Everything you need to Know about Tax Audits

First, we will get to know the meaning of tax audit in the scope of the Income Tax Act, 1961, a tax audit is an examination of an individual’s or business’s financial records to verify compliance with tax laws and ensure that income, deductions, and other tax-related figures are accurately reported.

Essentially, it is a process conducted to check whether the taxpayer has maintained proper books of accounts and adhered to the tax regulations set by the government.

How is Tax Audit different from other audits?

A tax audit is different from other audits in purpose and scope. A statutory audit ensures a company’s financial statements present a true and fair view and is required under the Companies Act, whereas a tax audit focuses only on tax compliance under income tax laws. An internal audit helps a company assess and improve its internal controls and efficiency, acting as a self-check, while a tax audit is legally mandated to verify tax accuracy. A GST audit ensures compliance with GST laws and correct tax payments, differing from a tax audit in scope and objectives. Whereas a Tax Audit is conducted to:

• Ensure proper maintenance of books of accounts.
• Verify the correctness of income and deductions claimed.
• Identify and rectify tax evasion or discrepancies.
• Simplify the tax assessment process by making financial data more transparent.

Who Needs a Tax Audit?

The need for a tax audit arises based on turnover or gross receipts in business or profession. In India, as per Section 44AB of the Income Tax Act, 1961, tax audit is mandatory if:

• A business has a turnover exceeding ₹1 crore (₹10 crores if not more than 5% of the transactions are made through cash).
• A professional has gross receipts exceeding ₹50 lakh.
• A taxpayer declares income lower than the presumptive taxation scheme* threshold.

*Presumptive Taxation Scheme: In presumptive taxation cases, a tax audit is required if the taxpayer declares income lower than the prescribed limit under the relevant sections and their total income exceeds the basic exemption limit. The important provisions are:

1. Section 44AD: Presumptive Taxation for Businesses

• Applicable to individuals, HUFs, and partnerships (excluding LLPs) engaged in eligible businesses.
• Presumptive income: 8% of turnover (6% for digital transactions).
• Tax Audit required if:
  • Declared income is less than 8% (or 6%) of turnover, and
  • Total income exceeds the basic exemption limit.

1. Section 44ADA: Presumptive Taxation for Professionals

• Applicable to specified professionals (e.g., doctors, lawyers, architects).
• Presumptive income: 50% of gross receipts.
• Tax Audit required if:
  • Declared income is less than 50% of gross receipts, and
  • Total income exceeds the basic exemption limit.

1. Section 44AE: Presumptive Taxation for Transporters

• Applicable to persons owning up to 10 goods carriages.
• Presumptive income: ₹1,000 per ton per month (for heavy goods vehicles) or ₹7,500 per month per vehicle.
• Audit required if income is declared lower than the presumptive income.

1. Process of Tax Audit:

The tax audit is conducted by a Chartered Accountant (CA), who examines the books of accounts and prepares an audit report in Form 3CA/3CB along with Form 3CD, which contains detailed tax-related information.

Now let us get a quick understanding of the purpose of the above-mentioned forms:

Form 3CA → Used when the taxpayer is already audited under another law (e.g., Companies Act for companies).

Form 3CB → Used when the taxpayer is not required to be audited under any other law but needs a tax audit under Section 44AB.

Form 3CD → A detailed statement of financial and tax-related data, attached to both 3CA and 3CB.

The auditor submits the report electronically to the tax authorities before the due date of filing the income tax return.

2. Consequences of Not Complying with Tax Audit Requirements

Failure to comply with tax audit requirements can lead to penalties under Section 271B of the Income Tax Act, which is lower of:

• 5% of total sales/receipts, or
• ₹1,50,000.

Additionally, non-compliance may invite scrutiny from tax authorities, leading to further investigations.

In conclusion, a tax audit plays a vital role in ensuring tax compliance, financial discipline, and transparency. While it may seem burdensome, it helps businesses avoid legal issues and fosters credibility with financial institutions and regulators. For the government, it enhances revenue collection, curbs tax evasion, and improves tax administration, contributing to a fairer economy. Ultimately, tax audits build trust within the public and support the funding of essential public services, benefiting the broader economy and society.