Presumptions in tax assessments

In tax examinations, the Bureau of Internal Revenue (BIR) usually applies a set of standard procedures, with two being the most common. First, it compares the purchases reported on the Summary List of Sales (SLS) submitted by suppliers, on the one hand, with the purchases reported on the value-added tax (VAT) returns/Summary List of Purchases (SLP) by the taxpayer, also known as the Reconciliation Listing for Enforcement System (RELIEF) audit.

Second, it compares the expense items reported in the Financial Statements (FS)/Income Tax Return (ITR) with the items reported on the Alphabetical List of Payees From Whom Taxes Were Withheld (Alphalist).

Where the amounts per SLS submitted by suppliers are higher than the amounts on the taxpayer’s VAT returns/SLP, or where the expense amounts per taxpayer’s Alphalist are greater than those reflected in the FS/ITR, the BIR examiners will assess deficiency income tax and VAT on the basis that the unreported purchases and expenses result in undeclared income. This approach and conclusion traces its roots from the “Net Worth Method” first used in 1956 in the case of Eugenio Perez vs. J. Antonio Araneta to prove unreported income.

THE ‘NET WORTH METHOD’
In the Net Worth Method, there are five ways by which taxpayers may be assessed for deficiency income tax:
· The taxpayer’s own books and records, if made available by lawful means. When truthful, the taxpayer’s own books and records usually establish the nature and source of the unreported income; if false, these at least afford a starting point from which income items may be verified from other sources.
· Books and records and corroborative statements of third persons who have dealt with the taxpayer, often establishing payment of monies which would constitute taxable income to the taxpayer.
· Bank deposits and bank records.
· Increase in net worth; including investments, purchases of property and other business transactions by the taxpayer.
· Analysis of expenditures, to show that expenditures were in excess of declared or available income or expenditures for claimed items of deductions were fictitious or overstated.
The purpose of each of these is to establish taxable but unreported income and any combination of the methods may be resorted to by the government to support its case.
More recently, however, the Court of Tax Appeals (CTA) has promulgated decisions which effectively restrict an unfettered use of the Net Worth Method.

AMOUNTS PER SLS SUBMITTED BY SUPPLIERS HIGHER THAN THOSE IN VAT RETURNS/SLP
Three elements are required for the imposition of income tax, namely: (a) there must be gain or profit, (b) the gain or profit is realized or received, actually or constructively, and (c) it is not exempted by law or treaty. Income tax is assessed on income received from any property, activity or service and it must be clearly established that the taxpayer received such income.
In a January 2015 case, the CTA ruled that a finding of underdeclaration of purchases does not, by itself, result in the imposition of income tax and VAT. The CTA ruled that deficiency income tax and VAT may be assessed when there was an income realized by the taxpayer and such income was not reported. No deficiency assessment can be made on account of undeclared purchases. The CTA said that a taxpayer is free to deduct from its gross income a lesser amount, or not claim any deduction at all. What is prohibited by the income tax law is to claim a deduction beyond the authorized amount, not an underdeclaration of purchase or unaccounted expense.

The same is true for VAT, which is based either on the gross selling price or gross value in money of the goods or properties sold, bartered or exchanged, or gross receipts derived from the sale or exchange of services. Section 108 (A) of the Tax Code defines “gross receipts” as the total amount of money or its equivalent representing the contract price, compensation, service fee, rental or royalty, including the amount charged for materials supplied with the services and deposits and advance payments actually or constructively received during the taxable period for the services performed or to be performed for another person, excluding VAT.

In assessing VAT, it must be shown that the taxpayer received an amount of money or its equivalent from its sale, barter or exchange of goods or properties, or from the sale or exchange of services performed. VAT, like income tax, also cannot be assessed based on underdeclared purchases.

AMOUNTS PER TAXPAYER’S ALPHALIST GREATER THAN FS/ITR TOTAL
Similarly, in a January 2014 case, the CTA rejected the BIR’s allegation that the taxpayer had undeclared income on the basis that there was an unaccounted source of cash and therefore undeclared income since the income payments per Alphalist were greater than the expenses per FS/ITR. The CTA said that such comparison failed to show that the income payments to the taxpayer’s payees per se could be equated to taxable income. The purported unaccounted cash could well be presented in the balance sheet for accounting purposes and not in the Income Statement; hence, it is not proper to form the conclusion that the supposed unaccounted cash is part of the reportable income in the Income Statement.

Thus, even if the expenses per Alphalist were to be considered as income, the same shall be offset by treating the equivalent payments as purchases for which input tax credits may be claimed. Thus, no taxable income will result from the said transactions.

In these and other similar CTA decisions, the message is clear. While tax assessments are presumed to be correct, the assessment itself should not be based on presumptions regardless of how logical the presumption might be. The assessment must be based on actual facts in order to stand the test of judicial scrutiny — a reiteration of a 2005 decision by the CTA that in a naked or a baseless assessment, the determination of the tax due is without rational basis, and that the determination must rest on all the evidence introduced and its ultimate determination must find support on credible evidence.

In a February 2015 decision, the CTA also ruled that while the BIR can resort to the Best Evidence Obtainable Rule and estimate the tax liability of taxpayers who failed to submit their accounting records lost due to calamities, the BIR is still, however, required to provide sufficient basis for its estimate.

Given the seriousness of a BIR tax assessment, it is important that taxpayers have a clear understanding of the due process and other legal considerations involved in the tax assessment. They must be equipped with the latest jurisprudence not only for better compliance but also to defend themselves against tax assessments.

Erickson Errol R. Sabile is a Tax Senior Director of SGV & Co.

Word ‘zero-rated’ required to be imprinted on VAT invoices/ORs supporting VAT zero-rated transactions

TAXPAYERS engaged in the sale of goods or services which are subject to value-added tax (VAT) at zero percent are not liable to output taxes on said sales. Nonetheless, they incur input taxes passed on by their suppliers. If there are no other sales subject to output taxes, the input taxes remain unutilized. These may remain in the taxpayer’s returns until they are utilized in the future. Also, one of the options available to the taxpayer is to recover the same in the form refund.

However, recovery of input taxes through refund is not an easy process. First and foremost, a taxpayer must be able to substantiate the fact that it sales are really VAT “zero-rated.” And there are specific requirements to be indicated in the sales invoices or official receipts for the sales to qualify as zero-rated.

Recently in G.R 185115, February 18, 2015, the Supreme Court (SC) was again faced with the issue of whether the word zero-rated should be printed in VAT invoices or official receipts in order that a claim for refund of unutilized input taxes may prosper. It may be recalled that Section 113 (B)(2)(C) of the National Internal Revenue Code of 1997 expressly requires that the term zero-rated sale shall be written or printed prominently on the VAT invoice or official receipt if the sale is subject to zero-percent VAT. In a case involving an entity engaged in the production and sale of electricity, the Court of Tax Appeals found that taxpayer failed to substantiate its claim for refund and to strictly follow the invoicing requirements as set in Section 113 (B) (2) (C) of the National Internal Revenue Code of 1997 and the implementing regulations which require the imprinting of the term zero-rated. However, a dissenting opinion was entered into opining that the word zero-rated need not be imprinted on the face of the receipt or invoice. The opinion mentioned that the absence of the word zero-rated does not affect the admissibility and competence of the receipt or invoice as evidence to support the claim for refund. Thus, when the case was elevated to the SC, the issue of whether failure to print the word zero-rated on VAT invoices/official receipts is fatal to claim for refund was raised.

In resolving the issue, the SC emphasized that this matter had already been settled by the High Court in a number of cases. The High Court held that the invoicing requirements set forth in the law are intended for the efficient enforcement of the Tax Code. The Court also said that the provision on invoicing requirements is reasonable and is in accord with the efficient collection of VAT from the covered sales of goods and services. Finally, the High Court stressed that it is fatal in claims for refund or credit of input VAT on zero-rated sales if there was failure to write or print prominently the term zero-rated on the VAT invoice or official receipts. The Court even emphasized that the same rule applies even if the claims were made prior to the effectivity of Republic Act 9337.

The invoice or official receipt required to be issued for sales of goods or services is not just a matter of form. It also affects the substance and nature of the transactions. This is especially true with respect to zero-rated sales or receipts where its zero-rated character may not be acceptable if not properly labeled or described as zero-rated with the imprinting of the word zero-rated. Taxpayers, therefore, are obliged to comply with the mandatory information required to be indicated in the invoices and receipts.

****

The author is a junior associate of Du-Baladad and Associates Law Offices (BDB Law), a member firm of World Tax Services (WTS) Alliance.

The article is for general information only and is not intended, nor should be construed as a substitute for tax, legal or financial advice on any specific matter. Applicability of this article to any actual or particular tax or legal issue should be supported therefore by a professional study or advice.  If you have any comments or questions concerning the article, you may e-mail the author at ayesha.matanog@bdblaw.com.ph or call 403-2001 local 170.

source:  Business Mirror