JUNE 20, 2016

By S Sivakumar, LL.B., FCA, FCS, ACSI, MBA, Advocate

THE Delhi High Court has done it yet again. In Mega Cabs Private Ltd v Union of India and Ors - 2016-TIOL-1061-HC-DEL-ST, the High Court has struck down Rule 5A(2) of the Service Tax Rules, 1994 on the basis that Section 94(2)(k) of the Finance Act, 1994, introduced with effect from August 6, 2014 does not authorize audit by either the Service Tax Department or the Comptroller and Auditor General of India ('CAG'). The Government would seem to have eggs all over its face, especially seen in the context of the various steps taken by it to perpetuate the departmental audit, in recent months.

As is well known, the Delhi High Court had struck down the then prevailing Rule 5A(2) on August 4, 2014 in Travelite (India) v UOI and Ors - 2014-TIOL-1304-HC-DEL-ST, prompting the Central Government to obtain an ex-parte stay from the Supreme Court - 2014-TIOL-101-SC-ST-LB. In the Travelite case, the Petitioner had challenged the validity of Rule 5A(2) of the Service Tax Rules, 1994, brought into force by Notification no. 45/2007-ST dated 28.12.2007 as well as the instruction of the CBEC. No. 137/26/2007-CX.4 dated 1.1.2008.

While striking down Rule 5A(2), the Court had then held as under, in the Travelite case:

14. It is clear that the CBEC, under the power vested in it by Section 37B of the Central Excise Act, 1944 read with Section 83 of the Finance Act, 1994 issues these circulars as instructions with respect to the levy of service tax. Consequently, such circulars cannot possibly override the statute, or be contrary to the statute. The impugned circular seeks to put in place a mechanism for audit and scrutiny of documents with the objective of safeguarding the interests of the Revenue, in furtherance of the amendments made in the Service Tax Rules, as indicated in paragraph 7 of the circular. Since the parent statute in this regard, the Finance Act, 1994 itself does not authorise a general audit of the type envisioned by the impugned Rule 5A(2), and furthermore only stipulates that a special audit can be undertaken if the circumstances outlined in Section 72A are fulfilled, this Court finds that the impugned CBEC circular is not only an attempt to widen the scope of the law impermissibly but also is patently contrary to the statute. The impugned circular, to the extent it provides clarifications on a Rule5A(2) audit, is hereby quashed; consequently, the impugned letter is quashed and set aside.

The Parliament had inserted clause(k) to Sub-Section (2) of Section 94, with effect from 6-8-2014, which reads as under:

[(k) imposition, on persons liable to pay service tax, for the proper levy and collection of the tax, of duty of furnishing information, keeping records and the manner in which such records shall be verified;]

The Government further moved to substitute the then prevailing version with a new version of Rule 5A(2) with effect from December 5, 2014, which reads as under:

[(2) Every assessee, shall, on demand make available to the officer empowered under sub-rule (1) or the audit party deputed by the Commissioner or the Comptroller and Auditor General of India, or a cost accountant or chartered accountant nominated under section 72A of the Finance Act, 1994,-

(i) the records maintained or prepared by him in terms of sub-rule (2) of rule 5;

(ii) the cost audit reports, if any, under section 148 of the Companies Act, 2013 (18 of 2013); and

(iii) the income-tax audit report, if any, under section 44AB of the Income-tax Act, 1961 (43 of 1961),

for the scrutiny of the officer or the audit party, or the cost accountant or chartered accountant, within the time limit specified by the said officer or the audit party or the cost accountant or chartered accountant, as the case may be.]

It is this substituted version of Rule 5A(2) that has been struck down by the Delhi High Court, and quite rightfully so. In Para 35, while dealing with the powers of the CAG to conduct audit, the High Court has held as under:

35. Rule 5A(2) envisages that even the CAG can require production of documents from an individual service tax Assessee 'on demand'. This appears to have no rational basis. As rightly pointed out by Mr Mittal, the powers and functions of CAG flow from Articles 148 and 149 of the Constitution of India read with the Comptroller and Auditor-General's (Duties, Powers and Conditions of Service) Act, 1971. This Court in K. Satyanarayanan v. Union of India (supra) explained that the essential function of the CAG is to audit the accounts of public sector undertakings. Although in  Association of Unified Tele Services Providers v. Union of India -  2014-TIOL-49-SC-MISC  the Supreme Court has, in the context of the functioning of telecom companies accepted the plea that their accounts can be subjected to scrutiny by the CAG, to expect the CAG to undertake an audit of the records of every service tax Assessee would indeed be extraordinary. Importantly, as far as the telecom service providers are concerned they are subjected to conditions of their licence which envisage their making available all their accounts for scrutiny. As far as the service tax Assessees are concerned one would still have to turn to the provisions of the FA to examine whether this kind of an access to the books of accounts etc. of an Assessee can be given to the CAG or just about any officer of the Department. With there being no such authorisation under the FA, the answer has to be in the negative.

While dealing with the powers of the Department to conduct audit, the High Court has held as under:

38. The main plank of the defence of the Respondents in the present case to justify the amendment to Rule 5A(2) is Section 94(2)(k) of the FA introduced by the Finance Act of 2014 with effect from 6th August 2014. Considerable reliance is placed on the expression -keeping records and the manner in which such records shall be verified" occurring in the above provision. Although in the circular issued consequent upon the amendment by the CBEC on 10th December 2014 it is asserted by the Department that the expression 'verified' is of wide import and would include within its scope audit by the Department officers, the Court is unable to agree. The expression 'verified' has to be interpreted in the context of what is permissible under the FA itself. The verification of the records can take place by the officers of the Department provided such officers are authorised to undertake an assessment of a return or of adjudication for the purposes of Section 73 of the FA. It is not any and every officer of the Department who could be entrusted with the power to demand production of records of an Assessee. Therefore, the Court does not agree with the submission that the expression 'verify' is wide enough to permit the audit of the accounts of the Assessee by any officer of the Service Tax Department.

39. There is a distinction between auditing the accounts of an Assessee and verifying the records of an Assessee. Audit is a special function which has to be carried out by duly qualified persons like a Cost Accountant or a CA. It cannot possibly be undertaken by any officer of the Service Tax Department.

As a Chartered accountant myself, I found it very obnoxious and insulting for the Department to take the view that a Departmental officer at the level of a Superintendent can undertake an 'audit' which can only be conducted by a qualified professional like a CA. In T D Venkata Rao v Union of India (1999) 237 ITR 325 (SC), the Apex Court had upheld that, in the context of Section 44AB of the Income tax Act,1961 dealing with tax audit, the superiority of CAs by noting that chartered accountants, by reason of their training have special aptitude in the matter of audits and no other person is eligible to conduct audit. The Department also is taking the view that, while the Departmental officers are authorized to conduct a general audit, Section 72A authorizes a special audit by CAs. The Delhi High Court has taken the sail out of this agreement, for good.

It would seem, in hindsight, that the Government would have been better off by not going in for a substitution of Rule 5A(2) and justifying the audit under this Rule by invoking the powers granted to it under Section 94(2)(k). Per se…it would seem to have been improbable that the Government introduced clause (k) of Section 94(2) with effect from 6-8-2014 with a view to cover departmental and CAG audit, when the Rule 5A(2) as it then existed had been struck down by the Delhi High Court in the Travelite case barely two days ago, i.e on 4-8-2014. The attempt of the Government to justify departmental and CAG audit by inserting a new Rule 5A(2) and then to legalize under Section 94(2)(k), valiant though, has come a cropper.

The Government, twice bitten by the Delhi High Court, is bound to follow its usual and expected move, of running to the Supreme Court.

Be that as it may… handling an audit by the Departmental officers could turn out to a nightmare for an average service tax assessee. Apart from the need to work for weeks and months on the seemingly irrelevant information that the Internal Audit Team would ask to be kept ready, the assessee is also required, in most cases, to undertake the arduous task of undertaking a line item wise reconciliation between the Form 26AS data available with the Income tax Department and the service tax records. The lack of updated knowledge is obvious in the IAP teams. The strong-arm tactics used by these teams is another cause for the wide spread resentment emanating from the taxpayers.

The Government, it would seem, has learnt its lessons, vis-à-vis the departmental audit, if the provisions of the model GST law released last week, is any indication. We find a detailed definition of audit under Section 2(14) of the proposed model GST law, which reads as under:

14) “audit” means detailed examination of records, returns and other documents maintained or furnished by the taxable person under this Act or rules made thereunderor under any other law for the time being in force to verify, inter alia, the correctness of turnover declared, taxes paid, refund claimed and input tax credit availed, and to assess his compliance with the provisions of this Act or rules made thereunder;

We also find a dedicated section 41 to deal with departmental audit, which reads as under:

49. Audit by tax authorities

(1) The [Commissioner of CGST/Commissioner of SGST] or any officer authorised by him, by way of a general or a specific order, may undertake audit of the business transactions of any taxable person for such period, at such frequency and in such manner as may be prescribed.

(2) The tax authorities referred to in sub-section (1) may conduct audit at the place of business of the taxable person and/or in their office.

(3) The taxable person shall be informed, by way of a notice, sufficiently in advance, not less than fifteen working days, prior to the conduct of audit in the manner prescribed.

(4) The audit under sub-section (1) shall be carried out in a transparent manner and completed within a period of three months from the date of commencement of audit: Provided that where the [Commissioner] is satisfied that audit in respect of such taxable person cannot be completed within three months from the date of commencement of audit, he may, for the reasons to be recorded in writing, extend the period by a further period not exceeding six months.

Explanation.- For the purposes of this sub-section, 'commencement of audit' shall mean the date on which the records and other documents, called for by the tax authorities, are made available by the taxable person or the actual institution of audit at the place of business, whichever is later.

(5) During the course of audit, the authorised officer may require the taxable person, (i) to afford him the necessary facility to verify the books of account or other documents as he may require and which may be available at such place, (ii) to furnish such information as he may require and render assistance for timely completion of the audit.

(6) On conclusion of audit, the proper officer shall without delay inform the taxable person, whose records are audited, of the findings, the taxable person's rights and obligations and the reasons for the findings.

(7) Where the audit conducted under sub-section (1) results in detection of tax not paid or short paid or erroneously refunded, or input tax credit erroneously availed, the proper officer may initiate action under section 51.

Under the current VAT law there is no provision for audit by the Departmental officers. We also do not find the concept of audit by the Income tax Department. Hence, even under the GST law, assuming that it does get introduced at some point of time, the validity of the audit related provisions would be challenged, for sure.

Before concluding…

Insofar as the legality of the adjudication and/or appellate proceedings already concluded on the basis of audits conducted by the Service Tax Department, it would seem that, assessees would find it difficult to challenge these proceedings. Under the Income tax law, the Courts have held that, while the search or similar proceedings could be illegal, the evidence collected can still be used against the assessees. A similar view is possible in respect of proceedings, including levy of substantial amounts of service tax, concluded on the basis of service tax audits, notwithstanding this decision of the Delhi High Court.

So, isn't this a Pyrrhic victory?