1. Introduction
Section 65 of the CGST Act empowers the department to conduct an audit of any registered person to verify the correctness of turnover declared, taxes paid, input tax credit availed, and compliance with GST provisions. This audit, while routine in appearance, has significant legal, financial, and strategic implications for taxpayers.
This comprehensive guide demystifies the audit process under Section 65 and equips businesses and professionals with law-backed interpretations, strategic response methods, and ready-to-use annexures for compliance and closure.
2. Legal Foundation: Section 65 of the CGST Act
Section 65(1) empowers the Commissioner or an authorized officer to undertake an audit at the place of business of the registered person or at their office.
Rule 101 of CGST Rules outlines the procedural framework, including audit intimation (Form ADT-01), conduct, timelines, findings (Form ADT-02), and closure.
Key legal points:
Applicable only to registered persons
No minimum turnover threshold
Covers a complete review of returns, ledgers, ITC, and refunds
Timeline: Audit to be completed within 3 months from commencement, extendable to 6 months with approval
3. End-to-End Audit Procedure Under Section 65
| Step | Action/Form | Rule/Section | Timeline |
|---|---|---|---|
| Audit Intimation | Form ADT-01 | Rule 101(2) | At least 15 days prior to audit |
| Audit Commencement | Access to records | Rule 101(3) | Begins from actual inspection |
| Audit Completion | Form ADT-02 | Section 65(4) | Within 3 months (max 6) |
| Reply to Observations | Structured Letter | Natural justice | Within reasonable period |
| Final Action | SCN/DRC-01 or Closure | Section 73/74 | Based on audit findings |
Important: Courts have clarified that the audit officially starts from the first access of records (physical or digital), not merely the date of ADT-01.
4. Risk Triggers for Audit Selection
The audit selection is risk-based, not random. GSTN systems apply data analytics to flag anomalies. Key risk indicators:
| Risk Parameter | Red Flag Triggered |
| ITC > GSTR-2A/2B | Suspected excess/fake credit |
| GSTR-1 vs 3B vs Books variance | Underreporting or tax avoidance |
| Repeated refunds | Suspicion of LUT misuse or inflated exports |
| Low cash tax ratio | Fake invoicing or excessive ITC usage |
| E-way bills > GSTR-1 | Unbilled or parallel transactions |
5. Internal Audit Checklist Before a GST Audit
| Area | Checklist |
| ITC Reconciliation | Match GSTR-3B with GSTR-2B and purchase register |
| Turnover Matching | GSTR-1, 3B, books of accounts and ITR alignment |
| RCM Liabilities | Validate expenses subject to RCM and cash payment verification |
| Refund History | Confirm export documentation, FIRC, and LUT |
| Expense Ledger | Flag blocked credit under Section 17(5) |
| Vendor Payments | Track unpaid invoices >180 days (Rule 37) |
6. Model Reply Format to ADT-02
[On Business Letterhead]
To: The Jurisdictional GST Officer
Subject: Reply to Form ADT-02 dated [DD/MM/YYYY] for GSTIN [XXXXX]
Sir/Madam,
Pursuant to the audit conducted under Section 65 and observations made in Form ADT-02, we submit our para-wise response:
Observation 1: ITC not appearing in GSTR-2B
Response: The said ITC relates to valid tax invoices where supply and payment are recorded. Delay in vendor filing GSTR-1 resulted in non-appearance. Reliance placed on Rule 36(4) and Circular 123/2019.
Observation 2: Outward turnover mismatch
Response: The difference relates to year-end adjustments. Tax has been paid and disclosed in the next month. Reconciliation attached.
Observation 3: Blocked credit under Section 17(5)
Response: The credit pertains to canteen and insurance expenses mandated under the Factories Act. Eligible under Circular 122/41/2019.
Observation 4: RCM tax missed
Response: Admitted. Paid with interest voluntarily via DRC-03. Proof enclosed.
We respectfully request closure of the audit and undertake continued compliance.
Sincerely,
[Authorized Signatory]
7. Litigation vs. Closure: Strategic Matrix
| Scenario | Settle Under Section 73(5) | Litigation Recommended |
| Minor ITC mismatch with documentary proof | Yes | No |
| Valuation of related party transactions | No | Yes (Interpretation issue) |
| Audit conducted beyond 6-month limit | No | Yes (Refer Ketan Motors v. UOI) |
| Free supplies taxed under Rule 28 | No | Yes (Refer Circular 92/11/2019) |
8. GSTR Reconciliation Template (1 vs 3B vs Books)
| Description | GSTR-1 | GSTR-3B | Books | Remarks |
| Taxable Sales | ₹X | ₹X | ₹X | Should align across all |
| Export under LUT | ₹X | ₹X | ₹X | Verify FIRC and shipping bills |
| Credit Notes | ₹X | ₹X | ₹X | Impact on net turnover |
| RCM Liabilities | ₹X | ₹X | ₹X | Must match expense ledgers |
9. Blocked ITC Table with Exceptions
| Category | Blocked? | Exception (If Any) |
| Motor vehicles (<13 passengers) | Yes | Allowed if used for transport or resale |
| Food & beverages | Yes | If mandated under any law |
| Rent-a-cab, insurance | Yes | If obligatory under labour or factory laws |
| Construction of immovable property | Yes | If used for further taxable output supply |
| Club, health, or leisure services | Yes | No exceptions |
10. Compliance Do’s and Don’ts
| Do's | Don'ts |
| Maintain invoice-level ITC and RCM ledgers | Never ignore minor audit remarks |
| Pre-audit reconciliation of returns | Don't provide originals without record |
| Attach legal circulars with ADT-02 reply | Avoid verbal undertakings without documentation |
| Use DRC-03 for quick closure where needed | Don't admit findings without internal verification |
Audit under Section 65 is a checkpoint in the GST journey. It must be navigated with:
Preparedness (documentation & reconciliations)
Precision (ADT-02 replies)
Protection (litigation when needed)
With the right legal approach and compliance hygiene, an audit becomes a closure tool, not a crisis.
