You are required to file income tax every financial year, and so you may look up tips for filing income tax or learn how to calculate taxable income. You may also be required to get a tax audit to ensure that your accounts are up to date. So, let us look at what a tax audit is and its role in determining your tax liability.
What is a tax audit?
To put it simply, a tax audit is a legal way of verifying your income and expenditure based on the claims you make. As per the Indian income tax guidelines, any company or person earning an income as specified by certain sections of the Income Tax Act is eligible to undergo a tax audit.
This means you will first have to understand whether your gross income and expenditure in one financial year qualify you for an audit or not. Then, as per the requirements of the section under which you qualify, you will have to abide by certain protocols, maintain accounts, and have them reviewed by a CA.
What are the objectives of an Income Tax audit?
- Ensure compliance: The main goal of a tax audit is to check if businesses and professionals are following the rules of the Income Tax Act. This involves carefully examining their accounts, financial statements, and other records to make sure they stick to tax laws and regulations. By looking closely at income, expenses, and deductions, the audit aims to spot any mistakes or rule-breaking
- Check financial accuracy: A key part of tax audits is making sure financial statements are accurate. The audit involves a detailed review to ensure these statements correctly reflect the financial health of the business or profession. This thorough check boosts the reliability of the financial reports, making them trustworthy for the government, investors, and lenders
- Prevent tax evasion: Another objective of tax audits is to stop tax evasion and ensure taxpayers pay what they owe honestly. By examining financial transactions and reporting practices, tax audits help deter tax evasion. Finding and fixing discrepancies helps keep the tax system fair and equal for all taxpayers
- Increase transparency: Tax audits play a big role in making financial dealings transparent. By systematically reviewing financial records, audits highlight the organisation's economic activities. This openness is important for tax authorities and other stakeholders, building trust in the financial system
- Support tax administration: Tax audits help tax authorities by providing accurate and reliable information, which is crucial for assessing and collecting the right amount of taxes. The data from audits also helps create and apply tax policies that suit changing economic conditions
- Reduce risk for taxpayers: Tax audits are not just about compliance; they also help taxpayers avoid risks. Spotting and fixing problems during an audit can prevent future disputes with tax authorities, reducing the chance of fines or legal issues. This proactive approach helps businesses and professionals stay financially stable and compliant
Who is liable to get a tax audit done?
A business owner must have a tax audit if their total sales, turnover, or gross income go over Rs 1 crore in a financial year. Changes made in the Finance Acts of 2020 and 2021 increased this amount to Rs 5 crore and then Rs 10 crore, depending on how much of their business transactions are in cash.
Category of Person |
Threshold Criteria |
Carrying on business (not under presumptive taxation) |
Turnover exceeds ₹1 crore in a financial year. If cash transactions do not exceed 5% of total receipts/payments, the limit increases to ₹10 crores (effective FY 2020-21). |
Business under Section 44BB, 44AE, or 44BBB (Presumptive Taxation) |
Declares profits lower than prescribed under the presumptive scheme. |
Business under Section 44AD (Presumptive Taxation) |
Declares income below prescribed limits under the scheme and has taxable income exceeding the basic exemption limit. |
Business opting out of presumptive taxation under Section 44AD |
Tax audit is required if income exceeds the exemption limit in the 5 consecutive financial years after opting out of presumptive taxation. |
Professionals under Section 44ADA (Presumptive Taxation) |
Tax audit not required if turnover is within ₹2 crore in the financial year. |
Carrying on profession (general) |
Gross receipts exceed ₹50 lakh in a financial year. |
Profession under Section 44ADA (Presumptive Taxation) |
Claims profits lower than 50% of gross receipts, and income exceeds the basic exemption limit. |
Business loss (not presumptive taxation) |
If turnover exceeds ₹1 crore and the taxpayer has a loss with total income above the exemption limit, tax audit applies under Section 44AB. |
Business under Section 44AD with a loss (below threshold) |
Tax audit not applicable for losses if total income is below the basic exemption limit. |
Important sections of the Income Tax Act
Here is a look at all you need to know about tax audits and maintenance of books under a few such sections of the Income Tax Act.
Income tax audit under section 44AB
According to Section 44AB of the Income Tax Act, 1961, a tax audit is required for businesses and professionals if their total sales or earnings go over a certain limit. As recently as January 2022, the limit is Rs. 1 crore for businesses and Rs. 50 lakhs for professionals.
Income tax audit under section 44AA
According to Section 44AA of the Income Tax Act, people running high-income businesses or professions must keep records of their financial transactions. Section 44AB then requires that a chartered accountant reviews these records through an extra audit.
Income tax audit under section 44AD
If your turnover from the previous year does not exceed the Rs. 2 crore limit, then under section 44AD of the Income Tax Act, you can opt for presumptive taxation. However, to do that, you need to be:
- An Indian resident
- A resident of a Hindu Undivided Family
- A resident partnership firm
If you do not fall in one of these 3 categories, you cannot apply for presumptive taxation. It is important to remember that limited liability partnership firms are not eligible to apply for presumptive taxation. Further, you cannot apply for presumptive taxation if you have claimed deductions under section 80HH to 80RRB, 10A, 10B, 10AA, or 10BB of the Income Tax Act.
If you are availing of presumptive taxation, your income will be computed at the presumptive rate of 8% or 6%. You will not be allowed to claim the various allowances and disallowances specified by the law. You will also not be able to claim a separate deduction for depreciation.
If you opt for presumptive taxation and your income exceeds the basic threshold limit, you will need to maintain books. Suppose you declare a profit that is not following section 44AD for 5 consecutive years, adding up to the recent year. In that case, you will not be able to claim the benefits of this provision for 5 subsequent years starting from the year of declaration.
Income tax audit under section 44AE
Section 44AE is only applicable for small businesses that conduct activities like hiring, plying, or leasing goods carriages. Your business must not have more than 10 good carriage vehicles, and you cannot claim deductions for expenditures such as depreciation.
Income tax audit under section 44ADA
The presumptive taxation scheme added a new section, section 44 ADA, with effect from 1 April 2017, to reduce the burden of taxation on smaller businesses. This section abolishes the need to maintain books as tax is calculated as a percentage of total sales.
To be eligible for this scheme, you need to be an Indian resident who is an individual, HUF, or represents a partnership but not a limited liability partnership. Further, your business needs to fall under categories such as:
- Engineering
- Legal
- Architectural
- Accountancy
- Medical
- Technical consultant
- Interiors
Other professionals such as authorised representatives, film artists, certain sports-related persons, and company secretaries are also part of this list.
Under section 44ADA of the Income Tax Act, you can opt in and out of the presumptive scheme without the five-year restriction. However, section 44 AA of the Income Tax Act also mentions that you will need to maintain books if you claim a lower profit than that specified under section 44ADA or if your total income exceeds the basic exemption limit.
Forms required to be submitted under Section 44AB
Section 44AB of the Income Tax Act, 1961 mandates tax audit for certain businesses. The following are the forms required to be submitted under Section 44AB:
- Form 3CA: For business entities who are required to get their accounts audited under any other law.
- Form 3CB: For business entities who are not required to get their accounts audited under any other law.
- Form 3CD: For all businesses whose accounts are subject to tax audit.
Filing Of Income Tax Audit Report Under Section 44AB
- Mandatory for certain taxpayers like businesses and professionals.
- Required if turnover exceeds specified limits.
- Due date is generally the same as the income tax return filing due date.
- Contains details of audited financial statements and other relevant information.
- Helps ensure accuracy and compliance with tax laws.
- Failure to file can result in penalties.
- Provides transparency and accountability in tax reporting.
Penalty for non-compliance of income tax audit under Section 44AB
Section 44AB of the Income Tax Act, 1961 mandates tax audit for certain businesses. Non-compliance with this section can result in the following consequences:
- A penalty of 0.5% of the total sales, turnover or gross receipts, subject to a maximum of Rs. 1,50,000.
- Disallowance of certain expenses and/or failing to take benefits such as carrying forward losses, depreciation, etc.
- Imposition of interest on the tax due and not paid along with the penalty.
- Non-compliance can also result in scrutiny assessment, prosecution, and imprisonment.
Conclusion
Understanding the various sections of the Income Tax Act and compliance requirements is important for businesses and taxpayers in India. Tax audits, mandated by section 44AB, play a crucial role in ensuring tax compliance and detecting and preventing tax evasion and fraud.
Failure to comply with the audit requirements can lead to penalties, disallowances, interest, and legal action. By staying informed and compliant with the regulations, individuals and businesses can minimise their tax liabilities and avoid unnecessary consequences.
