When a tax audit applies, and what changes when it does

Owners usually learn that a tax audit applies to them in the month it is due. By then the useful decisions (about record-keeping, about timing, about whether the threshold could have been managed) are already behind them.

The threshold is not a single number

The common belief is that tax audit applies above one turnover figure. In practice the applicable threshold depends on several things at once:

• Whether you carry on business or a profession, since these have different limits
• The proportion of your receipts and payments made otherwise than in cash, which can raise the applicable limit substantially for businesses
• Whether you have opted into or out of a presumptive taxation scheme, and whether you have done so in earlier years
• Whether you are declaring profits lower than a presumptive scheme would deem

That last one surprises people most. A business below the turnover threshold can still be required to have accounts audited if it declares income below the presumptive rate and its total income exceeds the basic exemption limit.

Because the interaction is genuinely fact-specific, the applicable threshold for your case is a question to settle with your accountant at the start of the year, not at the end.

What changes before the audit

The requirement does not begin when the report is signed. It begins with what the auditor will need to see:

Records that support the figures. Not just a trial balance, but the underlying documentation. Purchase invoices, bank reconciliations, stock records, fixed asset register, loan confirmations.

Disclosures that need a year's worth of tracking. Several items in a tax audit report cannot be reconstructed at year end without considerable effort: payments attracting disallowance, amounts due to micro and small enterprises, loans accepted or repaid otherwise than through banking channels, and TDS compliance across every applicable section.

A business that has tracked these monthly signs off quickly. One that has not spends weeks reconstructing.

The consequence of missing it

There is a penalty for failure to get accounts audited, calculated with reference to turnover and subject to a ceiling. The monetary penalty, however, is often the smaller problem.

The larger problem is that an unaudited business with a requirement to be audited has a visible, dated gap in its record. That gap appears in every subsequent diligence, every loan application and every assessment, and it invites scrutiny of the years around it.

If you are near the threshold

Three practical points:

1. Determine it early in the year, not at the end. Whether you will cross is usually forecastable by the second quarter.
2. Understand how your payment and receipt modes affect the applicable limit. The proportion transacted through banking channels can materially change which threshold applies to you. Structuring genuine transactions through banking channels is ordinary good practice with a real consequence here.
3. Do not engineer turnover to stay below a line. Deferring genuine revenue to manage a threshold creates a worse problem than the one it solves, and it is visible in the year-on-year pattern.

What a tax audit is not

It is not an opinion on whether your business is well run, and it is not a statutory audit under company law. It is a report in a prescribed form, on prescribed particulars, for the tax authority's use.

It is also not, in itself, a sign of anything adverse. Crossing the threshold means the business grew.

On eligibility

Whether any particular Chartered Accountant may accept your tax audit engagement depends on independence requirements, existing relationships and limits on the number of such engagements. That is confirmed case by case before an engagement is accepted, not assumed.

Note. Thresholds, conditions and prescribed particulars change. Confirm the current position from the Income Tax Department's official resources or take advice on your specific facts.