Income Tax Audit: Rules & Types

Understanding Tax Audit in India

A tax audit is essentially a formal review of financial records. According to Section 44AB of the Income Tax Act, certain individuals and businesses are required to have their books of accounts audited. This becomes mandatory when business turnover or professional receipts exceed specified thresholds. Here’s a comprehensive overview of tax audits in India.

What Is a Tax Audit?

A tax audit involves the examination and verification of the financial statements of a business or professional. It ensures that income, expenditure, taxes, and deductions are reported accurately and in accordance with tax regulations.

Objectives of a Tax Audit

• Ensure the proper maintenance of books of accounts, certified by a Chartered Accountant (CA).
  
  

• Detect and report any irregularities or observations during the audit of financial statements.
  
  

• Furnish key financial data to tax authorities, including depreciation details and other compliance-related information.
  
  

• Assist tax authorities in validating income tax returns by confirming accurate income, deduction claims, and adherence to tax laws.

Purpose of Conducting a Tax Audit

The main goal of a tax audit is to ensure compliance with the provisions of the Income Tax Act. It simplifies the process of filing returns and helps uncover discrepancies or errors in the accounts early. This ensures accurate disclosure and makes it easier for the tax department to review the return filed.

Who Needs to Undergo a Tax Audit?

A tax audit is mandatory in the following cases:

• Businesses with total sales, turnover, or gross receipts exceeding ₹1 crore in a financial year.
  
  

• Professionals whose total receipts exceed ₹50 lakh, unless at least 95% of receipts are digital—in which case, the limit extends to ₹75 lakh.
  
  

• Those under presumptive taxation who declare profits below the required percentage or choose to exit the scheme.
  
  

Following amendments by the Finance Act, 2021, businesses with turnover up to ₹10 crore may be exempt if their cash transactions are limited to 5% or less of total transactions.

Who Is Required to Undergo a Tax Audit in India?

Under Indian tax laws, certain individuals and entities are required to have their accounts audited. These tax audits apply to specific categories as mandated by the Income Tax Act.

Any business whose annual turnover, sales, or receipts exceed ₹1 crore is obligated to undergo a tax audit. For professionals, this requirement applies if total receipts go beyond ₹50 lakh in a financial year. Professionals include fields such as engineering, law, medicine, architecture, interior design, and more. The complete list of qualifying professions can be found in Rule 6F of the Income Tax Rules, 1962.

If you’re availing of the presumptive taxation scheme and your turnover surpasses ₹2 crore, a tax audit becomes necessary. Additionally, if your declared profits are lower than those specified under the presumptive scheme, a tax audit is also required to substantiate the lower profit claim.

Failure to conduct a mandatory tax audit may lead to penalties. However, Section 273B provides exceptions for genuine causes such as natural disasters, strikes, theft of records, or auditor resignation, where delays or omissions might be condoned.

Who Can Conduct a Tax Audit?

A tax audit must be performed by a Chartered Accountant or a CA firm. There is a cap of 60 audits per Chartered Accountant. In the case of a CA firm, this limit applies separately to each partner.

What Is the Turnover Threshold for a Tax Audit?

A tax audit is required if:

• Business turnover exceeds ₹1 crore
  
  

• Professional receipts exceed ₹50 lakh
  
  

Other specific cases, such as opting out of presumptive taxation or declaring lower profits, may also require a tax audit.

Recent Changes to Tax Audit Rules

As per the Finance Act, 2021, effective from April 1, 2021, the audit threshold for businesses was raised to ₹10 crore. This higher limit applies only if cash transactions (both receipts and payments) do not exceed 5% of total transactions.

This change provides relief to businesses that primarily operate digitally, promoting reduced reliance on cash dealings.

Who Must Undergo a Tax Audit?

The following categories of taxpayers are required to get their accounts audited under the Income Tax Act, based on specific criteria:

1. Businesses

2. Professionals

3. Business Reporting a Loss

Key Rules for Conducting a Tax Audit in India

Understanding the tax audit regulations is crucial for staying compliant. Here are the primary guidelines to keep in mind:

1. Running Multiple Businesses
If you manage more than one business, and the combined turnover exceeds ₹1 crore, you are required to have your accounts audited, regardless of the turnover of each individual business.

2. Engaging in Multiple Professions
In cases where you’re involved in several professional services, a tax audit becomes mandatory if the total gross receipts from all professions together go beyond ₹50 lakh in a financial year.

3. Operating Both Business and Profession
If you run both a business and a profession, each must be considered separately. A tax audit is only required if either:

• The business turnover is above ₹1 crore, or
  
  

• The professional receipts exceed ₹50 lakh.
  For instance, if your business turnover is ₹90 lakh and your professional earnings are ₹40 lakh, a tax audit is not necessary.
  
  

4. Turnover vs. Income from Asset Sales
When calculating turnover, earnings from the sale of fixed or capital assets (like property or vehicles) do not count as business income. Items excluded from turnover/gross receipts include:

• Capital investments (e.g., stocks, bonds, mutual funds)
  
  

• Sale of fixed assets
  
  

• Rental income
  
  

• Non-business interest earnings
  
  

• Reimbursements received from clients
  
  

5. Revising a Filed Tax Audit Report
Once a tax audit report is submitted electronically, it cannot be modified casually. However, revisions are allowed if:

• The books of accounts are updated (e.g., post-AGM adjustments)
  
  

• Legal amendments or changes in interpretation arise
  The revised report must include a valid reason for the correction while filing.
  
  

How Is a Tax Audit Conducted in India?

A tax audit involves submitting specific forms based on the type of entity and requirement. The commonly used forms include:

• Form 3CA – For companies or professionals where an audit is already mandated under another law.
  
  

• Form 3CB – Applicable to entities where no legal requirement for an audit exists apart from the tax audit.
  
  

• Form 3CD – A detailed annexure to Forms 3CA/3CB that outlines essential information about the taxpayer’s financial activities.
  
  

• Form 3CE – Used by non-residents or foreign entities who receive fees or royalties from the Indian government or businesses in exchange for technical services.
  
  

The Direct Taxes Committee of the ICAI regularly issues guidance notes to help Chartered Accountants stay updated with tax audit procedures and form changes. For instance, in 2018, significant updates were made to Form 3CD to reflect changes in reporting requirements.

When Should the Tax Audit Report Be Filed?

Once the audit is completed, your auditor will electronically share the tax audit report for your approval and submission. You have the right to reject this report if needed; however, doing so will require the audit process to start from the beginning. The due date to file the tax audit report is 30th September of the assessment year. For entities required to submit Form 3CE, the deadline is 30th November of the assessment year.

Understanding the tax audit process is a crucial part of income tax compliance. Equally important is knowing how to compute taxable income and take steps to legally reduce your tax burden.

How to Calculate Taxable Income for Your Business

As previously stated, a tax audit becomes necessary if your business turnover exceeds ₹1 crore or professional receipts exceed ₹50 lakh in a financial year. However, if you’re engaged in both business and profession, the audit requirement is not based on your combined income. For example, if your business turnover is ₹95 lakh and professional income is ₹48 lakh, a tax audit is not required.

It’s also important to know what doesn’t count as business income when determining taxable income. Profits from the sale of fixed assets like vehicles or machinery, returns on investment assets like mutual funds or shares, rental income, client reimbursements, and non-business interest earnings are not included if your total income is below the specified threshold.

How to Reduce Your Tax Liability as a Business Owner or Professional

• Purchase in your business name: Buying capital assets like smartphones, laptops, or vehicles under your company allows you to claim depreciation.
  
  

• Treat utilities as business expenses: Costs such as internet, electricity, and air conditioning can be claimed as business-related deductions.
  
  

• File returns before the deadline: Doing so not only ensures compliance but also enables you to carry forward business losses for up to eight years.
  
  

• Stay updated with tax regulations: Government updates can provide additional deductions, especially for MSMEs. Being informed ensures you don’t miss out on benefits.
  
  

• Claim business-related expenses: Travel, meals with clients, or other work-related costs can be written off, provided you keep detailed bills and receipts.
  
  

• Utilize start-up expense deductions: Costs incurred before your business officially begins—known as preliminary expenses—can be claimed under Section 35D over five years.
  
  

Following these strategies helps lower your taxable income and ensures you’re prepared for a timely tax audit. Remember, not filing your audit on time may cost you up to ₹1.5 lakh in penalties.

Penalty for Delay or Non-Filing of Tax Audit Report

If you fail to complete or submit a required tax audit within the stipulated deadline, you may face a penalty. This is calculated as the lower of 0.5% of your total turnover or ₹1,50,000. The intent of this penalty is to promote timely submission of accurate financial records and uphold compliance with tax norms.

That said, penalties can be waived in certain situations. Exemptions are allowed in cases of:

• Natural disasters impacting business
  
  

• Sudden resignation of the auditor
  
  

• Extended strikes or lockouts
  
  

• Loss of records due to unforeseen events
  
  

• Illness or death of the person responsible for accounting
  
  

Such genuine, uncontrollable circumstances are taken into consideration to provide relief from penalties for delayed compliance.

Distinction Between Tax Audit and Statutory Audit

While both tax audit and statutory audit involve reviewing a company’s financial records, their objectives and scope differ significantly. The table below outlines the primary differences between the two:

Types of Audits in India

In India, audits can be categorized based on how they are conducted. The three primary types include:

1. Field Audit
   Carried out at the taxpayer’s business premises. If needed, it can also take place at the workplace of an employee or representative, in which case relevant records must be provided at that location.
   
   

2. Office Audit
   Takes place at a designated tax office. The taxpayer is informed in advance via a notice outlining which documents need to be brought during the visit.
   
   

3. Correspondence Audit
   This involves receiving a written request from the tax department for specific documents related to your tax return. You are expected to respond by mailing the necessary records as per the instructions given.
   
   

Conclusion

Tax audits in India serve as an essential tool to ensure accurate reporting of income and strict adherence to tax regulations by businesses and professionals. Their primary aim is to validate the correctness of declared income, deductions, and other financial information, ultimately helping to prevent tax evasion and uphold transparency.

These audits become compulsory for taxpayers once certain thresholds are crossed—₹10 crore in turnover for businesses with minimal cash dealings and ₹50 lakh in gross receipts for professionals. Conducted by certified Chartered Accountants, tax audits follow specific procedures and formats mandated by the Income Tax Department.

Familiarity with the turnover criteria and applicable rules is key to staying compliant. Timely and accurate preparation of the audit report not only avoids penalties but also simplifies the tax filing process. Additionally, understanding how to correctly compute taxable income and lawfully reduce tax liability through deductions and exemptions can offer significant financial advantages.

It’s equally important to distinguish between tax and statutory audits. While statutory audits are focused on validating financial statements under company law, tax audits concentrate on compliance with the Income Tax Act. Various audit types—including internal, compliance, and statutory audits—help maintain comprehensive oversight of financial operations.

In summary, tax audits play a vital role in India’s financial and regulatory system, reinforcing integrity and compliance across the professional and business landscape.