Opting for presumptive taxation while filing ITR? You may have to face tax audit; here's what you must know

One important yet relatively under-discussed change in the Income-tax Act, 2025 is the manner in which it deals with taxpayers eligible for presumptive taxation who declare profits lower than the prescribed presumptive rates.

Under the Income-tax Act, 1961, there was considerable debate regarding whether an eligible business covered by Section 44AD was mandatorily required to undergo a tax audit merely because it disclosed profits less than 6%/8% of the turnover. The new Act appears to have addressed this issue by introducing an explicit audit requirement.

This change has significant implications for small and medium businesses, particularly those operating on low margins.

Position Under the Income-tax Act, 1961

Prior to the amendment made to Section 44AD of the 1961 Act vide Finance Act 2016, the said Section laid down that in cases where the turnover declared is less than the prescribed percentage, an audit was mandatorily required. Sub-section (5) of Section 44AD as it stood before the amendment, read as under:

"(5) Notwithstanding anything contained in the foregoing provisions of this Section, an eligible assessee who claims that his profits and gains from eligible business are lower than the profits and gains specified in sub-Section (1) and whose total income exceeds the maximum amount not chargeable to income-tax, shall be required to keep and maintain such books of account and other documents as required under sub-Section (2) of Section 44AA and get them audited and furnish a report of such audit as required under Section 44AB."

After, the amendment Section 44AD read as follows:

"(4) Where an eligible assessee declares profit for any previous year in accordance with the provisions of this section and he declares profit for any of the five assessment years relevant to the previous year succeeding such previous year not in accordance with the provisions of sub-section (1), he shall not be eligible to claim the benefit of the provisions of this section for five assessment years subsequent to the assessment year relevant to the previous year in which the profit has not been declared in accordance with the provisions of sub-section (1).

(5) Notwithstanding anything contained in the foregoing provisions of this section, an eligible assessee to whom the provisions of sub-section (4) are applicable and whose total income exceeds the maximum amount which is not chargeable to income-tax, shall be required to keep and maintain such books of account and other documents as required under sub-Section (2) of Section 44AA and get them audited and furnish a report of such audit as required under Section 44AB."

Further, 44AB which governs the audit requirements provided that the audit would be required only if sub-Section (4) of 44AD was applicable. Thus the audit requirement in relation to Section 44AD was primarily linked to Section 44AD(4), the so-called five-year lock-in mechanism introduced by the Finance Act, 2016. When a taxpayer opted for presumptive taxation and subsequently declared income lower than the presumptive rate within the prescribed period, books of account and audit could become mandatory if the total income exceeded the basic exemption limit.

Therefore, there was a view that an assessee who had never opted for Section 44AD could maintain regular books, disclose actual profits below 6%/8%, and avoid audit provided the turnover remained below the applicable audit threshold. This interpretation was not free from controversy, but the absence of an express statutory provision gave rise to differing views.

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New Framework Under the Income-tax Act, 2025

The Income-tax Act, 2025 replaces Section 44AD with Section 58 and Section 44AB with Section 63.
While the presumptive income rates and turnover thresholds have largely been retained, the language of the audit provision has undergone a significant change.

Section 58 continues to prescribe deemed profits for eligible businesses at 8% and 6% depending upon the conditions therein. The noteworthy change emerges from Section 58(3) read with Section 63(1) Table Serial No. 2, which sets out circumstances requiring tax audit. Under the new scheme, an audit is expressly attracted where a person carrying on a business covered by Section 58 claims profits lower than the deemed profits prescribed under that section.

Unlike the earlier framework, this provision operates as an independent audit trigger and is not dependent upon the taxpayer having previously opted into the presumptive scheme or violating a lock-in requirement.

Key takeaways

The change is likely to affect small businesses which operate on low margins. Such taxpayers may now need to carefully evaluate whether declaring actual profits below the presumptive benchmark is worth the additional compliance burden arising from maintenance of books and tax audit requirements. The new legislation appears to settle the issue by clearly linking lower-than-presumptive profit declarations with a mandatory audit requirement under Section 63.

Whether viewed as a compliance-enhancing measure or an expansion of the audit base, the amendment undoubtedly brings greater certainty to an area that previously operated in a zone of ambiguity.