Audit by department: Justified or not?

[Pradeep Jain]

Introduction

“Audit” – One of the most dreaded consequence of getting registered with the service tax department. Nobody wants to get strangled in the vicious circles of departmental audit and yet, sooner or later, you have to face the dungeon of audit. Times and now, questions have been raised on the qualifications and eligibility of the officers of the department to conduct audit, but the Government has proved to be adamant in continuing the ritual despite of the poor results of such audits. This piece of articulation is on the journey of provisions related to audit in the Chapter V of the Finance Act, 1994 governing the service tax law.

The mysterious provisions

Rule 5(2) of the Service Tax Rules, 1994	It requires the Assessee to furnish to the Superintendent of Central Excise a list in duplicate of all the records prepared or maintained by him for accounting of transactions, in regard to providing any service, receipt or procurement of anybody’s service and payment of such service.
Types of documents that can be asked to be made available “on demand”	The assessee is required to furnish following documents on demand:- (i)    Records mentioned in terms of Rule 5(2); (ii)   Cost Audit Reports, if any, under Section 148 of the Companies Act, 2013; (iii)   Income Tax Audit Report, if any, under Section 44AB of the Income Tax Act, 1961.
Section 72A of the Finance Act (Special Audit)	It is only where one of the three contingencies as mentioned in Section 72A of the Finance Act exists, that the Commissioner may direct the Assessee to “get his accounts audited either by a Chartered Accountant or a Cost Accountant nominated by such Commissioner”. The extent of the audit and the period for which it should be conducted is also to be specified by the Commissioner.
Section 82 of the Finance Act (Power to search premises)	This power can be exercised when the officer has a reason to believe that:- there are documents or books that have been secreted in a place; and such documents or books are useful or relevant for any proceedings.

The dispute

The service tax department undertakes audit at frequent intervals and all the records maintained by the service provider are scrutinized. The outcome is in form of audit paras, some genuine and some issued for procedural lapses, almost all result into issue of show cause notice. As the audit is an unwarranted situation, some of the assessees keep their fingers crossed and some opt for legal way to avoid the same. So, the issue of legality of audit by departmental officers has been commented by various Courts.

Judicial pronouncements

• The very first stone was thrown by the Hon’ble High Court of Delhi in the case of Travelite (India) Vs. Union of India & Ors. [ 2014 (8) TMI 200 - DELHI HIGH COURT ]. It very specifically held that Rule 5A(2) of the Service Tax Rules ultra vires the provisions of the Finance Act. It quashed the rule stating that no Service Tax Audit can be conducted by the Department and only Special Audit within the Statute as mentioned under Section 72A of the Finance Act can be done either by a Chartered Accountant or Cost Accountant only in specified certain circumstances”. It was further held that Service Tax Audit as envisaged in Rule 5A(2) of the Service Tax Rules does not have appropriate statutory backing of the Finance Act.

• Following the same decision, the service tax audit by departmental officers was denied in the cases of ACL Education Centre Pvt. Ltd. & Ors. Vs. Union of India [ 2014 (1) TMI 1562 - ALLAHABAD HIGH COURT ] and SKP Securities Ltd. Vs. DD (RA-IDT) & Ors. [ 2013 (1) TMI 549 - CALCUTTA HIGH COURT ].

• As on December 18, 2014, the Hon’ble Apex Court granted stay on the operation of the Hon’ble Delhi High Court judgment in the Travelite case. This decision has been cited at Union of India And Ors Vs. M/s Travelite (India) [2014 (12) TMI 1099 – SUPREME COURT]

Circulars & Notification issued to nullify the HC decisions

• Circular No. 986/10/2014-CX dated October 9, 2014 was issued by the board which intended to clarify that judgment under the Travelite case does not deal with the issue of audit in the Central Excise. It was further clarified that there is adequate statutory backing for Audit by the Central Excise officers by virtue of Section 37(2)(x) of the Central Excise Act, 1944 and Rule 22 of the Central Excise Rules, 2002 for conducting Central Excise Audit.

• Notification No. 23/2014-ST dated December 5, 2014 was issued to substitute rule 5A(2) to bring within its purview the officer authorised by the Commissioner or the Audit Party deputed by the Commissioner or CAG to conduct Service Tax Audit alongwith the Chartered Accountant or a Cost Accountant.  

• Circular No. 181/7/2014-ST dated December 10, 2014 was issued to clarify that by virtue of amendment made in Section 94(2)(k) of the Finance Act by Section 114(J) of the Finance Act, 2014 w.e.f. August 6, 2014; now the Rule 5A(2) of the Service Tax Rules has legal backing. Therefore, it was clarified that the judgment of Travelite (India) is not applicable.

• Circular No. 995/2/2015-CX dated February 27, 2015 was issued by the CBEC on the subject – “Central Excise and Service Tax Audit norms to be followed by the Audit Commissionerates”. In this circular, directions were given to field formations regarding planning and conduct of audits and audit procedures to be followed.

Thus, after judicial pronouncements quashing the validity of audit by service tax authority, amendment was made in legal provisions to nullify the effect. Subsequent circulars issued in this respect also indicate that the Revenue is not in mood of giving up the audit powers.

Recently held:-

Recently, in the case of Mega Cabs Pvt. Ltd. Vs. Union of India And Ors [ 2016 (6) TMI 163 - DELHI HIGH COURT ], the Hon’ble Delhi high Court has delivered a landmark judgment covering the following issues:-

1. Whether Service Tax Department or CAG can conduct Service Tax Audit?
2.  Whether substituted Rule 5A(2) of the Service Tax Rules, 1994 (“the Service Tax Rules”) is ultra vires the provisions of the Finance Act, 1994 (“the Finance Act”)?

In this case, M/s Mega Cabs Pvt. Ltd. (“the Petitioner”) received a letter in which it was intimated that the audit will be done of its service tax records by service tax officers in terms of rule 5(2) of the Service Tax Rules . Being aggrieved, the Petitioner filed a petition before the Hon’ble High Court of Delhi, challenging the Impugned letter, along with Rule 5A(2) of the Service Tax Rules (as amended) on the grounds that it is beyond the rule making powers of the Central Government. The Petitioner also challenged the constitutional validity of Section 94(2)(k) of the Finance Act on the ground that it gives “plainly unguided and uncontrolled” delegated powers to the Central Government for framing rules and also the Circular No. 181/7/2014-ST dated December 10, 2014 which clarifies that by virtue of amendments made by Notification No. 23/2014-ST dated December 5, 2014 , now the audit by service tax department has legal backing.

The Delhi High Court analyzed the provisions of the Finance Act extensively and observed as under:-

• Rule 5A(2) of the Service Tax Rules, as amended, to the extent that it authorizes the officers of the Service Tax Department, the audit party deputed by a Commissioner or the CAG to seek production of the documents mentioned therein on demand, was held as ultra vires the Finance Act and, therefore, struck it down to that extent;
• It was held that the expression ‘verify’ in Section 94(2)(k) of the Finance Act cannot be construed as audit of the accounts of an Assessee and, therefore, Rule 5A(2) of the Service Tax Rules, cannot be sustained with reference to Section 94(2)(k) of the Finance Act ;
• Circular No. 181/7/2014-ST dated December 10, 2014 was declared as ultra vires the Finance Act and was struck down.
• It quashed the Impugned Letter addressed to the Petitioner as being unsustainable in law.
• It declared Circular No. 995/2/2015-CX dated February 27, 2015 and the Central Excise and Service Tax Audit Manual 2015 issued by the Directorate General of Audit of the CBEC, as ultra vires the Finance Act, as they do not have any statutory backing and cannot be relied upon by the Department to legally justify the audit undertaken by officers of the Service Tax Department.

While winding

It is pretty much clear from the recent decision that the tussle between the courts and the government is a long running drama and the end to it is no way near. On one hand the courts have understood the pain of the assessees to be assessed by ineligible auditors and on the other hand the government does not want to let the assessees breath freely. As of now the situation seems to be in favour of assessees, only until the department does not issue any such letter for audit.

P.S. the situation in favour of assessees can be said only if they opt for suit in the court of law, otherwise no benefit of these decisions is ever available to them and litigation has its own costs.