India: Hon'ble Delhi High Court Renders Rule 5A(2) Of Service Tax Rules As Ultra Vires The Finance Act, 1994 - The Mega Issue:

Last Updated: 12 December 2016
Article by Shammi Kapoor and Shilpa Sharma

Factual Background:

Mega Cabs Pvt. Ltd. ("the Petitioner") had challenged Rule 5A(2) of the Service Tax Rules, 1994 ("Service Tax Rules"), as amended by Notification No. 23/2014-ST dated 05.12.2014, which empowers deputing department officers or officers from the Comptroller and Auditor General of India ("CAG") to "demand" documents mentioned therein for the purposes of scrutiny. It was contended that the said rule was in conflict with Section 72A of the Finance Act, 1994 ("the Act") and beyond the rule making power of the Central Government. The petitioner had also challenged the constitutional validity of Section 94(2)(k) of the Act on the ground that it gives "plainly unguided and uncontrolled" delegated powers to the Central Government for framing rules, inasmuch as it suffers from the vice of excessive delegation.

The petitioner has also challenged the Board Circular No. 181/7/2014-ST dated 10.12.2014, which states that since a clear statutory backing for conducting audit is available under Section 92(4)(k) of the Act, the departmental officers would be directed to audit service tax Assessee in terms of the departmental instructions already issued.

Lastly, the petitioner also challenges a letter dated 30.04.2015, issued by the Commissioner of Service Tax, New Delhi, informing that a team of officers of the said Commissionerate comprising three Superintendents and an Inspector would be verifying the relevant records of the Petitioner's business in terms of Rule 5A to the Service Tax Rules read with Section 94(1), 94 (2)(k) and 94(2)(n) of the Act, as amended, during the first week of May, 2015, for the financial years 2010-11 to 2013-14.

After considering the elaborate submissions made by both sides, the Hon'ble High Court observed as under:

  • Insofar as far as Section 72 of the Act is concerned, it is not any or every officer of the service tax department who can exercise the power thereunder It is only such officer who is entrusted with such power who can proceed to ask for the documents, records, accounts etc.
  • It is only where one of the three contingencies mentioned in Section 72A [i.e. Special Audit] exists that the Commissioner may direct the Assessee to "get his accounts audited either by a Chartered Accountant or a Cost Accountant nominated by such Commissioner". The extent of the audit and the period for which it should be conducted is also to be specified by the Commissioner.

Analysis of the amended Rule 5A(2) of the Act:

* There are three distinct types of documents that can be asked to be made available "on demand" by an Assessee:

  1. the records mentioned in terms of Rule 5(2);
  2. cost audit reports, if any, under Section 148 of the Companies Act, 2013; and
  3. the income tax audit report, if any, under Section 44AB of the Income Tax Act, 1961.

    • Rule 5(2) requires the Assessee to furnish to the Superintendent of Central Excise a list in duplicate of all the records prepared or maintained by the Assessee for accounting of transactions.
    • Interestingly, Rule 5A(2) does not restrict itself to such records as mentioned in Rule 5(2) but also required production of cost audit reports under Section 148 of the Companies Act, 2013 and the Income Tax Audit report under Section 44AB of the Income Tax Act 1961. These documents are not envisaged to be produced under Rule 5(2) and definitely not under any of the provisions of the Act.
    • Rule 5A(2) lists out the following persons who can make a demand for such documents from an Assessee: (i) officer empowered under Rule 5A(1), (ii) the audit party deputed by the Commissioner, (iii) the CAG, (iv) a Cost Accountant, (v) a Chartered Accountant.

The Petitioner had no objection in producing before a Cost Accountant or a CA the documents of accounts, records etc. but only if such Cost Accountant or CA has been nominated by the Commissioner for the purpose of special audit under Section 72A of the Act.

As far as an officer of the department was concerned, although under Rule 5A(1) such officer is authorised by the Commissioner to have access to unregistered premises for the purposes of carrying out any "scrutiny, verification and checks as may be necessary to safeguard the interests of the Revenue", such officer can, in terms of Rule 5A(2) simply demand the production of such documents without any requirement of recording reasons to believe that the production of such document is necessary. There is also no requirement of such officer having to be authorised to carry out a search under Section 82 of the Act or an assessment under Section 72 of the FA.

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.

This Hon'ble Delhi High Court in the case of K. Satyanarayanan vs. Union of India (ILR (1996) II Delhi), had 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 vs. 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.

As far as the service tax Assessees are concerned, one would still have to turn to the provisions of the Act 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. Since there was no such authorisation under the Act, the same was answered in the negative.

Analysis of the CBEC Instructions and Manual:

  • Circular No. 995/2/2015-CX dated 27.02.2015 [Central Excise and Service Tax Audit norms to be followed by the Audit Commissionerates], Para 5.1 of the said circular states that audit groups of two or three Superintendents and three to five Inspectors for conducting audit of large assesses/tax payers, two Superintendents for medium size Assessee and one to two for small size Assessees. There is no requirement that any of these officers should be duly authorised to carry out an assessment for the purpose of Section 72 of the Act or adjudication for the purposes under Section 73 of the FA. Thus, the entire instruction appears to be without any reference to the applicable provisions in the Act or the Rules.
  • Earlier Audit Manual of 2011 was held by this Court in Travelite (India) 2014-TIOL-1304-HC-DEL-ST to not have any statutory force. The 2015 Manual again fails to acknowledge that there is no statutory backing for the officers of the department to themselves undertake an audit of the Assessee's accounts and records.

Section 94 (2) (k) of the Act:

Although in the Circular 181/7/2014-ST, issued consequent upon the amendment by the CBEC on 10.12.2014, it is asserted by the Board that the expression 'verified' is of wide import and would include within its scope audit by the department officers, the Court disagreed with the same.

The court observed that the expression 'verified' has to be interpreted in the context of what is permissible under the Act 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 Act. 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 did 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.

The court further observed that 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.

Rule 5A (2) is ultra vires the Act:

Tested on the legal principles spelt out in the case of Municipal Corporation of Delhi v. Birla Cotton Spinning and Weaving Mills (AIR 1968 SC 1232); the court did not hesitate in concluding that Rule 5A(2) exceeds the scope of the provisions under the Act.

Validity of circulars, manual and the impugned letter:

As pointed out in Ratan Melting & Wire Industries 2008-TIOL-194-SC-CX-LB, a circular or a Manual cannot travel beyond the scope of the statute itself. It will have no binding effect if it does so. In the present case inasmuch as Section 94(2)(k) does not permit the exercise of audit to be undertaken by an officer of the department, the attempt in the circular to recognise such powers in the officers of the Central Excise and Service Tax Departments is held to be ultra vires the Act and therefore, legally unsustainable.

Conclusion:

  • Rule 5A(2) as amended in terms of Notification No. 23/2014-ST dated 05.12.2014, 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 Act and is therefore struck down;
  • Expression 'verify' in Section 94 (2) (k) of the Act 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 Act;
  • Circular No. 181/7/2014-ST dated 10.12.2014 is ultra vires the Act and is struck down.
  • 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 Act, as it does not have any statutory backing and cannot be relied upon by the department to legally justify the audit undertaken by officers of the Service Tax Department.

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