Tax Audit under Income Tax Act – Applicability, Limit & Penalty Explained

Introduction to Tax Audit

A Tax Audit, under the Income Tax Act, 1961, is an examination of the books of accounts of a business or profession by a Chartered Accountant to ensure compliance with the provisions of the Income Tax Law. The primary objective is to verify the accuracy of income, deductions, and adherence to tax regulations. This helps in transparent reporting of income and facilitates the assessment process by the income tax authorities.

The provisions governing tax audits are primarily laid down in Section 44AB of the Income Tax Act.

Applicability of Tax Audit (Section 44AB)

A tax audit is mandatory for certain taxpayers based on their turnover or gross receipts from business or profession. Here's a breakdown of the applicability criteria:

1. For Businesses:

• Turnover exceeding specified limit: If the total sales, turnover, or gross receipts in a business exceed ₹1 Crore in the previous year.

  Example 1: A trading business has a turnover of ₹1.2 Crore in the financial year. Since the turnover exceeds ₹1 Crore, a tax audit is mandatory for this business.

  • Increased Limit (for certain businesses): The turnover limit for a tax audit has been increased to ₹10 Crore if the cash receipts and cash payments during the year do not exceed 5% of the total receipts and payments, respectively. This relaxation is aimed at promoting digital transactions.

    Example 2: A manufacturing business has a turnover of ₹8 Crore. Its total cash receipts are ₹30 Lakhs (3.75% of turnover) and cash payments are ₹25 Lakhs (3.125% of turnover). Since both cash receipts and payments are less than 5% of the total, and turnover is below ₹10 Crore, a tax audit is not mandatory for this business.

    Example 3: A service provider has a gross receipt of ₹12 Crore. Its total cash receipts are ₹80 Lakhs (6.67% of gross receipts). Even though the turnover is below ₹10 Crore, since cash receipts exceed the 5% limit, the ₹1 Crore threshold applies. Therefore, a tax audit is mandatory for this business.

• Opting out of Presumptive Taxation: If a person carrying on a business is eligible for presumptive taxation under Section 44AD but claims that their profits and gains are lower than the deemed profits under that section and their total income exceeds the basic exemption limit.
• Failure to file return under Presumptive Taxation: If a person eligible for presumptive taxation under Section 44AD has opted out of it in any of the preceding five assessment years and does not opt back in (i.e., claims lower income), and their total income exceeds the basic exemption limit.
• Specific cases under Section 44AE: Persons carrying on business of plying, hiring, or leasing goods carriages who declare income lower than the presumptive income under Section 44AE.

2. For Professions:

• Gross receipts exceeding specified limit: If the gross receipts from a profession exceed ₹50 Lakhs in the previous year.

  Example 4: A doctor has gross receipts from his medical practice of ₹65 Lakhs in the financial year. Since the gross receipts exceed ₹50 Lakhs, a tax audit is mandatory for his profession.

• Opting out of Presumptive Taxation: If a person carrying on a specified profession is eligible for presumptive taxation under Section 44ADA but claims that their profits and gains are lower than the deemed profits under that section and their total income exceeds the basic exemption limit.

3. Other Cases:

• Section 44BB: For non-resident assessees engaged in the business of exploration, etc., of mineral oils, who claim profits lower than the presumptive income.
• Section 44BBB: For foreign companies engaged in civil construction, etc., projects, who claim profits lower than the presumptive income.

Understanding Presumptive Taxation and Tax Audit

Sections 44AD, 44ADA, and 44AE offer presumptive taxation schemes, allowing eligible taxpayers to declare income at a prescribed rate without maintaining detailed books of accounts. However, a tax audit becomes relevant if they deviate from these provisions:

• Section 44AD (Eligible Businesses): Applicable to resident individuals, HUFs, and partnership firms (excluding LLP) with turnover up to ₹2 Crore. If the assessee declares profits lower than 6% (for digital receipts) or 8% (for other receipts) of the turnover and their total income is above the basic exemption limit, a tax audit is mandatory.

  Example 5 (44AD - No Audit): A small trading business has a turnover of ₹90 Lakhs, all received digitally. They declare a profit of ₹5.4 Lakhs (6% of turnover). Since they declared the minimum presumptive profit and their turnover is within the limit, a tax audit is not required.

  Example 6 (44AD - Audit Required): A small business has a turnover of ₹80 Lakhs, all received digitally. They declare a profit of only ₹4 Lakhs (5% of turnover), which is less than the presumptive 6%. If their total income (including this profit) is above the basic exemption limit (e.g., ₹3 Lakhs for individuals below 60 years), a tax audit is mandatory.

• Section 44ADA (Eligible Professions): Applicable to resident individuals and partnership firms (excluding LLP) with gross receipts up to ₹50 Lakhs from specified professions. If the assessee declares profits lower than 50% of the gross receipts and their total income is above the basic exemption limit, a tax audit is mandatory.

  Example 7 (44ADA - No Audit): An architect has gross receipts of ₹40 Lakhs. They declare a profit of ₹20 Lakhs (50% of gross receipts). Since they declared the minimum presumptive profit, a tax audit is not required.

  Example 8 (44ADA - Audit Required): A consultant has gross receipts of ₹30 Lakhs. They declare a profit of only ₹12 Lakhs (40% of gross receipts), which is less than the presumptive 50%. If their total income (including this profit) is above the basic exemption limit (e.g., ₹3 Lakhs for individuals below 60 years), a tax audit is mandatory.

• Section 44AE (Plying, Hiring, or Leasing Goods Carriages): Applicable to assessees owning up to 10 goods carriages. If the assessee declares income lower than the presumptive income prescribed per vehicle per month, a tax audit is mandatory.

Objectives and Scope of Tax Audit

The tax audit primarily involves:

• Verifying that the books of accounts are properly maintained.
• Reporting observations and discrepancies found by the auditor.
• Certifying the correctness of the financial statements.
• Ensuring compliance with various provisions of the Income Tax Act, such as TDS/ TCS provisions, maintenance of books, and depreciation calculations.
• Reporting specific information as required by Form 3CD (Tax Audit Report).

Due Date for Filing Tax Audit Report

The tax audit report, along with the income tax return, must be filed by the 31st of October of the assessment year for businesses and professionals requiring a tax audit. For international transactions or specified domestic transactions, the due date is 30th November.

Penalty for Non-Compliance with Tax Audit

Failure to get accounts audited or failure to furnish the audit report by the due date can attract a penalty under Section 271B of the Income Tax Act. The penalty is the lower of the following:

• 0.5% (half percent) of the total sales, turnover, or gross receipts from business or profession in the previous year.
• ₹1,50,000 (One Lakh Fifty Thousand Rupees).

Example 9 (Penalty Calculation): A business with a turnover of ₹2.5 Crore fails to get its accounts audited. The penalty would be the lower of:

• 0.5% of ₹2,50,00,000 = ₹1,25,000
• ₹1,50,000

Example 10 (Penalty Calculation with higher turnover): A business with a turnover of ₹5 Crore fails to get its accounts audited. The penalty would be the lower of:

• 0.5% of ₹5,00,00,000 = ₹2,50,000
• ₹1,50,000

However, no penalty shall be imposed if the assessee proves that there was a reasonable cause for such failure.

Documents and Forms for Tax Audit

• Form 3CA: Used when the assessee is already required to get their accounts audited under any other law (e.g., Companies Act).
• Form 3CB: Used when the assessee is not required to get their accounts audited under any other law.
• Form 3CD: This is the most crucial part of the Tax Audit Report, containing various disclosures required under the Income Tax Act, signed by the auditor.