Quick Summary
- A tax audit is conducted to verify the accuracy and compliance of tax returns filed by individuals and businesses under the Indian Income Tax Act.
- Understanding the tax audit process will help in audit preparation and avoiding any errors in tax returns.
- Each type of audit serves different purposes and involves varying levels of scrutiny depending on the complexity and scale of the taxpayer’s operations.
Table of Contents
An income tax audit is conducted to evaluate or review the accounts of any individual or business to ensure that tax returns are accurately filed. The accounts are scrutinized or inspected during an audit to verify if they are in accordance with Indian income tax laws and regulations. It aims to ensure the factual veracity of the returns filed and keep fraudulent tax practices in check. A tax audit is mandatory as per the Section 44AB of the Income Tax Act, 1961 for a specific class of taxpayers.
Charted Accountant conducts tax audits on behalf of the Income Tax Department, The chartered accountant appointed for conducting a tax audit goes through the taxpayer’s financial records and verifies their compliance with various tax provisions. After completing the audit, the CA draws a report which the taxpayer must file along with their tax returns.
If tax auditors identify any errors during the tax audit, the taxpayer may be required to pay penalties, additional tax, and interest. So, a taxpayer must maintain accurate and complete records and ensure accordance with the income tax laws and provisions to avoid any hassles during the tax audit.
Understanding tax audits can help taxpayers ensure that they comply with tax laws. By being knowledgeable about tax audits and audit preparation, taxpayers can reduce the occurrence of discrepancies in their tax returns. Doing so can also help them communicate efficiently with tax auditors and help ensure a smoother audit process.
Further, understanding tax audits can help identify opportunities for tax savings and minimize the risk of future audits. It enables a taxpayer to devise a tax-paying strategy to optimize their tax situation.
Objectives of Tax Audit
Tax auditors conduct a tax audit to verify that businesses or individuals accurately file information regarding income, expenditure, and tax-deductible expenditures.
We can further summarize the objectives of a tax audit as follows:
- It ensures that all business owners maintain books of accounts accurately and are verified by a tax auditor.
- It helps to provide a report of observations after a method-bound examination of the books of account of the business.
- It reports recommended information such as compliance with different provisions of the income tax laws.
- It enables the tax authorities to check the accuracy of income tax returns.
- It makes it easier to calculate and verify information such as total income, claims for deductions, and so on, provided by the taxpayer.
- It helps prevent any fraudulent tax practices by business owners.
Also Read: Understanding Direct Tax and Indirect Tax: What You Need to Know
Why Is a Tax Audit Conducted?
The main purpose of conducting a tax audit is to ensure that individuals or businesses comply with the tax laws laid down in the Income Tax Act of India. Upon completion, it makes it easier for the taxpayer to file tax returns.
A tax audit checks for any inaccuracies at an early stage by looking at account books. It also ensures that the information disclosed by the taxpayer is factually accurate. Further, it makes it easier for the tax authorities to examine income tax returns.
Who Is Mandatorily Subject to a Tax Audit?
There are certain categories of taxpayers for whom a tax audit is necessary. Let’s have a look at them.
| Category of Person | Threshold |
| Business | |
| Businesses not opting for presumptive tax scheme | Total sales, turnover or gross receipts exceed Rs 1 crore in the FY |
| Businesses eligible for presumptive taxation under Section 44AE, 44BB or 44BBB | Profits or gains claimed below the prescribed limit under the presumptive tax scheme. |
| Businesses eligible for presumptive taxation under Section 44AE, 44BB or 44BBB | Taxable income is less than the prescribed limit but exceeds the basic threshold limit |
| Businesses cannot claim presumptive taxation under Section 44AD if they opt out for any one financial year during the lock-in period. | If income exceeds the non-taxable limit for five consecutive tax years after opting out of presumptive taxation. |
| Businesses declaring profits as per presumptive taxation scheme under Section 44AD | Total sales, turnover or gross receipts is less than Rs 2 crore in the financial year |
| Profession | |
| Carrying on Profession | Total gross receipts exceed Rs 50 lakh in the financial year |
| Profession eligible for presumptive taxation under Section 44ADA | Claims profits or gains which are less than the prescribed limit u/s 44ADA. The total income exceeds the basic exemption limit |
| Business Loss | |
| Businesses incurring losses that do not opt for presumptive scheme | Total sales exceed 1 crore |
| Total income exceeds the basic threshold limit but the taxpayer has incurred a loss | Sales above 11 crores |
| Businesses that opt for a presumptive scheme u/s 44AD but with income below the basic threshold limit | Tax audit not applicable |
| A business that opts for a presumptive scheme u/s 44AD but with a total income that exceeds the basic exemption limit | Taxable income declared below the limits prescribed under the presumptive tax scheme but exceeding the basic threshold limit. |
Types of Tax Audit in India
There are three main types of tax audits.They are
i) Correspondence Audit
This is considered to be the simplest form of an audit. In this audit, the IRS will send a letter that will mention the documents needed for the tax audit process. Based on the instruction, the taxpayer needs to mail the documents to the address provided in the mail.
ii) Office Audit
They conduct field audits at the office of the IRS. The taxpayer needs to carry all the necessary documents to the office to ensure a successful audit. Usually, we send a letter beforehand detailing the documents.
iii) Field Audit
They conduct field audits at the taxpayer’s office to do a thorough examination of the records. All the necessary documents need to be provided at the time of the audit.
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What to Do if You Receive a Tax Audit Notice
If you receive a tax audit notice, you do not have to panic. Just take care of the following steps.
- If you receive a tax audit notice, you must respond to it within the stipulated time. In case of any scrutiny arising, provide the department with the required documents to verify the details.
- Take an expert’s advice if you are not able to understand the terms of the notice yourself. You may take the help of a chartered accountant to understand how to deal with the notice.
- You may have to pay a huge penalty according to income tax laws if you don’t respond to the notices in time. Also, try to pay your returns on time to avoid getting any notices.
How to Reduce Tax Liability as a Business Owner or Professional
Your tax liability is the amount you owe the income tax department, local or state government. Anything that you need to pay taxes on is a tax liability. Also, there are many ways you can reduce tax liability as a business owner or professional. Here are some of them.
i) Limit Cash Transactions
If you pay a worker more than Rs. 20,000 in a day, you will not be eligible for deductions of expenses. So, make bank transfers to your employees instead. Also, ensure you record all the expenses you make.
ii) Donations
You can avail of tax benefits by donating to a registered charity and fund.
iii) Utility Expenses
The expenses you incur on your phone or vehicle for business purposes can be shown as utility expenses. These are liable for deductions.
iv) Depreciation
New machinery and equipment that are installed get a tax depreciation in that year.
v) Deduct Tax at the Source
If you deduct tax at the source when making a payment, it can reduce your tax burden.
Understanding Tax Audit Process: Key Takeaways
Tax authorities conduct a tax audit to verify whether taxpayers have complied with various tax provisions. Understanding the tax audit process will help in audit preparation and avoiding any errors in tax returns. Noncompliance can lead to penalties, additional taxes, and interest. So, taxpayers should file tax returns on time to avoid receiving any notices. Additionally, business owners or professionals can take steps to reduce tax liability.
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Frequently Asked Questions
Who is eligible for a tax audit?
A tax audit is necessary if a taxpayer’s sales, gross receipts, or turnover exceeds Rs.1 crore in a year.
Who is exempt from tax audits?
If a business’ total sales, turnover, or gross receipts are not over Rs. 2 crores in a year, they are exempt from a tax audit.
What are 3CA 3CB and 3CD?
Tax audit findings have to be provided in a report using audit forms. The statement with auditors’ information is Form 3CA and 3CB. On the other hand, the statement with details of the audit is from 3CD.
What is the tax audit limit of 10 crores?
The threshold limit that has been increased from Rs. 5 crores to Rs. 10 crores is applicable only when cash receipts and cash payments don’t exceed 5% of the total receipt or payment in a financial year.
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