Bombay H.C : Non-disclosure of related party transactions in audit report under section 12A(1)(b) would warrant special audit

High Court Of Bombay

Hiranandani Foundation VS. JDIT (Exemption) –II

Section : 142(2A), 12A

Mohit S. Shah, Cj And M.S. Sanklecha, J.

Writ Petition No. 1045 Of 2013

August  12, 2013

JUDGMENT

M. S. Sanklecha, J. – By this Petition under Article 226 of the Constitution of India, the petitioner seeks a writ of certiorari to quash and set aside the order dated 30 March 2013 passed by the Joint Director of Income Tax (Exemption) II under Section 142(2A) of the Income Tax Act, 1961 (in short “the Act”) directing the petitioner to subject its books of account to special audit for the Assessment Year 2010-11.

2. At the request of the Counsel for the parties, the petition is being finally disposed of at the stage of admission.

3. The Petitioner is a trust, registered under Section 12A of the said Act, having as its main object imparting of education and medical treatment for the public in general at large. For achieving its objects, the petitioner runs and manages various entities in the form of Hospitals, Nursing College and Schools affiliated to the ICSE/ISC/IB Bonds having a turnover of over Rs.100 Crores per annum.

4. On 30 September 2010, the petitioner has filed its return of income for the Assessment Year 2010-11, declaring its total taxable income at Rs. Nil while gross total income was Rs.9.65 crores and gross receipts were Rs.15.59 crores. The books of account of the petitioner was subjected to audit and audit report in form 10B under Section 12A(b) of the Act was also filed. The statutory auditors did not pass any adverse remarks with respect to the books of account maintained by the petitioner.

5. During the course of scrutiny assessment proceedings for Assessment Year 2010-11, various queries were raised by the Assessing Officer and the petitioner responded to the same. However, the Assessing Officer i.e. the Joint Director of Income Tax (Exemption) was not satisfied with the accounts of the petitioner and the audit thereof. Having regard to the nature and complexities in the accounts as the petitioner was running 10 entities having turnover of Rs. 103 Crores, the Assessing Officer issued a show cause notice on 13 February 2013 to the Petitioner-trust, calling upon it to show cause why a special audit under Section 142(2A) of the Act should not be conducted in respect of its books of account for the assessment year 2010-11 as there was non-disclosure of transactions with related parties, non-disclosure of accounting policies including disclosures of notes to accounts along with the balance sheet and profit and loss account and information regarding the incomes of the pharmacy shop running at both the hospitals and receipts therefrom was also shown as hospital revenue.

6. The petitioner replied to the show cause notice pointing out that the special audit was not called. It was pointed out that the Auditor had not reported related party transactions as those transactions were at arms length/ prevailing rates, so far as the objections with regard to non-filing of Accounting policy is concerned, it was submitted that details of sundry creditors and debtors were forwarded along with a note on accounts policy and the running of pharmacy at the hospital was not a business activity but incidental to its activity of running a hospital.

7. However, the Assessing Officer was not satisfied with the explanation given by the petitioner. Therefore, the Assessing Officer put up a proposal for special audit of the petitioner’s account under Section 142 (2A) of the said Act for the Assessment Year 2010-11 for the approval of the Commissioner of Income Tax.

8. On receipt of the proposal for special audit from the Assessing Officer, the Commissioner of Income Tax granted the petitioner a personal hearing. At the hearing, the petitioner contended that Special Audit is not warranted on any of the three grounds on which it is being sought to be done as the condition precedent for a special audit is complexity of accounts, which according to the petitioner, is not so in this case. It was submitted that merely because the entries are in large number and turnover is huge, ipso facto would not warrant a Special Audit. However, by communication dated 25 March 2013, the Commissioner of Income Tax did not accept the objections of the petitioner and approved the proposal of the Assessing Officer, inter alia, recording his satisfaction that the special audit under Section 142(2A) of the said Act is necessary in the present case.

9. Consequent to the above communication dated 25 March 2013 of the Commissioner of Income Tax, the Assessing Officer by order dated 30 March 2013 directed the petitioner to have its accounts audited by M/s. Chokshi & Chokshi, Chartered Accountants as the special auditor under Section 142(2A) of the said Act for the Assessment Year 2010-11. 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.

By the present Petition, the challenge is to the order dated 30 March 2013 of the Assessing Officer appointing a Special Auditor under Section 142(2A) of the said Act.

10. Mr. Sreedharan, learned Counsel appearing for the Petitioner in support of the Petition submits as under:—

(a) The Assessing Officer could not have invoked provisions of Section 142(2A) of the said Act as the condition precedent to invoke the same is complexity of the accounts. According to him, the Assessing Officer has not examined the petitioner’s books of account and, therefore, could not conclude that the accounts of the Petitioner are complex warranting a Special Audit. Consequently, primary requirement for invoking the jurisdiction under Section 142 (2A) of the Act is not fulfilled.

(b) In any event, the impugned order dated 30 March 2013, directing the special audit in the Assessment Year 2010-11 does not give any finding with regard to the complexity of the accounts and therefore, the impugned order is unsustainable. It was submitted that at no point of time, did the Assessing Officer examine the accounts of the Petitioner and made an attempt to understand the same.

(c) The doubts about the correctness of the accounts cannot be equated with complexity of the accounts. In case, the Assessing Officer found the audit carried out by the Petitioner’s Auditor is not acceptable, he was free to ignore the accounts and pass a best judgment assessment under Section 144 of the Act.

(d) It is not open to order special audit under Section 142(2A) of the said Act merely because auditor’s report casts suspicion on whether or not, the audit was properly carried out as that is not one of the condition which would warrant appointment of a Special Auditor; and

(e) The appointment of a Special Auditor at the fag end of the assessment proceedings under Section 142(2A) of the said Act caused serious prejudice to the Petitioner as it would entail the petitioner undergoing a special audit when in the facts of the case, the same is not warranted.

11. As against the above, Mr. Malhotra, in support of the impugned order submits as under:—

(a) The books of account had been verified by the Assessing Officer and it was during the course of the examination of the accounts that special audit is called for taking into account the nature and complexity of the accounts. In support, reliance was placed upon the Affidavit in reply dated 19 June 2013 filed by the Assessing Officer;

(b) The Assessing Officer 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 Assessing Officer concluded that there could be other transactions which are not reported by the petitioner as well as the auditor. These facts would warrant examination of the accounts by the Special Auditor;

(c) The petitioner is running 10 entities and has a turn over of Rs.103 Crores which consequently involves a large number of entries and it is impossible for the Assessing Officer to carry out the task of examining the accounts. This itself would require that the same be examined by a Special Auditor in terms of Section 142(2A) of the said Act; and

(d) No prejudice would be caused to the petitioner and it would certainly assists the revenue to determine correctly the income earned by the assessee and its liability to tax, if any. Particularly so, as the petitioner is claiming exemption under Section 11 of the Act on the ground that any excess of income over expenditure is utilized to fulfil the charitable objects of the Trust;

In the above circumstances, it was submitted that this Court should not entertain the Writ Petition.

12. Before considering the submissions, it may be convenient to reproduce the relevant provisions as applicable to the case:—

‘(a) The Special Audit is directed in accordance with Sub-section (2A) of Section 142 of the Act at the relevant time read as under:—

“If, at any stage of the proceedings before him, the (Assessing) Officer, having regard to the nature and complexity of the accounts of the assessee and the interests of the revenue, is of the opinion that 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 accountant, as defined in the Explanation below sub-section (2) of section 288, 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.”

(b) The audit report as furnished by the Petitioner in respect of its accounts to the revenue in accordance with the provisions of Section 12-A (1)(b) of the said Act which reads as under:—

“(b) Where the total income of the trust or institution as computed under this Act without giving effect to the provisions of section 11 and section 12 exceeds the maximum amount which is not chargeable to income-tax in any previous year, the accounts of the trust or institution for that year have been audited by an accountant as defined in the Explanation below sub-section (2) of section 288 and the person in receipt of the income furnishes along with the return of income for the relevant assessment year the report of such audit in the prescribed form duly signed and verified by such accountant and setting forth such particulars as may be prescribed.”‘

13. We have considered the rival submissions. The Petitioner’s principal submission before us is that a Special Audit could not have been directed under Section 142(2A) of the Act as the complexity of the accounts can only be determined if and when Assessing Officer examines the books of account. It is the petitioner’s case before us that the Assessing Officer has not examined/verified the books of account. 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) of the Act not being satisfied, the Special Audit could not be directed. We find that the Assessing Officer in his reply affidavit dated 19 June 2013 has in terms denied the assertion of the Petitioner that the books of account were not examined and/or verified by him. In the affidavit, he states “Hence it is factually not correct that books of account were not verified.” Further in the affidavit it is stated that while verifying books of account the Assessing Officer came to the conclusion that the audit report and the books of account submitted by assessee were faulty and unreliable as auditor had not reported related party transactions. Besides, we find that at no stage prior to the filing of this petition, has the petitioner taken up the plea that the Assessing Officer had not examined the books of account of the petitioner. In fact, even at the hearing before the Commissioner of Income Tax for purposes of considering grant to approval to carry out Special Audit, the petitioner’s only submission as recorded in the approval letter dated 25 March 2013 was only that the accounts are not complex. There is not even a suggestion about the Assessing Officer 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 Assessing Officer. 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.

14. The entire object of having the accounts audited by an independent Chartered Accountant 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 audit report of the Chartered Accountant is in form 10B as prescribed under Rule 17-B of the Income Tax Rules 1962. The audit report furnished by the auditor is taken into account while making an enquiry for the purpose of assessment under Section 143 of the said Act. 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 12-A(1)(b) of the Act. 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 12-A(1)(b) of the Act. 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) of the said Act, viz: nature and complexity of accounts of the assessee have been satisfied. The aforesaid prima facie satisfaction has been recorded by the Assessing Officer while issuing the notice dated13 February 2013 to the Petitioner and also final satisfaction with regard to the same in the approval dated 25 March 2013 granted by the Commissioner of Income Tax.

15. In view of the fact that the Special Audit under Section 142(2A) of the Act, in the present facts is warranted, no prejudice is caused to the petitioner. The absence of a Special Audit in the present facts, could have brought the exemption enjoyed under Section 11 of the Act by petitioner in jeopardy. This is because the Audit as required under Section 12A(1)(b) of the Act 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.

16. During the course of the hearing, the petitioner placed reliance upon the following decisions:—

(a) Sahara India (Firm) v. CIT [2008] 300 ITR 403/169 Taxman 328 (SC), the issue for consideration before the court was whether any hearing is to be given before passing an order for special audit under Section 142(2A) of the said Act is passed? In that context, the Court had made observations that recourse to the provisions of the special audit cannot be made only to shift his responsibility of scrutinizing the accounts to another auditor. The Court held that the exercise of powers under Section 142(2A) should not be arbitrary and/or unjust. In the circumstances the Court read the principle of natural justice i.e. personal hearing into the provisions. In the above context it also held that the requirement of the previous approval by the Chief Commissioner should also not be turned into an empty ritual. It would, therefore, be noticed that the factual matrix in the above case was different and whether or not the special audit is required would depend upon the facts of each case. In the facts of this case we find that special audit is warranted and by doing so the Assessing Officer is not abdicating his responsibility. Otherwise the provision for special audit would never be invoked.

(b) Delhi Development Authority v. Union of India [2013] 350 ITR 432/214 Taxman 130/[2012] 25 taxmann.com 234 (Delhi) wherein it has been recorded that before the special audit can be directed, the condition precedent is complexity of accounts and safeguarding the interest of revenue. Therefore, it was submitted that before special audit can be ordered, the Assessing Officer must be satisfied that the accounts are complicated, after having made a genuine and honest attempt to understand the accounts. In the present case, the Assessing Officer has found that the accounts of the petitioner are complex. This view has been approved by the Commissioner of Income Tax in his approval dated 25 March 2013. Besides the importance of Audit in case of a trust enjoying exemption under Section 11 of the Act cannot be minimized, keeping in view Section 12 (1)(b) of the Act. Therefore, in this case, the exercise of powers under Section 142 (2A) of the said Act cannot be said to be arbitrary and/or irrational.

(c) Nickunj Eximp Enterprises (P.) Ltd. v. Asstt. CIT [2012] 346 ITR 6/27 taxmann.com 117 (Bom.), wherein the matter was remanded as the objection of the assessee were not considered while passing an order for special audit under Section 142(2A) of the said Act. Therefore, the above case has no application to the present facts, and

(d) Bata India Ltd. v. CIT [2002] 257 ITR 622/125 Taxman 808 (Cal.) wherein the Court observed that the complexity of the accounts cannot be equated with the correctness thereof. Therefore, it was submitted by the petitioner that in case the Assessing Officer is of the view that the accounts of the petitioner are not correct, then the Assessing Officer could have disregarded the Accounts and completed the assessment on the basis of best judgment under Section 144 of the Act rather than directing to carry out of special audit. This may not be wholly desirable exercise in the present facts, where the petitioner is a charitable trust and if the course suggested by the learned counsel is adopted, it is likely that the exemption under Sections 11 and 12 of the Act may cease to be available to the petitioner. By virtue of directing a Special Audit of the petitioner’s books of account, the Assessing Officer is being far from arbitrary. This would only ensure that the benefit of exemption under Sections 11 and 12 of the Act is not denied if otherwise available to the petitioner.
Therefore, none of the above cases is applicable to the fact situation arising in the petitioner’s case.

17. As against the above, Counsel for the Revenue places reliance upon Jt. CIT v. I.T.C. Ltd. [1999] 106 Taxman 373/239 ITR 921 (Cal.) wherein it was held that it is not possible for an Assessing Officer 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 Assessing Officer 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 (2A) of the Act cannot be found fault with.

18. The learned Counsel for the petitioner drew our attention to the Finance Act, 2013, wherein the words “the nature and complexity of accounts under Section 142(2A) of the said Act” is now substituted with the words “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”. This amendment has come into force w.e.f. 1 June 2013. The aforesaid provision permits to order a special audit, inter alia, looking at the volume of the accounts or where there is a doubt about the correctness of the accounts. The Petitioner relied upon the above provisions to contend that prior to 1 June 2013, the volume of accounts and/or doubts about correctness of accounts would not warrant a special audit. As against the above, the contention of the revenue is that the amendment is applicable as it is clarificatory. In any event, we need not examine the same as we are of the view that even under the unamended provision of Section 142 (2A) of the said Act, the Assessing Officer has 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 Assessing Officer 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) of the Act is necessary. This is not a case involving some minor non-compliance on the part of the assessee/auditor which can be overlooked.

19. In the above circumstances, we see no reason to interfere with the order of the Assessing Officer, ordering a special audit.

20. Accordingly, Writ Petition is dismissed with no order as to costs.

[Citation : 359 ITR 29]