Validity of Service Tax Audit – June 2016
In the past there have been a lot of disputes with quashing of Rule on audit [5A(2)], leading to questioning of legality of service tax audit. When self assessment came the power of the revenue to scrutinise records was supposed to diassapear. CAs were however empowered under the law to be appointed by the revenue. A backdoor entry was adopted for continuing the assessment in the name of the audit in Central and State legislations. This is what was challenged.
In this article we look at the implications of recent decision of High Court which has held audit by department to be invalid. This article examines the validity of audit by department in light of latest decision.
In a latest development in Mega Cabs (2016-TIOL-1061-HC-DEL-ST) service tax audit by department has been held to be ultra vires service tax law. We would recall the provisions enabling service tax audit and its legality in this regards before examining implication of latest decision.
The rule making power under service tax is conferred upon executive in Section 94 of the Finance Act. Section 72A of the FA only prescribes a special audit to be got done by the Assessee on the direction of the Commissioner, by a Cost Accountant or a Chartered Accountant. A special audit could be undertaken if the circumstances outlined in Section 72A are fulfilled. Section 72A empowers an audit of an assessee’s records only in special circumstances, namely, when there is a failure to declare or compute the value of the taxable service correctly, when the utilization of CENVAT credit in excessive of the limit permissible or by fraud etc., or when the business operations of the assessee are dispersed across multiple locations.
The fact that Section 72A prescribes the conditions meriting such special audit leads to the inference that there was no intend to provide for a general audit that “every assessee” may be subjected to, “on demand”.
At the same time, as per erstwhile Rule 5A(2)[before amendment in December 2014] of Service Tax Rules, 1994 every assessee was required to make available on demand specified documents to the authorized officer or audit party deputed by the Commissioner or C&AG within 15 days from date of demand or such extended period allowed.
The Finance Act which is the parent statute under service tax does not authorize a general audit of type covered in Rule 5A(2) of ST Rules There was no other substantive provision which justified a probe into the records of the assessee, under conditions akin to those contemplated by Rule 5A(2)
In ACL Education Centre Private Limited v. UOI (2014-TIOL-120-HC-ALL-ST), the Allahabad High Court held that Rule 5A(2) only empowers the officers, as duly authorized by the Commissioner to ask for and collect records from the assessee. The audit can only be undertaken by an authorized Chartered Accountant or Cost Accountant, as provided in Section 72A.
The Calcutta High Court in SKP Securities Limited v. Deputy Director –(2013-TIOL-38-HC-KOL-ST). In this case, the High Court held that Chapter V of the Finance Act, 1994 or the CAG Act, 1971 does not empower the CAG to undertake audit of accounts of a non-governmental assessee as these assessees are not in the receipt of any aid or grant from the government.
In terms of HC decision in Travelite (India) Vs. UOI &Ors. (2014-TIOL-1304-HC-DEL-ST) on the Service Tax Audit issue it is held that: Rule 5A(2) of the Service tax Rules is ultra vires the provisions of the Finance Act and the rule has been struck down.The Court had held the opinion that any attempt to include provision for such a general audit through the back-door, such as through the impugned rule, is ultra-vires the rule making power conferred under Section 94(1). Rule 5A(2) must consequently be struck down. By order dated 18th December 2014, the Supreme Court while directing notice in the SLP directed that there would be a stay of the operation of the decision of this Court in Travelite (India) v. Union of India (supra).
The CBEC circular no.137/26/2007-CX 4 which sought to put in place a mechanism for department of audit and scrutiny of documents, was not only an attempt to widen the scope of the law impermissibly but also contrary to the statute. The said circular, to the extent it provides clarifications on a Rule 5A(2) audit, was also quashed by the Delhi High Court in the Travelite decision (2014-TIOL-1304-HC-DEL-ST).
Impact of amendment in Section 94
In this backdrop it is pertinent to note that the FA (No.2)Act, 2014 amended the provisions of rule-making powers under Section 94(2) to insert (k) as follows:
(1) The Central Government may, by notification in the Official Gazette, make rules for carrying out the provisions of this Chapter.
(2) In particular, and without prejudice to the generality of the foregoing power, such rules may provide for all or any of the following matters, namely(a)…………………………….
The substituted provision now reads as under:
(J) in section 94, in sub-section (2), for clause (k), the following clauses shall be substituted, namely:-
“(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,’………………………..
Similarly, an amendment was also made to the ST Rules by replacing Rule 5 A (2) with a new Rule 5A(2) by notification no. 23/2014-ST dated 5th December 2014. The amended rule read as under:
Rule 5A(1) An officer authorised by the Commissioner shall have access to any registered premises for carrying out any scrutiny, verification and checks to safeguard the interest of revenue.
audit party deputed by the Commissioner or the C&AG, or a cost accountant or chartered accountant nominated under section 72 under sub-rule (1) or the officer authorized by Commissioner, make available to the on demand(2) Every assessee shall,
A of the FA, 1994
(i) the records maintained or prepared by him in terms of sub-rule (2) of rule 5;
(ii) the cost audit reports, under Section 148 of the Companies Act, 2013; and
(iii) the income-tax audit report, under Section 44 AB of the Income-tax Act, 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.
It maybe noted Rule 5(2) requires the Assessee to furnish to the Superintendent of CE at the time of filing of first time return a list in duplicate of all the records prepared or maintained for accounting of transactions, of providing any service receipt or procurement of anybody’s service and payment of such service.
Paper writers comments:
In view of paper writers though inserted clause in Section 94(2) fixed a responsibility on the tax payer in relation to his obligation for furnishing of information, keeping records and the manner in which the records shall be verified. It did not specify who the records shall be verified by, and circumstances in which such verification is to be done.
Under substituted Rule 5A(1) officer authorised by the Commissioner can in terms of Rule 5A(2) demand the production of such documents by demanding for same. 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
In absence of any power given in the Act permitting same, the paper writer is of the view that cost audit and the Tax Audit report are not required to be produced under Rule 5(2) nor under any of the provisions of the FA. The substituted rule 5A(2) is going beyond the FA itself.
There is no provision in the FA to give unrestricted access to the books of accounts etc. of an Assessee to the CAG or any officer of the Department. The amended Rule 5A was going beyond the Act.
181/7/2014-ST was issued by the CBEC clarifying that in view of the insertion of Section 94 (2) (k), the officers of the Service Tax Departments could proceed with conducting audits as before. It was stated that that expression ‘verified’ used in Section 94 (2) (k) of the FA was of wide import and would include within its scope audit by the departmental officers.
In view of paper writer, 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. The expression ‘verify’ is cannot permit the audit of the accounts of the Assessee by any officer of the Service Tax Department.
Thereafter Circular No. 995/2/2015-CX dated 27th February 2015 issued by the CBEC on the subject contemplated the Department’s officers themselves undertaking audits. The entire instruction appears to be without any reference to the applicable provisions in the FA or the Rules.
Latest decision and its impact
The challenge in this petition by Mega Cabs supra was as follows:
i. Challenge to Rule 5A(2) of the ST Rules as amended to the extent that the amended Rule 5A(2) empowers deputing departmental officers or officers from ‘CAG’ to ‘demand’ documents mentioned therein. It is contended that this is in conflict with Section 72A of the FA and beyond the rule making power of the Central Government.
ii. Challenge to the constitutional validity of Section 94(2)(k) of the FA on the ground that it gives -plainly unguided and uncontrolled” delegated powers to the Central Government for framing rules.
iii. Challenged the Circular No. 181/7/2014-ST dated 10th December 2014 issued by the Central Board of Excise and Customs (‘CBEC’).
High Court held as follows:
(i) Rule 5A(2) as amended to the extent that it authorises the officers of the Service Tax Department, the audit party deputed by a Commissioner or the CAG to seek production of the documents mentioned therein on demand is ultra vires the FA and, therefore, stuck down;
(ii) Expression ‘verify’ in Section 94 (2) (k) of the FA cannot be construed as audit of the accounts of an Assessee and, therefore, Rule 5A(2) cannot be sustained with reference to Section 94(2)(k) of the FA.
(iii) Circular No. 181/7/2014-ST dated 10th December 2014 is ultra vires the FA and is struck down.
(v) CBEC Circular No.995/2/2015-CX dated 27.02.2015 and the Central Excise and Service Tax Audit Manual 2015 issued by the Directorate General of Audit of the CBEC are ultra vires the FA, does not have any statutory backing and cannot be relied upon to legally justify the audit undertaken by officers of the Service Tax Department.
In view of paper writer as of date the powers of conducting service tax audit has been quashed. Citing this decision the assesses who have got intimation letters by service tax dept could defer audit. There is a possibility that audit could be enabled by an amendment in Section 94(2) empowering the officers of the Service Tax Department, the audit party deputed by a Commissioner or the CAG to seek production of the documents on demand.
Further based on the decision, the question about validity of past periods audits and consequent demands raised based on soley on such audits done could be lgeally challenged assesses.
The assesses who are served audit notices can question the power to do the audit and seek clarity in writing. If forced on them they can lodge a letter of protest and then co operate with the audit exercise. In the reply to audit note agin the legality of the audit maybe questioned.
In this article the paper writers have sought to examine the legality of service tax audit in light of recent decision.