As businesses gear up to close their financial books for the year ending March 31, 2025, preparation for tax audits under the Income-tax Act, 1961 is already underway. For entities crossing the prescribed turnover thresholds or meeting other criteria under Section 44AB, a tax audit becomes a statutory requirement. Proper planning, timely documentation, and awareness of common pitfalls are key to ensuring a smooth and compliant tax audit process.
This blog outlines the essential steps and considerations for businesses to prepare for the tax audit for Financial Year (FY) 2024–25, covering turnover thresholds, important documentation, clauses under Form 3CD, disallowances under Section 40, and sector-specific considerations.
Understanding Applicability: Turnover Thresholds under Section 44AB
A tax audit is mandatory under Section 44AB of the Income-tax Act if a business’s gross receipts or turnover exceed ₹1 crore during the financial year. However, the threshold is enhanced to ₹10 crore where the aggregate of cash receipts and cash payments does not exceed 5% of total receipts and payments respectively.
For professionals, a tax audit is applicable if gross receipts exceed ₹50 lakhs in a financial year.
Additionally, presumptive taxation cases under Sections 44AD, 44ADA, or 44AE opting out of the scheme may also attract tax audit if their income is lower than the presumptive income and their total income exceeds the basic exemption limit.
Businesses must evaluate their position carefully to determine applicability based on their turnover and the nature of their operations.
Compile Documentation in Advance
Timely preparation of records can significantly ease the audit process. Businesses should ensure that the following documents are compiled and updated:
- Books of Accounts: Ledger, cash book, journal, inventory records, and subsidiary books.
- Bank Statements and Reconciliations: Ensure all bank accounts are reconciled and supported by proper explanations for significant transactions.
- Fixed Asset Register: Update depreciation schedules and ensure proper tagging and identification of assets.
- GST Returns and Reconciliation: Align turnover as per GST returns with the financial statements and Form 3CD disclosures.
- TDS Returns and Challans: Verify timely deposit of TDS and matching of TDS figures with books and Form 26AS.
- Loan Agreements and Interest Certificates: Especially important if interest is claimed under Section 36(1)(iii).
- Expense Invoices and Vouchers: Ensure completeness and availability of proper documentation for all material expenses.
Digital tools or accounting software can streamline documentation management and make it audit-ready.
Key Clauses under Form 3CD: What to Watch Out For
Form 3CD is a detailed audit report containing 44 clauses covering various financial and compliance aspects. Some critical clauses businesses should particularly focus on include:
- Clause 21(b): Disallowances under Section 40(a) and 40A—commonly scrutinized.
- Clause 16: Details of amounts not credited to the profit and loss account, like capital receipts.
- Clause 34: TDS/TCS compliance—non-deduction or late payment can result in disallowance of expenses.
- Clause 27: Reporting of transfer pricing compliance under Section 92E, if applicable.
- Clause 24: Deemed income under Section 41, such as recovery of previously disallowed expenses.
Businesses should engage proactively with their Chartered Accountant to ensure each clause is addressed with sufficient supporting documentation and justification.
Common Disallowances under Section 40: Avoidable Errors
Section 40 is one of the most referenced provisions during a tax audit. Common disallowances under this section that businesses should safeguard against include:
- Section 40(a)(i)/(ia): Expenses on which tax was deductible but not deducted or not deposited within the due date.
- Section 40A(3): Cash payments exceeding ₹10,000 to a single party on a single day—unless covered by exceptions.
- Section 40A(2)(b): Excessive payments to related parties—must be justified as being at arm’s length.
- Section 40(b): In case of partnership firms, disallowance of remuneration and interest to partners if it exceeds limits specified under the Act.
To avoid such disallowances, businesses must review their payments, ensure timely TDS compliance, and maintain transaction-wise clarity in books.
Industry-Specific Considerations
While the general principles of tax audit remain the same, certain sectors require additional care:
- Manufacturing and Trading: Inventory reconciliation, movement of goods, and valuation methods must be well-documented.
- Construction and Real Estate: Recognition of revenue as per project completion or percentage of completion method must be disclosed consistently.
- Service Sector: Proper linkage between invoice generation, revenue recognition, and GST returns is crucial.
- Startups and Tech Firms: ESOPs, deferred revenue, and foreign remittances should be clearly reported and substantiated.
Sector-specific peculiarities should be communicated to auditors in advance, and relevant policies must be disclosed.
Timeline and Coordination
The due date for furnishing the tax audit report (Form 3CB and 3CD) for FY 2024–25 is 30th September 2025, unless extended by CBDT. It is advisable not to leave things to the last minute. Businesses should aim to complete the audit well in advance to allow for final tax return filing by 31st October 2025 (for audit cases).
Smooth coordination between internal finance teams and the tax auditor can reduce last-minute errors, save time, and avoid penalties for non-compliance.
Final Thoughts
A tax audit is more than just a compliance exercise—it provides an opportunity for businesses to evaluate their financial practices, detect inefficiencies, and strengthen internal controls. By preparing early and being aware of common audit challenges, businesses can not only ensure compliance but also demonstrate their commitment to transparency and good governance.
Engaging with a Chartered Accountant at the planning stage can make a substantial difference in managing audit risks and ensuring seamless completion. As tax laws evolve and compliance becomes more stringent, proactive preparation remains the most reliable strategy for businesses to navigate the audit season efficiently.
