Section 142(2A) of the Income-Tax Act, 1961 empowers the assessing officer (AO) to order special audit of the accounts of the taxpayer to determine the correct income. Before having recourse to special audit, the AO should be guided by the following principles:

He should form an opinion that the nature of the accounts of the assessee is complex.

The interest of the Revenue will be adversely affected if the special audit is not directed.

The opinion should be formed objectively on the basis of the available material.

He should take the approval of the Commissioner or Chief Commissioner who should apply his mind to all the materials placed before him.

Assessment proceedings must be pending.

The Central Board of Direct Taxes (CBDT) issued Instruction No. 1076 dated July 12, 1977, laying down guidelines for special audit. Such audit can be ordered even in cases where the accounts have already been audited. Rule 14A of the Income-Tax Rules prescribed the form of the audit report. Failure to comply with a direction for special audit entails a best judgment assessment under Section 144. It will also attract penalty under Section 271(1)(b). It is also an offence punishable under Section 276D.

The period for the submission of audit report may be extended by the AO on application made by the assessee. However, it cannot exceed 180 days from the date on which the direction for special audit is received by the assessee.

The provision cannot be invoked on flimsy grounds such as stocks not being reconciled; litigation is pending; difficulty in verification of claims, etc. Courts have recognised that audit places a heavy burden on the person whose accounts are to be audited. The complexity or otherwise of the accounts will become obvious only when the records are produced and the accounts are examined. Mere failure to respond to statutory notice cannot invite special audit.

There was a difference of opinion among the various High Courts and the Supreme Court on the question of giving an opportunity to the assessee to be heard before special audit is ordered. The matter went up to the Supreme Court.

Apex court ruling

In Rajesh Kumar vs Deputy CIT (287 ITR 91), the Supreme Court observed that the AO's power to order special audit is not administrative but quasi-judicial in nature. Subsequently, in the Sahara India case, the Supreme Court expressed doubts about its own ruling in the above case and referred the matter to a larger Bench.

In this situation, Finance Bill, 2007 has chosen to amend Section 142(2A) and provides, prospectively, that the AO should give the assessee a reasonable opportunity of being heard before directing a special audit. It will be open to the party to show that no special audit is required.

It may be noted that the proposal for special audit requires approval by the Commissioner or Chief Commissioner. The Department has a panel of auditors from whom the special auditor will be nominated. The superior authority will scrutinise the objections from the assessee before agreeing with the AO's recommendations for special audit.

By way of a bonus to the assessee, Clause 37 of the Finance Bill inserts a proviso to Section 142(2D) of the Act laying down that wherever directions for special audit are given, the expenses of such audit, including the remuneration of the chartered accountant concerned, shall be determined by the Commissioner or Chief Commissioner in accordance with the prescribed guidelines. The expenses so determined shall be paid by the Central Government. At present, expenses on special audit have to be borne by the assessee and are collected under the Revenue Recovery Code.

This is a sort of double jeopardy. The assessee suffers special audit and also pays for it. The Finance Bill, 2007 removes this hardship.

The amendments take effect from June 2007. It could have been made retrospective so that the reference before the Full Bench of the Supreme Court becomes unnecessary.

T. C. A. Ramanujam
(The author is a former Chief Commissioner of Income-Tax.)