Special Audit – AO to decide if Accounts are complex, Court can interfere sparingly

CA Sandeep Kanoi

Recently Delhi High Court has in the case of AT&T Communication Services India (P) Ltd vs. CIT held that The question whether the accounts and the related documents and records available with the A.O. present complexity is essentially to be  decided by the A.O. and in this area the power of the court to intrude should necessarily be used sparingly.

In the case before us the A.O. has taken the view that there is complexity in the accounts of the assessee. He has referred to the three segments or sources of revenue of the petitioner and has held that it is required to identify the method and the relevant accounting standard applicable for recognition of income from these revenues and also to ascertain the correctness of the income recognized.

Paragraph 2 of the order passed under Section 142(2A) on 26.12.2011 contains a detailed discussion as to the complexity of the accounts. The profit and loss account, balance sheet and the computation of the income were before the A.O. It can hardly be disputed that the profit and loss account and  the balance sheet fit the description of “accounts”.

The complexity arising out of such accounts is the difficulty in allocating the expenses incurred by the petitioner against the three segments of revenues namely; (i) market research, administrative support and liaison services; (ii) network connectivity services and (iii) managed network services. The A.O. further proceeds to state in the impugned order that the allocation of costs/expenses impacts the profit and loss account (and the ultimate profit figure) and the method and the basis for such allocation is required to be verified and examined by the special auditor.

The other complexity adverted to by the respondent is the plea taken by the  petitioner that the overseas payments cannot be characterized as fees for technical services but represented purchase price of goods and services and therefore there was no obligation on its part to deduct tax under Section 195.

Yet one more complexity is the nature of the other costs debited in the profit and loss account which include infrastructure costs, last mile charges and inter group charges. The precise nature of these costs is required to be ascertained not only from the legal aspect but also from the accounting aspect, to determine the applicability of Section 40(a)(ia).

One more important issue which according the A.O. is quite complex is the “last mile charges”. Noting that this is a heavily capital intensive project and the capitalised infrastructure is eligible for depreciation, the respondent has observed that the assessee has deducted the entire last mile charges from the services revenue thereby nullifying any income on this score. According to him the inclusion of the last mile charges in the profit and loss account as a debit, when the capitalised infrastructure cost is eligible also to depreciation, may amount to double deduction. Whether this would amount to double deduction is an aspect which the special audit was required to examined.

Held :-  The question whether the accounts and the related documents and records available with the A.O. present complexity is essentially to be  decided by the A.O. and in this area the power of the court to intrude should necessarily be used sparingly. It is the A.O. who has to complete the assessment. It is he who has to understand and appreciate the accounts. If he finds that the accounts are complex, the court normally will not interfere under Article 226. The power of the court to control the discretion of the A.O. in this field is limited only to examine whether his discretion to refer the accounts for special audit was exercised objectively, as far as the accounts, records, documents and other material present before the A.O. would permit. There must be valid material before the A.O. from which he apprehends that there is complexity. As to what material would make the accounts complex is essentially for the A.O. to determine and unless his decision can be attacked on the ground of perversity or absolute arbitrariness or mala fide, it should not be interfered with. In the present case we are satisfied that the accounts including the documents, records and other material before the A.O. did make the issues for his decision complex requiring a special audit. We are accordingly not inclined to accept the contention of the assessee to the contrary.