SERVICE TAX AUDIT UNDER RULE 5A OF SERVICE TAX RULES, 1994 BY SERVICE TAX AUTHORITIES – ULTRA VIRES?

[Mr. M. GOVINDARAJAN]

Section 72A of Chapter V of Finance Act, 1994 (‘Act’ for short), inserted vide Finance Act, 2012 w.e.f. 28.05.2012 envisages an audit of an assessee’s records in special circumstances the person liable to pay service tax-

• has failed to declare or determine the value of a taxable service correctly; or
•  has availed and utilized credit of duty or tax paid-

• which is not within the normal limits having regard to the nature of taxable service provided, the extent of capital goods used or the type of inputs or input services used, or any other relevant factors as he may deem appropriate; or
• by means of fraud, collusion, or any willful misstatement or suppression of facts; or

• has operations spread out in multiple locations and it is not possible or practicable to obtain a true and complete picture of his accounts from the registered premises falling under the jurisdiction of the said Commissioner, he may direct such person to get his accounts audited by a chartered accountant or cost accountant nominated by him, to the extent and for the period as may be specified by the Commissioner.

Rule 5A of Service Tax Rules, 1994 (‘Rules’ for short), inserted vide Notification No. 45/2007, dated 28.12.2007, provides for access to a registered premises.  The said Rule provides that an officer authorized by the Commissioner in this behalf shall have access to any premises registered under these rules for the purpose of carrying out any scrutiny, verification and checks as may be necessary to safeguard the interest of revenue.  Every assessee shall, on demand, make available to-

• the officer authorized; or
• the audit party deputed by the Commissioner; or
• the Comptroller and Auditor General of India,

within a reasonable time not exceeding fifteen working days from the day when such demand is made, or such further period as may be allowed by such officer or the audit party, as the case may be,-

•  the records as mentioned in sub-rule (2) of rule 5;
•  trial balance or its equivalent;  and
• the income-tax audit report, if any, under section 44AB of the Income-tax Act, 1961 ( 43 of 1961), for the scrutiny of the officer or audit party, as the case may be.

Vide Instruction No. 137/26/2007-CX 4, dated 01.01.2008 the Board gives instruction in regard to Rule 5A as – “A new Rule 5A has been incorporated in the said Rules to prescribe that an officer authorized by the Commission shall have access to any premises registered under the Service Tax Rules for the purpose of carrying out any scrutiny, verification and checks as may be necessary to safeguard the interest of revenue and that the assessee shall provide, on demand, the specified records including trial balance or the equivalent.   It may be noted that this does not envisage issue of any notification by a Commissioner for such authorization of officers.   The requirement of authorization could be fulfilled by issue of an office order”.

In ‘Travelite (India) V. Union of India’ – 2014 (8) TMI 200 - DELHI HIGH COURT  the petitioner is a registered service tax assessee.  The Commissioner of service tax issued a letter dated 07.11.2012 to the assessee sought its records for the year 2007 – 08 till 2011 – 12 for scrutiny by an audit party under Rule 5A (2).   The petitioner challenged the said letter and also the validity of Rule 5A and the instruction dated 01.01.2008.

The petitioner submitted the following arguments before the High Court-

• the powers of an assessing officer to call for records in respect of any period during which the Department seek to intensively scrutinize receipts etc., i.e., a special audit can be ordered by recourse to Section 72A of the Act;
• the Finance Act does not contain any substantive power to call for records for scrutiny as is permissible under Rule 5A(2) or for the purpose of scrutiny by any authority outside of those created under the Act, such as C&AG;
• a rule must conform to the statute under which it was framed and must be within the rule making power of the authority;
• the impugned rule is not only unjustified in the context of the substantive provisions of law in the relevant statute but also is squarely inconsistent with section 72A of the Act, which empowers the Commissioner to order an audit under special circumstances only;
• Rule 5A is not within the rule making power conferred on the executive under Section 94 of the Act;
• The impugned instruction, which stipulates the modalities for the conduct of the audit, cannot widen the scope of the law;
• A substantive obligation, such as that of handing over records to an audit party, cannot find its basis in a non statutory instrument like Service Tax Manual;
• An audit, in any event, carries civil consequences, cannot be ordered without a notice issued to the assessee indicating the reasons for the audit.

The Revenue put forth the following arguments before the High Court:

• Introduction of Rule 5A was made pursuant to the power conferred under Section 94 of the Finance Act and not pursuant to Section 72A;
• The rule is also sought to be justified by invoking the Service Tax Manual, 2011 as the basis for ordering an audit;
• After its initial letter, it had sent repeated reminders to the petitioner dated 26.12.2012, 30.1.2013, 8.3.2013 before it had issued summons on 17.05.2013;
• The petitioner alleged arbitrariness of the rule only on 01.04.2013 for the first time, until then, the petitioner had maintained that it would co-operate with the authorities towards completing the audit;
• These delaying tactics of the petitioner betray mala fide.

The High Court analyzed the provisions of Section 72A, Rule 5A and the instructions dated 01.01.2008.  The High Court found that apart from Section 94 the Revenue could not show any other substantive provision which justifies a probe into the records of the assessee under conditions akin to these contemplated by Rule 5A(2).  The Revenue was also unable to show the compulsion of arming authorities with such sweeping powers under the Rules.  The High Court held that if the legislature contemplates a situation and enacts or provides for a part of it, the other parts are deemed to have been excluded.   The law is also wells settled that a rule acquires statutory force, so long as it-

• Conforms to the provisions of the statute under which it is framed; and
• It must be within the rule making power of the executive authority charged with framing the rules.

The mere fact that a rule making power is phrased in terms that indicates a general delegation of power, cannot lead to the inference that such power may be exercised to make rules that exceed the bounds of the statute.   Rules may only give effect to the statute’s provisions and intent and cannot be used to create substantive rights, obligations or liabilities that are not within the contemplation of the statute.    The High Court found that the impugned instruction, being in furtherance of Rule 5A(2), which rule is ultra vires the Finance Act, 1994, is void for the same reasons.  The High Court further held that executive instructions without statutory force, cannot possibly override the law, consequently any notice, circular, guideline etc., contrary to statutory laws cannot be enforced.

The High Court held that the impugned circular seeks to put in place a mechanism for audit and scrutiny of documents with the objective of safeguarding the interests of the Revenue, in furtherance of the amendments made in the Service Tax Rules, as indicated in para 7 of the circular.   Since the parent statute itself does not authorize a general audit of the type envisioned by the impugned Rule 5A(2) and furthermore only stipulates that a special audit can be undertaken if the circumstances outline in Section 72A are fulfilled, the High Court found that the impugned circular is not only an attempt to widen the scope of the law impermissibly but also is patently contrary to the statute.  The High Court quashed to the extent it provides clarifications on a Rule 5A(2) audit and set aside the impugned letter.