Whether notes of accounts can be basis for AO to pass an order u/s 142(2A) for conducting special audit - NO: Delhi HC

THE issues before the Bench are - Whether notes of accounts can be the basis for the AO to pass an order u/s 142(2A) for conducting special audit; Whether it is necessary on the part of the AO that he should have examined the books of accounts or the relevant accounting entries himself before forming an opinion for special audit u/s 142(2A); Whether the accounts can be said to become complex merely because there are large number of entries and Whether the special auditor cannot go into and examine the said legal issue or question regarding taxability. And the answers go in favour of the assessee.

Facts of the case

The

assessee, Delhi Development Authority, is a statutory body/authority created by the Delhi Development Act, 1957, to promote and secure development of Delhi. The AO issued the direction for special audit in the case of the assessee in respect of each of the AYs for 2003-04 to 2009-10. The grounds for initiation of special audit in most of the years were similar. It was the contention of the petitioner assessee that the order of special audit in respect of 2003-04 formed the basis of the subsequent orders. The assessee had filed these writ petitions against the AO and the Director of Income Tax (Exemptions)/Commissioner of Income Tax (Exemptions) who had given directions or approval for initiation of special audit u/s 142(2A) of the Act.

Having heard the matter, the High Court held that,

++ for the AY 2003-04 and 2004-05, the AO did not call for, examine or consider the books of accounts or even sample accounts. Failure to even call for books of accounts or relevant accounts and examination thereof is an indication of the casual and unacceptable approach and exercise of power. It was contended by Additional Solicitor General that in this case books of accounts were not required to be examined as the notes of accounts stated/recorded by the assessee's auditor itself justify and establish complexities in accounts and also disclose the need to have special audit in the interest of Revenue. In the present case, one is not concerned with an assessee who does not maintain books of accounts as per law or has duplicate books of account. It is a case of a statutory authority which is maintaining books of accounts. Notes of accounts may be the basis for the AO to ask for queries and examine the accounts but, before an order u/s 142(2A) was passed and it was necessary and required that the AO should have examined the books of accounts or the relevant accounting entries himself before forming an opinion. Non-examination of books of account would show that there was haste and hurry and that the AO not fully appreciate the consequences and the harassment/inconvenience which the assessee may suffer if a wrong order directing special audit was passed or directed;

++ assessment proceedings in respect of AY 2003-04, were initiated by selecting the case for scrutiny and issue of notice u/s 143(2) for the first hearing on 9th November, 2004. A questionnaire dated 1st November, 2003 was issued to the assessee for 9th November, 2004. There is dispute as to what had happened on 9th November, 2004. The order sheet records no one had appeared but the petitioner (assessee) had written a letter dated 17th January, 2005. There was some controversy between the assessee and the AO about the manner and nature in which the proceedings were being conducted. Acrimony and bitterness on both sides is apparent from the letter;

++ the note reveals that the AO felt that the case required detailed scrutiny or monitoring, verification of entries, which were substantial in number. Detailed scrutiny of large number of entries by itself, on standalone basis, will not amount to complexity of accounts. The accounts do not become complex because merely there are large number of entries, e.g., a petrol pump may have substantial sales, to thousands of customers daily at prices fixed under law/Rules, but this by itself will not be the accounts complex. Similarly, an AO is required to scrutinize the entries and verify them, but this does not require services of a special auditor or a Chartered Accountant to undertake the said exercise;

++ section 142(2A) is not a provision by which the AO delegates his powers and functions, which he can perform to the special auditor. The said provision has been enacted to enable the AO to take help of a specialist, who understands accounts and accounting practices to examine the accounts when they are complex and the AO feels that he cannot understand them and comprehend them fully, till he has help and assistance of a special auditor. Interest of the Revenue being the other consideration. In the present case, the Revenue has not submitted that test check of entries was undertaken, but anomalies or mistakes were detected. For proceeding further, and to compute the taxable income, help and assistance of an accounting expert was required;

++ the AO felt that special auditor is required for determining and deciding certain legal issues, i.e., nature and character of Nazul I and Nazul II land, payments received and the treatment of the said payments, receipts or expenditure in the books for the purposes of taxation. The special auditor cannot go into and examine the said legal issue or question regarding taxability. This has to be determined and decided by the AO. This determination/decision requires passing of the assessment order. However, at this stage, the AO should indicate his prima facie or tentative view on why the legal issue requires examination of accounts by the specialist. A Chartered Accountant, a specialist in accounts does not have a role to play and cannot be delegated and asked to decipher, decide or express his opinion on nature and character of Nazul I or Nazul II land receipts and payments;

++ in a given case, the complexities of account and the legal issue may be intertwined or connected and, therefore, examination of accounts may indirectly or directly require his opinion on a legal matter/issue, but this is not true or so stated in the present case. The case and the stand of the assessee is that as per the statute, including the Rules, Nazul I and Nazul II land, payments received, expenditure incurred etc., belong to the Central Government and nothing whatsoever can be attributed to them. There is no examination, consideration of the legal aspect and formation of a tentative view. The decision on this legal issue cannot be transposed and passed to the Chartered Accountant as a special auditor as he is not a specialist and mandated by the Act to undertake the said exercise. The case of the assessee is that it is maintaining separate accounts for Nazul I and Nazul II lands and the General Development Account. The said accounts are audited by the Comptroller and Auditor General and have been accepted by the Central Government;

++ there is also a merit in the contention raised by the petitioner that the AOs have repeatedly in all orders, for the purpose of recording reasons, taken the “notes of accounts” and verbatim incorporated the same. This is apparently correct and, therefore, discloses non-consideration and non-application of mind, which constitutes an error in the decision making process. It is an easy and convenient manner to transfer the obligation of scrutiny and examination to the special auditor. It may be true and correct that certain aspects mentioned in the Notes of Accounts may, if required and necessary and after in depth examination, justify appointment of a special auditor but the AO has to be cautious and careful to segregate them from others while recording the reasons. If such an exercise is undertaken, it will show due and proper application of mind and not exercise of power u/s 142(2A) on the pretend or on the pretext that such power exists and, therefore, should be exercised. Existence of the power is not in dispute; it is the exercise of power, which is in dispute and question. The exercise of power must withstand and meet the requirements prescribed. Failure to exclude irrelevant and extraneous matters negates the “opinion” as the said matters should not cloud or dent formation of opinion. Reasons recorded must be genuine and have a nexus with the twin statutory requirements i.e. complexity of accounts and interest of the Revenue;

++ one additional ground and reason for AY 2003-04 is also noticed. After the issue of show cause notice and hearing by the Commissioner of Income Tax on 22nd March, 2005 and the report received from the AO, the then Commissioner, who had given the hearing did not grant approval. However, upon transfers when a new incumbent joined as the Commissioner after nearly six months on 31st May, 2005 vide Order No. 79/2005 dated 31st May, 2005 approval was granted;

++ what is rather surprising and noticeable is that right from the first year 2003-04 onwards and in all the AYs thereafter, the AOs have directed special audit. The reasons given for the AY 2003-04 have been substantially followed in the subsequent years or have been taken from the notes of accounts for the year in question;

++ direction for special auditor in the first year swayed and it is apparent has been largely responsible for the direction of special audit in the subsequent years. There is also justification and merit in the plea of the petitioner that in case special audit was not directed in the subsequent years, the direction for special audit in the first year, i.e., AY 2003-04 would itself falter because the reasons to some extent are followed/reiterated and are inter connected. The reasons recorded for the first year have, therefore, prompted and compelled the Revenue/AOs to direct special audit in the subsequent years;

++ as noticed in the AYs 2003-04 and 2004-05, books of accounts were not called and examined. In the counter affidavit, it is stated that accounts/statement and replies were called for and considered. The reasons recorded do not refer to examination of books of accounts or any entries therein which could be a cause for confusion or complexity relating to accounts. In the counter affidavit, it is stated that the AO asked for the details and after considering the details came to the conclusion that the details supplied were too complex;

++ in the AY 2005-06, a genuine attempt to understand the accounts and entries should be made. Details and questions should be raised with regard to accounts and entries and only when the explanation offered is not satisfactory, or verification is not possible without the help and assistance of a special auditor, action u/s 142(2A) is required. Secondly, in the audit report, it was mentioned that the petitioner had received earnest money and security deposits from contractors. Section 269SS, it was observed applied to loan and deposits and examination and whether there was violation of Section 269SS involved accounting complexity. The petitioner had stated that the deposits made were not released except by way of account payee cheques. The AO records this aspect was not verifiable in view of the nature and complexity involved. In the reply, the petitioner had also stated that Section 269SS was not applicable to a corporation established under the Central, State or Provincial Act. Payments or refunds by the petitioner could be verified from the accounts and bank records. The petitioner could be asked to collate the deposits received with payments made. This would not be a complex accounting exercise, if it is not specifically indicated and stated why and how it involved complexity in accounts;

++ in the AY 2006-07, the respondents have stated that books of accounts were produced but the copy of the C&AG report was not filed before the AO. Again it was stated that the cash books were maintained at different zone levels and monthly accounts were prepared and sent to the Head Officer for consolidation. Similarly, applicability of Section 269 SS involved complexity of accounts. The petitioner has stated that a preliminary questionnaire dated 12th November, 2008, was issued fixing the hearing on 18th November, 2008. On the date of the hearing, the petitioners were informed that there was change in jurisdiction and the case was transferred to Deputy Director of Income Tax (Exemption) Trust Circle-II. The petitioner was asked to and had filed reply to the questionnaire along with a note on the accounting procedure and had produced sample books on 26th November, 2008. Books of accounts were not opened by the AO nor any specific query was raised on any entry in the books. On 4th December, 2008, show cause notice was issued and after reply was filed on 11th December, 2008, impugned order directing special audit dated 29th December, 2008 was passed;

++ in the AY 2007-08, reference is made to complexity of accounts as accounts were maintained at zonal level and then transferred to the Head Office on monthly basis and applicability of Section 269SS was involved. This amounts to complexity of accounts. The petitioner on the other hand has stated that questionnaire dated 12th November, 2008 was issued by the Director of Income Tax (Exemption) Range-I, but subsequently jurisdiction was transferred to Deputy Director of Income Tax, Trust Circle-II and the case was adjourned to 26th November, 2008. In terms of notice dated 18th November, 2008, reply to the questionnaire was filed on 26th November, 2008 and on the said date the books of accounts were produced. However, they were never opened and no specific query was raised on any entry in the books of accounts. Thereafter, show cause notice dated 4th December, 2008, was issued. Reply was filed on 11th December, 2008 and on 29th December, 2008, order u/s 142(2A) directing special audit was passed;

++ in the writ petition for AY 2008-09, the petitioner has stated that scrutiny notice dated 16th September, 2009, was issued. On 28th July, 2010, a fresh notice with preliminary questionnaire was issued. Reply to the questionnaire was filed on 2nd August, 2010. On 28th November, 2010, copy of the audit report of AG was filed and books of accounts of Commonwealth Games was called for but no examination was undertaken nor any query was asked. On 26th November, 2010, show cause notice u/s 142(2A) was issued. On 6th December, 2010, reply thereto was filed. By the order dated 15th December, 2010, special audit was directed. In the show cause notice, in addition to the other grounds it was stated that in the year, expenditure for commonwealth games was incurred on construction. The books of accounts did not reveal whether a transparent tender process was resorted to. In receipt and payment accounts, there was expenditure of Rs.39 crores under the head “Commonwealth Games Reserve Fund break-up”. Rs.300 crores had been transferred to Commonwealth Game Reserve” from income and expenditure account. There was need to verify whether the threshold limit below which tendering was not done, was breached. It was to be examined whether contracts were broken down into smaller contract. Monitoring mechanism in cases of small contracts was required to be verified. In the reply dated 6th December, 2010, it was stated that in the last hearing or earlier, no accounting issue was raised that was difficult to understand or comprehend. The C&AG report had been submitted. It was submitted that the accounts were maintained in a systematic manner and in just one hearing nobody could come to the conclusion that the accounts were complex. There was no complexity in the accounts. Question of transparency in tendering is not an accounting issue or problem;

++ in the AY 2009-10, in the counter affidavit, it is stated that the books of accounts were produced. Cash book etc were maintained on zone level and entries were subsequently made on monthly basis at the Head Office. This process involved complexity. Verification of loan and deposits and applicability of Section 269SS also involved complexity. The Director of Income Tax (Exemption) while granting approval for audit has stated that special audit had been directed for the AY 2008-09 and the reasons were not being repeated. He has further recorded that the direction for special audit was derived from the fact that the assessee had failed to give proper reply regarding declared income and whether any part of the property was used for benefit of person referred in Section 13(3). Special audit was necessary to examine irregularities committed in connection with the expenditure in relation to Commonwealth games. It is pointed out by the petitioner that in the show cause notice, there is no reference to Section 13(3) or any related person and misuse of assets or funds by a related person. Irregularities can be examined and verified by the AO and for this purpose, special audit is not required. Exemption and verification by themselves cannot and do not constitute complexity in accounts;

++ inconsistencies, vague views and non- application of mind, it has been argued, is apparent from other reasons recorded. To avoid prolixity we are not specifically dealing with the said contention on each reason/ground in detail. But it does appear that some of the reasons do not relate to complexities of accounts or are not relevant;

++ the AO had not obtained comments/ findings on the C&AG report but he had directed the special auditor to obtain/ask for the same, and then give his opinion. The aforesaid reason itself justifies quashing of the said order on the ground of non application of mind and failure to exercise jurisdiction keeping in view the parameters of Section 142(2A);

++ one more additional factor for the initial AYs may be noted that the petitioner DDA was granted registration as a charitable institution under Chapter 12AA of the Act in 2006 with retrospective effect w.e.f. 1st April, 2002. This fact was not in the knowledge of the respondent authorities when the first few orders for special audit were passed. Counsel for the Revenue has relied upon Section 13(3) of the Act and submitted that the registration u/s 12AA is not final and facts and accounts of each year have to be examined. There can be no doubt that facts and accounts of each year have to be examined but this is different from stating or alleging that Section 13(3) is applicable. Various contentions and issues have to be examined before a finding is recorded that Section 13(3) is attracted and applicable. It is the contention of the petitioner that misappropriation, if any, by the employees or third persons which causes loss to the petitioner cannot be a ground to invoke Section 13(3) as the petitioner is a distinct taxable entity. The petitioner suffers when there is misappropriation of the funds or misuse of assets/funds because of malafide or criminal intent of a third person. These are aspects and facts which are to be examined in the assessment proceedings. However, the contentions raised by the petitioner are relevant factors which have to be considered. It is different matter that the AO may or may not accept the said contention. The contention is as such not an accounting issue, unless it is held that the accounts indicate or prima facie show misuse or wrong use of funds by related persons and Section 13(3) is attracted. For details and exact figures in a given matter, special audit may be justified. The legal contention raised by the petitioner cannot be decided by a special auditor and has to be decided by the AO;

++ in these circumstances, we have no option but to quash the direction/orders for special audit in each of these years. The writ petitions are allowed and the orders u/s 142(2A) are quashed. This, however, does not mean that if the AO during the course of the assessment proceedings feels and requires special audit, he cannot record reasons and justify special audit. It will be open to the AO in the course of the assessment proceedings to record fresh reasons and direct special audit u/s 142(2A) of the Act. It will be equally open to the petitioner to contest the direction for special audit in accordance with law on the ground that the mandatory conditions stipulated in the said Section are not satisfied;

++ pursuant to interim orders passed in writ petitions the assessment proceedings for the AYs 2003-04 onwards have been stayed. Now, assessment proceedings have to be restarted but taking up of all the AYs together would unnecessarily entail difficulties and result in assessments being framed in haste and hurry. The petitioner and the AO will be put to considerable inconvenience. In these circumstances, the assessment proceedings for the AY 2003-04 shall be taken up for scrutiny and hearing first and will be completed before the assessment proceedings for other years are taken up for hearing. The interim stay orders granted earlier will continue for the AYs 2004- 05 onwards till the assessment proceedings for the AY 2003-04 are concluded.