A simple mistake

Can the Bureau of Internal Revenue (BIR) issue an assessment even after the lapse of the three-year prescriptive period even if it is clear that no fraud was committed? This is the question I usually received from clients. And my answer to this question is, “Yes.”

The general rule is that the BIR is given three years to issue an assessment against a taxpayer. However, Section 222 of the Tax Code of 1997, as amended, provides three instances where the prescriptive period is extended to 10 years from discovery. These are: (1) if the return is false; (2) if the return is fraudulent with the intent to evade taxes; and (3) if no return is filed. Among these three cases, the issue normally lies in what constitutes a false return. Would a simple mistake make a return false for purposes of applying the 10-year prescriptive period?

Even the Court of Tax Appeals (CTA) has differing views on what constitutes a false return. In CTA Case No. 6707, the return filed by the taxpayer was understated by more than 30%. Applying Section 248 (B) of the 1997 Tax Code, as amended, the BIR found prima facie evidence of a false return. Accordingly, CTA ruled that the applicable prescriptive period is 10 years from the discovery of the falsity.

There is also a case where the CTA ruled that even if the under-declaration is less than 30%, the same constitutes a false return. In CTA EB Case No. 1059 issued in 2015, the Court ruled that for as long as there is a deviation from the truth, even without the need of considering the percentage of under-declaration or overstatement, a taxpayer can still be considered as having filed a false return.

However, in CTA Case No. 6002, the CTA held that an honest mistake would not constitute a false return. The CTA explained that only false returns which are filed by a taxpayer with intent to evade taxes should warrant an application of the 10-year prescriptive period.

Moreover, in CTA Case No. 4464, the CTA held that the fact that the respondent and the petitioner differ in the interpretation of the law does not necessarily make the data contained in the return made by a taxpayer a “false return.” There must appear, if not a design to mislead or deceive on the part of the taxpayer, at least culpable negligence. A mistake, not culpable in respect of its value, would not constitute a false return (Words and Phrases, Volume 16, page 173).

The Supreme Court, however, clarified this matter.

In the case of Samar-I Electric Cooperative (SIEC) vs. Commissioner of Internal Revenue (CIR), G.R. No. 193100, the Supreme Court (SC) ruled that substantial under-declaration of withholding taxes constitutes a false return. This was further explained by the SC through citing the case of Aznar vs. Court of Tax Appeals. 

According to the SC, the proper and reasonable interpretation of Section 332 (now Section 222) should be that in the three different cases of (1) false return, (2) fraudulent return with intent to evade tax, and (3) failure to file a return, the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time within ten years after the discovery of the (1) falsity, (2) fraud, or (3) omission. The law should be interpreted to mean as a separation of the three different situations of a false return, the fraudulent return with intent to evade tax, and the failure to file a return is strengthened immeasurably by the last portion of the provision which segregates the situations into three different classes, namely “falsity,” “fraud,” and “omission.” That there is a difference between “false return” and “fraudulent return” cannot be denied; while the first merely implies deviation from the truth, whether intentional or not, the second implies intentional or deceitful entry with intent to evade taxes.

The ordinary period of prescription of five years (now three years) within which to assess tax liabilities should be applicable to normal circumstances. But whenever the government is placed at a disadvantage so as to prevent its lawful agents from the proper assessment of tax liabilities due to false returns, fraudulent return intended to evade payment of tax or failure to file returns, the period of 10 years provided for in Sec. 332 (now Section 222) from the time of the discovery of the falsity, fraud or omission even seems to be inadequate and should be the one enforced.

It is noteworthy to mention, however, that in this particular case, the taxpayer was not able to refute the finding of the BIR before the courts. Hence, the SC held that the returns filed constitute falsity.

Interestingly, in the most recent SC decision, in the case of CIR vs. Philippine Daily Inquirer (PDI), G.R. No. 213943, promulgated on March 22, 2017, the SC held that since there is not enough evidence to prove fraud or intentional falsity on the part of the taxpayer and so the 10-year prescriptive period does not apply. It further elucidated that “while the filing of a fraudulent return necessarily implies that the act of the taxpayer was intentional and done with intent to evade the taxes due, the filing of a false return can be intentional or due to an honest mistake. In CIR vs. B.F. Goodrich Phils., Inc., the Court stated that the entry of wrong information due to mistake, carelessness, or ignorance, without intent to evade tax, does not constitute a false return.”

The significant difference of this most recent case with the case of SIEC cited above is that PDI was able to refute some of the findings of the BIR. Hence, the SC was not convinced that the falsity is intentional.

This recent decision of the SC hopefully clarifies that an intentional mistake should not make a return false for purposes of applying the 10-year prescriptive period. Notwithstanding this, it is still important that the taxpayer should ensure that all items reported in a return are correct to avoid any issues on whether or not such error or omission constitutes a false return. Otherwise, such falsity may indeed result in severe consequences. 

Edward L. Roguel is a partner with the Tax Advisory and Compliance division of Punongbayan & Araullo.

As published in Business World, dated on 25 April 2017