ITAT Quashes Assessment Orders on Grounds of Invalid Special Audit Reference: Allows Appeals of Legal Heirs [Read Order]

The appeals were filed by the legal heirs, Rama Devi, B. Pramod, and B.V. Santosh, challenging the assessment orders passed on the deceased assessee, Laxman Rao. The AO had issued notice under Section 153A following a search operation conducted in December 2016 and subsequently invoked Section 142(2A) to refer the case for special audit just before the statutory deadline for completing assessment.

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A search was conducted on 06.12.2016, and subsequent notices under Section 153A were issued nearly a year later. The legal heirs submitted that Laxman Rao had passed away in February 2017, and they filed returns in response on his behalf. The AO proceeded with assessment proceedings and on 31.12.2018, the last day of the limitation period, referred the case for a special audit under Section 142(2A), thereby extending the assessment deadline.

The special audit was completed, and the assessment orders were passed on August 23, 2019, adding ₹2.80 crore in long-term capital gains and other unexplained investments across the relevant years.

Before the CIT(A), the assessee challenged the validity of the audit reference, contending that there were no books of accounts, no business income, and only basic cash flow statements were submitted, making the reference unjustified. However, the CIT(A) upheld the AO’s decision and dismissed the appeal.

The Tribunal found merit in the assessee’s arguments. It held that the AO’s action to refer the case to a special auditor was not based on objective satisfaction or detailed analysis of records, but was merely a tool to extend the time limit for completion of the assessment.

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It asserted that invoking Section 142(2A) requires a clear demonstration of complexity in accounts, multiplicity of transactions, or specialised business activity, which was absent in this case. The assessee had declared income only from house property and other sources and had not maintained any books of accounts, factors that disqualify the case from special audit referral.

The ITAT also noted the timeline, the referral was made on the very last day of the time limit for assessment, and the records failed to show any complexity or abnormality that justified the reference. The cash flow statements relied on by the AO were only four pages long and did not constitute voluminous or complex data requiring a special auditor’s intervention.

The Bench, comprising Vijay Pal Rao (Vice President) and Manjunatha G (Accountant Member), observed that the referral to a special audit was arbitrary and thus invalid under law. Consequently, since the time extension granted due to such referral was illegal, the final assessment orders dated August 23, 2019, were held to be time-barred and void.

In the same proceedings, the assessee’s appeal for AY 2017– 18 was also dismissed. During the hearing, the counsel withdrew the challenge to the special audit reference for that year and contested only the addition of ₹6 lakh as unexplained investment. The Tribunal upheld the lower authority’s findings, noting that the assessee failed to establish the source of the amount. As a result, the ITAT allowed the appeals for AYs 2014–15 and 2015–16, holding that the assessment orders were barred by limitation due to an invalid audit reference.