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'Issue-based' VAT audits are coming

Assessment and collection of taxes -- these are the two chief functions of the Bureau of Internal Revenue (BIR), which is tasked to interpret and implement the provisions of the National Internal Revenue Code of 1997, as amended. To meet the objective, the Tax Code grants broad powers to the Commissioner of Internal Revenue which includes the power to authorize the examination of any taxpayer and the assessment of the correct amount of tax through the examination of any book, paper, record, or other data which may be relevant or material to such inquiry -- commonly known as tax audits.

Recently, the BIR lifted the suspension of tax audits pursuant to Revenue Memorandum Circular No. 91-2016. In the same direction, pursuant to Revenue Memorandum Order (RMO) No. 59-2016, the BIR introduced the “issue-based” approach of audit under the enhanced Value-Added Tax (VAT) Audit Program (VAP) which aims to focus on the analysis of specific identified risks, to increase collections, and to enhance voluntary compliance by focusing on quality audit of VAT returns.

As compared to its predecessor, the enhanced audit program revised the selection criteria (mandatory and priority) of taxpayers under the following cases:

Mandatory Case:

1. Taxpayers with VAT returns reflecting erroneous input tax carry-over.

Priority Cases:

1. Taxpayers whose VAT compliance is below the established industry benchmarks;

2. Taxpayers with zero-rated and/or exempt sales due to availment of tax incentives or exemptions;

3. Taxpayers engaged in business where 80%, more or less, of their transactions are on a cash basis and whose purchases of goods and services do not generate substantial amount of input tax, such as restaurants, remittance/payment centers, etc.;

4. Taxpayers with VATable transactions which were subjected to expanded withholding tax but with no VAT remittance;

5. Taxpayers who failed to remit/declare VAT due from purchase of services from non-resident aliens;

6. Taxpayers who fail to declare gross sales/receipts subjected to VAT withholding on purchases of goods/services with waiver of privilege to claim input tax credit [creditable];

7. Taxpayers whose gross sales/receipts per income tax returns are greater than gross sales/receipts declared per VAT returns; and

8. Taxpayers filing percentage tax returns whose gross sales/receipts exceed the VAT threshold.

As noted above, the VAP prioritizes the taxpayers whose VAT compliance is below the established industry benchmarks. One may recall that the BIR has adopted the “benchmarking method” which establishes pre-determined standards or criteria to measure taxpayers’ level of compliance on a per industry basis. This audit method was introduced by the BIR as early as 2006 and was recently reiterated in the 2015 BIR Audit Program for the regular tax audits. While we recognize that this measure will assist the BIR in its objective of setting an industry standard for taxpayer performance, the BIR should exercise caution in light of unfavorable taxpayer experience relating to arbitrary classification through the application of a one-size fits all standard of audit for taxpayers’ in the same industry. The BIR should remember that classes of taxpayers within an industry group exist because of substantial distinctions (e.g., a large manufacturing company vs. a small-medium manufacturing company). Hence, a benchmark for a particular class of taxpayer is not necessarily applicable to a different class of taxpayer within the same industry.

In line with this, the RO assigned shall perform audit analysis and prepare an Audit Plan for each case to determine the scope of the audit and to ensure that the audit activity is properly planned to address the identified risks. The challenge now is how to apply the safeguards to ensure quality audit.

As regards the revised procedures, another welcome development is the return of the Notice of Informal Conference (NIC) stage in the VAP. Under the reporting process, the taxpayer shall be given the opportunity to present its explanations and the related documents. Under the current rules in the conduct of regular audit, the issuance of Preliminary Assessment Notice (PAN) and Final Assessment Notice (FAN) will be in accordance with existing revenue issuances excluding the NIC stage. With the proper enforcement of this procedure, taxpayers are given more time to evaluate BIR’s findings.

Also, in case there are deficiency VAT liabilities as result of the audit, any deficiency taxes agreed to be paid by the taxpayer, should have, at the very least, duly issued Preliminary Assessment Notice. Hence, taxpayers are encouraged to undergo the due process requirement in the issuance of a deficiency tax assessment and take advantage of all the remedies available to all taxpayers.

Moreover, it is interesting to note that Revenue Officers (RO) are given within sixty (60) and ninety (90) days covering one (1) and two (2) quarters, respectively, to finish their cases and submit reports of investigation from the date of issuance of electronic letters of authority. This is a welcome development since this will not somehow prolong the agony of the taxpayer under audit (at least a taxpayer is aware that its case will not take forever). But the question is whether or not the 60 or 90 day period will suffice to produce quality audits considering the existing workload of ROs. Or will it only bring additional burden to the already clogged case dockets of the BIR?

It is clear that the objective of the VAP is to increase collections and enhance taxpayers’ voluntary compliance by focusing on specific and identified risks in the VAT returns. In this light, while we appreciate the BIR’s efforts to ensure more transparent rules on tax audits, we believe that the RMO can better serve its purpose by providing clearer information on how the pre-determined standards or criteria are formulated; consider taxpayers whose VAT compliance is below the established industry benchmarks compliant as long as the difference or decrease in VAT payments are justified; and to consider evaluating further the timeline within which the ROs can finish their cases and submit reports to the advantage of both stakeholders.

After all, the BIR’s operational procedures should be convenient, just and effective, to raise the level of voluntary compliance, thereby allowing the government to raise much-needed revenue for nation-building.

Daryl Matthew A. Sales is a tax manager of the Tax Advisory and Compliance Division of Punongbayan & Araullo.

As published in Business World, dated 27 September 2016