Order of Special Audit u/s 142(2A) - Scope of discretionary power of AO "

Sub Section (2A) of Section 142 of Chapter XIV of the Income Tax Act, 1961 enables the AO to direct the assessee to get his account audited by a chartered accountant (known as special audit)

With effect from 1-6-2007, Finance Act, 2007, inserted a proviso to this sub-section as,

""Provided that the Assessing Officer shall not direct the assessee to get the accounts so audited unless the assessee has been given a reasonable opportunity of being heard.""

Since  this amendment was brought into with effect from 1-6-2007, can it be said that before amendment, the AO was having discretionary power for ordering special audit. That would not mean that the principles of natural justice are not required to be complied with. Only because certain consequences would ensue if the principles of natural justice are required to be complied with, the same by itself would not mean that the court would not insist on complying with the fundamental principles of law. 

In the present (Reported in 2008 -TMI - 3592 - Supreme Court) AO has directed the assessee to get its account audited. Learned counsel appearing for the revenue submitted that the order of special audit is only a step towards assessment and being in the nature of an inquiry before assessment, is purely an administrative act giving rise to no civil consequence and, therefore, at that stage a pre-decisional hearing is not required. He further, argued that, that since a post-decisional hearing in terms of sub-section (3) of Section 142 is contemplated, the requirement of natural justice is fully met. 

In this case, the apex court has observed that,

""Indubitably, before passing the said orders, no show cause notice was given to the appellants.  On the contrary, it appears from the record that on 9^th March, 2006, the appellants were required to furnish by 20^th March, 2006 details/explanation in respect of queries raised vide order sheet entry dated 16^th February, 2006 but in the meanwhile, the impugned orders were passed on 14^th March, 2006 itself.  It is manifestly clear that when the impugned orders were made, the Assessing Officer had no occasion to have even a glimpse of the accounts maintained by the appellants.  Therefore, in the light of the legal position noted above, we have no option but to hold that the impugned orders dated 14^th March, 2006, are vitiated by the failure to observe the principle audi alteram partem. ""

Since the matter was debatable, the honorable Supreme Court further observed that,

""We hold that the law on the subject, clarified by us, will apply prospectively and it will not be open to the appellants to urge before the Appellate Authority that the extended period of limitation under Explanation 1 (iii) to Section 153 (3) of the Act was not available to the Assessing Officer because of an invalid order under Section 142 (2A) of the Act.  However, it will be open to the appellants to question before the appellate authority, if so advised, the correctness of the material gathered on the basis of the audit report submitted under sub-section 2A of Section 142 of the Act. 

(For full text of judgment - visit 2008 -TMI - 3592 - Supreme Court)

Audi alteram partem requirement: pre decisional hearing required before ordering a special audit, with prospective application. Power to direct a special audit permits the Assessing Officer to require an assessee's accounts to be audited, but such orders are subject to procedural fairness; an order made without giving the assessee an opportunity to be heard is vitiated for failure to observe the audi alteram partem principle. The court applied this clarification prospectively while preserving the assessee's ability to challenge audit derived material on appeal.