As many taxpayers have recently received a Letter of Authority (LOA) from the Bureau of Internal Revenue (BIR), anxieties loom since normally, significant findings are initially identified and alleged in a BIR audit. More often, such findings come from the BIR’s comparisons of the taxpayers’ books against the tax returns. Out of the said approach, millions or hundreds of millions, or even billions of alleged discrepancies are frequently left to the taxpayers to reconcile. No wonder, on the part of the taxpayers, stress could be sky high during BIR audits.
What are examples of the BIR’s comparisons during a BIR audit, and what may a taxpayer do about these?
One of the very common procedures of the BIR during BIR audits is the comparison of the expenses recorded per book against the tax base reported in the withholding tax returns. The differences that arise are assessed for non-withholding of tax on expenses with the corresponding disallowance of the expenses as a deduction for income tax purposes. So, here, there is an alleged withholding tax deficiency and an alleged income tax deficiency.
For the above-mentioned differences, it is worth checking whether there are expenses which are exempt from withholding taxes. For expanded withholding tax, some exempt transactions are payments to GPPs and payments to PEZA entities under ITH or 5% SCIT. For final withholding tax, transactions that are incurred outside the Philippines are some of the possible reconciliations. On the other hand, for withholding tax on compensation, the reconciliations could come from the employer’s share in government mandatory contributions, HMO premiums for group insurance, or de minimis benefits.
Another comparison being made by the BIR is the comparison of the taxpayer’s income and expenses per book against those reported in the income tax returns (ITR) and Value-added tax (VAT) returns, and any differences may be assessed for deficiency income tax or deficiency VAT.
In the above type of finding, more often than not, discrepancies are just due to the timing differences in the reporting of the income and expenses between the books and the tax returns. For instance, if you are engaged in the sale of real estate, the recognition of taxable income from such sale could be different based on the tax rules and the accounting rules. Unlike in the accounting rules, there is an installment method that may be applied for sale of real estates if the initial payments will not exceed 25% of the contract price under the tax rules.
In addition, another timing difference that may occur is the lease expenses recognized by the taxpayer. Amortization of recognized right-of-use asset (ROUA) and interest expense on lease liability are the expenses recorded per books, while for income tax purposes, the lease expense deductible is the amount incurred during the period based on the lease contract.
There could be other reconciliations apart from the mentioned above; hence, taxpayers may want to be proactive and consider doing some preparations which could help deal with the possible tax findings even before the LOA is served at the doorsteps.
It is prudent to have the books versus tax returns reconciled on a periodic basis, be it monthly or quarterly, so that the taxpayer will not be surprised by the possible alleged differences when the BIR audit comes in later. It will benefit the taxpayer to spot the discrepancies that need to be properly addressed ahead of the BIR audit.
To ease the burden of collating the documents that BIR may request during the BIR audit, it is best to strictly observe the proper documentation and to have an organized recordkeeping of the documents. Invoices, receipts, contracts, or other pertinent documents related to the transactions should be kept and secured in a manner that is easy to retrieve. These documents will help the taxpayers address the nature of the discrepancies that may be alleged by the BIR in an audit.
Being informed of tax updates and the changes in the tax rules and procedures is crucial. With numerous tax rules and updates, it will be helpful for a taxpayer to attend tax seminars held by the BIR or by tax consultants. The knowledge of the tax rules will lead a taxpayer to identify the possible reasons why certain amounts in the books are different from the amounts per tax returns.
Just as we give importance to our physical well-being by undergoing a regular medical check-up, it is also important that, as a taxpayer, a periodic tax health check conducted by the Company’s tax team or by the Company’s tax consultant is conducted periodically. This preemptive practice could immediately address the possible tax issues that may arise during a BIR audit.
Being proactive will surely reduce unnecessary stress and can help the taxpayers address issues that might be raised by the BIR in an audit process. By anticipating the potential discrepancies, it allows the taxpayer to prepare and have a less daunting BIR audit to ease anxieties.
Let's Talk Tax is a weekly newspaper column of P&A Grant Thornton that aims to keep the public informed of various developments in taxation. This article is not intended to be a substitute for competent professional advice.
As published in BusinessWorld, dated 10 October 2023
