Income Tax Audit: Rules and Types

An audit is nothing but an official inspection. As per the Income Tax audit under section 44AB, specific categories of individuals and certain businesses, must have their books of accounts audited. A tax audit is necessary for businesses and people once you do business over and above a specific amount. Here is all that you need to know about tax audits in India.

What is a Tax Audit?

A tax audit is when the financial records of a business or professional are checked and reviewed. This process makes sure that all details about income, expenses, taxes, and deductions are correct.

Objectives of tax audit

• Verify that books of accounts are maintained accurately and certified by a Chartered Accountant (tax auditor).
• Identify and report any discrepancies or observations found during the systematic examination of books of accounts.
• Provide information required by tax authorities, such as tax depreciation and compliance with income tax provisions.
• Enable tax authorities to verify the correctness of income tax returns filed by ensuring accurate calculation of total income, deductions claimed, and compliance with tax laws.

Why is a tax audit conducted?

Its core purpose is to ensure that your business abides by the tax laws put in place by the Income Tax Act of India. Once completed, the tax audit makes it easy for you to file tax returns. A tax audit catches any errors or discrepancies early on by looking into your books of accounts and ensures that you are disclosing the information you are supposed to. Also, once you carry out a tax audit, it is easy for the tax authorities to go through your Income Tax Returns.

Who is mandatorily subject to tax audit?

A taxpayer is mandatorily subject to tax audit if their business's total sales, turnover, or gross receipts exceed Rs. 1 crore in the financial year. For professionals, this threshold is Rs 50 lakh, unless 95% of receipts are in digital mode, where the threshold is Rs. 75 lakh. Additionally, specific conditions under presumptive taxation schemes apply, such as declaring profits below prescribed limits or opting out of such schemes. Amendments under the Finance Act 2021 raised the turnover threshold to Rs. 10 crore if cash transactions are within 5% of total transactions, providing relief to certain businesses from mandatory audits.

Who is supposed to have a tax audit in India?

Certain people must have an income tax audit, and as per the law, these are the categories that must participate in a tax audit.

Any business where the total sales, turnover, or receipts exceed Rs. 1 crore in a year should have a tax audit in India. As a professional, receipts over Rs. 50 lakh makes you eligible for a tax audit. Here, a professional includes the likes of an engineer, architect, interior decorator, legal and medical professional. For the complete list of professionals, you must refer to Rule 6F of the income tax rules, 1962.

If you have opted for the presumptive taxation scheme as a professional or businessperson, and your total sales/ turnover is more than Rs. 2 crore, you must carry out a tax audit. Similarly, if you find that your profits are lesser than what was determined by the presumptive taxation scheme, you have to carry out a tax audit to confirm this.

If it is stipulated that you are to get a tax audit done and you do not, you will have to pay a penalty. However, as per section 273B, there are certain situations where not filing your tax audit report or doing so late is allowed. Examples of this are natural calamities, strikes or lock-outs, theft of documents or the resignation of the auditor.

Who conducts a tax audit?

A chartered accountant or a firm of CA conducts this audit. However, the tax audit limit rests at 60 audits per CA. In the case of a firm, the tax audit limit applies to each firm’s partners.

What is the Turnover Limit for Income Tax Audit?

A taxpayer must get a tax audit done if their business's sales, turnover, or gross receipts are over ₹1 crore, or if their profession's earnings exceed ₹50 lakh in a financial year. There are other situations where a tax audit might also be required. We have listed these situations in the tables below.

Updates to tax audit rules

Finance Act 2021: From 1st April 2021, for businesses, the threshold for needing a tax audit has increased to ₹10 crore, as long as cash transactions do not make up more than 5% of total transactions. This means cash receipts or payments must not exceed 5% of the total receipts or payments.

Taxpayers who must get a tax audit

The following categories of taxpayers are required to get their records audited:

Category of person	Condition for tax audit
Business
Not under presumptive taxation	Sales, turnover, or gross receipts exceed ₹1 crore. If cash transactions are up to 5% of total receipts/payments, the threshold is ₹10 crores (from FY 2020-21).
Under presumptive taxation (Sections 44AE, 44BB, 44BBB)	Claims profits or gains lower than prescribed limits under the presumptive taxation scheme.
Under presumptive taxation (Section 44AD)	Declares income below prescribed limits and income exceeds ₹2.5 lakhs.
Opted out of presumptive taxation (Section 44AD)	Income exceeds ₹2.5 lakhs in the subsequent 5 years after opting out during the lock-in period of 5 consecutive years.
Profession
Carrying on profession	Gross receipts exceed ₹50 lakhs in a year.
Under presumptive taxation (Section 44ADA)	Claims profits below 50% of total receipts and income exceeds ₹2.5 lakhs.
Business loss
Not under presumptive taxation	Sales, turnover, or gross receipts exceed ₹1 crore or total income exceeds ₹2.5 lakhs despite business loss.

Guidelines for Governing Tax Audit

Here are some key points about tax audits:

1. Multiple businesses: If you run more than one business and the total turnover from all of them is over ₹1 crore, you must have your accounts audited
2. Multiple professions: If you are involved in more than one profession and the combined gross receipts from all these professions exceed ₹50 lakh, you must get your account books audited
3. Both business and profession: If you operate a business and a profession, audits depend on their individual turnovers. An audit is needed if your business turnover is over ₹1 crore or if your profession's gross receipts are over ₹50 lakh. For example, if your business turnover is ₹90 lakh and profession receipts are ₹40 lakh, no audit is required
4. Turnover limits and asset sales: If your business or profession turnover is below ₹1 crore or ₹50 lakh, but you have sold a fixed asset (like a vehicle or property), the profit from the sale does not count towards your business or professional earnings. Items excluded from turnover/gross receipts include:
   • Investment assets (e.g. shares, stocks, securities)
   • Fixed assets
   • Rental income
   • Non-business interest income
   • Client-reimbursed expenses
5. Revising audit reports: Once a tax audit report is filed online, it cannot be changed. However, if the accounts are revised (e.g. company account changes after the Annual General Meeting, changes in law, or its interpretation), the audit report can also be updated. The reason for the change must be clearly stated when filing the revised report

How to do a tax audit in India?

To complete the tax audit in India, you are required to submit the necessary forms. The four most commonly required ones are as follows.

• Form 3CA: This is for companies or professionals who have to carry out a tax audit mandatorily.
• Form 3CB: This is for a business or profession that is not mandated by any other law to have a tax audit carried out.
• Form 3CD: This form is best viewed as a detailed statement of particulars. It comprises various details of the business and its transactions.
• Form 3CE: This form is for NRIs and foreign companies. You are required to submit it if you receive fees/ royalty from any Indian concern or the government instead of rendering technical services.

The direct taxes committee of the ICAI regularly issues guidance notes on tax audits to keep tax auditors abreast with the latest changes in the tax audit report requirements. This may be with regard to changes in the information that is to be disclosed, the contribution of the auditors, and amendments to forms, as was the case with form 3CD in 2018.

By when should you have the tax audit report?

The auditor will hand over the tax audit report to you electronically to approve and then file. Note that you do have the option to reject the tax audit report, in which case it will have to be carried out again from scratch. The tax audit due date is 30 September of the assessment year, and for form 3CE, it is 30 November of the assessment year.

Although understanding tax audits in India is the biggest tax return trip, knowing how to calculate taxable income and reduce tax liability will help you.

How to calculate taxable income for your business?

As mentioned before, you are required to have a tax audit done if your total income from all businesses is over Rs. 1 crore and that from all professions are over Rs. 50 lakh. However, if you are a business owner and a professional, your audit is not on the basis of your cumulative income. This means if your total turnover from the business is Rs. 95 lakh and that from your profession is Rs. 48 lakh, you do not require a tax audit done.

In addition, if you are wondering how to calculate taxable income in India, remember that if the amount is below the threshold, your earnings from the sale of an asset will also not be considered a profit. This applies to fixed assets such as machinery or cars, assets held as investments such as stocks, expenses reimbursed by a client, rental income, etc.

How to reduce your tax liability as a business owner or professional?

• Make purchases in your company’s name. This is because based on what you have purchased, computers, vehicles, or smartphones; you can claim depreciation on such capital expenses.
• Consider utilities to be business expenses. Paying for electricity, internet connections, air conditioning, etc. can be written off, lowering your taxable income.
• File your taxes on or before the due date. Apart from ensuring that you are a law-abiding entity, this tip for filing taxes also helps you in other ways. This is because as you can carry forward a loss from your business for up to 8 consecutive years.
• Stay abreast of the changes instated by the government. The government revises the policies from time to time to help businesses, especially small and medium enterprises. Familiarising yourself with these changes will ensure that you are making the most of every deduction possible to lower your taxable income.
• Write off business expenses. Whether travelling for work or entertaining clients, they are counted as business expenses, and you can use them to lower your taxable income. However, to do so, you must keep a detailed record of all such expenses. This means preserving bills and receipts meticulously.
• Make the most of start-up expenses. Also known as preliminary expenses, these give you tax benefits under section 35D of the Income Tax Act. Typically comprising expenses that you incur before the commencement of your business, these can be written off over five consecutive years as per the provisions of the law.
• So, keep pointers in mind to reduce your tax liability and carry out your tax audit on time. Remember that if you do not, you will have a penalty of up to Rs. 1.5 lakh to pay.

Penalty of non-filing or delay in filing tax audit report

Failure to comply with tax audit requirements can result in penalties for taxpayers. If a taxpayer is obligated to conduct a tax audit but fails to do so or submits the audit report after the deadline, they may face a penalty. This penalty is calculated as the lesser of 0.5% of their total sales, turnover, or gross receipts, or Rs 1,50,000. The objective of this penalty is to ensure timely and accurate reporting of financial information, facilitating transparency and compliance with tax laws.

However, there are exemptions to this penalty under certain circumstances. If there is a valid reason for the delay in filing the tax audit report, such as natural calamities affecting business operations, sudden resignation of the tax auditor, prolonged strikes or lockouts, loss of accounting records due to unforeseen events, or physical incapacity or death of the person responsible for maintaining accounts, no penalty will be levied. These exemptions recognise situations beyond the taxpayer's control that hinder compliance with audit requirements, thereby providing relief in genuine cases of unavoidable delays.

Difference between tax audit and statutory audit

The roles of a tax audit and a statutory audit are quite different. Below is a chart that explains the purposes and functions of these audits and highlights the differences between them:

Area for Comparison	Statutory Audit	Tax Audit
Purpose	Mandatory for all businesses to ensure compliance with regulatory standards.	Required under the Income Tax Act if turnover exceeds ₹1 crore or specified thresholds.
Who Conducts the Audit	External auditor appointed by the company.	Conducted by a Chartered Accountant.
Scope of Audit	Examines the company’s complete financial records and accounting practices.	Focuses on accounts related to taxable income and compliance with tax laws.
Key Function	Ensures accuracy and transparency of the company’s financial statements.	Verifies taxable income and maintains compliance with tax provisions.

 

What are the types of audits in India?

When it comes to the type of audits or classification of audits, you will find that there are three main types:

1. Field audit: This is conducted at your office typically. On the off-chance that it is to be conducted at your representative’s place of work, you will have to provide the necessary documents to them.
2. Office audit: This is conducted at an IRS office, and you are supposed to visit the office with the necessary documents in tow. Typically, a letter will be sent to you stating the documents you must carry.
3. Correspondence audit: In this type of audit, the IRS sends you a letter requesting documents that will provide clarity/ missing information regarding your tax returns. Basis the instructions, you are required to mail the documents in simply.

Conclusion

In conclusion, a tax audit in India plays a crucial role in ensuring that businesses and professionals accurately report their income and adhere to tax laws. The primary objectives of a tax audit are to verify the correctness of income, deductions, and other relevant financial details, thus preventing tax evasion and promoting transparency.

Tax audits are mandatory for individuals and entities with turnovers exceeding prescribed limits: ₹10 crore for businesses with minimal cash transactions and ₹50 lakh for professionals. These audits are conducted by qualified Chartered Accountants who follow specific guidelines set by authorities.

Understanding the turnover limits and guidelines governing tax audits is essential for compliance. Timely preparation and filing of the tax audit report are crucial to avoid hefty penalties for non-compliance or delays. Calculating taxable income accurately and identifying ways to reduce tax liability, such as through legitimate deductions and exemptions, can significantly benefit business owners and professionals.

It is important to note the difference between tax audits and statutory audits. While statutory audits focus on the correctness of financial statements as per company laws, tax audits ensure compliance with tax laws. Various types of audits, including internal, compliance, and statutory, provide a broad overview of financial practices.

Overall, tax audits form an integral part of the regulatory framework in India, promoting financial integrity and compliance amidst businesses and professionals.