By TIOL News Service

NEW DELHI, APR 03, 2014: THE issue before the Bench is - Whether when assessee had huge related party transactions and also failed to furnish bifurcated expenses incurred on SEZ and non-SEZ projects, resorting to Special Audit provisions cannot be faulted with in such a case. And the answer favours the Revenue.

Facts of the case

The assessee is a real estate developer engaged in creation, execution and sale of residential and commercial projects. It also earns income from Special Economic Zone (SEZ) on which it had claimed deduction u/s 80-IAB. It had filed its return of income on 15th October, 2010 declaring income of Rs.474,34,24,620/-. As per the assessee, for computing the said income, they had followed Percentage of Completion Method (POCM). It had also claimed deduction of Rs.178.63 crores u/s 80-IAB in respect of profits derived from projects in SEZ areas. The assessee had granted loans and advances to its subsidiaries and shown interest income @ 6.5% per annum in respect of said loans and advances as received from its subsidiaries. Statutory notice u/s 143(2) with a detailed questionnaire was issued to the assessee fixing the case for scrutiny assessment. On the said date, part details were filed but in the meanwhile another questionnaire was issued. The assessee claimed that it had complied with the details, information and clarifications requisitioned. However, show cause notice u/s 142(2A) was issued for referring the accounts for special audit and the assessee was asked to respond. The assessee objected against it on the ground that it was unwarranted and contrary to law. The AO had directed the assessee to get their accounts for the FY 2009-10 from a Chartered Accountant, who was nominated as per the provisions relating to conduct of special audit u/s 142(2A). The Special Auditor was required to submit report in Form 16 as per Rule 14A of the Income Tax Rules within sixty days from the date of receipt of the directions and the assessee was asked to extend full and complete cooperation for completion of the special audit within the stipulated time. The assessee had challenged the said direction of special audit stating and pleading that the mandate was contrary to the statutory pre-conditions stipulated in Section 142(2A).

During assessment, AO had made observations with regard to DLF Phase-V project, Jallandhar Project, City Court Sikandar Pur project and Courtyard project. A reference was also made relating to Cross Point Project and Kolkatta Project and observations on various entries. Thereafter method of accounting on issue of stock to the contractors stands elucidated and observed that on the basis of the entries, there was difficulty in understanding the accounts. There were multiple transactions in relation to sale of plots and development cost with sister concerns. Transactions relating to land purchases were routed through various related group concerns which were very intricate and complex. Project at Indore, Kakanad and Begur were referred to. AO noted that it appeared that different revenue recognition methods had been adopted. Lastly, reference was made to the special audit reports for the earlier years and detailed working of each project undertaken in the earlier years had resulted in additions. Books of accounts and related bills and vouchers were not only complex but voluminous as there were large numbers of ongoing projects.

In response, assessee had submitted that consistently it was following the policy of accounting construction costs only when bills were approved and verified and thereupon final liability became crystalised or due for payment. Entry with regard to purchases of stocks was made not upon receipt of material but after the inspection and when the material was accepted. On the question of Internal Development Charges (IDC), it was stated that saleable area at PhaseV Gurgaon stood increased and this was the cause for confusion and errors made in the special audit report for the last year. Several factual assertions made by AO were disputed, on the questions relating to submissions of reply or part replies, sale of construction material, bills, vouchers in respect of Cross Point and Kolkatta Projects and material issued note and material receipt note. The assessee claimed that entries in the books of account including stock register, were explained to AO. With regard to the observations on land purchases through various related concerns, it was stated that this was not complex and the observation made by AO was vague, ambiguous and confused and was driven by focused intent to subject the accounts for special audit. The assessee had themselves stated that substantial additions had been made on POCM issue earlier. It may have succeeded before CIT(A) in the AY 2007-08 and 2008-09, but further appeals were pending. With regard to AY 2006-07, addition of more than Rs.120 crores stands sustained in the first appeal. The assessee had made inquisitive observations with regard to AY 2009-10 as it was indicated that the assessee had made addition of Rs. 120.62 crores on the lines of the Special Auditor's working for the AY 2008-09.

Held that,

++ while examining the question of complexity in accounts, we have to apply the test of "reasonable man" by replacing the word and qualities of a reasonable man, with the word and qualities of a reasonably competent Assessing Officer. The question of complexity of accounts has to be judged applying the yardstick or test; whether the accounts would be complex and difficult to understand to a normal assessing officer who has basic understanding of accounts etc., without the aid, assistance and help of a special auditor. Thus due regard has to be given to nature and character of transactions, method of accounting, whether actuarial were adopted for making entries, basis and effect thereof, etc., though mere volume of entries might not be a justification by themself as volume and complexity are somewhat different. Accounts should be intricate and difficult to understand. Every scrutiny assessment entails investigation and verification of the books of accounts, genuineness of the transactions or entries reflected in the books, computation of income etc. It is an exercise which demands expertise and a degree of skill to understand the accounts and decipher whether true and full income has been disclosed; whether there has been jugglery in the accounts or camouflage has been adopted. No undesirable assumptions should be made and a return filed is presumed to be correct, but a deep and in depth scrutiny depending upon the facts may be warranted. Section 142(2A) is an enabling provision to help and assist the Assessing Officer to complete scrutiny assessment with the help of assistance of an accountant;

++ what is apparent that the matter of computation of income by applying POCM has been subject matter of debate and opposite positions have been taken and adopted by the Revenue and the petitioner. As noticed above, the petitioner, in respect of Phase V, Gurgaon project has stated that during the assessment year 2009-10, the saleable area had increased due to increased permissible height in the building from 25,34,775 sq. ft. to 37,65,972 in respect of one building and 12,49,200 sq. ft. to 19,25,500 sq. ft. in respect of second building. This necessarily would involve reworking of the entire project costs including reduced budget costs of all components etc. like EDC, IDC, construction cost, etc. This is also discernible from the reply filed by the petitioner in which they have disputed the calculations made by the special auditors in the last assessment year. Referring to the reply of the petitioner, AO has observed that during the assessment proceedings on number of instances or entries, queries were raised and 4 or 5 persons were required to clarify the facts. The ledger account did not contain narration therefore scrutiny of the entries had become cumbersome and difficult;

++ on the question of loans and advances to the subsidiaries, the petitioner had submitted that the loans and advances to the subsidiaries should not and would not affect interest payments in the hands of the holding company. We are not primarily concerned with the legal submissions in the present case because the legal principle applicable depends upon facts which have to be verified and ascertained. The petitioner in response to the show cause notice had stated that the petitioner had own funds to the extent of Rs.12,830 crores and had borrowed funds to the extent of Rs.12,638 crores during the year in question. The petitioner has granted loans and advances to the extent of Rs.10,14,344.97 lacs to the subsidiary companies @ 6.5% per annum which as per the petitioner was the borrowing costs. It was claimed that in view of the aforesaid position, the petitioner was not evading tax as the transactions were tax and revenue neutral. The Assessing Officer has observed that it has to be shown and established that the charging of interest @ 6.5% was a revenue neutral exercise. This could be only ascertained after all entries were examined by the special auditor. On the question of commercial expediency, it has been observed in the impugned order that it would come into play when the actual picture was ascertained i.e. extending of loan to the subsidiary and charging of interest was thoroughly examined;

++ with regard to the profit from SEZ and non-SEZ projects it was noted that profit of Rs.1,78,63.73 lacs has been declared on SEZ income/turnover of Rs.2,38,31.36 lacs and profit of Rs.6,57,01.92 lacs has been declared on non-SEZ income/turnover of Rs.24,19,20.81 lacs. The order records that the petitioner was required to submit comparative detail with regard to expenditure in SEZ and non-SEZ income projects but this was not filed. The affairs of the company, therefore, were not transparent and required audit. SEZ and non-SEZ income figures mentioned by the Assessing Officer were contested in the reply. Discrepancies were alleged. Reference was made to the earlier reports of the statutory auditor and the fact that in the special audit reports no adverse inference was drawn in respect of deduction under Section 80IAB. Further provisions of Section 142(2A) were not invoked for the AY 2009-10 in regard to SEZ accounts. We do not find any merit in the contention raised by the petitioner that related party transactions or reasonableness of interest paid to the petitioner on loans and advances by its subsidiary was an issue which was never raised in the show cause notice and therefore, there was violation of principles of natural justice. This question was specifically raised in the show cause notice and answer or reply was called for. Even if the said aspect was not independently examined by raising a written question in the assessment proceedings, it is apparent that the Assessing Officer had transactions between the petitioner and related companies. The petitioner had stated that till 25th February, 2013, ten hearings were held before the Assessing Officer and 78 queries were raised through questionnaire/order sheet/verbally. The claim of the petitioner was that he has complied with all the queries. Thus it is accepted and admitted position that detailed queries in writing and orally were raised. This shows due application of mind and focus on the issues and aspects that arose for consideration. The said facts are indicative of the assessing officer's conduct in trying to understand the accounts and whether true and correct income had been disclosed. The aforesaid submissions of the petitioner, therefore, do not appeal to us;

++ in view of the aforesaid discussion, we are satisfied that in the present case the Assessing Officer had applied his mind to various aspects like nature of accounts, method of maintaining accounts, entries recorded etc. and reached the conclusion that the accounts were complex and it was in the interest of the Revenue that special audit u/s 142 (2A), should be directed. No doubt in the past also special audit was directed but the Assessing Officer has not directed special audit in the present assessment year without examining the accounts for the year in question, the entries made, peculiarity involved etc. Special audit has not been directed for getting over the limitation or in routine. Powers u/s 142(2A) have to be exercised in terms of the legislative provisions. The object and purpose behind the legislation is to facilitate investigation and proper determination of the tax liability. The importance and relevancy of the legislation cannot be underestimated and it is a power available with the Assessing Officer to aid and assist him. Accounts should be accurate and provide real time record of the financial transactions of the assessee. Preparation of accounts is the work of the accountant on the payrolls or employed by the assessee. In order to ensure reliability and accuracy, enterprises resort to internal audit and an external audit which can be a statutory audit. Internal audits are normally conducted in house generally by acquainted or qualified accountants. Statutory audit is compulsory under the Companies Act, 1956. Enron and other cases abroad and Satyam's case in India have highlighted the need and necessity to have controls and system of checks, perhaps even beyond scope of traditional audit. Financial statements and accounts are being increasingly exiguously examined to rule out possibility of wrong doings, cover up or evasion of taxes. Financial statements and accounts are coming under increasing scrutiny and investigation. A Chartered Accountant is a financial investigator and prober, is required to be curious, tenacious and well conversant to identify and unearth frauds, misreporting and wrong claims in the accounts;

++ the aforesaid observations should not be construed as a general expression or opinion, that every account or statement of income must be viewed with suspicion, distrust and scepticism. The past instances are mere warnings, for closer and more indepth scrutiny. It is also a fact that the business transactions have become more complicated and accounting entries more complex than ever before. This may be one of the causes why possibly the frauds could not be detected in some cases. Indeed such cases have made the audit work more comprehensive, intrusive and investigative. Ethical managements may at times regard such enquiries as an unwarranted intrusion or a hounding approach. Section 142(2A) does not permit fishing or roving inquiry approach or a witch hunt but is a regulated provision which accepts the need and necessity of the Assessing Officer to take help of an expert accountant i.e. a Chartered Accountant, a person who is academically qualified and has practical experience to understand accounts and unearth tax evasion or furnishing of inaccurate particulars etc. The provision balances the right of the Revenue with the inconvenience which the assessee may face. Assessing Officers are not Chartered Accountants and when required and permissible, therefore, can take help and assistance from the qualified specialists to complete the assessment and determine the taxable income of an assessee. In view of the aforesaid we do not find any merit in the present Writ Petition. Stay order is vacated and the assessment proceedings will continue as per law. There will be no order as to costs.

(See 2014-TIOL-413-HC-DEL-IT)