AB of the Act. An auditor is a professional person. He has to function independently.   He is not an employee of the assessee.   In case of mis conduct he may become liable to be proceeded against by a statutory authority under the Chartered Accountants Act, 1949. Besides the assessee has to pay a hefty amount as fee of the special auditor.   Moreover, during the audit of the accounts again by the Special auditor, he has to answer a large number of questions. The principles of natural justice are to be followed even though no express provision is laid down in this behalf, compliance with the principles of natural justice would be implicit. If the assessee is put to notice he could show that the nature of accounts is not such which would require the appointment of special auditors. He could further show that what the Assessing Officer considers to be complex is, in fact, not so.   It was also open to him to show that the same would not be in the interests of the Revenue.

It would be relevant to take note of the insertion of proviso to Section 142(2D) with effect from 01.06.2007 which provides that the expenses of the auditor appointed in terms of the said provision shall, henceforth, be paid by the Central Government.

What is the type of this Special Audit?   The Supreme Court observed that unlike the compulsory audit under Section 44AB, it is not limited to mere production of the books and vouchers before an auditor and verification thereof. It would involve submission of explanation and clarification which may be required by the special auditor on various issues with relevant data, document etc., which, in the normal course, an assessee is required to explain before the Assessing Officer, therefore special audit is more or less in the nature of investigation and in some cases may even turn out to be stigmatic.   The Supreme Court is of the view that even after the obligation to pay auditor’s fees and incidental expenses has been taken over by the Central Government, civil consequences would still ensure on the passing of an order for special audit.