During a Bureau of Internal Revenue (BIR) tax audit, taxpayers avoid, as much as possible, receiving a Final Assessment Notice (FAN) or think of elevating their concerns to the Court of Tax Appeals. These late stages of the tax assessment process mean incurring significant costs and expending effort to challenge the assessment or defend taxpayers’ arguments, with little to no assurance of a reduction or cancellation of the assessment.
Accordingly, most taxpayers try to end the tax assessment process at the initial stage (during Notice of Discrepancy or Preliminary Assessment Notice stages). During these stages, the closure of the assessment normally involves dealing with the findings or computation of tax deficiencies by the BIR.
There are common findings generally observed for most tax assessments. They can be addressed through reconciliation, factual arguments, and submission of documents. One need not escalate the assessment to FAN or elevate the case to the Court if the tax assessment can be closed or terminated at the early stages of the assessment process.
Below are some of the common BIR findings and how to address them.
DIFFERENCES OF AMOUNTS PER BOOKS VS PER TAX RETURNS
The BIR’s part in the audit procedure is to compare the income based on the taxpayer’s books such as financial statements, trial balance, or schedules as against income per duly filed income tax return (ITR) or Value-Added Tax (VAT) return. Any difference may result in income tax and/or VAT deficiencies.
It is expected that the taxpayer reconcile and explain the differences. It is important to note that not all differences may result in tax deficiencies. Certain transactions may follow specific tax rules for reporting income or expenses which are different from accounting rules for reporting. For instance, for tax purposes, income recognition of a real estate company follows the 25% deferred or installment rule. Lessors or lessees of real property declare income or claim expenses based on contract of lease, while construction companies recognize income based on architects’ or engineers’ certificates showing percentage of project completion. Hence, the resulting book versus tax return differences must be explained by the taxpayers to the BIR examiners to avoid substantial deficiency tax assessments.
Income and expenses per books can also be based on provisions or estimates, whereas per tax returns, these are based on closed and completed transactions. For example, provisions for sales return and discounts are deducted from the sales per books, but it is only upon actual sales return or availment of discount that these are allowed as deductions from taxable sales in the ITR. Provisions for bad debts are deductible as expenses per books, but only when the receivables are actually written off that such are allowed as deductible expense in the ITR. Again, these differences on the timing of reporting expenses in the books as compared to tax returns must also be reconciled by the taxpayers to refute the BIR findings.
The BIR normally requests supporting documents to substantiate claims for exemption from taxes, deductible expenses, claims for input taxes, and income tax credits.
If the taxpayer fails to submit documents supporting the exemptions, such as certificate of tax incentives or VAT zero-rating certificate, the BIR will impose deficiency taxes on the reported exempt or zero-rated income.
Similarly, if the taxpayer submits documents that are not compliant with the VAT invoicing requirements, the BIR will disallow the VAT input and compute for the VAT deficiency on the transactions. Examples of this noncompliance with invoicing requirements are: a) failure to present the zero-rated sales in the zero-rated sale section of the VAT official receipt (OR) or sales invoice, b) input VAT on purchase of goods unsupported by a VAT sales invoice and the input VAT for purchase of services is not supported by VAT OR, or c) failure to indicate required taxpayer’s information such as tax identification number (TIN) in the VAT sales invoice or OR.
RECONCILIATION WITH THIRD-PARTY INFORMATION
The BIR has a database gathered from the attachments of tax returns, such as the Summary List of Sales, Purchases, and Importations (SLSPI), and alphalist of payees (Alphalist). Using this information, the BIR matches the data provided by customers or suppliers as against the taxpayers’ declaration. Any difference would again result in tax deficiency findings. The common explanations for these findings are timing differences or errors in reporting.
In some cases, the deficiency findings can be attributed to timing differences between the income reported by the seller, as compared to the purchases reported by the buyer. On one hand, the seller of services may have declared its income in the Summary List of Sales (SLS) based on collection. On the other hand, the buyer may have reported the purchase of services in the Summary List of Purchases (SLP) upon receipt of billing invoices, notwithstanding that the proper timing of reporting purchases on services is upon payment.
Another reason for the difference is mistake or error in computing the tax bases. Some taxpayers compute taxable sales net of estimated sales returns and allowances, while others recognize as tax base for purchases the amount gross of VAT or net of withholding taxes. Other common errors also result in significant differences, such as typographical error in the customer’s or supplier’s TIN, double reporting of sales or purchases, imports erroneously reported under local purchases, or even sliding and transposition errors.
These are some common findings of the BIR during tax assessments. Taxpayers who have gone through the painstaking assessment process have realized the importance of adopting preventive measures to avoid paying significant tax deficiencies due to noncompliance with tax rules. Taxpayers should always be aware of tax updates and changes in tax rules and procedures. They should also conduct their own tax health checks from time to time to set in place remedial measures as early as possible. Company policies and protocols must likewise be adopted to specifically guide the tax department in complying with tax rules.
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 09 November 2021