Whether special audit is warranted u/s 12A(b) when assessee has failed to report related party transactions in audit report and assessee is involved in relatively large number of transactions - YES: HC

THE issues before the Bench are - Whether a special audit is warranted under section 12A(b) when the assessee had failed to report its related party transactions in its audit report and the assessee is involved in relatively large number of transactions and Whether prima facie this would satisfy the condition of complexity of the accounts as required by section 12A(b). And the verdict goes against the assessee.

Facts of the case

The assessee is a trust having as its main object imparting of education and medical treatment to the general public at large. For achieving its objects, the assessee runs and manages various entities in the form of Hospitals, Nursing College and schools. The assessee had filed its return of income, declaring its total taxable income at Rs. Nil .The books of account of the assessee were subjected to audit and audit report in form 10B under section 12A(b) were also filed. The statutory auditors did not pass any adverse remarks with respect to the books of account maintained by the assessee.

The AO put up a proposal for special audit of the petitioner's account under Section 142 (2A) for the approval of the CIT. The CIT conformed the AO's proposal.

Subsequently, the AO appointed M/s. Chokshi & Chokshi, Chartered Accountants as the special auditor under section 142(2A). The terms of reference for Special Audit, inter alia, included whether the accounts are maintained as per general accounting standards along with supporting evidences as well as to report transactions undertaken by trust with related persons besides determining the surplus receipts in view of running a pharmacy in the two hospitals.

On appeal, the assessee submitted that a Special Audit could not have been directed under section 142(2A) as the complexity of the accounts can only be determined if and when AO examines the books of accounts and the AO had not examined/verified the books of accounts. Therefore, no occasion would arise to take a view with regard to the complexity of the accounts so as to direct Special Audit. Thus, the condition precedent for application of section 142(2A) not being satisfied, the Special Audit could not be directed.

The Revenue submitted that the books of account had been verified by the AO and it was during the course of the examination of the accounts that special audit was called for taking into account the nature and complexity of the accounts. The AO had found that the auditor had not discharged its obligations of reporting on related party transactions in the audit report on the ground that according to the auditor, the related parties transactions were at arm's length. In view of the above, the AO concluded that there could be other transactions which are not reported by the petitioner as well as the auditor. These facts warrant the examination of the accounts by the Special Auditor.

After having heard the parties, the High Court held that,

++ we find that at no stage prior to the filing of this petition, has the assessee taken up the plea that the AO had not examined the books of accounts of the petitioner. In fact, even at the hearing before the CIT for purposes of considering grant of approval to carry out Special Audit, the assessee's only submission was that the accounts are not complex. There is not even a suggestion about the AO concluding about the complexity of the accounts without having verified/examined the same. Therefore, in view of the above, there is no reason to disbelieve the statement made on oath by the AO. Thus, the principal challenge of the petitioner with regard to direction of Special Audit is not sustainable. The Accounts have been verified and taking into account the complexity of the Accounts, the Special Audit has been directed;

++ the entire object of having the accounts audited by an independent Chartered Account in respect of the trust is to ensure that the income of the trust has not been diverted for purposes other then the objects of the trust. The petitioner is a charitable trust which undertakes charitable objects and the income is exempted from tax, inter alia, on the basis of audit and audit report submitted under Section 12A(1)(b);

++ the auditor in terms of the prescribed form has to report related parties transactions which have taken place. It is not disputed that the related party transactions were not referred to in the form 10B furnished in the audit report. In that view of the matter, it is natural for doubt to arise about the correctness of the audit done of the accounts by an independent auditor and in particular, the satisfaction of Section 12A (1) (b). Therefore, the nature of accounts being that of a trust, its genuineness is dependent upon a proper audit. In the circumstances, we find that the nature of accounts were such that the directions for Special Audit in these facts was warranted. We, therefore, find that the condition precedent for exercising powers under Section 142(2A), viz: nature and complexity of accounts of the assessee have been satisfied;

++ in view of the fact that the Special Audit under Section142(2A), in the present facts is warranted, no prejudice is caused to the assessee. The absence of a Special Audit in the present facts, could have brought the exemption enjoyed under Section 11 by assessee in jeopardy. This is because the Audit as required under Section 12A (1)(b) is not found satisfactory then it is the special audit which would determine the correct position. Therefore, we find that no prejudice is caused to the petitioner by subjecting its accounts to special audit;

++ the AO is to look into the accounts and to verify whether each of the entries in the accounts reflects genuine transactions if the transactions are large in number. Therefore, in such a case, looking at large number of the transactions, the AO can ask for the approval for the appointment of special auditor. In the present facts also, the transactions are large in number as it cover 10 entities and having turnover of Rs.100 Crores. Thus, the appointment of Special Auditor in terms of Section 142;

++ we are of the view that even under the unamended provision of Section 142 (2A), the AO had properly exercised its jurisdiction to order a special audit after obtaining the approval of the Chief Commissioner for the same. The Chief Commissioner has recorded that the AO had sufficient material to record his satisfaction that having regard to the nature and complexity of accounts of the assessee and interests of the revenue, a special audit u/s 142 (2A) is necessary. This is not a case involving some minor noncompliance on the part of the assessee/auditor which can be overlooked.