AUDIT UNDER SECTION 142(2A) OF INCOME TAX ACT, 1961

[Mr. M. GOVINDARAJAN]

Of late there has been demand for increased public scrutiny of accounts in spite of statutory audit. Enron and other cases abroad and Satyam’s case in India have highlighted the need and necessity to have controls and system of checks, perhaps even beyond scope of traditional audit. Financial statements and accounts are coming under increasing scrutiny and investigation.  Section 142(2A) of the Income Tax Act, 1961 (‘Act’ for short) provides for special audit that may be ordered by the Assessing Officer is the accounts are complex.

Section 142(2A) of the Act provides that if, at any stage of the proceedings before him, the Assessing Officer, having regard to the-

• nature and complexity of the accounts,
• volume of the accounts,
• doubts about the correctness of the accounts,
• multiplicity of transactions in the accounts or specialized nature of business activity 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 or Commissioner, direct the assessee to get the accounts audited by an Chartered Accountant nominated by the Chief Commissioner or 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 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.

The ‘Kerala High Court in ‘Muthoottu Mini Kuries V. Deputy Commissioner of Income Tax’ – 2001 (1) TMI 42 - KERALA High Court  held that the Assessing Officer should normally have workable skill and idea of accounting because of the nature of duty entrusted to them. The Assessing Officer was not a layman or one with no experience in dealing with the accounts. He was supposed to be acquainted with regard to matters required to be examined.

In ‘Rajesh Kumar V. Deputy Commissioner of Income Tax’ – 2006 (11) TMI 135 - SUPREME Court  the Supreme Court observed that an order under Section 142(2A) does entail civil consequences and not administrative. The three factors to be kept in mind by the authorities were-

• nature of accounts;
• complexity of accounts; and
• interests of revenue

 and opinion on the said aspects must be formed. The Supreme Court held that the special audit should not be ordered for an underline purpose which was not bona fide. It should not be ordered and approved mechanically and certainly not for unauthorized purpose of extension of limitation to complete the assessment.

In ‘Sahara India (Firm) V. Commissioner of Income Tax’ – 2008 (4) TMI 4 - Supreme Court the Supreme Court held that the object being the special audit should be directed, if it assists and succors, the Assessing Officer in framing correct and proper assessment based on the accounts maintained by the assessee i.e., the Assessing Officer must reach a finding that the accounts of the assessee were complex and in order to protect the interests of the Revenue, recourse to the said provision should be made. The expression or word ‘complexity’ refers to state of quality of being intricate or difficult to understand the accounts, appreciate the entries, in the event of doubt, seek explanation and then form the required opinion based upon the objective criteria and not purely on the basis of subjective satisfaction. The provision did not entitle the Assessing Officer to pass the buck to the special auditor as it was the Assessing Officer’s responsibility to scrutinize the accounts.  However the Supreme Court rejected the contention that special audit need not be directed because audit had been concluded under Section 44AB, inter alia, observing that the two provisions had altogether different connotations and implications. Unlike compulsory audit under Section 44AB, special audit was not limited to mere production of books or vouchers and verification thereof by the auditor but involved submission of explanations and clarifications, which might be required by the special auditor on various issues with relevant data, documents etc., Special audit was more or less in the nature of investigation and in some cases might even turn out to be stigmatic.

In ‘Delhi Development Authority V. Union of India’ – 2012 (9) TMI 410 - DELHI HIGH COURT the Delhi High Court discussed about the complexity of accounts. It observed that detailed scrutiny of large number of entries by itself on standalone basis might not amount reflect complexity of accounts. Every Assessing Officer was required to scrutinize the entries and verify them but this does not require services of a special auditor to undertake the exercise.

The Delhi High Court further elaborated when the special audit can be undertaken by the Assessing Officer.  Section 142(2A) was not a provision which enabled the Assessing Officer to delegate his powers and functions which he could perform, to the Special Auditor. The provision had been enacted to enable the Assessing Officer to take help of a specialist, who understood accounts and accountancy practices when the accounts were complex and the Assessing Officer affirms that he could not understand and comprehend them fully till he took the said help and assistance. Interests of the Revenue were another aspect, which had to be taken into account. A genuine attempt to understand the accounts and entries must be made and only when questions were raised with regard to accounts and entries and when the explanation offered was unsatisfactory or verification was not possible without help and assistance of the special auditor, action under Section 142(2A) was required.

In ‘DLF Limited and another V. Additional Commissioner of Income Tax and another’ – 2014 (4) TMI 78 - DELHI HIGH COURT the High Court held that the powers under Section 142(2A) have to be exercised in terms of the legislative provisions. The object and purpose behind the legislation is to facilitate investigation and proper determination of the tax liability. The importance and relevancy of the legislation cannot be underestimated and it is a power available with the Assessing Officer to aid and assist him. Accounts should be accurate and provide real time record of the financial transactions of the assessee.  It is also a fact that the business transactions have become more complicated and accounting entries more complex than ever before.  This may be one of the cause why possibly frauds could not be detected in some cases. Indeed such cases have made the audit work more comprehensive, intrusive and investigative. Ethical managements may at times regard such enquiries as an unwarranted intrusion or a hounding approach. Section 142(2A) does not permit fishing or roving inquiry approach or a witch hunt but is regulated provision which accepts the need and necessity of the Assessing Officer to take help of an expert accountant, i.e., a Chartered Accountant, a person who is academically qualified and has practical experience to understand accounts and unearth tax evasion or furnishing of inaccurate particulars etc., The provision balances the right of the Revenue with the inconvenience which the Assessee may face. Assessing Officers are not Chartered Accountants and when required and permissible, they can take help and assistance from the qualified specialists to complete the assessment and determine the taxable income of the assessee.