Tax Audit as a Tool for Lower Profit Declaration Under Income-Tax Act 2025

Introduction

As professionals, we are allowed to declare a minimum of 50% of our gross receipts as income for tax computation under the presumptive taxation scheme. Similarly, for businesses where cash receipts and cash payments do not exceed 5% of total transactions, income can be declared at 6% of total turnover, whereas for other businesses it is 8% of turnover. Now, what happens if a businessman or a professional want to declare income lower than these prescribed rates? They choose tax audits but it right as per Income-tax Act, 2025 (“ITA 2025”)? What does law say about this? Let’s discuss.

Provision

I was reading and interpreting the provisions of the ITA 2025 in this regard and understood that already among tax professionals this issue has generated considerable discussion, particularly regarding the applicability of tax audit where income is declared lower than presumptive income under Section 58 (formerly 44AD). The issue appears technical at first glance, but its impact may extend to lakhs of small businesses and professionals who rely upon presumptive taxation for ease of compliance.

This issue mainly revolves around whether every taxpayer opting for presumptive taxation and declaring lower profits would now compulsorily require a tax audit, even in ordinary business cases(I will be giving examples as well ahead). While one interpretation gives that now scope of audit will get wider, as it will cover many assesses while another view states that the law may not have intended such a broad consequence as it’s intent is to reduce compliance burden.

Presumptive taxation

As we know that presumptive taxation is a simplified taxation scheme where the government presumes a fixed percentage of profit and allows taxpayers to pay tax without maintaining detailed books of account. Hence, instead of calculating actual profit, the law assumes profit at a prescribed percentage of turnover or receipts.

Under the Income-tax Act, 2025, Section 58 deals with presumptive taxation and Section 63 deals with compulsory tax audit.

The scheme broadly covers:

Example of people who can opt of this scheme are traders, small manufacturers, retailers, transporters, doctors, architects, consultants, professionals etc with a purpose that compliance burden can be reduced, maintenance of complex books can be avoided, simpler tax filing and encouraging voluntary tax compliance.

What am I trying to discuss?

The confusion arises from Section 58(3) of ITA 2025, as this provision states that if an assessee declares income lower than presumptive income and total income exceeds the basic exemption limit, then the books of account must be maintained, and tax audit under Section 63 becomes mandatory.

When I read it first time at that time, this provision appeared to be straightforward, However, maybe the drafting created some ambiguity regarding whether this rule applies to all presumptive taxpayers, or only certain specified categories. This distinction is extremely important because it may determine whether lakhs of small businesses will now require compulsory tax audit.

One of the interpretation of this section argues that Section 58(3) applies universally to all categories covered under Section 58(2).

The reasoning is based on the language:

“Any assessee mentioned in column C of the Table in sub-section (2)”

Since all categories fall within that table, this interpretation states that any lower profit declaration, by any presumptive taxpayer automatically triggers audit.

As per this interpretation, audit is required if either a retail trader or a freelancer or any of the transport business declaring lower income. Hence, this would significantly widen the audit net.

Practical problems

Such an interpretation may create serious practical and policy concerns as it defeats the main purpose of presumptive scheme as it exists to reduce compliance burden, and if every lower declaration leads to audit, then it may be the reason that the small taxpayers will be avoiding genuine disclosures, businesses that are suffering losses may be forced to get expensive audits done, compliance cost may become disproportionate, etc.

Illustration

A small shopkeeper with Rs. 60 lakh turnover may genuinely earn only 3% profit due to Competition, online discounts, high rent, economic slowdown, etc, but as per above interpretation, declaring actual income could trigger mandatory audit. This also goes against the objective of ease of doing business.

On the other hand this even creates the redundancy in other sections, as I tried to point out that Sections 58(7), 58(8), and Section 63 already contain specific provisions dealing with audit consequences, but if Section 58(3) would cover all the cases, then why were these additional provisions inserted? Why create separate audit triggers?

As per my experience, the courts generally avoid interpretations that make statutory provisions redundant. This principle is called “Doctrine of Harmonious Construction” which means every section should be interpreted in a way that gives effect to all provisions.

The alternative interpretation

I feel it’s the more sensible interpretation as it suggests that Section 58(3) may apply only to goods carriage business, and the specified professions. The reasoning is highly technical but legally significant, for others filing a simple ITR form 3 will work.

Here, Section 58(3) uses the phrase “specified business or profession”, Supporters of this interpretation argue that serial no. 2 and 3 are specifically identified activities, whereas serial No. 1 is a general residual category. Therefore “specified business” may not include ordinary business under serial no. 1, which gives a sensible interpretation.

Future litigation

This controversy has high litigation potential because the wording supports more than one interpretation as discussed by me, the both interpretations have legal backing, and the financial consequences are substantial and as far as my experience is seen, the tax officers initially adopt stricter interpretations to expand audit applicability.

However, on the other hand the appellate authorities and courts may examine legislative intent, scheme of presumptive taxation, practical consequences, harmonious interpretation principles, until the clarity emerges, taxpayers and professionals may adopt differing positions based on their risk appetite.

Impact on small businesses

If strict interpretation is adopted, consequences may include increased compliance cost, Small taxpayers may need to get their books audited, with a proper bookkeeping, and a detailed documentation, this will lead to higher litigation and the disputes may arise regarding applicability, penalties, and validity of audit notices.

Example

Suppose a trader has turnover of Rs. 1 crore, presumptive rate assumes 8% profit, presumptive income becomes Rs. 8 lakhs but due to poor market conditions, actual profit is only Rs. 4 lakhs.

Here, If the strict interpretation is followed, then in this case this trader must maintain books, get accounts audited, face higher compliance burden, but if other interpretation is accepted then the audit may not automatically apply in ordinary business cases, ITR 3 will work. Hence, this single issue can significantly affect small businesses.

Judicial pronouncements

Here I am trying to include the most important and relevant judicial pronouncements that delt with presumptive taxation via actual profit, Whether lower profit can be accepted, best judgment assessment and estimation of income, the importance of audited books over presumptive percentages and principle that presumptive provisions are optional, not mandatory.

CIT v. Surinder Pal Anand Citation: (2010) 48 DTR 135 (P&H)

It states that Section 44AD is a beneficial provision, that means once assessee opts for presumptive taxation, detailed scrutiny of expenses is not required, presumptive provisions are meant to simplify compliance.

CIT v. Bhaichand H. Gandhi Citation: (1983) 141 ITR 67 (Bom.)

Tax provisions intended to simplify compliance should be interpreted liberally in favour of taxpayers unless legislature clearly provides otherwise. As I stated earlier in the article, the intent of this section 58(3) should not be interpreted expansively to mandate audit in every lower-profit case.

Kachwala Gems v. Joint CIT Citation: (2007) 288 ITR 10 (SC)

It gave judgement stating that estimation of income is permissible, However estimation cannot be arbitrary and also stated that the past history of assessee is an important factor. Hence, if taxpayer shows lower profit than presumptive rate and maintains books, actual results cannot be ignored merely because presumptive percentage is higher.

CIT v. Gotan Lime Khanij Udyog Citation: 256 ITR 243 (Raj)

It gave judgement that where books are accepted, income cannot be estimated without specific defects. Hence it supports the proposition that audited books showing lower profit deserve consideration.

CIT v. A. Krishnaswami MudaliarCitation: 53 ITR 122 (SC)

Books regularly maintained and found reliable carry significant evidentiary value. It strengthens the argument that audited accounts reflecting lower income cannot be brushed aside merely because presumptive rates exist.

Padmanaban Prabaharan v. ITO Citation: ITA No. 1603/Chny/2026, Assessment Year: 2016-17 of ITAT Chennai

The ITAT recently held that income cannot automatically be estimated at 8% merely because turnover exists where books were audited, past profit history was lower, no serious defects were found. The tribunal reduced estimation from 8% to 4%.

Even Supreme court opted principle of interpretation via CIT v. Hindustan Bulk Carriers with citation, (2003) 259 ITR 449 (SC) stating that a provision should not be interpreted in a manner that renders another provision redundant. This directly supports our argument that Sections 58(7), 58(8) and 63.

Conclusion

One view suggests that every lower profit declaration under presumptive taxation triggers compulsory tax audit, another interpretation restricts such applicability only to specified businesses and professions. Sections 58 and 63 indicates that ordinary businesses may not automatically fall within mandatory audit merely because lower profits are declared. At the same time, absence of express clarity keeps the issue prone to departmental disputes as well as future litigation.

As I gave examples in above articles, for the small taxpayers, the final interpretation is crucial as it directly affects compliance burden, professional costs, and ease of doing business. Also a harmonious reading of Sections 58 and 63 indicates that the legislature did not intend compulsory audit for every ordinary business declaring lower profits. However, the issue remains susceptible to litigation until CBDT clarification or judicial interpretation emerges.

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Author can be contacted at aman.rajput@mail.ca.in