Tax Audit FY 2025-26: Section 44AB, Form 3CD Nuances & AY 2026-27 Changes

Summary: The tax audit for the previous year 2025-26 occupies an unusual position as the last audit cycle under section 44AB of the Income-tax Act, 1961, before the Income-tax Act, 2025 applies from tax year 2026-27, and as the first full cycle in which the amendments to Form 3CD made by the Income-tax (Eighth Amendment) Rules, 2025 operate. The article examines the important qualifications and compliance nuances that can alter the general position under section 44AB, including the two independent and cumulative five-per-cent cash tests, the different denominators applicable to receipts and payments, the treatment of non-account-payee instruments, the practical meaning of turnover, the independent operation of section 44AB(e), and the consequences of section 44AD(4). It also addresses Clause 22 and section 43B(h) for payments to micro and small enterprises, Clause 20(b) and Clause 26 for employees’ and employers’ contributions, and the disclosures introduced by Notification No. 23/2025, including Clause 36B for share buy-back consideration. The discussion further covers Clause 31 and non-cash modes, revision of tax audit reports, and the transition to section 63 and Form No. 26 under the Income-tax Act, 2025, including new requirements concerning electronic books, server information, audit observations and the fee for delayed audit-report compliance. The article concludes that the value of tax audit increasingly depends upon the quality of verification and supporting documentation as the reporting framework moves to Form No. 26.

Tax audit under section 44AB: The nuances that decide that applicability and reporting for AY 2026-27

1. The 5% test in the first proviso is two tests, not one

The tax audit being completed for the previous year 2025-26 occupies an unusual position. It is the last audit cycle to be conducted under section 44AB of the Income-tax Act, 1961, since the Income-tax Act, 2025 has come into force with effect from 1 April 2026 and applies from tax year 2026-27. It is also the first full cycle in which every amendment made to Form 3CD by the Income-tax (Eighth Amendment) Rules, 2025 operates. The Institute of Chartered Accountants of India has released the eleventh edition of its Guidance Note on Tax Audit under Section 44AB of the Income-tax Act, 1961 (Revised 2026) and has stated that it is intended to be the concluding edition under the 1961 Act.

The provisions themselves are familiar. What continues to generate assessment adjustments, penalty proceedings and professional exposure are the nuances within them – the points at which a provision does not operate the way its summary suggests. The discussion below addresses those points, with the statutory position drawn from the Act, the Rules and material issued by the Central Board of Direct Taxes.

Section 44AB(a) requires audit where total sales, turnover or gross receipts in business exceed one crore rupees. The first proviso substitutes ten crore rupees for one crore rupees where two conditions are simultaneously satisfied: the aggregate of all amounts received, including for sales, turnover or gross receipts, in cash does not exceed five per cent of the said amount; and the aggregate of all payments made, including for expenditure, in cash does not exceed five per cent of the said payment.

Three features of this proviso are regularly overlooked.

First, the two limbs are independent and cumulative. Satisfaction of the receipts condition does not assist an assessee who fails the payments condition. An entity with negligible cash sales but substantial cash payments towards freight, daily wages or petty purchases falls back to the one crore rupee threshold.

Second, the denominators differ between the two limbs. The receipts limb tests cash receipts against total receipts; the payments limb tests cash payments against total payments. Neither is tested against turnover. Total receipts includes loans raised, capital introduced, proceeds of asset disposals and refunds; total payments includes loan repayments, capital expenditure, drawings and tax payments. Computing the ratio against turnover, which is the common shortcut, produces an incorrect result in both directions.

Third, the proviso to section 44AB provides that a payment or receipt by a cheque drawn on a bank or by a bank draft, which is not an account payee cheque or account payee bank draft, shall be deemed to be a payment or receipt in cash. Bearer and self-drawn instruments therefore count against the five per cent limits.

A contemporaneous working of the two ratios, with the composition of each denominator identified, is the appropriate audit record. Reconstructing it at the assessment stage is considerably harder.

2. Turnover is undefined in the statute

The Act does not define “total sales, turnover or gross receipts” for the purposes of section 44AB. The operative meaning is drawn from the ICAI Guidance Note, which has not been displaced by any departmental instruction.

The consequences are practical. Proceeds from the sale of a fixed asset or an investment do not form part of turnover. Trade discounts, sales returns and cancellations are deducted rather than added. Where goods and services tax is accounted for under the exclusive method and routed through a separate liability account, it does not form part of turnover; where the inclusive method is followed, the gross figure carries the tax. For an assessee whose net turnover lies near one crore rupees, the choice of accounting method can determine applicability. The method must be consistently applied and disclosed; a change made in the final quarter to avoid the threshold invites the obvious inference.

In derivatives, the Guidance Note position on turnover computation was revised, and the premium received on the sale of options is no longer added separately to the absolute profit and loss figures. Audit utilities and working paper templates carried forward from earlier years frequently continue to apply the superseded method, inflating turnover and drawing assessees into audit who are not covered.

3. Section 44AB(e) operates independently of turnover

Section 44AD(4) provides that where an eligible assessee declares profit in accordance with section 44AD for a previous year and thereafter declares profit not in accordance with that section for any of the five succeeding assessment years, the assessee shall not be eligible to claim the benefit of section 44AD for five assessment years subsequent to the assessment year in which the profit was not so declared. Section 44AB(e) then requires audit for those years if total income exceeds the maximum amount not chargeable to income-tax.

The nuance is that section 44AB(e) contains no turnover threshold. An assessee locked out under section 44AD(4) requires tax audit in each of the five barred assessment years wherever the basic exemption limit is crossed, irrespective of whether turnover is forty lakh rupees or four crore rupees. Small traders who declare a lower actual profit in a single adverse year frequently do so without appreciating that the consequence extends across five subsequent assessment years.

The converse position also requires care. An eligible assessee validly declaring income at or above the deemed rate under section 44AD, within the prescribed turnover limit, is outside section 44AB altogether. Crossing one crore rupees of turnover does not by itself attract audit for such an assessee.

4. Clause 22 and the deliberate exclusion of section 43B(h) from the proviso

Clause (22) of Form 3CD was substituted by Notification No. 23/2025 and now requires reporting of the amount payable to micro and small enterprises beyond the time limit specified in section 15 of the Micro, Small and Medium Enterprises Development Act, 2006, the interest inadmissible under section 23 of that Act, and a distinction between amounts paid within and beyond the prescribed period. TaxGuru’s coverage of Clause 22 and section 43B(h) also discusses the amended reporting framework.

The substantive provision is clause (h) of section 43B. Its distinguishing feature is that it stands excluded from the proviso to section 43B. For every other clause of section 43B, payment before the due date for furnishing the return under section 139(1) preserves the deduction in the year of accrual. For clause (h) it does not. Where a sum payable to a micro or small enterprise remains unpaid beyond the section 15 time limit as at the close of the previous year, the deduction shifts to the year of actual payment, and payment before the return due date is of no assistance.

Two boundaries determine the outcome and are frequently misapplied.

The first is the identification of the time limit. Section 15 of the MSMED Act requires payment on or before the date agreed in writing, which cannot exceed forty-five days from the day of acceptance or the day of deemed acceptance; where there is no written agreement, the period is fifteen days from that date. The clock therefore runs from acceptance or deemed acceptance of goods or services, not from the invoice date. Where the section 15 period had not expired as on 31 March, no disallowance arises even though the sum is outstanding.

The second is the class of supplier. Section 43B(h) applies to micro and small enterprises. Medium enterprises are outside its scope. The obligations under section 15 attach to suppliers who are micro or small enterprises within the meaning of the MSMED Act, and the position of entities registered on the Udyam portal solely in the capacity of traders continues to be a matter on which the Ministry of Micro, Small and Medium Enterprises has issued clarificatory guidance. A vendor master carrying the Udyam registration number, the enterprise classification and the nature of activity, supported by annual declarations from vendors, is the practical foundation for this clause. Consistency between the amounts reported in clause 22 and the half-yearly MSME Form I filed with the Registrar of Companies is a visible cross-registry check.

5. Clause 20(b) and clause 26 report different things and carry different consequences

The distinction between the employees’ contribution and the employer’s contribution to provident fund and employees’ state insurance is now settled. In Checkmate Services (P.) Ltd. v. Commissioner of Income Tax (Civil Appeal No. 2833 of 2016, judgment dated 12 October 2022), the Supreme Court held that the employees’ contribution, which reaches the assessee as a deemed receipt under section 2(24)(x), is deductible under section 36(1)(va) only if deposited within the due date prescribed by the relevant labour legislation. The relief available under section 43B, permitting payment up to the due date for furnishing the return, applies to the employer’s contribution and does not extend to the employees’ share.

The reporting consequence is that clause 20(b) requires the due date under the respective Act and the actual date of payment, month by month. Any delay results in a permanent disallowance for that month’s employees’ contribution. The corresponding employer’s contribution, if deposited before the return due date, remains allowable and is reported under clause 26.

An annual summary in clause 20(b) does not discharge the reporting requirement, because the provision operates month by month. Further, disallowances disclosed in clause 20(b) form the basis for adjustments at the processing stage under section 143(1)(a). Where a delay is reported in Form 3CD but the corresponding addition is not made in the return of income, an intimation follows as a matter of course.

6. The new disclosures introduced by Notification No. 23/2025

The Income-tax (Eighth Amendment) Rules, 2025, notified by Notification No. 23/2025 dated 28 March 2025 [F. No. 370142/10/2025-TPL, GSR 207(E)], apply to reports signed on or after 1 April 2025. The principal changes are summarised below. TaxGuru’s publication on CBDT’s amendment to Form 3CD reproduces the Notification and discusses these changes.

Clause 36B warrants particular attention. Following the amendments made by the Finance (No. 2) Act, 2024 with effect from 1 October 2024, the entire consideration received on buy-back is treated as dividend in the hands of the shareholder under section 2(22)(f), and the cost of acquisition of the shares is available as a capital loss. Reporting only the net gain understates the dividend income and omits the loss available for set-off. Both figures are required.

7. Clause 31 and the treatment of non-cash modes

Sections 269SS and 269T regulate the acceptance and repayment of loans, deposits and specified sums otherwise than by account payee cheque, account payee bank draft or the prescribed electronic modes, where the amount is twenty thousand rupees or more. Section 269ST prohibits receipt of two lakh rupees or more in cash from a person in a day, in respect of a single transaction, or in respect of transactions relating to one event or occasion. The corresponding penalties under sections 271D, 271E and 271DA are equal to the amount of the transaction, subject to the relief available under section 273B. TaxGuru’s summary of sections 269SS, 269ST and 269T and Clause 31 reporting provides related discussion.

Whether a settlement effected by journal entry, book adjustment or conversion of a liability constitutes acceptance or repayment “otherwise than by account payee cheque” has been the subject of extended litigation. The direction of departmental thinking is now discernible from the Frequently Asked Questions on Form No. 26 published by the Income Tax Department, which state that reporting covers all modes including journal entries, conversion of assets or liabilities and other non-cash modes, using prescribed mode codes. That is a reporting requirement rather than an extension of the substantive provision, but the appropriate course under the existing Form 3CD is to report such transactions in clause 31 with the mode described, and to record the assessee’s position in the observations rather than to omit the disclosure.

8. The limits on revision of the report

The third proviso to Rule 6G permits a revised report where payment is made subsequent to furnishing of the report and requires recalculation of the disallowance under section 40 or section 43B. That is the ground expressly contemplated by the Rule. A revised report on other grounds, including correction of a genuine computational error, carries the auditor’s reasons and a fresh Unique Document Identification Number. Revision undertaken to alter a considered professional position following the issue of a notice stands on an altogether different footing.

9. What changes from tax year 2026-27

Tax audit under the Income-tax Act, 2025 is governed by section 63, read with Rule 47 of the Income-tax Rules, 2026. The Frequently Asked Questions issued by the Income Tax Department confirm that Forms 3CA, 3CB and 3CD continue for previous years relevant to assessment years up to 2026-27, and that Form No. 26 applies for tax years commencing on or after 1 April 2026. The thresholds are unchanged. Form No. 26 consolidates the three existing forms into a single form comprising particulars of the assessee, the statement of particulars under section 63, and the two alternative audit reports corresponding to the erstwhile Forms 3CA and 3CB, with schedules that open only where the corresponding clause is answered in the affirmative.

Three consequences deserve advance attention. Rule 46 requires books maintained electronically to remain accessible in India at all times with a daily backup on servers located in India, and Form No. 26 requires disclosure of the internet protocol address and country of the server together with the address of the backup server. The audit report requires the impact on profit, loss or book profit of any observation, qualification, adverse remark, disclaimer or emphasis of matter in the statutory audit, and requires observations to be categorised as made on a test-check basis applying materiality, based on management representation, or unable to verify.

The third consequence is the most significant for assessees who habitually file late. Section 446 of the Income-tax Act, 2025 originally provided for a penalty for failure to get accounts audited, mirroring section 271B. The Finance Act, 2026 substituted sections 427 and 428 with effect from 1 April 2026, and failure to get the accounts audited and furnish the report under section 63 now attracts a fee of seventy-five thousand rupees for a delay of up to one month and one lakh fifty thousand rupees thereafter. A fee is not a penalty. The defence of reasonable cause under section 273B of the 1961 Act, which has for decades protected assessees who obtained the report in time but filed late, has no counterpart in a fee provision.

Conclusion

The provisions examined above share a common characteristic: each contains a qualification that displaces the general rule. The proviso to section 44AB imposes two tests rather than one. Section 44AB(e) applies without reference to turnover. Section 43B(h) is excluded from the proviso that saves every other clause of that section. Section 36(1)(va) is not relieved by section 43B. In each case, the general rule applied without the qualification produces the wrong answer.

The Supreme Court, in Shaji Poulose v. Institute of Chartered Accountants of India (Transferred Case (Civil) No. 29 of 2021, judgment dated 17 May 2024), while upholding the ceiling on the number of tax audit assignments, described the purpose of section 44AB as being to prevent evasion of taxes, plug loopholes enabling tax avoidance and facilitate tax administration. As the reporting framework moves to Form No. 26, with structured schedules, mandatory categorisation of observations and closer alignment with the return of income, the value of the exercise will depend increasingly on the quality of the underlying verification and the documentation supporting it.

Sources relied upon

• Income-tax Act, 1961 – sections 2(22)(e), 2(22)(f), 2(24)(x), 36(1)(va), 37(1), 40, 43B, 44AB, 44AD, 44ADA, 44BBC, 143(1)(a), 269SS, 269T, 269ST, 271B, 271D, 271DA, 271E, 273B
• Income-tax Rules, 1962 – Rule 6G, Rule 6GB, Form No. 3CA, Form No. 3CB, Form No. 3CD
• CBDT Notification No. 23/2025 dated 28 March 2025 [F. No. 370142/10/2025-TPL, GSR 207(E)] – Income-tax (Eighth Amendment) Rules, 2025
• CBDT Notification No. 9/2025 dated 21 January 2025 – Rule 6GB, conditions under section 44BBC
• Micro, Small and Medium Enterprises Development Act, 2006 – sections 15, 16 and 23
• Checkmate Services (P.) Ltd. v. Commissioner of Income Tax, Civil Appeal No. 2833 of 2016, Supreme Court of India, judgment dated 12 October 2022
• Shaji Poulose v. Institute of Chartered Accountants of India, Transferred Case (Civil) No. 29 of 2021, Supreme Court of India, judgment dated 17 May 2024
• Institute of Chartered Accountants of India, Direct Taxes Committee – Guidance Note on Tax Audit under Section 44AB of the Income-tax Act, 1961 (Revised 2026), Eleventh Edition
• Income-tax Act, 2025 – sections 63, 263(1), 427, 428, 515(3)(b); Income-tax Rules, 2026 – Rules 46 and 47; Form No. 26
• Income Tax Department – Form No. 26: Frequently Asked Questions, available at incometaxindia.gov.in
• Finance (No. 2) Act, 2024 and Finance Act, 2026