RAMO 1-2000

March 17, 2000

REVENUE AUDIT MEMORANDUM ORDER NO. 01-00 SUBJECT : TO

I.

Objective

II.

Quality Audit

:

Updated Handbook on Audit Procedures and Techniques Volume I (Revision —Year 2000) All Internal Revenue Officers and Others Concerned

This Order prescribes the use of the Updated Handbook on Audit Procedures and Techniques (Volume I) in the audit of tax returns. The Handbook is intended to provide revenue officers with minimum standard procedures and a uniform guideline for the proper examination and/or investigation of tax liabilities. This updated version was prepared in order to conform with the provisions of the Tax Reform Act of 1997". The purpose of auditing a tax return is to determine the taxpayer's substantially correct tax liability. A quality audit is the examination of the taxpayer's books and records in sufficient depth for the purpose of ascertaining the correctness and validity of entries and the propriety of application of tax laws. To ensure quality audit of tax returns, revenue officers are enjoined to utilize their technical skill, training and experience, and follow the minimum audit procedures prescribed in the Handbook under Annex "A" hereof.

III. Reporting Requirements

Revenue Officers are required to make a report after the audit has been conducted. All reports should contain the minimum documentary requirements specified under Chapter XVII of the Handbook.

IV. Repealing Clause

This Order supersedes Revenue Audit Memorandum Order No. 2-95,

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all revenue issuances and portions thereof inconsistent herewith.

V.

Effectivity

All revenue officers and other employees concerned are hereby directed to refer to the aforesaid Handbook in the audit/investigation of tax returns immediately after the approval of this Order. CTSHDI

(SGD.) DAKILA B. FONACIER Commissioner Bureau of Internal Revenue HANDBOOK ON AUDIT PROCEDURES AND TECHNIQUES VOLUME I

(Revision - Year 2000) PREFACE

The enactment of the National Internal Revenue Code of 1997 and its implementation effective January 1, 1998 marked significant changes in Philippine taxation and the BIR's tax administration policies. Hence, it is necessary to revise and update the existing revenue issuances and assessment manuals in accordance with the new provisions of the Tax Code.

In order to utilize audit as an effective tool in the enhancement of voluntary compliance, the first volume of the Handbook on Audit Procedures and Techniques has been revised and updated to conform with the new Tax Code. This volume discusses general procedures and techniques designed to assist the Revenue Officer in the investigation of tax liabilities of taxpayers. The audit procedures and techniques for the investigation of Value-Added Tax liabilities are prescribed in a separate manual. ACKNOWLEDGMENT

The updating of this Handbook on Audit Procedures and Techniques — Volume I was completed under the leadership of Commissioner Dakila B. Fonacier and Deputy Commissioners Romeo S. Panganiban, Estelita C. Aguirre, Sixto S. Esquivias IV and Lilia C. Guillermo. This Handbook is a project of the Assessment Service with the Assessment Programs Division as the lead division which spearheaded the project. Acknowledgment is also extended to Atty. Arnulfo B. Romero, Mr. Rodolfo Mendoza and Mr. Manny B. Jimenez for their comments and invaluable contribution to the project. Copyright 2015

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ASSESSMENT SERVICE Nars P. Tamayo

Acting Assistant Commissioner

Elvira R. Vera

Acting Head Revenue Executive Assistant ASSESSMENT PROGRAMS DIVISION

Leticia C. Batausa

Officer-In-Charge

Ione S. Alejo

Section Chief

Elenita V. Balonzo

Section Chief

Cristina T. Billones

Section Chief

Urania C. Salvacion

Section Chief

Gladys M. Aquino

Revenue Officer III

Dessie V. Garcia

Revenue Officer II

Elmira C. Viray

Revenue Officer I

Gean M. Dienzo

Computer Operator I

Cristina V. Pangan

Computer Operator I Table of Contents

I.

Introduction

II.

Accounting Methods

III.

Bookkeeping Systems

Revenue Tax Administration Purpose Contents of the Handbook

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IV. Accounting Records

V.

Journal Ledger Subsidiary Book Computerized Accounting System

Accounting Period Calendar Year Fiscal Year

VI. Financial Statements Income Statement Balance Sheet

VII. Purpose and Standards of Audit

General Standards Standards of Preliminary Planning Standards of Field Work Standards of Public Relations

VIII. Preliminary Approach to Examination

Pre-audit Analysis of Tax Returns Work Planning Contact with Taxpayer Preliminary Evaluation of Miscellaneous Records Initial Examination Techniques Evaluation of Internal Control Sampling Techniques

IX. Balance Sheet Approach to Examination

Cash on Hand and in Bank Notes and Accounts Receivable Allowance for Bad Debts Inventories Advances to Stockholders/Officers Investments Depreciable Assets Allowances for Depreciation, Amortization and Other Valuations Reserves Intangible Assets Prepaid Expenses and Deferred Charges Other Assets Exchange, Clearing or Suspense Accounts

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X.

Current and Accrued Liabilities including Notes Payable Fixed Liabilities Deferred Credits Loans From Shareholders/Officers/Owners Capital Accounts Capital or Owner's Equity Partners' Capital Stockholders' Equity Capital Stock Retained Earnings

Audit of Income and Expenses Audit of Income Accounts

Sales Rent Income Professional Fees Income From Sale of Asset Other Income Audit of Expense Accounts Purchases Cost of Goods Sold Salaries, Wages and Other Employees' Benefits Fringe Benefits Rents Royalties Interest Taxes Repairs Bad Debts Losses Abandonment and Demolition Casualty/Theft Net Operating Loss Carry Over Depreciation Depletion Contribution Transportation and Travel, Representation and Entertainment Stationery and Office Supplies Professional Fees Insurance Fees Light and Power, Telephone and Telegraph Miscellaneous Expenses

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XI.

Audit of Minimum Corporate Income Tax and Improper Accumulation of Earnings Tax

XII. Auditing Computer-Produced Records

Impact of Computer Records on Audit Accounting Software Systems Audit Techniques for Computer-Produced Records

XIII. Indirect Approach

Percentage Method Net Worth Method Bank Deposit Method Cash Expenditure Method Unit and Value Method Third Party Information (Access to Records) Method

XIV. Audit Procedures on Other Kinds of Taxes Withholding Taxes Capital Gains Tax Estate Tax Donor's Tax

XV. General Policies in the Investigation of Tax Fraud Cases Jurisdiction Procedures Civil Fraud

XVI. Closing Conference XVII.

Report Making

Document Locator Form Table of Contents Narrative Report Duly Accomplished Revenue Officer's Audit Report Working Papers Attachments to the Docket of the Case

Appendix

Revenue Memorandum Order No. 15-95 General Policies in the Investigation of Tax Fraud Cases

Revenue Memorandum Order No. 53-98 Checklist of Documents to be Submitted by a Taxpayer upon Audit of his Tax Liabilities as well as of the Mandatory Reporting Requirements to be Prepared by Copyright 2015

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a Revenue Officer, all of which comprise a complete Tax Docket

I.

INTRODUCTION

A

Revenue Tax Administration

The function of the Bureau of Internal Revenue is to administer the provisions of the National Internal Revenue Code. It is the duty of the Bureau to implement the Tax Code and related laws enacted by Congress in a fair and impartial manner. The mission of the Bureau is to enforce internal revenue laws with impartiality, consistency, collect the correct amount of taxes at the least cost to the government and least inconvenience to the taxpayer and serve the public honestly and efficiently in a manner that will elicit the highest level of confidence in the Bureau of Internal Revenue.

Investigation supports the mission of the Bureau by enhancing a high degree of compliance and encouraging the correct reporting of income, transfer, business and other taxes. This is accomplished by: 1.

Measuring the degree of voluntary compliance as reflected on filed returns;

3.

Conducting quality audit of selected tax returns on a timely basis.

2.

Reducing non-compliance by identifying returns and taxpayers that need to be investigated; and

The purpose of auditing a tax return is to determine the taxpayer's correct tax liability. A quality audit is the examination of a taxpayer's books and records in sufficient depth so as to ascertain the correctness and validity of entries thereon and- the propriety of application of tax laws. ADaSEH

B.

Purpose

The updated Handbook on Audit Procedures and Techniques has been prepared to equip all Revenue Officers who conduct field examinations with-the necessary knowledge for the proper examination of tax returns and provide them with confidence in carrying out the investigation. This Handbook is designed to ensure that. the Revenue Officer acquires useful auditing skills, progresses from simple audit techniques to more sophisticated procedures, and advances in examination procedures from a single proprietorship to a large corporation and from a simple bookkeeping system to a highly computerized one. The Revenue Officer's job is to familiarize himself with the business activity and/or undertaking of the taxpayers assigned to him for audit, to evaluate the various methods and procedures the taxpayers apply, to be imaginative, observant and inquisitive in his examination, and above all, to use common sense.

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C.

Contents of the Handbook

The handbook contains guides, instructions and suggestions in the conduct of audit for various taxpayers. The discussions begin with the analysis of tax returns and financial statements, familiarization with accounting methods, bookkeeping systems, books of accounts and other related records. The audit procedures for balance sheet and income statement accounts are laid out together with investigation techniques for each type of tax. This does not preclude, however, the Revenue Officer from carrying out other audit techniques which are deemed necessary in the circumstances surrounding a particular case. The Handbook is neither intended to provide a source of tax law or procedural doctrine nor a substitute reference material of revenue issuances. Each Revenue Officer is presumed to have a working knowledge of the Tax Code, the latest amendments thereon, and an update of existing revenue regulations, revenue rulings, revenue memorandum orders and other issuances. The other contents of the handbook include documentary requirements in the investigation process and proper report making.

II.

Accounting Methods

The taxable income of a taxpayer shall be computed in accordance with the method of accounting he regularly employs in keeping his books. However, if the taxpayer does not regularly employ a method of accounting which reasonably shows his correct income, the computation of income shall be made in such manner as in the opinion of the Commissioner of Internal Revenue or his -duly authorized representative that clearly reflects such income. The methods of accounting recognized under the Tax Code are:

A. Cash Basis is a method of accounting whereby all items of gross income received during the year shall be accounted for such taxable year and that only expenses actually paid for shall be claimed as deductions during the year. This method of accounting is generally used by taxpayers who do not keep regular books of accounts. Under this method, income is realized upon receipt of cash or its equivalent including those constructively received (such as deposits for the taxpayer's account by customers) but not including gifts or donations. Users of cash basis accounting are mostly individuals engaged in business and practice of profession, professional partnerships and professional service organizations.

B. Accrual Basis is a method of accounting for income in the period it is earned regardless of whether it has been received or not. In the same manner, expenses are accounted for in the period they are incurred and not in the period they are paid. Under this method, net income is being measured by the excess of income earned during the period over the expenses incurred. Expenses not being claimed as deductions by Copyright 2015

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taxpayers in the current year when they are incurred cannot be claimed as deduction from income for the succeeding year. Thus, a taxpayer who is authorized to deduct certain expenses and other allowable deductions for the current year but failed to do so cannot deduct the same for the next year. The accrual basis of accounting is being used by taxpayers whose nature of business uses inventories since this method of accounting will correctly reflect income by matching purchases and expenses against sales. This method is being applied by most medium and large corporations. HETDAa

C. Completion of Contract Basis is an accounting method applicable to contractors in the construction of building, installation of equipment and other fixed assets, or other construction work covering a period in excess of one year.

Under this method, gross income is to be reported in the taxable year in which the contract is fully completed and accepted by the contractee if the taxpayer elected it as a consistent practice to treat such income, provided that such method clearly reflects the net income. Under this method, all expenditures, are deducted from gross income during the life of the contract which are properly allocated thereto, taking into consideration any materials and supplies charged to the work under the contract but remaining on hand at the time of the completion. However, pursuant to Republic Act No. 8424 which took effect on January 1, 1998, contractors are no longer allowed to adopt this method of reporting their income derived in whole or in part from long-term contracts.

D. Percentage of Completion Basis is a method applicable in the case of a building, installation or construction contract covering a period in excess of one year whereby gross income derived from such contract may be reported upon the basis of percentage of completion. In determining the percentage of completion of a contract, generally one of the following methods is used:

1. 2.

The costs incurred under the contract as of the end of the tax year are compared with the estimated total contract costs; or The work performed on the contract as of the end of the tax year is compared with the estimated work to be performed.

In such case, the return should be accompanied by a certificate of the architect or engineer showing the percentage of completion during the taxable year of the entire work performed under contract. There should be deducted from such gross income all expenditures made during the taxable year on account of the contract, account being taken of the materials and supplies on hand at the beginning and end of the taxable period for use in connection with the work under the contract but not yet so applied. Beginning January 1, 1998 income from log-term contracts are required to be reported using this method only. Copyright 2015

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E. Installment Basis is a method considered appropriate when collections extend over relatively long periods of time and there is a strong possibility that full collection will not be made. As customers make installment payments, the seller recognizes the gross profit on sale in proportion to the cash collected. F. Crop Year Basis is a method applicable only to farmers engaged in the production of crops which take more than a year from the time of planting to the process of gathering and disposal. Expenses paid or incurred are deductible in the year the gross income from the sale of the crops are realized. In relation to the foregoing accounting methods, the Tax Code provides for a tax credit system in computing the tax payable by certain taxpayers. While the tax credit system is not an accounting system, it is discussed here for the proper understanding of the computation of taxes due from taxpayers.

The tax credit system is a method used to account for the creditable taxes deducted by the withholding agents from the income payments to certain payees (as in the case of withholding tax at source pursuant to Revenue Regulations (RR) No. 6-85, as amended by RR 2-98, or the creditable tax added to the sales price (as in the case of value-added tax). The creditable taxes should be clearly identified in the books of the taxpayer, such as: 1.

Creditable income tax (asset)

2.

VAT input tax (asset)

3.

Withholding tax payable-Compensation (liability)

4.

Withholding tax payable-Expanded Withholding Tax (EWT) (liability)

5.

VAT output tax (liability)

III.

Bookkeeping Systems

Bookkeeping may be classified into two systems, namely, (1) the single entry and (2) the double entry.

A. Single Entry System of bookkeeping is basically a type of "net worth" method of arriving at net income. It records only the debit or credit of each transaction, or an account with the debtor or creditor and a simple record of cash receipts and disbursements.

Whenever a system of record keeping does not include equal debit and credit to asset, liability, proprietorship, income and expense accounts, it is referred to AA a "single entry system". The single entry is often used by comparatively simple ventures such as small retail or commission merchants, professional firms, estates and trusts. In many Copyright 2015

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cases, the only record of income and deductions consists of entries on the stubs of their checkbooks. Some taxpayers maintain an income tax folder in which they place documents to support their income tax deductions. A single entry system may be merely a chronological record of transactions posted in a notebook or journal. Sometimes, the records consist of a complete set of journals (cash, sales, purchases and general journal) and general ledger providing important accounts. The accounting cycle starts with source documents (invoices, bills, paid checks, loan documents, bank deposit slips, and bank statements) proceeding to the cash receipts and cash disbursements journal, working paper summary and ending with the tax return.

Reconciliation of the taxpayer's books, working paper summary and records to the return is a very important audit step. In this way, the Revenue Officer will become familiar with the taxpayer's accounting system, policies and control procedures. If the records available are organized, this will lend more credibility to the tax return, but if they are inadequate, then the Revenue Officer should closely scrutinize the information on the income tax return. Therefore, when encountered with the lack of formal books and records, the Revenue Officer must use source documents and other available documents to establish the taxpayer's financial position which shall be compared with the taxpayer's standard of living and business activity for validation. HTSAEa

useful: 1.

The following formulae for reconstruction of income and expenses may be found

Computation of Sales

Cash Sales (cash book) Add: Sales on account: Collections from customers (cash book) Less: Accounts receivable (beginning balance) Collections from sales for the period Add: Accounts receivable (ending balance) TOTAL SALES

2.

xx xx xx xx xx —

Computation of Purchases

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Cash purchases (cash book) Add: Purchases on account: Payments to creditors (cash book) Less: Accounts payable (beginning balance) Payments for purchases for the period Add: Accounts payable (ending balance) CD Technologies Asia, Inc. and Accesslaw, Inc.

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xx xx xx xx

xx 11

3.

— TOTAL PURCHASES ==

—

Computation of Expenses

Cash payments for allowable expenses (cash book) Add: Prepaid expenses (beginning balance) Accrued expenses (ending balance) Total Less: Prepaid expenses (ending balance) Accrued expenses (beginning balance) TOTAL EXPENSES

xx xx — xx xx —

xx

xx xx — xx xx — xx ==

B. Double Entry System — Under this system of bookkeeping, accounting recognizes the two-fold effect of every recorded event, the debit and the credit or the object of the event and the equitable interest in that object. Every recorded event affecting one side must necessarily affect the other side. This can be presented in an equation: Assets = Liabilities + Capital

This can be analyzed into its component elements which show that there are two distinct parties that have right in the assets of the business, the creditors and the owners. The rights of the creditors are the claims of such creditors on the assets of the business which are referred to as liabilities and the rights of the owners on the business are referred to as capital.

In the double entry method, any net increase and net decrease in asset has a corresponding increase and decrease in either liabilities or capital. Audit of accounting records under this system shall be detailed as presented in the discussions of audit of real and nominal accounts. IV. Accounting Records

Taxpayers are required by law and regulations to keep and maintain accounting records in sufficient detail to enable them to make a proper return of income. The Commissioner of Internal Revenue is authorized to examine such records or other data which may be relevant in ascertaining the correctness of the tax returns. The books and records kept must be sufficient to establish the amount of the gross income and the deductions, credits and other matters required to be shown in the tax return. The primary records commonly used by all types of businesses, considering the different accounting systems and reporting methods of the business are invoices,

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vouchers, bills, receipts and other source documents which are also the supporting documents in the selling and buying of merchandise, services and other assets used in the business. For companies which require the use of inventories, the primary records include the detailed inventory list. Other primary records used in financial transactions are the cancelled checks, duplicate deposit slips, bank statements and notes.

The secondary records, regardless of the accounting method used by the taxpayer, include permanent books of accounts and working papers which summarize and list the individual documents including adjustments, when necessary. These records are properly classified in such a way that the taxpayer will be able to determine the financial status of his business in a given period of time and the profit and loss for the period. All records required to be kept by the taxpayers should be preserved by them for proper administration of any internal revenue law. Below are the regular accounting records being used by taxpayers:

A. Journal is a book of original entry in which transactions affecting the business of a taxpayer are recorded consecutively day by day as they occur. Journal consists of the following:

1. Sales Journal. This is a book whereby sales on account are recorded which are supported by sales invoices and which are also the documents that will serve as the basis of recording the transactions in the books of accounts. Cash sales are usually recorded in the cash book although it may be posted in both books representing a debit to cash in the cash book and a credit to sales in the sales book.

Every entry in the sales journal represents a debit to a customer's account and a credit to sales to be posted in the general ledger. Sales returns and allowances are also recorded in the sales book which represents a debit to Sales Returns and Allowances and a credit to Accounts Receivable to be posted in the general ledger. This would mean a decrease in Sales and eventually a decrease in an asset account. 2. Purchase Journal. This is a book used to record exclusively all transactions involving the purchase or acquisition of merchandise on account.

The business document that serves as evidence of a purchase transaction is the purchase invoice. An entry to record charge purchases is a debit to Purchases and a credit to Accounts Payable to be posted in the general ledger. Purchase returns and allowances are also recorded in this book and posted in the

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general ledger representing a debit to Accounts Payable and a credit to Purchase Returns and Allowances which would mean a decrease in the purchases account.

In certain instances where the volume of business is large and under the Value-Added Tax system, taxpayers maintain subsidiary sales and purchase journals where details of daily sales and purchases are recorded. 3. Cash Book is a book whereby all transactions involving cash such as cash receipts or cash disbursements are recorded. Types of this book are the following:

3.1

Cash receipts book — a book whereby all transactions involving cash receipts of whatever source are recorded. EHSTcC

3.2.

Cash disbursements book — a book whereby all transactions involving cash or check disbursements are recorded.

B Ledger is a book of final entry wherein the classified accounts or items of all transactions entered in the journal are posted. All entries in the journal must be posted to the ledger and shall be classified accordingly so as to show the assets, liabilities, capital and the operating accounts. This will be the basis for the preparation of the balance sheet and the profit and loss statement covering the operation of the business. No entry shall be made in the ledger unless said entry originates from the journal. The accounts contained in the general ledger provide the Revenue Officer with insight of the operations of the business. When pertinent, the chart of accounts and subsidiary ledgers, if any, should be requested from the taxpayer. If a private ledger is maintained, it should also be requested. As the Revenue Officer goes through the ledger, unusual or non-recurring items should be noted and verified. Most of these items are classified as follows: 1. 2.

3.

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Unusual in amount — The Revenue Officer should be alert for month end entries with significant amounts which may affect income and expenses.

Unusual by Source — means the books of accounts from where the entry to the ledger account originates. Hence, expenses or adjustments to income which do not ordinarily originate from the cash journals, sales and purchase books should be investigated. Such adjustments originating from the general journal or journal vouchers should be thoroughly examined as to supporting documents and proper authorization. Unusual by nature — An entry in a ledger account may be unusual by nature as well as by the account itself. Accounts with abnormal balances such as receivable accounts with credit balances may indicate income which is credited to receivables instead of sales. Unusual accounts such as

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suspense, other receivables, due to stockholders, and such other unusual liability accounts should be analyzed as there may be some income components lodged in these accounts.

C. Subsidiary Book. In the general ledger, accounts are usually transferred and grouped into certain accounts to a subsidiary book. This general ledger account is called control account. Control accounts in the general ledger contain summarized information that is recorded in detail in a subsidiary book or ledger. It is, therefore, the control account which contains summarized information and the subsidiary ledger contains the same information but in detail.

Thus, in order to relieve the general ledger of too many individual accounts, business concerns having numerous accounts with customers and creditors will transfer said accounts to separate ledgers — one for customers and another for creditors. For example, the control account for the customer's subsidiary book will be called "Accounts Receivable", while the control account for the creditor's subsidiary book will be called "Accounts Payable".

All corporations, companies, partnerships or persons required by law to pay internal revenue taxes have the option to keep this kind of book depending on the need of their business, provided that where such books are kept, they shall form part of the accounting records of the taxpayer and shall be subject to the same rules and regulations as to their keeping, translation, production and inspection as are applicable to the journal and the ledger. D. Computerized Accounting System. This method of accounting is now being used by most companies. It is a system whereby information are fed into the computer thus providing uniformity in the processing of transactions. Types of System under this method are the following:

1.

2.

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Simple System. Transactions are easily traced in a small computer system where the primary function performed is the sorting and manipulation of input data and the printing of output reports. There is no loss of audit trail. Audit of this type of system requires little training and background in Information Systems (IS). An example of this type of system are shipping data that are encoded and processed throughout the system along with accounts receivable ledgers. The output is a multicopy sales invoice for each sale, an updated subsidiary ledger, and a sales journal.

Complex System. This is characterized by the batch processing mode, the existence of one Central Processing Unit (CPU) and the extensive use of master files on magnetic media in processing. In this type of system, processing is usually confined to calculations, extensions, summarizations

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3.

and the like. There is some loss of audit trail but the same is not significant. The audit of such system can be done by auditors with limited specialized training in IS auditing. Because of the extent of a printed audit trail, the auditors have the option of performing audit tests with or without the use of the computer based on his experience.

Sophisticated System. In this type of system, transactions are initiated within the computer. There is extensive data processing and consequently, a substantial loss of audit trail. Most of the output is in machine-readable form. Heavily reliance must be placed on internal control in the audit of said system. Since many of these tests require IS skills beyond the knowledge of most auditors, IS specialists are usually called upon by the auditors. Careful advanced planning is necessary because records needed in audit and the approach to be used in testing must be made before data are processed.

V.

Accounting Periods Accounting periods are generally classified into two. They are: 1.

Calendar year; and

2.

Fiscal year

1.

when the taxpayer is an individual;

2.

when the taxpayer does not keep books of accounts; and

3.

when the taxpayer has no annual accounting period.

A. Calendar Year — is an accounting period which starts from January 1, and ends on December 31. This is used by most taxpayers who elect the calendar year as their accounting period. However, the calendar year shall be the basis of computing the net income in the following cases:

B. Fiscal year — is an accounting period of twelve months ending on the last day of any month other than December 31. Corporations and duly registered general co-partnerships are allowed to use this type of accounting period.

A taxpayer may have a taxable period of less than twelve (12) months in the following cases: Copyright 2015

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1.

when a corporation is newly organized and commenced operations on any day within the year;

2.

when a corporation changes its accounting period;

3.

when a corporation is dissolved;

5.

in case of final return of the decedent and such period ends at the time of his death.

4.

when the Commissioner of Internal Revenue, by authority, terminates the taxable period of a taxpayer pursuant to Section 6 (D) of the Tax Code; and

Change in Accounting Period — An individual cannot change his accounting period from the calendar year to the fiscal year. He is only allowed to use the calendar year. A corporation and a general co-partnership have the option to choose between the calendar year and the fiscal year. The application for a change in accounting period should be filed in writing with the Commissioner of Internal Revenue, through the Revenue District Office, where the business is registered, within thirty (30) days prior to the date fixed for filing of the return on the basis of the original accounting period designating therein the proposed date for the closing of its new taxable year. VI. Financial Statements

Financial Statements are reports signifying the end result of the financial accounting process. These reports are as follows:

A. Income Statement — is a report that summarizes the business activities for a given period and reports the net income or loss resulting from operations and from certain other activities. It is variously called the earnings statement, the statement of profit and loss, and the statement of operations. It normally consists of the following sections or items: 1.

Sales — reports the total sales to customers and fees received from clients for the period. All sales transactions should be recorded and invoiced. EaISTD

2.

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Cost of goods sold — refers to cost of goods relating to sales when merchandise is acquired from outsiders. This is the sum of the beginning inventory, purchases and all other buying, freight and storage costs relating to the acquisition of goods and subtracting the ending inventory thereof. When the goods are manufactured by the seller, the cost of goods

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3.

4.

manufactured must first be calculated. This is the sum of the cost of goods in process at the beginning, the cost of materials put into production, the cost of labor applied and factory overhead incurred. The total cost as thus obtained represents the cost of both completed work and uncompleted work still in production. The ending goods in process inventory, then, must be subtracted from this total in arriving at the cost of the product completed and made available for sale.

Operating expenses — are expenses incurred or utilized in the course of business or pursuant to the practice of profession. They are generally reported in two categories: 3.1

Selling expenses; and

3.2

General and administrative expenses

In case of self-employed individual taxpayers, professionals, non-resident aliens, estates and trusts engaged in trade or business, general professional partnerships and their individual partners, allowable expenses are subject to the provisions of Section 34 of the Tax Code. However, in lieu of the deductions allowed under the aforementioned section of the Tax Code, an individual subject to tax under Section 24, other than non-resident aliens, may elect a standard deduction in an amount not exceeding ten percent (10%) of his gross income. Other Income and Expenses — include items identified with financial management and miscellaneous recurring activities. Other income include interest and dividend income and income from rentals, royalties and service fees. Other expenses include interest expense and expenses related to the miscellaneous income items reported.

B. Balance Sheet — is a report that shows the financial position of the business unit as of a specified moment of time. It is a status report rather than a flow report. It is variously called statement of financial position, statement of condition, statement of resources and liabilities and the statement of net worth. The balance sheet is the fundamental accounting statement in the sense that every accounting transaction can be analyzed in terms of its effect on the balance sheet. In order to understand the information a balance sheet conveys and how economic events affect the balance sheet, it is essential that the reader be absolutely clear as to the meaning of its two sides in the equation: ASSETS = LIABILITIES +OWNER'S EQUITY 1.

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Assets — are economic benefits obtained or controlled by a particular entity as a result of past transactions or events. They include those costs that have not been matched with revenues in the past and are expected to afford economic utility in the production of revenue in the future. It

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2.

3.

includes both monetary assets, such as cash, marketable securities and receivables and non-monetary assets, those costs recognized as recoverable; and hence, properly assignable to revenues of future period, such as inventories, prepaid insurance, equipment and patents.

Liabilities — measure the claims of creditors against entity resources. The method for settlement of liabilities varies. Liabilities may call for settlement by cash payment or settlement through goods to be delivered or services to be performed.

Owner's Equity — is the residual interest in the assets of an entity that remains after deducting its liabilities. It measures the interest of the ownership group in the total resources of the enterprise. Such equities originally arise as the result of contributions by the owners and the equities change with the change in net assets resulting from operations.

VII. Purpose and Standards of Audit

The basic purpose of tax examination is the determination of correct taxable income as defined by the National Internal Revenue Code and other internal revenue tax liabilities of the person or entity whose return is being examined.

In conducting the examination, the Revenue Officer's responsibility is two-fold: to the taxpayer and to the Philippine Government. Minimum standards of examination may be extended beyond the originally intended scope, or beyond minimum requirements because of situations or facts not apparent at the outset. The extent of verification to be done in any single tax examination is a matter of auditing judgment for which no rigid guide can be established. The degree of checking or scope of a tax examination may be influenced by an analysis of the taxpayer's accounting procedures and the results achieved therefrom, for they measure the credibility of the records and the degree of the existing system of internal control of the taxpayer.

Standard refers to the criteria by which the quality of performance of auditing examinations are measured. A.

General Standards 1. 2. 3.

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An impartial mental attitude must be maintained in all affairs relating to an examination in order to assure a fair application of tax laws, regulations and rulings. Professional skill and ingenuity must be exercised in the performance of the examination and the preparation of the report.

Issues should be raised only when, in the Revenue Officer's opinion, they

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4. B.

have real merit and only when they will contribute in the proper determination of tax liability. The confidential nature of all information pertaining to any assignment must be strictly observed.

Standard of Preliminary Planning 1.

2. 3.

Sound judgment should be exercised in selecting from assigned returns those which are most likely to contain areas of non-compliance and, where otherwise permissible, survey procedures should be employed to dispose of those which do not warrant further consideration. Advance planning of work schedules with reasonable accuracy is essential for the effective use of time.

A general work plan should be formulated in each case prior to contacting the taxpayer which includes the development of issues suggested by the return and other information. The following steps may be included in the work plan: 3.1

Prepare a list of items which suggest a need for special consideration.

3.2

Draw-up a list of questions to be asked from the taxpayer.

3.3 C.

Identify other agencies or offices where the Revenue Officer can have access to their records if the taxpayer cannot present the documents requested.

Standards of Field Work 1.

2. 3.

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Audits should normally be performed at the taxpayer's place of business because of the accessibility of the books and records and to permit actual observation of taxpayers facilities and scope of operations. Otherwise, it should be performed in the office of the Bureau of Internal Revenue. The use of accounting skills, tax knowledge and ingenuity should be directed toward recognizing and raising issues which relate to non-compliance areas. Adequate evidential matter should be obtained through inspection, observation, inquiry, analysis and documentation to afford a reasonable basis for consideration of each issue with regard to the position of both the government and the taxpayer.

The position taken with respect to each issue should be supported by

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adequate authority. D.

Standards of Reporting 1. 2.

Reports are to be prepared in a complete, clear, concise, and legible manner in order that they may be easily read and understood.

Working papers should be legible, in the Revenue Officer's own handwriting, properly labeled, indexed, signed and arranged in a logical and orderly manner. aEIcHA

3.

E.

Working papers should be used as a practical and professional tool to aid the Revenue Officer in the discussion of issues or questions with the taxpayer or his authorized representative. It also generally provides a record of the audit procedures undertaken by the Revenue Officer.

Standards of Public Relations 1. 2. 3. 4.

Initial contact for audit arrangements should be made with the taxpayer and care should be exercised in explaining the type of records required.

Revenue Officers must be fully cognizant of the proper sources for gathering information and of the rights of the taxpayer and his representatives.

Necessary time and patience should be devoted to a discussion of any proposed adjustments to ensure that the taxpayer has a proper understanding of the issues. Tact and discretion are required in pointing out errors in books and records in order to avoid discrediting an employee or representative of the taxpayer.

VIII. Preliminary Approach to Examination A.

Pre-Audit Analysis of Tax Return

Analysis of the return is essential to an effective audit. Preliminary analysis is used to identify potential issues which will be developed further after contacting the taxpayer. All information contained in any attachment to the tax return should be thoroughly and completely scrutinized to ascertain whether or not all of the information is adequately reflected in the tax return. Before contacting the taxpayer, the Revenue Officer should familiarize himself with the following: 1.

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The business organization of the taxpayer and whether it has business establishments other than its main or head office;

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2.

The location of the business and its branches as this has a relation to the volume of business;

3.

The economic activity in which the taxpayer is engaged in;

4.

The accounting books and records that would ordinarily be kept;

5.

The accounting methods and policies and the degree of internal control;

6.

The overall composition of the tax return;

7.

The types of income reported;

8.

The reasonableness of deductions;

9.

Unusual or unfamiliar items;

10.

Apparently questionable or unallowable items;

12.

Inconsistencies between items and also in the treatment with respect to bad debts, inventory valuation methods, depreciation rates and methods, etc.;

11.

13. 14. 15.

B.

Gross profit and selling expense percentage as well as significant variations between prior and current years;

Prior years entries in the reconciliation schedules of retained earnings in a corporate return and of a partner's capital account in a partnership return which affect the year under examination; The status of the retained earnings account as well as the basis of assets and depreciation allowed or allowable; and

The report of the tax liabilities of the taxpayer for the immediately preceding period in order to be aware of the deficiencies that were reported. Review of prior year's examination records will clarify some doubts or questions in the Revenue Officer's mind regarding certain items or bring light to situation that otherwise would have remained concealed on the basis of the return alone.

Work Planning Work properly planned achieves good results.

In order to avoid any situation where the Revenue Officer will be faced with a situation of a cramped audit workload and schedule, he should prioritize the audit of the assigned cases in the following manner: Copyright 2015

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1.

2. 3. 4.

Returns or cases where the statute of limitations is about to prescribe should be given first priority. Prescriptive period is three (3) years counted from the date prescribed by law for the filing of the return, provided that in case a return is filed beyond the prescribed period, the three-year period shall be counted from the day the return; was filed. Claims for refund should be given the next priority in order to develop good BIR-taxpayer relationship. Cases assigned for reinvestigation should also be given priority attention.

Returns which would be more productive in terms of revenues should be given precedence over the less productive ones.

In work planning, an Audit Program should be prepared for each and every case. An Audit Program is a checklist of the various auditing procedures to be undertaken and the various books of accounts, records, documents and business forms to be verified in order to assess the correct tax due from a taxpayer. This checklist would serve as a guide for the Revenue Officer to conduct a "quality audit" within the time frame allowed to conclude a tax audit. It is also a tool of the tax administrators to check on the progress of the tax audit and for proper evaluation of the performance of the Revenue Officer. C.

Contact With Taxpayer

1.

Arranging for an Appointment

2.

Serving of Letter of Authority

A telephone or a personal call by the Revenue Officer should be made to the taxpayer himself and not his representative. 2.1

2.2 2.3

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On the first opportunity of the Revenue Officer to have personal contact with the taxpayer, he should present the Letter of Authority (LA) together with a copy of the Taxpayer's Bill of Rights. The LA should be served by the Revenue Officer assigned to the case and no one else. He should have the proper identification card and should be in proper attire. A Letter of Authority authorizes or empowers a designated Revenue Officer to examine, verify and scrutinize a taxpayer's books and records in relation to his internal revenue tax liabilities for a particular period.

A Letter of Authority must be served or presented to the taxpayer within 30 days from its date of issue; otherwise, it becomes null and void unless revalidated. The taxpayer has all the right to refuse its service if presented beyond the 30-day period depending on the policy set by top management. Revalidation is done by issuing a new Letter of Authority or by just simply

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stamping the words "Revalidated on _____________" on the face of the copy of the Letter of Authority issued. ASICDH

3.

Request for Accounting Records

The Revenue Officer should clearly specify the records he desires to be assembled for his examination. Among the books and records that may be required are:

4.

3.1

receipts (official receipts, warehouse receipts, delivery receipts, etc.)

3.2

invoices (sales and purchases invoices)

3.3

vouchers

3.4

cancelled checks

3.5

bills and statements of accounts (utility bills, payment notices, etc.)

3.6

contracts (sales/purchase contracts, loan contracts)

3.7

journals (regular and subsidiary journals)

3.8

ledgers (regular and subsidiary ledgers)

Initial Interview

The initial interview is the most important part of the examination process and should be conducted in all audits. Request should be made for a personal interview with the taxpayer himself.

The interrogation should be so conducted as to encourage the taxpayer to contribute willingly useful information which will assist in the proper determination of his tax liability. The information developed by this method will determine the eventual outcome of the case. The preliminary interview should, as far as practicable, cover the following:

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4.1

Discussion of sources of income — This may uncover possible sources of income which have not been reported such as interests on investments and deposits, dividends, rents, sales of properties as well as information on the taxpayer's financial history and standard of living;

4.2

Records kept for each source of income;

4.3

Handling and recording of cash transactions;

4.4

Records of loans from banks and/or loans to others

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4.5

Real or personal properties bought or sold in current year;

4.6

Correctness of personal and additional exemptions claimed;

4.7

Other items that would be relevant in the examination, to wit; a.

The responsible officers of the firm in order to facilitate acquisition of information/data:

b.

Place and time of audit.

c.

Ocular inspection of the factory, branches, outlets, etc.;

d.

Officers to whom the tax audit findings will be discussed; and

e.

Financial history and standard of living of the owner/owners.

D.

Preliminary Evaluation of Miscellaneous Records

1.

Minute Book

2.

Stock Transfer Book

3.

Partnership Agreement

The investigation on the taxpayer's books of accounts may begin with miscellaneous records other than accounting ledgers and journals. More often than not, scrutiny of these records may reveal items which the Revenue Officer should take into consideration as the examination progresses. The records and information to be obtained are the following: The review of the minute book should not be confined to the taxable year under audit but should cover at least some period immediately before or after. As the Revenue Officer scans the minute book, he should note appropriate transactions and items of significance, such as contracts entered into by the taxpayer, stock issuance, dividend declaration and compensation of officers. This book contains the names of stockholders, past and present, with the number of shares cancelled and issued. This book is also vital in computing documentary stamp tax, liabilities. A general knowledge of the names of large shareholders is also of value when checking the salary expense. When the stock and transfer book is not available, the record of dividend payment is an alternative source of similar information. A copy of the partnership agreement should be obtained and certain provisions affecting partner's salaries, profit and loss sharing, interest on capital, other allowances and other matters which may have tax consequences should be noted.

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4.

Audit Report of Independent Auditors

The Revenue Officer should read the auditor's report accompanying the financial statements. Sometimes, Revenue Officers fail to evaluate the auditor's report. However, there are cases when auditors do not issue an unqualified opinion. Any qualification or unusual comments in the auditor's report or certificate such as expression of opinion as to taxpayer's depreciation policy, inventory and cost valuation, adequacy of reserves, status of collectibility of receivables and the like should be noted for consideration and should be related to the examination of accounts.

In cases where the auditor issues two reports, one for management and the other for attachment to the tax return, the former should be studied and compared with the latter. Income and net worth in both reports may vary from income and net worth per books due to the auditor's adjusting entries not reflected in the books. Thus, the adjusting entries and supporting documents should be examined. If needed, the auditor's working papers should be looked into to explain these entries. 5.

Auditor's Working Papers

6.

Statements and Schedules Filed with Government Regulatory Agencies

7.

Appraisal Reports

E.

Initial Examination Techniques

1.

Understanding the Taxpayer's Books and Records

Audits, particularly of large companies, may frequently be simplified and facilitated, if the examining Revenue Officers are given access to the auditor's working papers. Where necessary, authorization from the taxpayer or requests for access to said working papers signed by duly authorized officials shall be secured to be able to scrutinize the working papers of auditors, particularly the year-end adjustments, intercompany transactions, nature of receivables and other peculiar accounts. Certain taxpayers are required to file financial statements and other reports with government bodies such as the Securities and Exchange Commission for corporate taxpayers, the Garments and Textile Export Board for-garments exporters, the Board of Investments for exporters, and other similar government offices. The Revenue Officer should compare the statements filed with the Bureau of Internal Revenue against those filed with other government offices. Any discrepancy should be inquired into and material differences should undergo an in-depth investigation. Appraisal reports, particularly real estate appraisals, are important in many cases such as for estate tax valuation of properties, capital gains tax verification, and donor's tax investigation.

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One technique that should be commonly used is for the Revenue Officer to interview the taxpayer or his representative and ask him to walk him through the book recording of a sale, purchase and expense transaction in order to have a thorough understanding of the taxpayer's accounting system and records. 2.

Reconciliation of Books and Returns

Another step in understanding the records is to perform a reconciliation of the books with the return. The following actions are recommended to assist the Revenue Officer in the reconciliation process: 2.1

Request for a Chart of Accounts and identify account numbers and account titles.

2.2

Identify unusual accounts.

2.3

Scan the general ledger to discover unusual account entries.

2.4

AHaETS

Ask the taxpayer for the ,tax working papers or any other type of working papers that were used to prepare the return. If the working-papers are in the hands of the external auditor, the taxpayer should be advised to secure a copy thereof from their auditor.

2.5

3.

If no working papers are available, request the taxpayer to prepare the reconciliation and supporting schedules used to arrive at the reconciliation of data as reflected in the books and the tax returns.

Evaluate the Statement of Changes in Financial Position, if the taxpayer has one, to identify sales and purchases of fixed assets, investments made and disposed, loan and debt payments, capital contributions and other transactions that might not be readily apparent on the balance sheet and income statement.

Performance of Compliance Tests

The Revenue Officer should establish the level of reliance that can be placed on the books and records and determine whether the books show all the transactions which occurred. To accomplish this, a compliance test should be performed on some transactions through the backward and forward approaches in verification as follows: 3.1

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In the backward approach, the figures per tax return are traced to the trial balance, then to the general ledger, the various journals, and ultimately to the source documents such as sales invoice or official receipts.

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3.2

In the forward approach, the Revenue Officer should select a supporting document, say a sales invoice, and trace it through the sales journal, general ledger, trial balance and finally to the tax return.

The backward approach is effective in checking unsupported expenses while the forward approach is used in uncovering unreported income. 4.

Analysis of Adjusting Journal Entries

It is important that the Revenue Officer understands adjusting journal entries because tax issues are frequently discovered in the adjusting journal entries. These adjusting journal entries are usually accruals, deferrals, corrections or reclassifications of accounts. 4.1

4.2

4.3

4.4

Accruals are normally entries to record certain known and fixed amount of obligations or liabilities. Accruals are also used to book uncertain,. contingent liabilities. Contingent liabilities are not fixed in amount or date and are not deductible for tax purposes.

Deferrals are typically used to defer or postpone recognition of income or expenses. An inspection of the deferred income account may reflect amounts representing services already performed. It may also show goods already shipped and received by the customer. In both of these situations, a deferral of income is not proper.

Corrections of prior year's earnings, other adjustments and reclassifications are made through adjusting journal entries which are recorded in the general journal or in the journal vouchers. Usually, these entries are taken from the auditor's working papers. The examining Revenue Officer should scrutinize these entries, specially those credited directly to retained earnings, analyze the tax issues involved, and note down possible tax assessments. When scanning adjusting journal entries, the following should also be looked into closely: 4.4.1 Unusual and non-recurring entries;

4.5

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4.4.2 Entries reducing assets as there could possibly be unreported gain on sale, incorrectly computed gain on sale, incorrectly computed installment sale, non-taxable exchange, or withdrawal of goods by the owner; and Entries increasing liabilities as these could represent fictitious or contingent liabilities, fictitious expenses, invalid loans to shareholders, or undeclared income credited to liability accounts.

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F.

Evaluation of Internal Control

Internal Control is a system of procedures in place to ensure that all business transactions are properly recorded and assets are adequately safeguarded.

It is mandatory for the Revenue Officer to evaluate internal control for him to decide up to what extent the system can be relied upon. This will also determine the nature, extent and timing of audit tests to be applied in the examination and to plan subsequent audit procedures. 1.

Principles of Internal Control

Good internal control assures good record keeping and the inability of the employees and the owner from misappropriating the assets. Some broad principles of internal control are:

2.

1.1

Responsibilities should be clearly established.

1.2

Adequate records should be maintained.

1.3

Assets should be insured and employees bonded.

1.4

Record keeping and custody should be separated.

1.5

Responsibility for related transactions should be divided.

1.6

Personnel should be rotated.

1.7

Automation should be used whenever practical.

1.8

Employees should be informed of prescribed procedures.

1.9

The system should be under constant review.

Elements of Internal Control Internal control can be divided into three elements:

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2.1

Control Environment

2.2

Accounting System

This includes the entity's organizational structure, methods of assigning authority and responsibility, engagement in related-party transactions and compliance with various laws, rules, and regulations.

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This consists of the methods and records established to capture financial transactions such as sales, purchases, investments and payment of expenses and liabilities. This element is important to the Revenue Officer for him to understand how transactions are initiated and recorded and to determine the degree of reliability to be placed in the taxpayers books and records. 2.3

3.

Control Procedures

These include the adequate use of documents to ensure the proper recording, valuation and timing of transactions. Reconciliations of accounts should be done periodically and management should review reports for accuracy and completeness.

Standard Procedures in Evaluating Internal Control

To establish the scope of the audit and degree of compliance tests to be performed, internal control should first be valuated based on the following techniques: 3.1 3.2

Reconcile the returns with the books and records. Difficulty in reconciling the return with the books and records may be an indication of inadequate internal control in either financial or tax accounting.

3.3

Interview responsible company personnel and observe business operations.

3.5

Secure and study copies of operating manuals or instructional booklets that may lead to an easy understanding of the taxpayer's business operations.

3.4

3.6

Review the chart of accounts and identify unusual accounts or note those accounts which should be included but not indicated.

Determine if the taxpayer's personal transactions are segregated from business operations or if separate bank accounts are maintained by the owner and the business.

3.7

Determine if bank accounts are reconciled monthly.

3.9

Determine if pre-numbered documents are being used.

3.8

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Identify the personnel responsible for record keeping and determine their responsibilities and authority in the business operation.

Determine the books and records maintained and the frequency of recording transactions. Determine the extent of involvement of auditors and other third parties in

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3.11

the business.

Determine if certified audits for any reason were conducted. If so, copies of documents in relation thereto should be secured. HIAESC

3.12

Determine if the income reported by the taxpayer reflects his lifestyle.

The effective evaluation of internal control is dependent upon a very good interview, observation of the business operation, and testing of the system.

G.

Sampling Techniques

1.

Two Basic Types of Sampling

Sampling is a large and important part of the examination of a tax return. It is the application of examination procedures to less than 100% of the items in an account to evaluate its accuracy. 1.1

Statistical Sampling

1.2

Judgmental Sampling

Statistical sampling is the formal mathematical selection and examination of transactions, amounts or accounts based on the probability that moderately large number of items taken as samples will produce results from which conclusions may be made. In selecting accounts and transactions to be tested, judgmental sampling should be applied as it involves the use of professional judgment in planning and performing the sampling and analyzing the results.

Judgmental sampling may include any or both of the following methods: 1.2.1 Block Sampling — uses groups of continuous items selected from an account balance or class of transactions. An example is a Revenue Officer's decision to sample one month of travel expense to reach a conclusion for the year.

1.2.2 Peso limitation sampling or cut-off sampling — selects a minimum peso amount and transactions in excess of the said amount are verified. 2.

Factors to be Considered in Planning the Sample 2.1

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The extent of sampling to be done is dependent on the degree of internal control. Thus, a small sample size is required if internal control can be greatly relied upon. 2.2

Accounting System

2.3

Materiality

2.4

Analytical Review

Large errors or high frequency of errors in the accounting system may require a large sample size. In choosing appropriate material limits, the absolute size of an item, the relative size and the nature of the business, and industry/business practice should be considered. Materiality of an item should be related to its tax consequence. In analytical review, the following considerations should be studied: a.

Taxpayer's standard of living

b.

Interest in closely held companies

c.

Transactions between related parties

d.

Transaction involving questions of fraud

f.

Significant adjustments on previous Revenue Officer's reports

e.

3.

Significant increases or decreases in taxable income from year to year

Sampling Techniques to be Applied in Testing Accounts and Transactions

There are many sampling techniques as there are cases. The Revenue Officer is not precluded from discovering and applying new techniques as may be needed in each particular case. Listed below are the suggested sampling techniques in testing income statement and balance sheet items: 3.1 3.2

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Select the first and last months of sales to ensure that income was not deferred to an improper year.

The last month of the period under examination should be tested because

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3.3 3.4 3.5

3.6 3.7

3.8

Selection of the largest three months incurrence of an expense account may reveal expenses that should be capitalized, personal expenses or padded expenses.

Scan the cash disbursements journal and general ledger for unusual or very large entries. This step also familiarizes the Revenue Officer with the accounts, payees, suppliers and clients of the taxpayer. Select at least one month's (or one week for a large corporation) file of cancelled checks. Thoroughly analyze each check together with the endorsement at the back. This could lead to the discovery of fictitious; payees, unusual transactions, personal items charged to expense and other possible disallowances. Inspection of the corporate minutes and the articles of incorporation could lead to a Revenue Officer's determination to sample a particular account.

Examine certain accounts in the income statement in relation to the balance sheet accounts. Thus, Accounts Receivable should be analyzed together with Sales. Bad Debts Expense should be verified together with the Allowance for Bad Debts. Likewise, Accounts Payable should be examined together with Purchases and other related expenses.

Test-check source documents and related transactions by considering the persons involved, nature of the contract, mode of payment and other important aspects.

3.9

Rounded figures should be checked as they may be estimates.

3.10

Utilize results of analytical review in selecting the sample.

3.11 4.

of the likelihood of errors and unallowable adjustments made before the end of the year.

Contract or limit the scope of the sample if the majority of the samples are completed and there are still no discrepancies.

Examining the Sample Items The sample items, as selected, should be verified as follows:

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4.1.

Analyze and determine the validity of the source documents.

4.2.

Examine collaborating documents.

4.3.

Check with third parties.

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4.4. 5.

Inspect and observe inventory flow, fixed assets acquired, sales transactions and other transactions which may require ocular inspection.

Analyzing the Results

Analyzing- the results of a sample is an important yet commonly missed step. The sample taken should be evaluated and considered in relation to any peculiar situation, such as related -party transactions or economically unsound transactions. One example would be purchases made at unusually high or low prices. If the results of the sampling indicates potential tax assessment, an in-depth analysis should be conducted as follows: 5.1.

Verify the account showing the discrepancy or possible source of tax deficiency.

5.2.

Trace the audit trail involving the transaction.

5.3.

Perform a 100% verification of such account.

5.4.

Consider performing third-party checks to substantiate transactions.

5.5.

Take a close look at how the taxpayer handled the entire transaction.

5.6.

Consider the adjustments associated to other accounts.

5.7. 6.

Discuss the problems or discrepancies with the taxpayer or his authorized representative.

Concluding the Sampling Results

The audit samples should be clearly documented in the working papers from which a conclusion shall be drawn. If a quality sample analysis has been performed, it will be easy to form a conclusion from the sample results. The conclusion reached should be clear, concise and final.

IX. Balance Sheet Approach To Examination

A series of suggestions on the procedures for commencing the examination of tax returns and appropriate accounting records have already been presented. The initial phase includes a verification of the net income per books with the reconciling items reflected in the tax return. After the foregoing process, the Revenue Officer should turn his attention primarily to the books and records bearing in mind that there are some reconciling items which affect the net income per books.

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other techniques which are deemed necessary in a particular case. A.

Cash on Hand and in Bank 1. 2.

3.

Compare deposits shown in the bank statement against entries in the cash receipts book and official receipts. .Note down any unrecorded or unreceipted deposit and investigate the source. Test check cash sales with the cash receipts book if they have been correctly recorded. Also check cash sales made at the beginning and end of the period under examination to determine if year-end sales have been recorded in the proper accounting period. Investigate entries in the general ledger cash account. Look for unusual items which do not originate from cash receipts or disbursements journals. These entries may indicate unauthorized withdrawals or expenditures, sales of capital assets, omitted sales, undisclosed bank accounts, etc. AcICTS

4.

5. 6.

7.

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Review cash receipts journal for items not identified with ordinary business sales, being alert to such items as sale of assets, miscellaneous income, sale of scrap, income received in advance, proceeds from issuance of capital stock and other taxable transactions. Review cash on hand and cash in bank accounts to determine if there are any credit balances during the period under examination. This may indicate unrecorded receipts.

Review cash disbursements journal for a representative period. Note any missing check numbers, checks payable to cash, large or unusual items and determine propriety thereof through a comparison with vouchers, journal entries and other related accounting records. If the taxpayer is on cash basis, ascertain if checks were written and recorded at the close of the period under audit but were issued thereafter. Verify checks issued during the latter part of the year to check the authenticity of expenses claimed. Give special consideration to checks issued for cashier's checks, sight drafts and other similar bank instruments where the payees and nature of the disbursements are clearly shown.

Obtain bank statements and cancelled checks for each bank account for one or more months, including the last month of the period under examination.

Note year-end bank overdrafts. This may indicate expenses which are

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11.

12. 13. 14. 15. 16. 17.

B.

fictitious or unallowable since funds were not available for payment.

Determine if there are checks which have remained outstanding for an unreasonable period of time. This may indicate improper, fictitious or duplication of disbursements. Old outstanding checks could possibly be restored to income. Determine whether voided checks have been properly adjusted in the books and credited to the appropriate expense accounts, if applicable. For a test period, check endorsements to verify if they are the same as that of the payees', noting any endorsements by the owner, or any questionable endorsement.

If records appear unreliable or have not been subjected to a competent independent audit, tests of footings and postings should be made for a representative period.

Test check disbursements from petty cash to determine if there are any unallowable items included. Scrutinize cash overages and shortages, being alert to occurrence of irregularities.

Tally debits and credits to the cash accounts per month against sales credit, debts to purchases and expense accounts and other sources and application of cash based on the worksheet of real and nominal accounts submitted by the taxpayer. Note down discrepancies and substantial accumulation of cash without reasonable credits.

Notes and Accounts Receivable 1. 2. 3. 4.

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Secure a breakdown of the receivables by class, whether notes or accounts and by debtors, such as customers, affiliated companies, officers, stockholders, employees and others.

Check entries in the general ledger control accounts. Look for unusual items, especially those which do not originate from the sales or cash receipts journals.

Determine if subsidiary ledgers are in agreement with control accounts, and if not, ascertain the reasons for any differences.

Note any credit balances in the general ledger or subsidiary accounts. This may indicate deposits or overpayments which could be considered as additional income or unrecorded sales. Also, credit balances may indicate a misapplied bad debt recovery or deposits received for so long a time that

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5. 6. 7. 8. 9. 10. 11. C.

there is little likelihood that they will ever be refunded. Whatever the cause, the credits, if material, should be isolated for consideration.

Some credit sales invoices and postings should be test checked from the sales journal to the subsidiary and control account.

Compare balances of accounts receivable and sales for the current year with that of the preceding year. Investigate significant changes. Investigate large and/or unusual balances classified as other accounts receivable.

In case of notes receivable, determine whether accrued income on interest bearing notes or accounts has been included in income.

Investigate the sources of notes receivable as there may be instances when the taxpayer has other sources of income other than his regular business. Determine whether accrued income on interest bearing notes or accounts has been included in income.

If needed, check the detailed listing of beginning receivables to cash collected as reflected in the cash receipts book. This may disclose diversion of funds and other irregularities.

Allowance for Bad Debts 1. 2. 3. 4.

Compare balances in the allowance account with that of the preceding year's. Investigate significant changes. Evaluate the reasonableness of the allowance by computing the ratio of the balance of allowance for bad debts to the trade accounts receivable balance. Compute the ratio of bad debts expense over sales. Analyze if such is reasonable.

5.

Review the aging schedule of accounts receivable.

7.

Ascertain that accounts written off are worthless by examining supporting documents such as reports of collection agencies, correspondence with

6.

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Ascertain the company's policy of providing for allowance for bad debts by examining minutes of meetings and other documents.

For accounts written off which were charged to expense, examine minute book for authorization to write off accounts.

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8. 9. D.

said customers and documents filed in court, and court decisions on collection cases.

If possible, check the financial status of the customers for which allowance for bad debts was provided. Check entries to the allowance account for possible bad debts recoveries and trace if the same were declared as income at the time of recovery.

Inventories 1. 2. 3. 4. 5. 6. 7. 8.

Verify the inventory valuation method being applied if such is acceptable for tax purposes and consistently applied from year to year. Compare inventory balances in the return under examination with the balances on the prior and subsequent year's returns and financial statement; then verify these with the taxpayer's records.

Check BIR authorization for changes in inventory valuation method and verify taxpayers compliance with the requirements set forth under existing rules and regulations. Check gross profit percentage variations. Conduct in-depth verification of items with substantial variations. Determine the significance of any notes or qualifying statements on financial reports prepared by independent accounting firms.

Determine the taxpayer's computation of standard rates, if standard rates are applied.

Verify cost of production reports and test check certain costs reflected therein to supporting documents.

9.

Determine if year-end purchases were included in the closing inventory.

11.

Determine if there have been write-downs for "excess" inventory to below cost. Verify authorization and supporting document/report for such write-downs.

10.

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Determine the correct cost components to be included in the inventory. The costs used in determining inventory depend on whether the business is of a service, merchandising or manufacturing nature.

Analyze unusual entries to cost of sales account such as materials, labor and overhead charges not directly related to sales or transfers of finished goods, if applicable.

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12.

E.

When items have been removed from inventory for the owners' or shareholders' use, check if these are properly recorded as part of sales. These required minimum audit procedures, however, should not deter the Revenue Officer from making a more detailed examination of the inventory account, when warranted.

Advances To Stockholders/Officers

This receivable account may represent an outright advance of money by the corporation to officers and/or stockholders. Usually, these advances vary in amounts over a period of time, consequently building up the current amount. The following verification procedures on this account should be conducted, if warranted: 1. 2. 3. 4.

Verify authorization from Board of Directors for advances and loans to stockholders and officers by checking duly approved minutes of meetings. Identify company officers and stockholders who are granted advances regularly.

Check payments of advances to the company if such loan re-payments earned interest for which no withholding tax was deducted.

Verify entries and supporting documents on cancellation of advances if the same do not originate from cash receipts. TESDcA

F.

Investment

The investments most commonly found on the books are stocks and bonds and, in some cases, real estate not used in actual business operations. The following procedures should be conducted in the examination of investments if such are material assets of the taxpayer: 1. 2.

3.

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Familiarize with the nature of investments, utilizing any records maintained by the taxpayers such as the investment ledgers, worksheets showing the breakdown of investments and other investment records.

Analyze sales and other credit entries to the account. If stocks sold are listed in the stock market, test check selling price of stocks sold at the prevailing "close" price at the Philippine Stock Exchange during the date of sale. Real properties sold should not fall below fair market value and/or zonal value where the zonal value has been established. The application of the "whichever is higher" rule shall be observed.

Verify journal entries to ascertain the selling price and gain on sale of investments. Vouch supporting documents such as deeds of sale, proof of remittance of taxes withheld, payment of documentary stamp tax and other

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4. 5. 6. G.

relevant records.

Investigate sales to related parties and/or officers or stockholders below fair market value.

Cross-check all investments during the year to the interest, dividend or rental income accounts. If investments or bonds were acquired at a premium or discount, determine whether the premium/discount is amortized over the life of the bond.

Depreciable Assets

This group includes tangible properties of relatively long life which are used in the operation of the business. However, natural resources such as oil or mineral lands are not included in this group of asset account. The following verification procedures should be undertaken on these accounts: 1.

2.

3.

Compare the asset and related reserve amounts as they appear on the tax return, balance sheet, depreciation schedule, and taxpayer's books and schedules. Compare the beginning and ending figures for the taxable year and reconcile differences or ask the taxpayer to make the necessary reconciliation. Verify the correctness of such reconciliation. Review depreciation schedule of fixed assets and ascertain propriety of depreciation expense claimed. Watch out for depreciation that may have been taken on assets which are already fully depreciated or charged off to expense. Review asset additions during the year by reference to invoices, contracts and other documents and determine if the proper cost basis was used. 3.1.

3.2. 3.3. 3.4.

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Note items which appear to have originated from unusual sources such as appraisal increases, transfers and exchanges, and determine propriety thereof. Ascertain if prior earnings were adequate to cover acquisitions.

Determine if acquisition and installation costs of fixed assets and leasehold improvements have been capitalized. Ascertain if assets include items of a personal nature. If the assets are used by the officers for their personal use, the depreciation should be disallowed.

Where construction or any other work of a capital nature is performed with the taxpayer's own labor, equipment and other assets for its own use, be certain that the basis of such asset

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3.5. 4.

5. H.

includes materials, labor and overhead including depreciation.

With regard to the basis of recognition of costs of assets, consider such items as trade-ins, acquisitions from related taxpayers, allocation of cost between land and building and other basis.

Decreases in the asset accounts during the year should be noted. The accuracy of the gains or losses resulting therefrom should be verified and ascertain that the appropriate tax on the transaction, such as value-added tax, if applicable, has been paid. Ascertain if the taxpayer has transferred assets to the owner, officers, stockholders or to a controlled domestic or foreign corporation for less than fair or adequate consideration.

Allowances For Depreciation, Amortization And Other Valuation Reserves 1. 2.

Review the nature and source of all accounts and ascertain if they are being used to claim unallowable deductions. With regard to depreciation, determine the correctness of the amount of asset being depreciated. No depreciation is allowable on the appraisal increase of fixed assets. Any foreseeable salvage value is to be deducted from the cost of the asset in determining the basis of depreciation. 2.1.

2.2.

No depreciation is allowable on a building until it is completed or on a machine until it is installed. Expenditures which are properly includible as an element of cost are freight-in, installation cost, title cost, and legal or brokerage fees in connection with acquisition. Where land and building are acquired on lump-sum, the following formula should be used in computing the building cost for depreciation computation: FMV or Zonal value of land ——————————— X FMV or Zonal value of land and building Total acquisition cost = Cost of Land Total acquisition cost Of land and building Pxxx Less: Cost of land per above computation xxx —— Cost of building Pxxx

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3.

====

Ascertain the taxpayer's depreciation and amortization policies and consider the following: 3.1. 3.2. 3.3.

4.

I.

Whether the methods applied by the taxpayer are in compliance with the Tax Code and existing revenue regulations; Whether the depreciation rates used by the taxpayer are fair and reasonable; and

Whether the taxpayer has applied the same method consistently from period to period.

Check authorization from minutes of meetings, fixed asset reports, or other supporting documents on credits for allowance for obsolescence and/or asset write-offs. If necessary, inspect assets claimed as obsolete and/or written off.

Intangible Assets 1. 2. 3. 4.

Investigate the nature of the intangible assets whether leases, patents, licenses, trademarks, goodwill, copyright, franchise and others. Costs of acquiring the intangible should be capitalized when useful lives can be estimated. If not, no amortization is allowable for tax purposes. Determine if the recorded cost and cost of current additions includes proper elements such as legal fees, application fees and other costs of acquisition. Examine contracts and other legal documents.

Verify correctness of deductions claimed as amortization of intangible assets as follows: 4.1. 4.2. 4.3. 4.4. 4.5.

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Leasehold costs are subject to amortization over the term of the lease. Goodwill cannot be amortized if it is for an indefinite period of time.

Research and development expenditures may either be capitalized or treated as outright deductible expense. Patents sold with the exclusive right to make, use and sell an article constitutes ordinary income.

Organization expenses are subject to amortization and are not deductible in full on the year incurred. Check the reasonableness of

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5. 6. 7. 8. J.

Determine if there have been transactions with related taxpayers. If so, verify if these are made at arms-length. Determine if income applicable to intangibles has been included as income (e.g. subleases, overriding royalties, franchise and other sources). Analyze any transaction involving transfer of foreign rights to any foreign entity for an equity interest or for nominal consideration.

Be alert to transactions which could have given rise to intangibles classifiable as asset account which may have been recorded as expense.

Prepaid Expenses And Deferred Charges 1. 2.

K.

the taxpayer's amortization policy on organization expense.

Verify the nature and source of these assets and the manner in which they are charged off to expense. When prepaid expenses are not reflected in the balance sheet, verify charges to expenses which entail advance payments such as insurance, rent, supplies, repairs and maintenance that are covered by contracts.

Other Assets 1. 2.

Obtain a schedule of other assets account when material in amount.

Investigate sources of charges to the account. Verify entries and supporting documents to check if the other assets are results of income-generating activities not reported in the financial statements. IcHDCS

L.

Exchange, Clearing or Suspense Account 1. 2.

M.

Obtain a schedule to determine the nature and purpose of the account if significant in amount.

Test check debit and credit entries, being aware of the possibility that such account may be used as a means for diverting sales, padding expenses, and concealing other irregularities.

Current And Accrued Liabilities Including Notes Payable

These liabilities are found on business records under various titles such as accounts payable, vouchers payable, notes payable, accrued expenses and other current liabilities. The audit procedures are as follows: 1.

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Reconcile subsidiary ledgers with the control accounts. Request the

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2. 3. 4. 5.

6.

7. N.

taxpayer for explanation of any discrepancies noted.

Note existence of debit balances in the general ledger or subsidiary accounts. This may indicate diversion of funds and other underdeclaration of income. Note accounts which have long overdue balances. These may indicate contested liabilities or accounts that no longer exist such as unclaimed wages or unclaimed deposits which should be reverted to income.

Review computation of year-end accruals with respect to their deductibility as expenses or purchases. Examine legitimacy of accounts payable to affiliates or related taxpayers. Test check payments made by tracing the same to supporting documents.

Investigate entries in the general ledger control accounts. Check unusual items such as those that do not originate from the voucher register or disbursement book. This may disclose unreported income, improper claim or overstated expense.

Be aware of any contingent liability by reviewing minutes of meetings and annual reports. Although this is not reflected in the tax return, an accrual may have been made for the item. Any claim for an expense or deduction arising from a contingent transaction shall not be considered as a deductible expense. A deductible expense must be reasonably determinable in amount and the liability must be fixed. If payables include liability on security deposits, secure a copy of the lease contract/agreement to determine provision on the application of lease deposits. These security deposits are taxable when received.

Fixed Liabilities 1.

2.

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Acquaint with the pertinent provisions of loan contracts, mortgage agreements, certificates of indebtedness, financing arrangements and consider possible adjustment areas as follows: 1.1.

determination of expenses, (e.g. interest and bank charges);

1.2.

refunding of debt; and

1.3.

legal, professional and other expenses of issuance.

Scrutinize any long-term outstanding liability to the owner, shareholders, officers or to a related taxpayer as this may constitute accumulated

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3.

4.

5.

O.

unreported income.

When the liability is secured by property pledged or mortgaged as collateral for the loan, determine if the property pledged/mortgaged is income producing. Review the terms and conditions stipulated on the loan agreement to determine if income derived therefrom remains to be reported by the taxpayer as the borrower. Verify if funds were borrowed for use of affiliates as the interest expenses thereon shall not be deductible on the part of the borrowing taxpayer. There should be a reallocation of profits and the tax burden must be shifted to the affiliate in accordance with existing rules and regulations. Determine whether the indebtedness will give rise to interest expense that are subject to limitations on deductibility under Section 34(B) of the Tax Code. Determine if loans were borrowed to finance acquisition of tax-exempt securities. If so, the interest expense is not considered deductible for income tax purposes.

Deferred Credits 1. 2.

3.

4.

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Check all payments received as recorded in the cash receipts book, (i.e. date of receipt, source of collection, and other entries).

Check if collections were included in the gross income during the year when the payments were actually received. Amounts are generally includible in gross income for tax purposes not later than the time of receipt if they are subject to free and unrestricted use by the taxpayer. Under this theory, collections, advance rentals, legal retainer and the like, advance sales of transportations tokens or communications tickets and other advances are income when received.

Look for credit balance of accounts which fall under deferred credits. They may be clearly labeled as advanced rentals, deferred service income or may be shown as a reserve account that is mixed with true liability accounts, or as a contra-balance in the receivables. If the taxpayer used the completed contract method of accounting for contracts entered into and construction work that actually commenced prior to January 1, 1998, income and expenses attributable to a particular job or project are properly deferred until completion of the project. The contracts and progress reports should be inspected to determine whether the reporting of income has been delayed beyond the completion of the project. When a taxpayer uses the installment method of reporting income, the

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unrecognized gain for tax purposes should be recorded as a deferred credit. This particular account should be checked to determine if the year-end balance remaining in the account reconciles with gross profit to be reported on the subsequent payments. Any difference would indicate erroneous computations of income from payments. P.

Loans from Shareholders/Officers/Owners 1. 2.

Determine whether there is a true debtor-creditor relationship. Excessively large liabilities in relation to capital stock (especially in the case of a new company) may indicate a thin capitalization situation. Check the financial statements of the corporation as well as that of the shareholders. If there is an interest expense account on the part of the corporation from such loan, there should also be a corresponding interest income account on the part of the shareholder.

There are certain tax advantages to the corporation or shareholder for an equity investment to be treated as a loan. Be sure that the taxpayer gets these benefits only when the facts of the case show that a "true loan" exists. If "loans" are found to be equity capital, the following procedures may be applied:

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2.1.

Disallow claim for interest expense and treat payments during the year as dividends.

2.2.

Treat loan repayments as dividends.

2.3.

Disallow bad debts deductions by the shareholders.

Check supporting loan documents issued in favor of the shareholders, officers or owners. If unsupported or if support is doubtful, the unsupported income may have been lodged in this account.

Verify certain payments of loans against check vouchers and cancelled checks. Verify the debit and credit entries in the general ledger account and watch out for unusual sources other than the cash receipts and disbursements book.

Examine adjustments, specially increases in the account, at the end of the year as this may constitute shifting of taxable income to this liability account. Verify general journal entries, journal vouchers and related

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documents supporting the entries. Q.

Capital Accounts 1.

Capital or Owner's Equity-for sole proprietorship 1.1. 1.2.

1.3

2.

Review debits and credits to the account during the period under audit and check supporting entries to the account. Increases which originate from sources other than profit and loss may indicate omitted income. Relate the account balance and withdrawals with the owner's standard of living. Where owners report no other sources of income, and withdrawals appear insufficient to maintain personal living expenses, there may be under reporting or diversion of income.

Partners' Capital — for partnerships 2.1. 2.2. 2.3. 2.4. 2.5.

3.

210. Reconcile amount appearing on the books, tax return and financial statements. Verify discrepancies, if any.

Review debits and credits to the account during the period under audit. Verify increases and decreases and check for unusual sources other than profit and loss. Reconcile amount appearing on the tax return, books and financial statements. Verify any differences noted. Examine pertinent provisions of partnership contract and check correctness of distribution of partnership income and expenses.

Ascertain that the correct tax has been withheld on distribution of partnership profits.

If the taxpayer claims that it is a general professional partnership, examine partnership contract and registration with the Securities and Exchange Commission.

Stockholders' Equity-for corporations 3.1.

Capital Stock

3.1.1. Review entries in the capital stock account and verify increases and decreases thereto. 3.1.2. Verify correctness of all items appearing on the return,

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books and financial statements. Investigate discrepancies, if any.

3.1.3. In case of additions to capital stock out of new issues during the period under audit, ascertain that the correct amount of documentary stamp tax has been paid. Secure a photocopy of the proof of payment. 3.1.4. Compare data from minute book with items recorded on the books of accounts to determine if entries have been made.

3.1.5. Determine if expenses relating to stock issuance (i.e. legal fees, registration fees, broker's commission and other expenses) have been properly handled.

3.1.6. Determine during the examination of a recapitalization of the stock in a closely held company, if the fair market value of the stock to be received by each exchanging shareholder is equal to the fair market value of the stock surrendered in the exchange. If there is a significant difference, consider the possibility of treating the difference as a donation subject to donor's tax. cAHDES

3.1.7. If a reorganization has taken place, examine the following documents: 3.1.7.1 The reorganization plan; 3.1.7.2 Journal entries giving effect to direct reorganization;

3.1.7.3 Notes of all minute book referring to the transaction, and

3.1.7.4 Notes of pertinent information from the correspondence file with other parties to the reorganization.

3.1.8. Examine by-laws, articles of incorporation or other documents in support of other transactions affecting capital stock.

3.1.9. Determine if the increase in capital stock is the direct consequence of an exchange of property under Section 40(C)(2) of the Tax Code. If so, confirm compliance with the conditions set for the non-recognition of gain or loss by performing the following audit procedures: Copyright 2015

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3.1.9.1 In case of merger or consolidation.

3.1.9.1.1 Verify if the plan of reorganization has been adopted by each of the parties to the reorganization.

3.1.9.1.2 Check if the income tax return filed for the taxable year in which the exchange took place incorporated all facts pertinent to the non-recognition of gain or loss upon such exchange, such as:

3.1.9.1.2.1 The historical cost or other basis of valuation of all properties, including all stocks or securities transferred incident to the plan; and

3.1.9.1.2.2 The nature and amount of liability assumed upon the exchange and the amount and nature of any liabilities to which any of the property acquired in the exchange is subject. 3.1.9.1.2.3 Verify Deed of Assignment of property for shares of stocks; and 3.1.9.1.2.4 Check in the required documentary stamp tax has been paid.

3.1.9.2 In case of transfer of property to a controlled corporation

3.1.9.2.1 Verify if the transferor and the transferee filed an income tax return for the taxable year in which the exchange was consummated with a complete statement of all facts pertinent to the exchange.

3.1.9.2.2 Verify Deed of Assignment of the property.

3.1.9.2.3 Determine if transferor of the property gains control of said corporation, alone or together with others, not exceeding four (4) Copyright 2015

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persons, pursuant to Sec. 40 (C)(2) of the NIRC.

3.1.9.2.4 Determine if the documentary stamp tax was paid.

3.1.9.3 In both cases, ascertain if the following information have been annotated at the back of the Transfer Certificates of Title or certificates of stock: 3.1.9.3.1 Date of execution of the deed of exchange.

3.1.9.3.2 The original or historical cost of property. 3.1.9.3.3 The fact that no gain or loss was recognized as a result of such exchange. 3.2.

Retained Earnings

The investigation of the retained earnings (or deficit, in case of accumulated losses) is a very important part of the audit process as this is related to the net worth method of investigation. It is the account to which the net income or net loss from operations is transferred and accumulated into. The minimum audit procedures that should be undertaken in analyzing this account are as follows: 3.2.1. Compare the amount of earnings retained in the business as shown on the return, financial statements, books of accounts and the schedule of reconciliation of net income per books and per return. Verify differences, if any.

3.2.2. Verify correctness of all items, both increases and decreases, appearing on the books or return. Trace beginning balance of retained earnings to the ending balance appearing in the balance sheet of the prior period. 3.2.3. Check increases which do not originate from net income. Verify entries from the general journal/journal vouchers, specially those recorded other than as year-end adjustment as these may indicate sales or income directly posted to the retained earnings account.

3.2.4. Determine if declared and unpaid dividends are properly recorded. Compare paid dividends to the minutes of the Copyright 2015

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Board of Directors meeting(s).

3.2.5. For taxpayers incurring continuous losses and deficit balance, investigate the real status of the business. Tour company premises, evaluate the volume of business, and compare the information gathered with the financial data reported. There may be underreporting of sales as there is very little reason for a business to exist if it is continuously incurring losses. 3.2.6. Examine supporting documents and authorization for all other debit and credit transactions in retained earnings to determine conformity with existing tax laws and regulations. X.

Audit of Income and Expenses

This Chapter discusses the books of accounts, accounting records and documents used to record income and expense transactions. It enumerates the audit procedures and techniques for income and expenses. The audit of income or revenues are applicable to resident and non-resident individuals engaged in business and the practice of profession, estates and trusts engaged in trade or business, general professional and business partnerships and corporations.

Expenses chargeable against income are allowable in their entirety only for business partnerships and corporations. Self-employed resident citizens and aliens engaged in business or the practice of profession, non-resident aliens engaged in business, estates and trusts engaged in trade or business and general professional partnerships as defined under Section 22 (B) of the Tax Code and their individual partners can claim expenses subject to the provisions of Section 34 of the Tax Code.

The subsequent discussions on the procedures and techniques in the investigation of income and expense accounts are general audit guides. The Revenue Officer should not be hindered in applying additional procedures and techniques, which he deems necessary, based on his initial findings, evaluation of internal control, reliability of accounting records, and analytical review of operations. A.

Audit of Income Accounts

1.

Sales 1.1 1.2

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Review the taxpayer's accounting method of revenue recognition if the same is acceptable and consistent with prior years. Ascertain that all sales were reported as of the cut-off date. Cut-off refers to the point at which entries from one accounting period stop and entries

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for the next period begin. This is usually the last day of a taxable year. If the last day of the taxable year is not used, the cut-off date must be the last day of the taxpayer's fiscal period. ASTcEa

1.3 1.4 1.5 1.6 1.7 1.8 1.9 1.10 1.11 1.12 1.13

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Verify revenues/sales recorded and deposited near the end of the tax year and immediately during the subsequent month to determine if these pertain to income earned for the tax year under examination. Account for all sales invoices issued. Match delivery receipts, gate passes, if any, against sales invoices issued.

Compare totals of sales invoices, sales summary, entries in subsidiary sales journals and general ledger accounts. Inquire and investigate discrepancies between book entries and returns filed. Reconcile credits to sales with debits to accounts receivable and debits to cash receipts book. Test check monthly entries. Research unusual and unfamiliar issuances of goods or goods which are not normally sold by the taxpayer.

Conduct interviews to secure information regarding the taxpayer's business, financial history, number of employees and other information which may lead to sales estimation.

Determine inventory method applied if acceptable and consistently followed.

Determine if merchandise is being withdrawn for personal use or for any other purpose not in relation to normal sales process. Scan credit memo issued to customers and test check entries to Sales Returns & Allowances and Sales Discounts to insure proper recording of credits. Verify cancelled sales invoices by test checking deposits made and withdrawal of goods on the day of cancellation. Tour the business premises to obtain information on: a.

Sales volume

b.

Volume of sales return and method of handling sales returns

c.

Major products

d.

Other by-products and scrap sales, if any

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1.14 1.15

1.16 1.17

2.

e.

Equipment used in operation

f.

Nature, quality and size of facilities

g.

Inventory level

In touring the premises, be observant and ask questions that will disclose significant facts and information relative to the taxpayer's business operations.

Review sales contracts, consignment agreements and other documents relative to sales.

On installment sales, ascertain that collections have been properly segregated as to the year of sales and that the proper gross profit ratios have been applied. Review unearned or deferred income accounts for any uncollected balances which have been outstanding for an unreasonable period of time. Determine whether sales on consigned goods are taken up at the time of shipment or after sixty (60) days from the date goods were consigned. Where the internal control is weak and records are unreliable or inadequate, apply other approaches to audit revenue such as cash analysis, net-worth analysis, third party verification, and other indirect approaches to investigation.

Rent Income 2.1

Obtain and review copies of lease contracts.

2.3

Relate real properties under lease agreement to assets declared in the balance sheet. Note inconsistencies between asset values and income generated.

2.2

2.4

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Conduct ocular inspection of the premises under lease. Identify tenants and monthly or annual rentals. Conduct interviews, if necessary.

Where the rental income is based on a percentage of sales of the lessee, the sales of the lessee should be tested for a representative period, say one month, to get a proper approximation of the lessee's sales during the taxable year under audit and the rental income received by the lessor. In such cases, proper authorization from the lessee should be obtained before conducting the test verification. Obtain information on rental of neighboring properties and compare with

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2.6 2.7 2.8 2.9

3.

Examine official receipts issued. Compare total collections per official receipts with entries in the cash receipts book and general ledger. Investigate discrepancies.

Ascertain acceptability and consistency of accounting methods used. For cash-basis taxpayers, prepaid rent and rental deposits constitute income during the year of receipt. Secure copies of lease contracts or agreements. Take note of lease contracts which are actually conditional sales.

Where necessary, obtain copies of Transfer Certificates of Title, tax declarations, mayor's or municipal permits, and real property tax receipts to determine properties which may be undisclosed/unrecorded by the taxpayer.

Professional Fees 3.1 3.2 3.3 3.4 3.5 3.6 3.7

4.

rent income reported.

Determine the taxpayer's accounting method of recognizing income, whether cash or accrual. Most professionals, however, adopt the cash basis of accounting. Examine contracts with clients and other correspondence/documents in relation to professional services rendered.

Compare income reported on the tax return with the books of accounts, creditable withholding tax forms, financial statements and official receipts issued. Verify discrepancies, noted, if any. Account for official receipts issued. Note any missing receipt or break in the series and investigate the reasons therefor.

Analyze the reasonableness of expenses claimed in relation to income declared. Conduct interviews and third party verification, if necessary.

Relate the income reported per tax return to the lifestyle and assets of the taxpayer. If the taxpayer's assets and estimated costs of living expenses are beyond the income earned, verify and compute for possible underdeclaration of income by using the net worth method of investigation.

Income from Sale of Asset

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4.1

Identify in the tax returns and financial statements any sale, exchange or disposal of assets other than inventories or stocks in trade.

4.2

Obtain copies of deeds of sale and other documents relating to the sale.

4.4

Compute any underdeclaration of sales by comparing the selling price with the existing fair market value, zonal value or value of similar properties sold.

4.3

4.5 4.6 4.7 4.8 5.

Determine zonal values, fair market values or appraisal values and compare with the actual selling price.

In case of disposal of capital assets, ascertain compliance with the provisions of the Tax Code on capital gains and losses. Verify sales of property reported on the installment basis and determine if all requirements pertaining thereto have been complied with.

Determine if proper accounting for depreciation, book value and salvage value was correctly taken up Inquire from certain company personnel on possible sales of assets which may not have been recorded in the books of accounts.

Other Income 5.1 5.2 5.3

Scrutinize the entries in the general ledger and general journal for any other income or other receivables recorded thereto. Test check entries in intercompany accounts to determine whether shifting of income or management fees may have been made and charged to affiliates. Investigate suspense accounts and unusual liability accounts, such as due to affiliates/due to stockholders and other payables to uncover possible income not recorded in the income accounts.

B.

Audit of Expense Accounts

1.

Purchases

For taxpayers engaged in trading and manufacturing businesses, the purchase account is one of the largest accounts in the income statement. Thus, there is a possibility that taxpayers may hide a number of non-deductible expenditures in this account due to the volume of transactions posted to it. The following audit procedures should be followed in examining purchases:

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1.1 1.2

1.3

1.4

Account for all purchase invoices and receiving reports as of the cut-off date. Determine if year-end purchases have been recorded in the proper accounting period.

Compare totals of purchases in the return, income statement, purchase book, subsidiary purchases book, if any, and general ledger. Determine any discrepancy and investigate its nature as well as the nature of year-end adjustments. Determine that the purchases declared are neither overstated nor understated by vouching the supporting documents, and test-checking the footings of invoices, purchase books and ledger accounts Under-statement of purchases may also mean underdeclared sales. Tour the premises where inventory items are kept and correlate actual inventory level against purchases reported. Test-check stock cards of major inventory items to evaluate accuracy of inventory reports. TDcAaH

1.5 1.6 1.7

1.8 1.9

2.

Scan the purchases book for possible unusual payees or unusual amount of purchases. Take note of suppliers not generally associated with the products or services handled by the taxpayer. Verify entries in the general ledger account which originate from unusual sources such as journal entries, debit and credit memoranda and other accounting records. Test check recorded purchases for a representative period with suppliers invoices and cancelled checks. Note if there are personal expenditures, withdrawals of merchandise by the owners, fictitious or duplicate invoices, cancelled purchase invoices, excessive rebates, discounts and allowances and purchases not received.

Where there are only a few major suppliers, conduct third party verification to ascertain the correctness of purchases declared, if there is suspicion of fraud or if the Revenue Officer believes that this is necessary. If purchases are from suppliers related to the owners or from affiliates, conduct a review of a number of transactions to uncover prices in excess of market value, excessive rebates and allowances, and other similar schemes.

Cost of Goods Sold

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2.1

Verify the inventory valuation method applied by the taxpayer whether first-in, first-out (FIFO) last-in, first-out (LIFO), specific identification, weighted average or simple average. Last-in, first-out is not acceptable for

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2.2 2.3 2.4

2.5

2.6

2.7 2.8

2.9

2.10 Copyright 2015

income tax purposes. Determine consistency of its application from year to year.

Obtain an understanding of the production process thru familiarization with the taxpayer's business, tour of the premises, conducting interviews, and analyzing cost of production reports.

Compare inventory balances in the return under examination with the balances for the prior and subsequent years' returns, and reconcile these with the general ledger and the physical inventory summary.

Check unauthorized changes in inventory valuation method from period to period. Conduct test-checking of inventory valuation of sample inventory items from the summary inventory sheets and determine if the taxpayer has not improperly valued any inventory item. Check gross profit variations. Any significant variation should be discussed with the taxpayer and a reasonable explanation in writing should be obtained. A material decrease in gross profit from one year to the next could be due to understated ending inventory.

Determine the significance of notes or qualifying statements on financial reports prepared by external auditors. Any unusual comments or qualifying statements about the inventories or cost of sales that have a material tax effect should be discussed with the taxpayer and, if necessary, with a representative of the external auditor. If the taxpayer applies standard or predetermined cost in costing goods manufactured, inspect the working papers and production report used to calculate the cost per unit and ensure that expenses included are allowable.

Analyze unusual entries to cost of sales. Account for labor, materials and overhead charges not directly related to sales or transfers of finished goods. Be alert on the possibility that the taxpayer may be trying to include a non-deductible item in the cost of sales account.

Determine whether year-end purchases are included in closing inventory. Review purchase invoices at the last month of the taxable year under audit. Compare quantities on the inventory summary for classes of goods purchased with the quantity in the ending inventory list and quantity of sales recorded at year-end for such goods. Thus, if a specific item or a certain quantity of goods were purchased on the last day of the year, it should be included in the ending inventory unless sold that same day.

Determine reductions in ending inventory values by reviewing authorization for write-downs and provision for obsolescence or decline in

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market values. Check minutes of meetings for such authorization. Analyze journal entries for the write-down or provision of allowance for obsolescence/decline in value. Check itemized inventory summary sheet and test-check the list with actual physical inventory. 3.

Salaries, Wages and Other Employees' Benefits 3.1

3.2 3.3 3.4 3.5 3.6

3.7

3.8

3.9 Copyright 2015

Evaluate the expense initially by comparing the ratio of salaries and wages to sales and the percentage of taxes withheld to total salaries, allowances bonuses and other compensation. Low ratios might indicate that the company hires sub-contractors or an understatement of expenses which may be a lead to underdeclared sales. High ratios may also mean an understatement of sales or padded payroll with functions or terminated employees. Review payroll sheets. All expenses claimed having the semblance of a compensation payment should be verified together.

Interview personnel assigned to prepare payroll and inquire if family members are included in the payroll. If so, check legitimacy of the work assignment and reasonableness of compensation paid. Compare payroll costs with industry standards and other independent data. Require explanations for significant deviations. Observe the actual number of employees and relate this to the declared sales. Inquire if independent contractors are hired in lieu of regular employees.

Perform a comparative analysis of salaries, wages and other employee benefits with prior and subsequent years. Material changes may indicate a change in the volume of business or in the policy of classifying manpower employed.

Determine if the taxpayer is properly withholding the correct amount of taxes on compensation by test-checking actual pay slips against employee records and BIR Form 1604 CF (Annual Alpha List of Employees from whom Withholding Tax has been deducted). Reconcile totals of wages paid which were subjected to withholding tax and totals of compensation paid which were not subjected to withholding tax with payroll expense claimed. Consider the possibility of disallowing any noted discrepancy in accordance with existing rules and regulations. Verify Social Security System Premium Remittance List to cross check the list of employees to whom compensation was paid.

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4.

Fringe Benefits

Fringe benefits tax is a final withholding tax imposed on the grossed-up monetary value of fringe benefits furnished, granted or paid by the employer to the employee, except rank and file employees as defined in Revenue Regulations No. 3-98. 4.1

4.2

4.3

Obtain a list of managerial and supervisory employees from the Human Resource or Personnel Department of the company being audited with the following information per personnel: a.

Nationality

b.

Citizenship

c.

Number of years with the company

d.

Position/Job designation

e.

Basic salary and allowances

f.

Other compensation and benefits

Secure copies of employment contracts and/or appointment papers and examine these documents to verify the nature and amount of other compensation, allowances and benefits which may be subject to fringe benefits tax.

Analyze expenses and other pertinent accounts where fringe benefits may have been lodged or recorded. Determine the amounts of benefits subject to the tax. 4.3.1 Include the value of following items/services as taxable fringe benefits pursuant to Sec. 2.33 (B) of Revenue Regulations No. 3-98: a.

Housing

b.

Expense Account

c.

Vehicle of any kind

d.

Household personnel, such as maid, driver and others

f.

Membership fees, dues and other expenses borne by the

e.

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Interest on loan at less than market rate to the extent of the difference between the market rate and actual rate granted

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employer for the employee in social and athletic clubs or other similar organizations g.

Expenses for foreign travel

h.

Holiday and vacation expenses

i.

Educational assistance to the employee or his dependents

j.

Life or health insurance and other non-life insurance premiums or similar amounts in excess of allowable amount under the law.

4.3.2 Exclude the following fringe benefits from the fringe benefits subject to FBT (Sec. 2.3.3.(c) of RR No. 3-98): a.

b. c. d.

Fringe benefits which are authorized and exempted from tax under the Tax Code or under any special law

Contributions of the employer for the benefit of the employee to retirement, insurance and hospitalization benefit plans

Benefits given to the rank and file, whether or not granted under a collective bargaining agreement. De Minimis benefits, such as: d.1 d.2 d.3

Medical cash allowance to dependents of employees not exceeding P750 per semester or P125 per month

Rice subsidy of P350 per month granted by an employer to his employees

d.4

Uniforms given to employees by the employer

d.6

Laundry allowance of P150 per month

d.5

d.7 Copyright 2015

Monetized unused vacation leave credits of employees not exceeding ten (10) days during the year

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d.8 d.9 d.10 e. 4.4 4.5

4.6

the form of a tangible personal property other than cash or gift certificate, with an annual monetary value not exceeding one-half (½) month of the basic salary of the employee receiving the award under an established written plan which does not discriminate in favor of highly paid employees Christmas and major anniversary celebrations for employees and their guests

Company picnics and sports tournament in the Philippines and are participated exclusively by employees Flowers, fruits, books or similar items given to employees under special circumstances (e.g. on account of illness, marriage, birth of a baby, etc.).

If the grant of the fringe benefits is for the convenience of the employer

Determine the correct valuation of fringe benefits based on the provisions on valuation prescribed and illustrated in RR No. 3-98

Compute for the amount of taxable fringe benefits by dividing the monetary value of the fringe benefit by the appropriate percentages in accordance with the following schedule: Effective January 1 ,1998 — 66% Effective January 1, 1999 — 67% Effective January 1, 2000 — 68%

Compute for the correct final withholding tax on fringe benefits by multiplying the grossed-up monetary value of the benefits with the following rates for the applicable taxable years: 1998 — 34% 1999 — 35% 2000 — 32%

The following are subject to different tax rates as provided by the NIRC and RR No. 3-98: a.

A non-resident alien individual not engaged in trade or business within the Philippines (Section 25 (B)) EADCHS

b. Copyright 2015

An alien individual employed by:

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b.1

Regional or area headquarters and regional operating headquarters of multinational corporations (Section 25 (C))

b.2

Offshore banking units (Section 25(1))

b.3 c. 4.7

4.8

4.9 5.

A Filipino citizen employed and occupying the same position as an alien employed by the above-mentioned entities (Section 25 (E))

Examine monthly final withholding tax returns with corresponding official receipts of payment to check if the correct final withholding tax on fringe benefits was paid. In case of underpayment or late payment, compute the deficiency tax due and/or penalties, where applicable. Compare the amount of fringe benefits per income tax return, audited financial statements and per books against the withholding tax returns and official receipts. If the taxpayer is on accrual basis, examine the journal entry made in accruing the expense at the end of the year. Verify if the tax has been paid on or before the due date on the first month of the following year. Disallow claims for fringe benefits in excess of supported amounts or where the payees are determined to be fictitious.

Rents 5.1

Verify pertinent provisions of the lease contract with the lessor.

5.3

Verify whether the corporation is renting property for which it has no actual business use. Any rentals in that case would be unreasonable and unnecessary; hence, the expense should be disallowed.

5.2

5.4 5.5 5.6 6.

Foreign petroleum service contractor and subcontractors (Section 25 (E))

Verify reasonableness of rentals paid by the lessee, particularly if the lessor is related directly to the taxpayer.

Determine the terms of the lease. If the lessee may take or acquire title to the property, the claim for rental expense should be disallowed. Determine if there are any capital expenditures included in the accounts.

Determine whether the proper amount of expanded withholding tax on rental payments has been withheld and remitted.

Royalties

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6.1 6.2 6.3 6.4

Verify minute book and pertinent provisions of the contract with the lessor. Check correctness of the amount of the expense by computing the percentage of royalty or terms specified in the contract in relation to the reported sales. Disallow excess claim.

Determine whether the proper amount of final withholding tax has been withheld and remitted.

If the recipient is a non-resident alien or foreign entity, determine whether the proper amount of tax has been withheld and remitted. 6.4.1 Check whether the recipient is a treaty country resident. If so, ask for a copy of a ruling issued for the use of the preferential tax rate.

6.4.2 If a copy of a ruling has been produced, verify from the issuing office [International Tax Affairs Division (ITAD) or Law Division] for the authenticity of such ruling.

6.4.3 If the recipient is a non-treaty country resident, verify if the appropriate tax rate provided for in the Tax Code is properly applied. 7.

Interest 7.1 7.2 7.3

Verify sources of interest expenses such as actual notes, loans, mortgage or bond instruments. Check whether the indebtedness is business related.

Determine the accounting method used by the taxpayer. If he uses accrual basis, only the interest accruing during the taxable year is deductible. Determine if interest paid or accrued applies to obligations due to related taxpayers. Consider such items as: a.

Arm's length features a.1 a.2

b. 7.4 Copyright 2015

Bona fide obligations

Interest in excess of the prevailing rates in unrelated transactions.

Accrual of items payable to related taxpayers which are not paid within the prescribed time limit.

Determine if deductions claimed relate to interest incurred in carrying tax

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free obligations. If so, then the interest claimed is not deductible. 7.5

Disallow interest claimed in excess of interest income subject to final tax.

7.6

Determine if the interest deduction includes any principal amount.

7.8

Ascertain if the loans acquired were not utilized but were loaned out to affiliates. If so, disallow interest expense claimed.

7.7

8.

Taxes 8.1 8.2 8.3

If the recipient is a non-resident alien or other foreign entity, determine if the proper amount of tax has been withheld (Follow procedures in 6.4 to 6.4.3. hereof).

Verify whether only the taxes properly paid or accrued during the year have been claimed. Determine that no protested taxes or reserves for deficiency taxes upon audit are claimed.

Determine existence of claims for taxes not allowable as deduction such as: a.

Income tax provided for under the Tax Code;

c.

Estate and gift taxes; and

b.

d. 8.4 8.5 9.

Repairs 9.1 9.2

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Income, war profits and excess profits taxes imposed by authority of any foreign country; Taxes assessed against local benefits of a kind tending to increase the value of the property assessed.

Determine if the taxpayer has title to the real and personal property being taxed. Determine if there are any taxes on the purchase of capital assets that were already capitalized but also charged to expense account. Determine depreciation policy of the taxpayer. A conservative depreciation policy often contemplates a high degree of current repair expenditures.

Verify nature of expenditures. If the expenditure prolongs the life or enhances the value of the existing assets, then it is not deductible but

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9.3

should be capitalized and depreciated over the years of their estimated usefulness. Check repair accounts for the possibility that personal expenses of owners or other company officers and employees are included.

10. Bad Debts 10.1

Obtain and review list of charged-off accounts

10.3

Determine if the charge-off is based on worthlessness of the debt within the year.

10.2

10.4 10.5 10.6 10.7

Determine with a reasonable degree of certainty the uncollectibility of the debt.

Determine if there are repossessed merchandise. If so, verify if the value of repossessed merchandise has been correctly assigned and deducted from the claimed amount of bad debts.

Verify losses on installment receivable if consideration on any repossessed merchandise had been taken into account and if portion of the losses had been charged to the unrealized gross profit account. Determine if the method of deducting bad debts is acceptable and consistent with the method applied in the preceding year.

Verify bad debts expense in relation to the examination of the allowance for doubtful accounts. SEcAIC

11. Losses 11.1

Abandonment and Demolition Losses

11.1.1 Verify if the amount of the abandonment loss is the adjusted basis of the abandoned asset.

11.1.2 Determine if the loss of missing assets really occurred within the taxable year.

11.1.3 Determine if the retirement or abandonment loss is specifically allowable under the taxpayer's method of accounting for depreciable property. 11.1.4 Determine the reason for the demolition of a building. If it was the taxpayer's intention to demolish the building when the property was first acquired, abandonment loss is not allowable. It should form Copyright 2015

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part of the cost of the building. 11.2

Losses from Casualty or Theft

Casualty loss refers to loss of property connected with trade or business. In the verification of casualty or theft losses, the following pointers should be observed:

11.2.1 Ascertain that a loss has actually been incurred by examining supporting documents such as police report or report of the fire department.

11.2.2 Ascertain that the loss is claimed in the proper year. Generally casualty loss, is claimed in the year incurred while losses from theft or embezzlement is claimed in the year discovered. 11.2.3 Ascertain that insurance proceeds or claims, salvage proceeds, or salvage value have been properly taken into account.

11.2.4 Ascertain that the adjusted basis of lost property has been properly computed. Consider reasonableness of values used in the computation and ascertain that the loss claimed does not exceed the adjusted basis. 11.2.5 Ascertain that the rule as to the manner of deductibility have been complied with (type of asset, whether insured or not, time or period held, and other relevant factors).

11.2.6 In cases involving loss of cash, be alert on the possibility that the cash stolen may not have been included as income. 112.7 Trace handling of losses involving inventory or stock in trade to preclude double claim of deduction. 11.2.8 Analyze any loss claimed for assets located in a foreign country.

11.2.9 Verify police blotters, fire department records and other independent documents in support of the claim. 11.3

Net Operating Loss Carry-over

Pursuant to Section 34 (D) (3) of the Tax Code, "net operating loss" means the excess of allowable deduction over the gross income of the business in a taxable year. The validity of the claim for net operating loss carry-over may be determined through the following procedures:

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11.3.1 Secure copies of income tax returns and the applicable audited financial statements for the three (3) consecutive taxable years immediately preceding the year of claim.

11.3.2 Verify audit reports, if any, covering the taxable years with net operating loss to ascertain correctness of amount claimed after audit. If the results of audit for prior years show a net income instead of loss, disallow claim for net operating loss carry-over. 11.3.3 Determine if the net loss was incurred during the taxable year in which the taxpayer was exempt from income tax. If so, the net operating loss carry-over should not be allowed as a deduction for the succeeding period. 11.3.4 Examine the taxpayer's stock and transfer book and report submitted to the Securities and Exchange Commission to ascertain that there is no substantial change in the ownership of the business or enterprise in that: a.

b.

Not less than seventy five percent (75%) in nominal value of outstanding issued shares, if the business is in the name of a corporation, is held by or on behalf of the same persons; or

Not less than seventy five percent (75%) of the paid up capital of the corporation, if the business is in the name of a corporation, is held by or on behalf of the same persons.

11.3.5 For operators of mines, other than oil and gas wells, which did not avail of the incentives under E.O. 226, otherwise known as the Omnibus Incentives Code of 1987, verify correctness of claim for net operating loss: a.

b. c.

Refer to audited financial statements and audit reports to check if the net loss was incurred during the first ten (10) years of operation;

Check if the period/taxable year when loss is claimed is within five (5) taxable years following the loss; and Ensure that there is no substantial change in the ownership of the business or enterprise as stated in Section 4 hereof.

12. Depreciation 12.1

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Compare total depreciation as shown by the depreciation schedule with the

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deduction claimed on the return. Reconcile any differences. Be alert for duplication of claimed deductions. 12.2

Review the rates of depreciation used to determine if they are reasonable.

12.4

Test check extensions and prove footings to determine if current depreciation has been correctly computed.

12.3

12.5 12.6

Test check a representative number of items listed on the depreciation schedule to determine if the accumulated depreciation at the end of the accounting period exceeds the depreciable basis of the asset.

Determine if there is any personal use of cars and other depreciable assets.

Ascertain if proper cost allocation has been made on bulk purchases of depreciable and non-depreciable assets.

13. Depletion 13.1

Determine if the taxpayer has an economic interest in the property.

13.3

The following additional guidelines should be followed in the verification of the deduction for depletion:

13.2

Determine if the taxpayer has acquired, at least by investment, any interest in oil, gas or mineral in a place, and secures, by any form of legal relationship, any income derived from the extraction of oil, gas or mineral.

13.3.1 Ascertain that the sales reported in relation to a property do not include sales applicable to another property, sales of purchased minerals, non-minerals sales or other income items. 13.3.2 Ascertain, where applicable, if mineral sales have been adjusted to "gross income from the property" by reduction of such factors as unallowable treatment cost, unallowable transportation costs, rents and royalties, including a proportionate part of lease bonuses, amounts paid to others in contract mining or similar operations where the other party has acquired an economic interest and is entitled to depletion, certain excise taxes, trade discounts allowed and other deductions. CSAcTa

13.3.3 In situations where the basis for percentage of depletion is not the actual sales price of a finished product but a value of the mineral at the point at which it has passed through the last allowable treatment process applicable thereto, determine if the value used is the correct representative market or field price. Copyright 2015

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13.3.4 Ascertain that mineral sales made to a business controlled by the taxpayer are not inflated to gain a tax advantage through depletion.

13.3.5 Ascertain that all expenses applicable to a property have been charged to that property including a proper allocation of general, administrative and overhead expenses. 13.3.6 Be alert on possible reduction of expenses by improper offsets such as income from scrap sales, cash discounts earned, sales of assets, and other income. 14. Contributions 14.1 14.2 14.3

Determine if the donee or recipient is the government or an accredited relief organization. Determine if the contribution is to be utilized for the rehabilitation of calamity stricken areas declared by the President. Verify if the claim is actually paid within the taxable year.

15. Transportation and Travel, Representation and Entertainment 15.1 15.2

15.3

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Determine if the expenditures have been incurred in relation to the business or practice of profession, not for personal use.

For transportation and travel expenses, the following information are necessary to properly determine deductibility: a.

Date of travel

b.

Purpose of the travel and written authority for the travel

c.

The person or persons who incurred the expenditure

d.

Place or places travelled

e.

Amount of expenditure

f.

Means of transportation or travel

Determine if taxpayer's travel and transportation and representation and entertainment expenses are recorded in a daily diary. If such expenses appear to be disproportionate to the taxpayer's income and business activities, the taxpayer should be required to corroborate the book entries by furnishing documentary proofs.

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15.4

Determine the policy with respect to reimbursement or giving grants of allowances to employees.

15.5

Ascertain the specific amounts recorded for these items.

15.7

Select a representative test period or periods and test check entries in the ledger against supporting receipts and documents.

15.6

15.8 15.9

Prepare a summary of the total expenses posted to the accounts and compare the same with the deductions claimed per tax return.

Determine from the analysis and verification of supporting documents the reliability of the records. Determine company-owned vehicles and the expenses incurred in connection with these vehicles.

16. Stationery and Office Supplies 16.1 16.2 16.3 16.4

Determine if the expenses claimed are not capitalizable office furniture and equipment. Verify if personal purchases by the taxpayer/owner are included in the account. Determine the reasonableness of the expenditures.

Compare receipts with the amounts claimed and investigate significant discrepancies.

17. Professional Fees 17.1 17.2 17.3 17.4

Determine if the charges include amounts incurred for legal, accounting, engineering, appraisal, surveying and other similar services.

Verify if the amounts are material and examine contracts to check the detailed description of the exact professional services rendered.

Check legal expenses or representation expenses as it might at times be political contributions, bribes or kickbacks, which should be disallowed. Determine charges for research and experimental expenses. These items should form part of the cost of patents, trade-marks and copyrights and other intangible assets subject to amortization.

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18.1 18.2

Verify insurance policies. Premiums paid by employers on individual life insurance policies of their employees are not deductible if the employer is a direct or indirect beneficiary of such proceeds. For individuals, ascertain if his claim for insurance premiums on health and/or hospitalization insurance, including for his family, does not exceed two thousand four hundred pesos (P2,400) during the taxable year, provided that: a.

b. 18.3 18.4

In case of married individuals, the combined income of the taxpayer and his spouse does not exceed two hundred fifty thousand pesos (P250,000) during the same taxable year; and Only the spouse claiming the additional exemption for dependents shall be entitled to this deduction.

Determine if the employee is the beneficiary of the insurance. Otherwise, the premiums paid shall be treated as an additional salary provided that it is reasonable. Check the account if it includes fire insurance, burglary insurance and other policies on officer's/stockholder's personal and real properties.

19. Light and Power, Telephone and Telegraph 19.1 19.2 19.3 19.4

Determine material amounts claimed as it may include capitalizable electrical equipment or purchases of capital items from utility companies. Examine the receipts issued by the utility companies. Compare the same with the amounts claimed per return. Investigate material discrepancies. Determine if there are personal expenses included in the expense account.

Relate the expense consumption against sales and production to determine any possible underdeclaration of sales.

20. Miscellaneous Expenses 20.1

Check the validity of the individual charges to the account.

20.2

Determine if deductions claimed are adequately substantiated.

20.3 XI. Copyright 2015

Ascertain if the miscellaneous expenses claimed do not contain any personal items.

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Tax A.

Minimum Corporate Income Tax

Pursuant to Section 27 (E)(1) of the Tax Code, a minimum corporate income tax (MCIT) of two percent (2%) of the gross income as of the end of the taxable year is imposed on a corporation taxable under Title II of the Tax Code, beginning on the fourth taxable year immediately following the year in which such corporation commenced its business operations, when the minimum income tax is greater than the tax computed under Section 27 (A) of the Tax Code. Any excess of the minimum corporate income over the normal income tax shall be carried forward and credited against the normal income tax for the three (3) immediately succeeding taxable years. The verification of the minimum corporate income tax may be conducted as follows: 1.

Determine the taxability of the taxpayer to the MCIT. The MCIT shall apply to domestic and resident foreign corporations subject to the normal corporate income tax and shall not be imposed upon any of the following: 1.1 1.2

Domestic corporations operating as proprietary educational institutions subject to ten percent (10%) income tax rate; Domestic corporations engaged in non-profit hospital operations subject to ten percent (10%) income tax rate; DCHaTc

1.3

1.4 1.5

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Domestic corporations engaged in business as depository banks under the expanded foreign currency deposit system, otherwise known a Foreign Currency Deposit Units (FCDUs), on their income from foreign currency transactions with local commercial banks, including branches of foreign banks, authorized by the Bangko Sentral ng Pilipinas (BSP) to transact business with foreign currency deposit system units and other depository banks under the foreign currency deposit system, including their interest income from foreign currency loans granted to residents of the Philippines under the expanded foreign currency deposit system, subject to final income tax at ten percent (10%) of such income; Resident foreign corporations engaged in business as international carrier subject to 2½% income tax on the "Gross Philippine Billings";

Resident foreign corporations engaged in business as Offshore Banking Units (OBUs) on their income from foreign currency transactions with local commercial banks, including branches of foreign banks, authorized by the Bangko Sentral ng Pilipinas (BSP)

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1.6 1.7 2.

to transact business with Offshore Banking Units (OBUs), including interest income from foreign currency loans granted to residents of the Philippines, subject to a final income tax at ten percent (10%) of such income; Resident foreign corporations engaged in business as regional operating headquarters subject to ten percent (10%) tax on their taxable income; and

Firms that are taxed under a special income tax regime such as those in accordance with RA Nos. 7916 and 7227.

Determine the gross income subject to MCIT. 2.1

Check the accuracy of the declaration of gross sales/receipts contributing to income taxable under Section 27 (A) of the Code.

2.1.1 Ascertain the accounting method employed by the taxpayer and verify consistency in its application. In case of sales of services by taxpayers employing the accrual basis of accounting, the term "gross receipts" shall mean amounts earned as gross income and these shall include amounts actually or constructively received during the taxable year.

2.1.2 Exclude items of sale specifically exempt from income tax, and those passive income subject to special tax rates.

2.2

2.1.3 Ascertain legitimacy of deductions from gross sales such as sales returns, discounts and allowances. Verify correctness of the claim for cost of goods sold. Ensure that only business expenses directly incurred to produce the merchandise to bring them to their present location and use or to provide the contracted services are included in this account. a.

b.

Copyright 2015

For trading or merchandising concern, "cost of goods sold" means the invoice cost of the goods sold, plus import duties, freight in transporting the goods to the place where the goods are actually sold, including insurance while the goods are in transit. For manufacturing concern, "cost of goods manufactured and sold" means all costs of production of finished goods, such as raw materials used, direct labor and manufacturing overhead, freight cost, insurance premiums and other costs incurred to bring the raw materials to the factory or

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c.

3.

Determine the period when the taxpayer becomes subject to the minimum corporate income tax. Verify the year of taxpayer's registration with the BIR to ascertain whether or not it is subject to MCIT: a.

b.

3.3

5.

B.

For sales of services, "cost of services" means all direct costs and expenses necessarily incurred to provide the services required by the customers and client including (1) salaries and employee benefits of personnel, consultants and specialists directly rendering the service; and (2) cost of facilities directly utilized in providing the service such as depreciation or rental of equipment used and cost of supplies. Except for banks and other financial institutions, cost of sales/services shall not include interest expense.

3.2

4.

warehouse.

Firms registered with BIR in 1994 and earlier years are covered by the MCIT beginning January 1, 1998. Firms registered with BIR in any month in 1998 are covered three calendar years thereafter.

For fiscal period taxpayer, taxable year 1998 shall mean any fiscal period ending any day from July 1, 1997 up to June 30, 1998.

Ascertain whether the first taxable period under the MCIT of the taxpayer using fiscal-year accounting covers month/months in 1997 prior to the imposition of MCIT. Be sure that the computed MCIT due for 1998 using the apportionment formula is correct.

Verify if the taxpayer is entitled to the relief from the imposition of the MCIT and secure documentary proof for the suspension of its imposition as approved by the Secretary of Finance.

Check accuracy of the amount of excess MCIT carried over and credited against the normal tax within the three (3) immediately succeeding years from payment thereof, if any. See to it that any excess MCIT are not claimed against MCIT itself or against any other losses.

Improperly Accumulated Earnings Tax

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earnings tax equal to ten percent (10%) of the improperly accumulated taxable income is imposed for each taxable year on the improperly accumulated taxable income of each corporation identified under Section 27 (B) of the Tax Code. The improperly accumulated earnings tax shall be determined as follows:

1.

2.

Ascertain the classification of the corporation and the business it is engaged in to determine whether the imposition of the improperly accumulated earnings tax shall apply. For this purpose, the fact that the corporation is a mere holding company or investment company is considered a prima facie evidence of a purpose to avoid the tax upon its shareholders or members; hence, the 10% tax will automatically apply. However, the following corporations are not subject to the improperly accumulated earnings tax: 1.1

Publicly-held corporations;

1.2

Banks and other non-bank financial intermediaries; and

1.3

Insurance companies.

2.1

Look into the following factors to ascertain if the accumulated profits are reasonably needed in the business:

Determine the reasonableness of the accumulation of profits or earnings and if the same is required for the purposes of the business, considering all the circumstances of the case.

a.

Nature of the company's business;

c.

The dividend distribution history of the corporation;

d.

The stock of the corporation is widely held in small blocks,

e.

The use of the undistributed profits or earnings;

g.

Advances or loss to stockholders, whether or not interest shall be paid;

b.

f.

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Financial condition of the corporation at the close of the taxable year;

Retention of cash, securities and other assets unrelated to the business operations;

Dealings between the corporation and its stockholders, such as withdrawals by the shareholders as personal loans or the

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i.

The need for business expansion;

k.

The earnings and expansion history of the taxpayer;

m.

Past tax avoidance history of the corporation;

o.

Sudden shift in corporate or dividend policy of the company;

n.

p. q.

2.3

Past savings effected by non-distribution of profits to stockholders; Portion of corporation;

shareholder's

assets

transferred

to

the

The percentage of income distributed to shareholders during the taxable year; and Retirement of stocks, this being a capital transaction and should result in reduction of capital instead of reduction of earnings and profits.

Secure copies of the board resolutions and verify therefrom any existence of undue accumulation of profits, correlating the findings with the plans per resolution as against the business activities and dealings made by the corporation. Require the taxpayer to submit documentary proof negating the clear preponderance of evidence that the profits were permitted to accumulate beyond the reasonable needs of the company's business. The accumulation of surplus for the reasonable needs of the business is not prevented if the purpose is not to prevent the imposition of the tax upon the shareholders. Undistributed income may be considered as properly accumulated in the following cases: a.

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The investment by the corporation of undistributed earnings in assets having no reasonable connection with the business;

j. l.

2.7

expenditure of funds by the corporation for the personal benefit of the shareholders;

The profit is retained for working capital needed by the business; The profit is invested in additions to plants, facilities and activities reasonably required by the business provided that

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c. d. 2.4

3.

The accumulation of earnings is in accordance with contract obligations placed to the credit of a sinking fund for the purpose of retiring bonds. The profit is intended as reserves to meet competition, for anticipated losses or reverses in business, and to meet business hazards and emergencies.

Verify whether the company's increase in capitalization, if any, is necessary in the light of the existing circumstances surrounding the business. Ascertain whether declaration of stock dividends from increased corporate capital was made to go around the surtax since stock dividends are not taxable unless there is a change of interest, or unless they are disposed of by the holders or redeemed by the additional tax if the aforementioned scheme was clearly established.

Determine the amount of improperly accumulated taxable income subject to the surtax. 3.1

3.2.

3.3 3.4

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the plans for expansion or improvement must be definite, concrete and capable of fulfillment and not what may be characterized as nebulous plans for future action.

Account for all the company's income during the year.

Determine all the appropriate adjustments to the improperly accumulated taxable income. For purposes of imposing the tax, the taxable income shall be adjusted by the following items: a.

Income exempt from tax;

b.

Income excluded from gross income;

c.

Income subject to final tax; and

d.

Amount of net operating loss carry-over deducted.

STDEcA

Deduct dividends actually or constructively paid and income tax paid for the taxable year from the adjusted taxable income.

Exclude the improperly accumulated income as of December 31, 1997 in the computation of accumulated taxable income subject to tax. The surtax shall likewise not apply to fiscal-period taxpayers where the twelve (12) month period ended any day from January up to November 1998.

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Compute the 10% surtax based on the adjusted improperly accumulated taxable income. The computation of the surtax shall be made on a year-to-year basis depending on the thorough evaluation of the circumstances proving that the company has indeed permitted itself to accumulate earnings or profits beyond the reasonable needs of the business. XII. Auditing Computer-Produced Records A.

Impact of Computer Records on Audit

B.

Accounting Software Systems

The use of computers to process accounting data has a significant effect on the audit skills of the Revenue Officer. The ability to understand and evaluate the taxpayer's information technology (IT) is important. The Revenue Officer must understand the flow of accounting data or audit trails on a computerized system to conduct a quality audit. Auditing computer records require basic techniques used in auditing manual books and records. There is still a need to: a.

Perform an effective preliminary analysis of the return;

b.

Interview the taxpayer;

c.

Tour the business premises;

d.

Evaluate internal controls;

f.

Re-evaluate your previous analysis of the return;

g.

Set the scope of the audit;

h.

Test the amounts you have identified as questionable;

i.

Ask questions about the data you have examined;

j.

Evaluate auditor's adjustments; and

e.

k.

Reconcile the information reflected in the books, financial statements and the tax returns;

Apply sound accounting principles, relevant provisions of the Tax Code and existing revenue issuances to reach the proper conclusion regarding the data examined.

As part of the initial interview, the Revenue Officer should ask questions to achieve a clear understanding of the taxpayer's books and records, such as: Copyright 2015

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a.

Find out what type of system software is being utilized.

c.

Determine who encodes the accounting transactions. If the same person enters both the payables and the receivables, there is no segregation of functions. This would allow one person to perpetuate or conceal errors by controlling the offsetting of debits and credits.

b.

d.

Determine who authorizes the debit and credit of certain accounts and write-off of certain transactions.

Find out what reports are generated and how often these are generated. Identify management reports which may be utilized to disclose audit findings.

In addition to asking the taxpayer about the particular information system, the Revenue Officer must study the software manual. The manual will tell how the system works and the types of reports available. The Revenue Officer shall determine the reasonable time to be spent in reviewing the software capabilities. C.

Audit Techniques For Computer — Produced Records

1.

Unusual in Amount

2.

Unusual by Source

The traditional audit approach to audit double-entry books and records is to scan through the general ledger and note any unusual entries. The purpose of this scanning is to identify entries in the computerized general ledger which are unusual due to the amount, source or nature. The basic technique for identifying large charges or variations to accounts in a computerized system consists of securing the monthly statements. Usually, these will be retained by the taxpayer. The monthly balances are reviewed for changes. Changes in the monthly account balances are then explored by reviewing the monthly detail and scanning the check register. The Revenue Officer must consider if the charge or variation could be expected, is reasonable and in the expected direction, and is material enough to warrant investigation. For example, if monthly trial balances showed rent expense of P500 and one month showed P1,500, you would ask the taxpayer about the P1,500 rent expense. The basic technique for detecting entries to accounts from unusual sources consists of comparing monthly posting summaries from each source with the chart of accounts. A computerized system will utilize monthly posting summaries. These summaries will show monthly changes to an account, most often by account number and originating journal. By comparing the accounts which show monthly changes with the chart of accounts, posting to unusual accounts can be detected. Scan the accounts payable listings for vendors that appear personal in nature.

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3.

Unusual by Nature

The basic technique for detecting entries to accounts, which are unusual by nature, involves the same process as shown for detecting entries from unusual sources. You are looking for debit posting to accounts which normally contain only credit posting and vice versa. An example would be a debit to a sales account, which could be a bad debt written-off. Accounts which exist at the beginning of the year and not at the end might indicate unauthorized accounting changes.

XIII. Indirect Approach to Investigation

Reconstruction of income is generally employed where the taxpayer keeps no record or inadequate records, or where there is strong suspicion that the taxpayer has received income from undisclosed sources.

Over the years, the Bureau of Internal Revenue has developed the following general methods for reconstructing a taxpayer's income. A.

Percentage method

B.

Net worth method

C.

Bank deposits method

D.

Cash expenditure method

E.

Unit and value method

F.

Third party information or access to records method

G.

Surveillance and assessment method

A.

Percentage Method

This method is the equivalent of a ratio analysis of percentages considered typical of the business under investigation to indicate potential areas of revenue adjustment in examination where revenue records do not exist. The computed amount of revenues based on the percentage computation is compared to the amount of revenues reflected on the return. The percentages used may be obtained from the taxpayer, industry publication, prior year's audit results, or third parties. The comparison will provide an indication on the possibility of revenue being understated. The extent of investigation required should be based on the degree of variance.

It must, however, be emphasized that in comparing transactions of similarly situated businesses, the name of the particular taxpayer used as the model must not be divulged to the taxpayer under investigation or in the report as this would constitute a violation by an internal Revenue Officer of the provisions of Section 270, National Copyright 2015

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Internal Revenue Code (NIRC) on unlawful divulgence of trade secrets.

aDCIHE

Significant ratios and trends to be analyzed are as follows: 1.

Percentage Mark-up

This is effective on businesses whose purchases can be readily broken down in groups with approximately the same percentage of mark-up. The purchases should be grouped in items with the same percentage of mark-up. The appropriate percentage of mark-up would then be applied to each group of items to arrive at the gross receipts.

The percentage of mark-up can be determined from selling prices obtained from the taxpayer. However, if cooperation from the taxpayer is lacking, the information should be obtained from competitive business establishments in the same industry.

Once the gross receipts are determined, the taxpayer should be given the opportunity to explain the discrepancy noted between the reconstructed gross receipts and the amounts reflected in the books and in the tax returns. The taxpayer may argue that the percentage mark-up should not be applied to purchases which were stolen, broken or spoiled. When reconstructing income using the mark-up method, possible unrecorded purchases should be considered. 2.

Gross Profit Ratio or Gross Margin Percentage The gross profit is expressed as a percentage of sales. Gross Profit Ratio =

(Sales-Cost Of Goods Sold) ——————————— Sales

Note: Sales should be net of Sales Discounts, Returns and Allowances.

Comparison should be made with prior period ratios to evaluate the taxpayer's own performance in previous years or with other firms in the same industry. 3.

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Profit Margin

Net Income ————— = Profit Margin

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Net Sales

If the profit margin is low, this will indicate that the firm's sales prices are relatively low or that its costs are relatively high or both. 4.

Total Assets Turnover Sales ————— Total Assets

= Total Assets Turnover

A high rate compared to the industry would signify sufficient volume of business and if a net loss is declared, questions must be raised or further investigation and analysis should be performed. e.

Inventory Turnover The inventory turnover is computed as follows: Inventory turnover=

Sales ————— Total Assets

or

Cost of Sales ————————— Beg. Invty. + End Invty./2

If the turnover is low, the company could be holding damaged or obsolete materials not actually worth their stated volume.

Average inventory at a given point X turnover rate = total purchases during the

year. B.

Net Worth Method

The fact that the taxpayer's books and records accurately reflect the figures on the income and business tax returns does not prevent the use of the net worth method of proof. The Revenue Officer can still look beyond the "self-serving declaration" in the taxpayer's books and records and use any evidences available to contravene their accuracy. However, this net worth method is most often used when one or more of the following conditions prevail: 1.

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The taxpayer maintains no books and records.

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2.

The taxpayer's books and records are not available.

3.

The taxpayer's books and records are inadequate.

4.

The taxpayer withholds books and records from investigation/verification by authorized Revenue Officer(s).

This is a method of reconstructing income which is based on the theory that if the taxpayer's net worth has increased in a given year in an amount larger than his reported income, he had understated his income for that year.

In applying this method, it is important to establish the net worth on a fixed starting date. This is to erase doubts that the increase in net worth or the excess of expenditures over reported income did not originate from prior accumulated funds (i.e. hoarded cash or undisclosed assets which do not represent income during the tax year). 1.

Net Worth Computation

Assets Less: Liabilities

xxx xxx —— xxx xxx —— xxx

Net Worth Less: Prior Year's Net Worth Increase (Decrease) in Net Worth Add: Non-deductible items Personal, lining and family expenses Income tax payments Insurance Premiums Gifts Non-deductible contributions Net capital loss Amnesty tax payments Estate and donor's taxes Other non-deductible items Net Income before further adjustments Less: Non-taxable items Gifts, donations and Inheritance received Non-taxable stock Dividends (if reflected in Assets) Copyright 2015

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xxx —— xxx

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Retirement pay from SSS Non-recognized gains from exchange of property under Sec. 40 of the Tax Code Social Security benefits received from foreign gov't. and institutions (PD220) Other non-taxable items Total non-taxable items Adjusted net income per investigation Less: Statutory Exemptions: 1. Exemption of Working Wife 2. Personal and addt'l. exemption 3. Special additional exemption Total Statutory exemption

xxx

xxx

xxx xxx ——

xxx xxx xxx ——

NET INCOME SUBJECT TO TAX 2.

xxx —— xxx xxx

Burden of Proof

xxx —— xxx ===

The "Net Worth" method to be acceptable must establish with reasonable certainty an opening net worth, to serve as a starting point from which to compute future increases in the taxpayer's assets. It must also introduce evidence to support the inference that the taxpayer's net increases are attributable to currently taxable income. In computing the increase, the taxpayer's assets are totalled and net worth as determined at the close of the previous taxable year is subtracted from the total at the close of the taxable year in question. The remainder, if .any, is the increase for the taxable year, and constitutes taxable income if no adjustments are required.

However, where net worth increase is the income determinant the Revenue Officer may, in making the final computation upon which to base the tax, add to the increase estimated living expenses incurred by the taxpayer since such expenditures are presumed to have come from income. The taxpayer, on the other hand, is entitled to reduce the reconstructed income by the amount of depreciation allowable on assets which Copyright 2015

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are not considered in determining net worth.

The factors to be considered in reconstructing net worth are variable, like availability of evidence. Generally, net worth has been computed on the basis of some, all or a combination of the following: a.

bank records

b.

securities

c.

financial statements

d.

fixed assets

e.

inventory

f.

all available records

3.

Determination of Opening/Net Worth: The COHAN Rule

C.

Bank Deposit Method

The difficulty of establishing the opening net worth of a taxpayer has led to the use of the Cohan rule to estimate or approximate the amount of cash at that time. The Cohan rule (established by the US Seventh Circuit Court of Appeals in Cohan vs. Commissioner) allows the use of estimates where the taxpayer lacks adequate records. When the taxpayer's records are apparently inaccurate or manifestly incomplete, the Revenue Officer may look at the bank deposits of the taxpayer as evidence income. Under the bank deposit method, the bank records of the taxpayer are analyzed and the Revenue Officer estimates income on the basis of the total bank deposits after eliminating non-income items. This method stands on the premise that deposits represent taxable income unless otherwise explained as being-non-taxable items. This method can be used if the Revenue Officer has been allowed access to the taxpayer's bank records or if the Revenue Officer has obtained documented evidence from reliable sources as to the taxpayer's bank accounts. cSATEH

While the mere deposit of money does not prove the receipt of taxable income as alleged by the Revenue Officer, the burden is on the taxpayer to prove that various deposits did not stem from the receipt of taxable income. The passage of time makes it difficult for the taxpayer to meet this burden but this does not relieve him from showing the non-taxable source to contradict the Revenue Officer's determination. If the bank deposit method is used in support of findings of fraud, however, the burden of proof is on the Revenue Officer. When computing taxable income under this method, it is appropriate to add to the amount of the bank deposit the amount of cash expenditures from undeposited funds for Copyright 2015

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personal expenses which is non-deductible for tax purposes. Withdrawals which can be identified as deductible are allowed against the taxable income determined.

In using this method, it is proper to prove the existence of a business and the practice of making deposit of business income into one or more bank accounts and then to adjust the total deposits for transfers, redeposits, deposits otherwise explained and finally to allow for ascertainable expenses, deductions and exemptions. 1.

Analysis of Bank Deposits

The Revenue Officer's careful analysis of the taxpayer's bank deposits constitutes the most important phase of his investigation. A review of the taxpayer's personal and business bank records for several months should be made. The following questions should be answered in analyzing the taxpayer's deposits: 1.1

Are deposits made on a basis consistent with the information secured during the initial interview?

1.2

Are there any large or unusual deposits?

1.3

Are there any deposits from sources not reflected on the tax return?

1.5

Are there checks endorsed by the taxpayer and deposited into an account not previously disclosed?

1.4

1.6 2.

Did the examination of the taxpayer's cancelled checks reveal additional bank accounts not previously disclosed by the taxpayer?

Are there checks for assets or personal expenses that affect the taxpayer's standard of living?

Computation of Gross Receipts Through Bank Deposit Method

Total Reconciled Bank Deposits Less: Non-taxable receipts deposited (sch. 1) Net Deposits that resulted from taxable receipts Add: a. Business expenses paid in cash (sch. 2) b. Capital items paid in cash c. Personal expenses paid in cash (sch. 3) d. Cash accumulated

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xxx —— xxx xxx xxx xxx Philippine Taxation Encyclopedia 2014

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during the year from receipts Increase in Accounts Receivable Decrease in accounts payable

e. f.

xxx xxx xxx ——

Total Less: Non-taxable cash used in (a) thru (d) Decrease in accounts receivable Increase in accounts payable

xxx —— xxx

xxx xxx xxx ——

Gross Receipts Schedule 1 Non-Taxable Receipts include:

xxx —— xxx ===

—

Checks drawn to cash that were redeposited

—

Second deposits of NSF checks

—

Transfers between accounts

—

Proceeds from loans, social security, exempt interest, etc.

Schedule 2 Business expenses paid in Cash Total business cash outlays per returns Less: Total checks written Non-business expenses paid by check Business expenses paid in check

xxx xxx

Business expenses paid in cash Schedule 3 Personal Expenses Paid in Cash Total personal expenses Less: Business expenses paid in cash Personal expenses paid in cash Copyright 2015

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xxx —— xxx === xxx (xxx) —— xxx === 87

Deposits may represent redeposited items and loans, in which case, taxable income as determined by the Revenue Officer should be reduced by such amounts. When there is evidence that some of the deposits were for non-taxable items and as such, there is no proof of the precise amount of taxable income, the Cohan principle may be resorted to. Deposits may also be shown to represent amounts on hand at the start of the year in which they are deposited rather than income in that year. The bank deposit method, like the net worth method, encompasses an area of uncertainty. Though the taxpayer's records are inadequate for precise and complete verification of its return, a determination of income by the bank deposit method will be rejected if it is inconsistent with surrounding circumstances and gives an absurd result. D.

Cash Expenditure Method

An outgrowth of the net worth method of determining income is the "excess cash expenditure method. This method assumes that the excess of a taxpayer's expenditures during a tax period over his reported income for that period is taxable to the extent not approved otherwise. The taxpayer may show that this excess resulted from non-taxable items such as loans, gifts, inheritance or assets on hand at the beginning of the period.

While it has been said that no opening net worth is needed when the cash expenditure method is used, the more impressive authority is to the contrary. The two steps involved in the cash expenditure method are: a) valuation of the taxpayer's assets at the beginning of the taxable period in order to determine the taxpayer's funds available for expenditure during the ensuing taxable periods and b) determination of the amount by which expenditures exceed reported income for the taxable period. To show a failure to report the full amount of income by the use of this method, it must be demonstrated that the expenditures made during the taxable year were in excess of the available funds during the year which were reported on the tax return. Total expenditures may not include checks drawn to cash and items for which the taxpayer has paid in cash, unless the cash bank withdrawals were not used to pay for the cash expenditure. The burden is on the taxpayer to establish the relationship between the cash withdrawal and individual items. Expenditures may not necessarily come from income, but very large expenditures for personal purposes each year may be interpreted as an indication that the income being reported was too small. Consideration must be given to non-taxable sources of cash. Here, too, the difficulty of establishing the amount of cash at the starting point has led to the use of Cohan rule to estimate the cash available at the opening of the taxable period. The method has to be rejected when it gives an unrealistic result. Proof in cash expenditure case may be difficult, for it is highly unusual for anyone to keep accurate records of personal living expenses. However, once the Revenue Officer has made a determination as to the amount of cash expenditures, the burden of proof to Copyright 2015

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establish a different amount is on the taxpayer. E.

Cash Expenditure Method

This is not considered as a primary method proof. The determination or verification of gross receipts may be computed by applying price and profit figures to the known ascertainable quality of business of the taxpayer. In addition, there are existing regulatory bodies to which the taxpayer reports units of production or service, some of which are: a.

records of sugar milled by a sugar central

b.

records of fish production to the Bureau of Fishery and Aquatic Resources

c.

records of production by pioneer and non-pioneer industries to the Board of Investments.

E.1. Examples Using Unit and Value Method Industry

Pizza Parlor

Item Being Tested Sales

Gas Station

Gasoline Sales

Exercise

Patronage

Hotels

Room Revenue

Laundry

Washer and Dryer

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Variables for Estimate of Item Being Tested

Pounds of flour used multiply by number of pizzas per pound multiply by average price per pizza Number of liters sold per supplier's invoices multiply by average price per liter Membership statistics, club individual membership fees, or monthly dues Number of rooms multiply by occupancy rate multiply by average room rate Cost per machine load multiply by

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Professional

Fees Billed

Real Estate

Rental Revenue

F.

number of times machine was used during business hours and number of machines Number of employees multiply by utilization rate multiply by hours in a year multiply by average billing rate Number of rental units multiply occupancy rate multiply by average rent

Third Party Information (Access to Records) Method

Third party contacts are a source of information that should not be forgotten. The Revenue Officer should determine when to make third party inquiries. The decision to make a third party inquiry is shaped by the size of the peso amount involved and the volume of the transaction. Third party inquiry through access to records can be time consuming. The Revenue Officer must weigh the benefits to be realized from work against the time required to make an access to records and the availability of the needed information through other methods. The need for the Revenue Officer to obtain third party information is most often involved in our attempts to verify gross receipts.

XIV. Audit Procedures on Other Kinds of Taxes A.

Withholding Taxes

The following audit procedures outline the steps to be performed by a Revenue Officer in the determination of the correct amount of withholding taxes due from withholding agents to ascertain if: 1.

The income payments were subjected to withholding taxes.

2.

The rate of tax and the amount of tax withheld is correct.

3.

The tax withheld is remitted within the due dates.

The audit procedures are classified according to the classification of withholding

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taxes, to wit: 1.

Withholding Tax on Compensation

2.

Expanded Withholding Tax

3.

Final Withholding Tax

4.

Withholding Tax on Government Money Payments

Audit procedures for the different kinds of withholding taxes. 1.

Withholding Tax on Compensation 1.1

1.2

1.3

1.4 1.5

2.

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Verify the number and list of employees per payroll records and the list of employees submitted to the Social Security System and the Department of Labor and Employment as against the alphalist of employees from whom taxes have been withheld which is attached to the annual information return (BIR Form 1604CF).

Examine payroll records. including confidential payroll, if any, employment contracts, supporting vouchers, receipts for advances/reimbursements of transportation and representation expenses, receipts for payment of compensation and reconcile amount of supported expenses with the figures per financial statements and withholding tax remittance returns. Determine the correctness of the amount of personal and additional exemptions claimed in the Certificate of Exemption (BIR Form 2305) as accomplished and filed by the employee. Check the computation of the correct withholding tax per payroll period. Examine monthly withholding tax remittance returns (BIR Form 1601C) and compare amounts remitted against the computed withholding tax on compensation per audit.

Reconcile the aggregate gross compensation income stated in the withholding certificate (BIR Form 2316) with the total amount indicated in the gross compensation income column of the alphalist.

Expanded Withholding Tax 2.1

Check amount payable or paid per income statement and income tax returns (BIR Forms 1701 and 1701Q) against those declared in the monthly and annual returns (BIR Forms 1601E and 1604E).

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2.2.

2.3 2.3 2.5

Ascertain validity of payments by and to prime contractors, and subcontractors, professionals, brokers, sub-brokers, agents of entertainers, etc. by examining contracts, subcontracts, vouchers, receipts and billings.

Determine the correctness of the amounts subject to withholding tax by comparing the total payments per supporting documents against the amount per withholding tax returns. Verify the correctness of the payee classification and withholding tax rate applied. Determine the dates of payment or the period when the obligation to pay the amount subject to withholding tax is due. The time to withhold is fixed at the time the obligation is due irrespective of the actual payment. SHacCD

3.

Final Withholding Taxes 3.1

3.2

3.3

Review the contracts for payment of certain items of income to resident and non-resident payees of interest and rent, Central Bank approval papers, commercial papers, employment contracts, contract for payment of royalties, records of prizes or winnings and financial statements.

Ascertain if the income payment was subjected to withholding tax in the year it was accrued, irrespective of whether the taxes withheld were remitted within ten (10) days following the month in which the payment was accrued. In the case of withholding tax on interest on bank deposits, the remittance shall be made quarterly within twenty five (25) days after the end of each quarter. Check the correctness of the basis and rate of withholding tax applied.

3.3.1 If a preferential tax rate is being availed of, verify the correctness of the rate used from the ruling issued either by the International Tax Affairs Division (ITAD) or Law Division. Also verify the authenticity of said ruling from the issuing office. 3.4 3.5 Copyright 2015

Ascertain the date of accrual of the income payment, to fix the time to withhold, irrespective of the actual remittance or non-remittance of the tax withheld by reason of official restriction. Verify correctness of remittance against monthly remittance returns (BIR Form 1601F) and annual information return (BIR Form

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1604CF). 4.

Withholding Tax on Government Money Payments 4.1 4.2

4.3 4.4

B.

Examine government contracts with suppliers, purchase records, payment orders, billing records, receipts, vouchers, cash book and reports of COA auditors.

Check money payments from vouchers, billing records, records of purchases, COA audit reports, etc. against monthly remittance returns (BIR Form 1600), books of accounts and other accounting records maintained. Determine the correctness of bases and rates of tax applied.

Check whether the correct amount of tax has been withheld and remitted within the prescribed period. Otherwise, impose appropriate penalties for non-withholding or non-remittance of the tax, as the case may be.

Be Capital Gains Tax on Sale, Transfer or Exchange of Real Property

This Section equips the Revenue Officer with minimum audit steps prescribed by existing revenue issuances in the proper determination of the correct capital gains tax due on sale, transfer or exchange of real properties. Additional audit techniques must be employed by the Revenue Officer depending on the complexity and materiality of the transactions involved. 1.

Ascertain authenticity of the following documents: 1.1

Deed of Sale/Transfer or Exchange

1.3

Latest Tax Declaration

1.4

Whether the proceeds of the sale or disposition was fully utilized in acquiring or constructing a new principal residence of the seller; and

1.2

2.

If the object of the sale or disposition is the principal residence of natural persons, verify the following:

2.2

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Transfer Certificate of Title (TCT)/Condominium Certificate Title (CCT)/Original Certificate of Title (OCT)

Whether such construction or acquisition of such new principal residence is within eighteen (18) months from date of sale or disposition.

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If both are in the affirmative, the sale or disposition shall be exempt from capital gains tax, subject to the following conditions:

2.2.1 The historical cost or adjusted basis of the real property sold or disposed shall be carried over to the new principal residence built; 2.2.2 The Commissioner shall have been duly notified by the taxpayer within thirty (30) days from the date of disposition through a prescribed return of his intention to avail of the exemption;

2.2.3 The exemption from capital gains tax shall be availed of only once in every ten (10) years; and 2.2.4 In case where the proceeds of the sale or disposition is not fully utilized, the portion for the unutilized part shall be subjected to tax using the formula: Gross Selling Price or Fair Market Value (whichever is higher) x Unutilized

3.

4. 5.

6.

Amount ——————— X 6% Gross Selling Price

For disposition of real property without any improvement, obtain a certificate from the City/Provincial/Municipal Assessor on the non-existence of improvement on the real property being sold, transferred or exchanged. Ascertain correctness of the value of the property sold by conducting an ocular inspection of the property.

If the seller is a non-resident alien claiming exemption from paying the capital gains tax, check the existence of a ruling issued to that effect pursuant to RMO 1-2000. Also verify the authenticity of said ruling from the issuing office. Review computation of the tax base for land and improvement in accordance with the following: 6.1

When the zonal value of land has been established

6.1.1 Determine the value of improvements by using the formulas shown below: a.

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Total Selling Price/

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Consideration per Deed of Sale (Land and Improvements) Less:- Zonal value of Land Value of Improvements b.

Improvements introduced from 1991 to present: Construction cost per building permit and/or occupancy permit

xxx

Construction cost per building permit and/or occupancy permit

xxx

Improvements introduced in 1986 to 1990:

Add 10% thereof per year after year of Construction Value of Improvements c.

xxx xxx —— xxx ===

xxx —— xxx ===

Improvements introduced in 1985 and prior years, and in cases of improvements in places other than the National Capital Region and chartered cities where there is no building permit and/or occupancy permit, use the following formula: Fair Market Value (FMV) per latest tax declaration Add: 100% of the FMV of the improvements per latest tax declaration, if classified as residential or agricultural other than fishpond/prawn farm or

xxx

xxx

150% of FMV of the improvements per latest tax declaration, if classified as commercial, industrial and/or Copyright 2015

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agricultural devoted to fishpond/prawn farm Value of improvements

xxx —— xxx

6.1.2 Determine tax base of land and improvements as follows: Zonal value of land Add: Value of Improvement under a, b or c of 6.1.1, as applicable Tax base of land and improvements 6.2

xxx

xxx —— xxx ===

When the zonal value of land has not been established

6.2.1 Determine the total selling price/consideration per deed of sale of land and improvement

6.2.2 Determine value of land and improvements by using the following formula: FMV of land per latest tax declaration Add: 100% of FMV of land per latest tax declaration if classified as residential or agricultural other than fishpond/prawn farm or

150% of FMV of land per latest tax declaration, if classified as commercial, industrial and agricultural devoted to fishpond/prawn farm Copyright 2015

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xxx 96

Value of land Add: Value of improvements (from b or c of 6.1.1) Value of Land and Improvements

6.2.3 Select tax base of land and improvements Selling Price (6.2.1 or total market value of land and improvements per 6.2.2), whichever is higher

7.

—— xxx xxx ——

xxx ===

In case of installment sales, determine whether the taxpayer is qualified to report his gain under the installment basis. An individual is qualified to account for his gain on installment basis if the initial payment does not exceed 25% of the selling price. The term "initial payment" means the payment or payments which the seller receives before or upon execution of the instrument of sale and payments which he expects or is scheduled to receive in cash or property (other than evidence of indebtedness of the purchaser) during the taxable year of sale or disposition. HcSaTI

Example: Assume that on October 15, 1998, an individual sold for P100,000 a real property with an adjusted basis of P60,000 under the following terms: P10,000 upon execution of sale; the balance of P90,000 in 18 equal monthly installments of P5,000 each beginning November 15, 1998. The taxpayer qualifies to pay the capital gains tax on installment because the initial payment consisting of the amount of P10,000 he received upon sale and the amount he expects or is scheduled to receive — P5,000 on November 15, 1998 and P5,000 on December 15, 1998, or a total of P20,000 during the year of sale do not exceed 25 % of the selling price. 7.1

Computation of amount of tax payable on installments.

If the taxpayer qualifies and elects to pay the capital gains tax in installments, the tax may be paid in installments, the amount of each installment of which shall be the proportion of the tax so determined which are: 7.1.1 On the date of sale or disposition, first payment (amount received, including the excess of the mortgage, if any,

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assumed by the purchaser) over the basis of the property sold; and

7.1.2 In succeeding payments, the installment payment received by the seller in relation to the total contract price. Illustrations:

Example 1. Assume that on January 2, 1998, an individual sold a piece of property with adjusted basis of P60,000 for P100,000 under the following terms: P20,000 downpayment; balance in five annual installments beginning 1999. Taxpayer elects and is qualified to pay the tax in installment. The periodic payment of the tax is computed as follows: Computation of total tax due: Selling Price Total Tax Due at 6% thereof

P100,000 P6,000

Portion of the tax payable upon sale or upon receipt of first payment is determined as follows: [First payment/Contract price] x Total Tax Due = Portion of Tax Payable

or

[P20,000/P100,000] x P6,000= P1,200

Portion of the tax payable annually for five years beginning 1999 is computed as follows: a.

b. c. d.

Installment payment received Total selling price Total capital gains tax Amount payable annually (a) divided by (b) multiplied by (c)

P16,000 P100,000 P6,000 P960

Example 2. Assume that in 1969, an individual acquired a property for P60,000. In 1999, he sold the property for P100,000. Terms of sale: Downpayment, January 2, 1998, P10,000; mortgage assumed, P40,000; balance payable in four annual installments beginning January 2, 1998. The taxpayer elects to pay the tax on the gain in installments.

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The tax payments on installments received is computed as follows: Computation of total capital gains tax: Selling Price Total Tax Due at 6% thereof

P100,000 P6,000

Computation of taxes payable on installments: Upon receipt of first payment

First payment received

P10,000

Total contract price: Selling Price Less: Mortgage assumed by buyer ———— Total contract price

P100,000 40,000 60,000

Total capital gains tax due

P6,000

Amount of tax payable:

[P10,000/P60,000] x P6,000 = P1,000 =======

Amount of succeeding tax payments: Annual installment receipts

Total contract price Total capital gains tax Annual tax payable on installments:

P12,500 ———— P60,000 ———— P6,000 ————

[P12,500/P60,000] x P6,000 = P1,250

Example 3. Assume that in 1998, an individual sold for P100,000 a piece of real property which he bought in 1980 for P40,000. Prior to sale, the property was mortgaged for P60,000. The terms of sale are as follows: Downpayment, P10,000; assumption of unpaid mortgage, P50,000; balance of P40,000 payable in four semi-annual payments beginning Copyright 2015

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January 15, 1999. The taxpayer elects to pay the tax in installments. Amount of tax payable in installments is computed as follows: Computation of total capital gains tax: Selling Price Total Tax Due at 6% thereof

P100,000 P6,000

Computation of tax payment in the year of sale: First payment:

Cash Excess of mortgage assumed by buyer over the acquisition cost (P50,000-P40,000)

P10,000

10,000 ———— 20,000 =======

Total first payment Total Contract Price: Selling Price Less: Mortgage Assumed

P100,000 50,000 ———— P50,000

Add: Excess of mortgage assumed over basis of property sold Total contract price Total basis of tax payable on first payment:

10,000 ———— P60,000 =======

First payment Contract Price Total capital gains tax

Amount of tax payable on first payment:

P20,000 P60,000 P60,000

P20,000/P60,000 x P6,000 = P2,000

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Basis of tax payable on succeeding semi-annual payments: Installment received Total contract price Total tax due

P10,000 P60,000 P6,000

Amount of tax payable semi-annually: [P10,000/P60,000] x 6,000 =

8. 9.

P1,000 ======

Confirm payment of Capital Gains Tax by cross-checking the payment thereof with the Batch Control Sheet prepared by the bank or the Collection Officer, as the case may be.

When there is delay in the presentation of sales, documents, require the taxpayer to submit documents such as cancelled checks, official receipts or certification of the archive official to show that there is no ante-dating of public instrument. The rules and regulations applicable at the date of execution of the contract shall be applied and the increments for late filing and payment of tax shall be imposed. If the taxpayer cannot show proofs that the same is not ante-dated, the rules applicable at the time of presentation of the document shall apply.

C.

Estate Tax

The following audit procedures were culled from existing revenue issuances. They enumerate the steps to be taken by a Revenue Officer in the processing, verification and investigation of estate tax returns of resident and non-resident decedents subject to estate tax. However, these do not preclude the application of other audit procedures as warranted by the circumstances surrounding each case. 1.

The estate tax return of a decedent and all his unverified income tax returns for the last three years prior to his death shall be simultaneously investigated by a Revenue Officer or a group of Revenue Officers, if so provided in the annual Audit Program. SEcTHA

2. Copyright 2015

The Revenue Officer should see to it that an income tax return covering the income and deductions of the decedent from January 1 to the date of his death has been filed. If the period covered by the return consists of less than twelve (12) months, such period shall be considered as a "taxable year". If the settlement of the estate of the decedent is the object of judicial

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testamentary or intestate proceedings, ascertain if: 2.1 2.2

3.

4.

5.

If the settlement of the estate is not the object of judicial testamentary or intestate proceedings, verify if the income of the properties left by the decedent is included in the income tax return of each heir or beneficiary according to his distributive share in the net income of the estate or co-ownership. Verify if a Notice of Death was filed within two (2) months after the decedent's death where the gross value of the estate exceeds twenty thousand pesos (P20,000). In case of failure to file the notice, impose the appropriate penalty even after the lapse of the prescribed period of two (2) months after the qualification of the executor or administrator. This contemplates the filing of the estate proceedings in courts and the appointment of the executor or administrator by the court. Determine if the value of the gross estate exceeds two million pesos (P2,000,000). If so, check whether the estate tax return is supported by a statement duly certified by a Certified Public Accountant showing the following information:

5.2

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Individual returns for the spouse, heirs or beneficiaries have been filed covering their respective income from the estate and applicable deductions for the period from the date immediately following the death of the decedent to the end of the taxable year. The estate's income tax return shall cover the income and deductions of the estate for the period from the date immediately following the death of the decedent to the end of the taxable year. Thereafter, quarterly and annual returns for the estate shall be filed until the estate is divided and distributed to the rightful heirs and beneficiaries.

5.1

6.

An income tax return for the estate as a taxable person has been filed by the fiduciary or administrator; and

5.3

Itemized assets of the decedent with their corresponding gross value at the time of his death, or in the case of a non-resident alien, of that part of his gross estate situated in the Philippines; Itemized deductions from gross estate allowed under Sec. 86 (A) of the Tax Code; and The amount of tax due whether paid or still due and outstanding.

Examine the inventory of assets and/or liabilities not reported in the said return. Prepare an adjusted schedule of assets and liabilities as basis in

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7.

8.

9.

10.

11.

12.

computing the yearly increase in the net worth of the taxpayer up to the time of his death.

Inquire on the source of acquisition of the property left by the decedent, whether it was acquired by purchase, donation or inheritance, for the purpose of ascertaining if such property is conjugal, exclusive or paraphernal property of the deceased.

Scrutinize the provisions of the insurance policies taken out by the deceased upon his own life as to the designation of the beneficiary. If the designation is revocable, the proceeds of the life insurance shall be included in the gross estate. If irrevocable, the proceeds thereof shall be excluded from the gross estate, irrespective of whether or not the insured retained the power of revocation, if the beneficiary named in the policy is the estate of the decedent. Verify if the land, as part of gross estate specially urban land, include improvements and buildings. Secure a certification from the Assessor's Officer as to the existence of non-existence of improvements on the land. Conduct an ocular inspection of the land whenever possible. Conduct third party verification on certain government agencies such as Office of the Register of Deeds, Securities and Exchange Commission, Land Transportation Office, Office of the Provincial, City or Municipal Assessor for possible properties listed and registered in the name of the decedent which may not have been included in the estate tax return.

Inquire into the bank deposits or other investments of the decedent. Pursuant to Sec. 6 (F)(1) of the Tax Code, the Commissioner is authorized to look into the bank deposits of a decedent for estate tax purposes, the provisions of Republic Act No. 1405 and other general or special laws notwithstanding. Foreign currency deposits, if any, shall be converted using the foreign exchange rate.

Ascertain if the shares of stocks are properly valued. In doing so, observe the following rules on valuation pursuant to RAMO No. 1-82: 12.1

For stocks listed or traded in the stock market:

12.1.1 The selling price shall be used where there are sales made on the valuation date. The mean between the highest and lowest selling prices on valuation dates shall be the fair market value per share.

12.1.2 If there were no sales on the valuation date but there were sales on dates within a reasonable period both before and Copyright 2015

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after the valuation date, the fair market value is determined by taking the weighted average of the mean between the highest and the lowest sales in the nearest trading date after the valuation date. The weighted average is to be computed inversely by the respective number of trading days between the selling dates and the valuation date. The reasonable period of valuation must not exceed six months before or after the valuation date. Example:

The valuation date is January 15, Friday. Sales of stock occurred on January 13, Wednesday or two trading days before valuation date at P10.00 and on Wednesday, January 20, three days after valuation date at P15.00, the fair market value of the shares to be taken is P12.00 computed as follows: (3xP10) + (2x15) = P30 + P30 = 60 = P 12.00 ——————— ————— 5 5

12.1.3 If actual sales of the shares are not available during a reasonable period beginning before and ending after the valuation date, the fair market value may be determined by taking the mean between bona fide bid and asked prices on the valuation date, or if none, by taking the weighted average of the mean between the bona fide bid and asked prices on the nearest trading date before and after the valuation date within a reasonable period in accordance with the formula in the preceding paragraph. 12.1.4 If there are no sales or bonafide bid and asked prices available on a date within a reasonable period before the valuation date, but such prices are available on a date within a reasonable period after the valuation date, then the mean between the highest and lowest available sale prices or bid and asked prices nearest the valuation date may be taken as the value of shares. DHIcET

12.1.5 If it is established that the selling or bid and asked prices as provided in the foregoing paragraphs do not reflect the fair market value thereof, modifications of the basis are to be made taking into consideration other relevant facts and elements of value. In some exceptional cases, the size of the block of stocks to be valued in relation to the number of shares transferred in sales may affect adversely the fair Copyright 2015

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12.2

market value of the stocks to be valued.

For unlisted stocks or stocks not quoted or traded in the stock market:

12.2.1 In general, the unlisted shares shall be valued at their book value nearest the valuation date. The book value of these unlisted shares of stock shall be prima facie considered as their fair market value. 12.2.2 In case the shares are valued on a basis lower than their book values, a justification for the deviation from the book value, together with the evidences in support thereof should be submitted. The following factors are considered relevant in the valuation of shares of stock of closed corporations: a.

b.

The economic outlook in general and the business condition and outcome of the specific industry in particular;

c.

The financial conditions of the business;

d.

The earning capacity of the company;

e.

The dividend paying capacity;

f.

Goodwill;

h.

Market price of stocks of corporations engaged in the same or similar line of business to be valued;

g.

i. j. k. l. Copyright 2015

The nature of the business and the financial history of the enterprise, from the date of the incorporation;

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Sales of stocks and size of the block of stock to be valued;

Existence of corporate debts in favor of the family of the principal; Restrictive agreements impairing the alienity of the stock; Investments in business or property maintained at a deficit; Dividend arrearages; Philippine Taxation Encyclopedia 2014

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13.

m.

Voting rights of stockholders; and

n.

Difficulty in liquidating the assets.

If such lower fair market valuation is not clearly established and documented, the book value of the unlisted shares of stocks shall be adopted. If there have been previous bona fide sales/exchanges of the unlisted shares of stock, the price at which these shares exchange hands should be taken/considered as its fair market value/s. Preferred shares of stocks shall always be valued at par.

Audit of itemized deductions under Section 86 (A) of the Tax Code: 13.1

Funeral Expenses

13.2

Judicial Expenses

13.3

Claims Against The Estate

Require the submission of invoices or official receipts evidencing actual funeral-expenses. Only actual funeral expenses or an amount equal to 5% of the gross estate whichever is lower, but in no case shall exceed P200,000, may be allowed as a deduction from gross estate. Check if the settlement of the estate is the object of judicial testamentary or intestate proceedings. If not, no deduction for judicial expenses shall be allowed. However, a reasonable amount for legal fees and accounting expenses incurred in the settlement of the estate of the decedent may be allowed. Scrutinize legal fees deducted in the estate tax return by checking the nature of the payment, the person to whom it was paid and the date of payment. 13.3.1 Verify if the claim is subject to Mortgage Redemption Insurance (MRI). If so, disallow deduction claimed.

13.3.2 In the verification of claims against the estate, secure certified true copies of the following documents and verify them: a.

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Duly notarized promissory notes or contract of loan signed by the debtor if the loan was contracted within three (3) years before the death of the decedent. Philippine Taxation Encyclopedia 2014

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b.

Vouchers, cancelled checks or other documents evidencing the advances made by individuals or corporations to the deceased;

c.

Latest balance sheet of the corporation; and

d.

Other documents or evidences relevant to the grant of the loan, i.e., real estate or chattel mortgage, a copy of the Transfer Certificate of Title to show annotations thereof.

13.3.3 Check the statement submitted by the administrator or executor regarding the disposition of the proceeds of the loan. If the administrator or executor fails to satisfactorily explain, in whole or in part, the disposition of the proceeds of the loan contracted within three (3) years before the death of the decedent, such proceeds or a portion thereof may be included as cash in the gross estate. 13.3.4 Where the settlement is made through the court in a testate or intestate proceeding, scrutinize pertinent documents filed with the court evidencing claims against the estate or the court order approving the said claims, if a decision thereon has already been issued.

13.3.5 Obtain a sworn certification from the creditor as to the exact balance of the liability of the deceased. The certification must be duly signed by the president, vice-president or other principal officer of the corporation in case the creditor is a corporation. 13.3.6 Ensure that the creditor agrees in writing allowing the verification by the Revenue Officer of his pertinent records for the purpose of substantiating the claims against the estate of the deceased. 13.4

Claims Against Insolvent Persons

13.4.1 Determine if the Accounts, or Notes Receivable has been included as part of the gross estate. If not, disallow the claim as a deduction.

13.4.2 Find out if the claims against insolvent persons may be considered as conjugal or separate property of the decedent. In case the claim is the exclusive or paraphernal property of the decedent, the same should not be considered in the Copyright 2015

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computation of the share of the surviving spouse. 13.5

Vanishing Deduction (Property Previously Taxed)

Ascertain compliance with all of the following conditions so that the claim for vanishing deduction may be allowed:

13.5.1 The prior decedent must have died or the donation must have been made within five (5) years before the decedent's death. acCITS

13.5.2 The property subject to the vanishing deduction must be the same property inherited or donated from the prior decedent or donor.

13.5.3 The vanishing deduction is based on the value of the property at the time of the donation or death of the prior decedent or at the time of the death of the present decedent, whichever is lower. The deduction is based on the value of each individual property. 13.5.4 The estate tax or donor's tax due on the donation or estate of the prior decedent must have been paid. 13.6

Transfers for Public Use

Failure to comply with any of the following requisites will result in the disallowance of the deduction:

13.6.1 The transferee is the government or any political subdivision thereof and the transfer is exclusively for public purpose. 13.6.2 The transfer must be by way of a last will and testament or donation mortis causa executed by the deceased before his death. 13.7

Losses

Examine closely the losses being claimed as a deduction from gross estate. Disallow the deduction if any of the following conditions is absent: 13.7.1 The value of the property lost must have been included in the gross estate.

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in whole or in part.

13.7.3 The loss must not have been claimed as a deduction for income tax. 13.7.4 The loss must have been incurred not later than six (6) months after the decedent's death. 13.8

Family Home

Check the computation for the allowance for Family Home as a deduction from the gross estate and its corresponding valuation in accordance with RR No. 17-93, to wit: 13.8.1 Valuation of Family Home

The decedent's family home shall be appraised as of the time of his death, at its current or fair market value or zonal value, whichever is higher.

13.8.2 Conditions for the allowance of family home as a deduction from the gross estate: a.

b.

c.

The family home must be the actual residential home of the decedent and his family at the time of his death, as certified by the Barangay Captain of the locality where the family home is situated;

The total value of the family home must be included as part of the gross estate of a person who died on or after July 28, 1992, the date of effectivity of R.A. 7499; and

Allowable deduction must be in the amount equivalent to the fair market value or zonal value of the family home as declared or included in the gross estate but not exceeding P1,000,000.

To illustrate: 1.

Decedent is an unmarried head of a family: Real and personal properties Family Home Gross Estate (Less): Deductions

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P5,000,000 2,000,000 ————— P7,000,000 109

Other deductions Family home Standard deduction Net Taxable Estate

P2,000,000 1,000,000 1,000,000 —————

(4,000,000) ————— P3,000,000 =========

Note: Although the family home is valued at P2 million, the maximum allowable deduction for the family home is P1 million only. b.

Real and personal properties Family home Gross Estate (Less): Deductions Other deductions Family home Standard deduction Net Taxable Estate

P5,000,000 800,000 ————— P5,800,000

P2,000,000 800,000 1,000,000 —————

(3,800,000) ————— P2,000,000 =========

Note: Deduction for family home is allowed for P800,000 only which is the declared value of the family home. 2.

Decedent is a married man with surviving spouse: a.

The family home is the decedent's exclusive property.

Exclusive

Conjugal Properties: Real properties Exclusive Properties: Family home Other exclusive properties Gross Estate (Less): Conjugal Deductions Other deductions

Conjugal

P5,000,000

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P5,000,000

P2,000,000 2,500,000 ————— P4,500,000

4,500,000 ————— ————— P5,000,000 P9,500,000

—————

(2,000,000) (2,000,000) ————— —————

Net Estate After Conjugal Deductions P4,500,000 (Less): Share of surviving spouse (P3,000,000/2) Family home (1,000,000) Copyright 2015

Total

P3,000,000

P7,500,000

(1,500,000) (1,500,000) (1,000,000

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Standard deduction Net Taxable Estate b.

————— P3,500,000 =========

(1,000,000) (1,000,000) ————— ————— P500,000 P4,000,000 ========= =========

Family home is a conjugal or community property

Exclusive

Conjugal Properties: Family home Other real properties Exclusive Real Properties Gross Estate (Less): Deductions: Conjugal deductions Share of surviving spouse: Conjugal property P7,000,000 Less: Conjugal 2,000,000 ————— deductions P5,000,000 Net conjugal estate ½ Share of surviving spouse Family home Standard deduction Net Taxable Estate

Conjugal

P2,000,000 ————— P2,000,000

Total P2,000,000 5,000,000

P2,000,000 5,000.000 P2,000,000 ————— ————— P7,000.000 P9,000,000 (P2,000,000) (P2,000,000)

————— P2,000,000 =========

(2,500,000) (1,000,000) (1,000,000) ————— P500,000 =========

(2,500,000) (1,000,000) (1,000,000) ————— P2,500,000 ========

Note: Family home allowance of P1,000,000 is considered as one item of deduction after the computation and deduction of the net share of the surviving spouse in the conjugal property. c. Same facts and figures as in (b) except for family home which has a fair market value/zonal value of only P1,500,000.

Exclusive

Conjugal Properties: Family home Other real properties Exclusive Real Properties

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Conjugal

P2,000,000 —————

Total P1,500,000 5,000,000

P1,500,000 5,000,000 2,000,000 ————— —————

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Gross Estate (Less): Deductions: Conjugal deductions Share of surviving spouse: Conjugal property Less: Conjugal deductions Net conjugal estate ½ Share of surviving spouse Family Home Standard deduction

P2,000,000

P6,500,000

P8,500,000

(2,000,000) (2,000,000) P6,500,000 2,000,000 ————— P4,500,000

————— P2,000,000 =========

Net Taxable Estate

(2,250,000) (2,250,000) (750,000) (750,000) (1,000,000) (1,000,000) ————— ————— P500,000 P2,500,000 ========= ========

Note: Since the fair market value/zonal value of the conjugal family home in the above example is P1,500,000, the Family Home deduction corresponding to ½ of such fair market value/zonal is P750,000 only.

d. Family home is conjugal property, but lot on which it stands is exclusively property.

Exclusive

Conjugal

Conjugal Properties: Other real properties Family home Exclusive Real Properties Other real properties Family lot Gross Estate (Less): Deductions: Other deductions Share of surviving spouse Conjugal properties Less: Conjugal Deductions Net conjugal estate ½ Share of surviving

Copyright 2015

Total P3,000,000 1,000,000

P2,000,000 400,000 ————— P2,400,000

P3,000,000 1,000,000

2,400,000 ————— ————— P4,000,000 P6,400,000 (1,000,000) (1,000,000)

P4,000,000 1,000,000 ————— P3,000,000

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(1,500,000) (1,500,000)

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spouse Family home and lot (P500,000 + P400,000) Standard deduction Net Taxable Estate 3.

P400,000

(500,000)

(900,000)

————— P2,000,000 =========

(1,000,000) ————— P=========

(1,000,000) ————— P2,000,000 ========

Conjugal

Total

Family home is conjugal property and both spouses died in the same year, leaving three (3) children: a.

Estate of HUSBAND:

Exclusive

Conjugal Properties: Real properties Personal properties Family home Exclusive Properties: Real properties Personal properties Gross Estate (Less): Deductions: Conjugal deductions Net Estate Less: Share of surviving spouse Family home Standard deduction Net Taxable Estate b.

Estate of WIFE:

Conjugal real properties Conjugal personal properties Family home Exclusive properties Paraphernal/exclusive personal properties Copyright 2015

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P6,000,000 4,000,000 2,000,000 4,000,000 1,000,000 ————— 5,000,000

P6,000,000 4,000,000 2,000,000

4,000,000 1,000,000 ————— ————— 12,000,000 P17,000,000

————— 5,000,000 =========

4,000,000 ————— 8,000,000 (4,000,000) (1,000,000) (1,000,000) ————— P2,000,000 =========

4,000,000 ————— P13,000,000 (4,000,000) (1,000,000) (1,000,000) ————— P7,000,0000 =========

Inherited Portion from Husband

Share from Conjugal Estate

Total

————— 5,000,000

P750,000 * 500,000 * 250,000 * 1,000,000

P3,000,000 2,000,000 1,000,000 -

P3,750,000 2.500,000 1,250,000 1,000,000

250,000

-

250,000

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————— P2,750,000

Gross Estate (Less): Deductions: Other deductions Family home Standard deduction Vanishing deduction **

P500,000

(2,000,000) (1,000,000) (1,000,000) (2,500,000) (1,000,000) (1,000,000) (1,964,286) (1,964,268) ————— ————— ————— P285,714 P2,000,000 P2,285,714 ======== ========= ========

Net taxable estate *

————— ————— P6,000,000 P8,750,000

In addition to ½ of the gross estate, the wife had a share as inheritance from the husband equivalent to the share of each child. Hence, since there were 3 children, the wife had a share of 1/4 on the other half of the estate. cDCSET

**

Vanishing deduction:

Inherited properties Less: 2,750,000 x P2,500,000 = ———— 8,750,000

P2,750,000

785,714 ————— Amount subject to vanishing deductionP1,964,286 100% Vanishing Deduction 13.9

Standard Deduction

P1,964,286 ========

An amount equivalent to one million pesos (P1,000,000) is allowed as a deduction pursuant to Sec. 86 (A) (5) of the Tax Code.

13.10 Medical Expenses

Medical expenses incurred by the decedent within one (1) year prior to his death subject to the following conditions: a.

b.

It must be substantiated by receipts.

The deductible amount shall not exceed five hundred thousand pesos (P500,000).

13.11 Amount received by heirs under R.A. 4917

Any amount received by the heirs from the decedent's employer or as a consequence of the death of the decedent-employee in accordance with Republic Act No. 4917, shall be allowed as a deduction, provided that such amount is

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13.

D.

included in the gross estate of the decedent.

In case of death of an individual who is a VAT-registered person, verify if the Value-Added Tax (VAT) has been paid or imposed on the transfer or transmission of the business assets to the heirs, even if the estate or the heirs of the decedent continue to operate the business. If the business assets are conjugal, only one-half (½), representing the share of the deceased, is subject to VAT.

Donor's Tax

Provided hereunder is an outline of the audit procedures which may be followed by a Revenue Officer in the processing and verification of donor's tax returns. 1. 2.

3.

Determine if the donor's tax return has been filed within thirty (30) days from the date of donation. If not, impose penalties incident to late filing and late payment of tax. Verify if the donor has made previous donations during the same taxable year from existing records available in the Revenue District Office or the Assessment Division for purpose of determining how much is the gross gift to date. Ascertain authenticity of the following documents: 3.1

Deed of Donation

3.3

Latest Tax Declaration, for real properties

3.2

4.

If donation involves shares of stocks, verify proper valuation thereof by following the procedures prescribed under RAMO No. 1-82. (Refer to procedure No. 12 in the investigation/verification of the estate tax liabilities of the decedent).

5.

Determine whether the essential elements of a gift are present.

7.

Determine the relation between the donor and the donee for the imposition of the proper donor's tax rate.

6.

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Transfer of Certificate of Title (TCT)/Condominium Certificate of Title (CCT)/Original Certificate of Title (OCT), for real properties

Ascertain whether the gross gift has been valued either at adjusted fair market value or zonal value, whichever is higher, at the time of the donation.

Verify if the donation of the land includes improvements and buildings.

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9.

Secure a certification from the Assessor's Office as to the existence or non-existence of improvements on the real property donated. Donation of land ordinarily includes the improvements unless specifically excluded in the Deed of Donation.

In case where the deduction is claimed, like liabilities or mortgage required to be assumed by the donee as a condition of the donation: 9.1 9.2 9.3

Ascertain the correct balance of the indebtedness as of the time of the donation. Verify the genuineness of the deduction claimed and require the submission of pertinent documents in support of the deduction.

Verify if the assumption of the liability is expressly stipulated in the Deed of Donation and is duly accepted by the donee. Otherwise, the claimed deduction should be disallowed.

XV. General Policies in the Investigation of Tax Fraud Cases A.

Jurisdiction 1.

Tax Fraud Division

2.

Special Investigation Division (SID)

1.1

2.1

The Tax Fraud Division (TFD) shall have jurisdiction to conduct or undertake the investigation and/or reinvestigation of cases referred to or developed by the Division, and those assigned referred or approved by the Commissioner of Internal Revenue. The SID shall have jurisdiction over the following cases: a.

Tax fraud cases referred to it by the Intelligence and Investigation Service (IIS).

b.

Tax fraud cases initiated and developed by the SID; and

c. 3.

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Tax fraud cases referred to it by the Revenue District Office (RDO).

Revenue District Offices 3.1

If in the course of the regular examination of returns, indications of fraud were discovered, the RDO must transmit the records of the case immediately to the SID which will conduct the formal investigation thereof.

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This shall be considered sufficient compliance with RMO No. 44-93. B.

Procedures

A preliminary investigation must first be conducted to establish the prima facie existence of fraud. This shall include the verification of the allegations on the confidential information and/or complaints filed, and the determination of the schemes and extent of fraud perpetrated by the denounced taxpayers.

The formal fraud investigation, which includes the examination of the taxpayers' books of accounts through the issuance of Letters of Authority, shall be conducted only after the prima facie existence of fraud has been established. 1.

Tax Fraud Division 1.1

Where indications of fraud have been established in a preliminary Investigation, the TFD through the Assistant Commissioner, Enforcement Service (ES) shall request/recommend the issuance of the corresponding Letter of Authority by the Commissioner which will automatically supersede all previously issued Letters of Authority with respect thereto. TCIDSa

1.2

1.3

1.4

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Thereafter, a copy thereof shall be immediately furnished the RDO and/or the SID of the Revenue Region having jurisdiction over the taxpayer who, upon receipt thereof, must immediately transmit to the TFD all the documents in their possession relative thereto; and must withdraw and cancel any issued Letter of Authority pertaining thereto. No letter of Authority shall be Issued for any taxpayer already covered by a Letter of Authority issued by the Commissioner.

Reports on cases recommended for criminal prosecution shall be forwarded to the Assistant Commissioner, Legal Service, Attn: Litigation and Prosecution Division, through the Inspection Service (IS). However, if after evaluation, the Litigation and Prosecution Division resolves that the evidence is not sufficient to warrant the filing of a criminal action against the taxpayer, the case shall be referred back to the TFD through the IS, for further documentation and/or appropriate action. No Assessment Notice shall be served upon any taxpayer recommended for criminal prosecution for tax evasion, following the Supreme Court's ruling in the case of Ungab vs. Cusi, 97 SCRA

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1.3 2.

877.

All other reports on cases not recommended for criminal prosecution shall be forwarded to the Commissioner, through the ES, for approval.

Special Investigation Division 2.1

The Chief of the SID shall issue the corresponding Letter of Authority if the prima facie existence of fraud has been established, and the same has been confirmed by the Regional Tax Fraud Committee (RTFC), composed of the following: a.

Regional Director - Chairman

b.

Chief, SID - Member

c.

RDO having jurisdiction over the taxpayer - Member

d.

Chief, Assessment Division - Member

e.

Chief, Legal Division - Member

The RDO shall then desist from issuing any Letter of Authority to the taxpayer concerned, and shall transmit to the SID all the documents in its possession relative thereto.

2.2

However, the RDO may assign one Revenue Officer, whose name shall be included in the Letter of Authority as the "RDO Assisting Revenue Officer" (RARO), to assist and coordinate with the SID in the formal investigation. Where the SID has established the prima facie existence of fraud against a taxpayer who has been the subject of an on-going or terminated investigation by the RDO, the SID shall nevertheless forward the records of the case for evaluation to the RTFC.

If after evaluation the RTFC confirms to the SID the prima facie existence of fraud, the following procedures shall be followed:

2.2.1 Where the investigation is on-going — the RDO concerned shall withdraw its Letter of Authority and immediately cease and desist from further investigation. The records of the case shall then be forwarded to the SID concerned which, thereafter, shall issue a Letter of Authority and Copyright 2015

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proceed with the formal fraud investigation.

2.2.2 Where investigation is already terminated — the office who has possession of the records shall, upon written request, immediately forward the records to the SID concerned.

2.3

If a re-investigation is necessary, the SID shall forward the same to the IIS with a recommendation for the issuance of the corresponding Letter of Authority by the Commissioner of Internal Revenue.

Where the business activities and/or establishments are situated in more than one revenue region, the tax fraud case must be referred to the TFD through the IIS.

2.3.1 If a prima facie existence of fraud was not established, after conducting the preliminary investigation, but a potential deficiency tax assessment exists, the case shall be referred to the RDO concerned for appropriate action.

2.3.2 Reports on cases recommended for criminal prosecution shall be forwarded to the Legal Division of the Revenue Region. If after evaluation and the Legal Division resolves that the evidence is not sufficient to warrant the filing of a criminal action against subject taxpayer, the case shall be referred back to the SID, for further documentation and/or appropriate action. 2.3.3 Reports on cases not recommended for criminal prosecution shall be forwarded to the Assessment Division of the Region. 3.

Revenue District Offices 3.

4. A.

Upon discovery of the indication(s) of fraud during the regular examination of the returns, the Revenue Officer should make a detailed report thereof to Revenue District Officer who shall immediately transmit the records of the case to the SID. The RDO shall then assign a RARO to assist and coordinate with the SID in the investigation of the said case.

Civil Fraud

In the case the quantum of evidence gathered does not warrant a criminal prosecution because it is not sufficient to prove the guilt of the taxpayer beyond reasonable doubt, but there exists a clear and convincing evidence that fraud has been

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committed, a corresponding 50% surcharge shall nevertheless be imposed. XVI. Closing Conference

Essential to an effective audit of internal revenue tax liabilities is the holding of a closing conference with the taxpayer before the preparation of the final report of investigation by the Revenue Officer assigned to the tax case. During this time, the Revenue Officer and his supervisor explain to the taxpayer how the assessment of his tax liability was arrived at. If necessary, the records of the case shall be presented to the taxpayer to document the Revenue Officer's findings. The taxpayer shall then be allowed to examine such records and to present his arguments. If the taxpayer agrees with the audit findings, he shall be made to sign an Agreement Form. If not, the Revenue Officer shall give the taxpayer enough time to document his objections to the proposed assessment. In both cases, the report of investigation shall be prepared and submitted to the Revenue District Officer for review and pre-approval prior to final review by the Assessment Division of the Regional Office or by the concerned office in the National Office (NO) for cases investigated by the audit divisions/teams in the NO. Upon receipt of the report of investigation, the Revenue District Officer (RDO) or head of the audit division/team in the NO shall send to the taxpayer a notice for informal conference. The notice should be accompanied by a summary of the Revenue Officer's findings.

The notice shall be made in writing and sent to the taxpayer at the address indicated in his return or his last known address. This notice, however, may be dispensed with in case the taxpayer agrees in writing to the proposed assessment, or where such proposed assessment has been paid. EHCDSI

In case the taxpayer responds to the notice within the period prescribed in the informal conference letter, he or his duly authorized representative shall again be allowed to examine the records of the case and to present his arguments in writing protesting the proposed assessment. Thereafter, the RDO or head of office/team shall, on the basis of the evidence on record, decide whether or not to approve the report before forwarding it to the Assessment Division or concerned office in the NO for approval and issuance of the corresponding Termination Letter or Assessment Notice, as the case may be.

In the event the taxpayer fails to respond to the notice for informal conference within the prescribed period, or when the response is found to be without merit, the report of investigation shall be given due course and shall be forwarded to the Assessment Division or to the concerned office in the NO for review. XVII.

Report Making

The Revenue Officer is required to make a report after the investigation/audit has been conducted. Before starting to write a report, the Revenue Officer should have in mind a definite outline as to arrangement in which the facts and evidence may be

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presented in the most effective manner. A good general plan is to state the problem, present the results of the investigation and set forth the conclusions and recommendations. The report to be prepared by the Revenue Officer in the conduct of his investigation shall contain the following: A.

Document Locator Form (BIR Form 23.02)

B.

Table of Contents

C.

Narrative Report

This form, which shall be duly accomplished by the Revenue Officer, indicates the dates when the docket was received and acted upon. The table of contents shall indicate the description and page number of each and every document attached to the report. This is a memorandum report prepared and submitted by the Revenue Officer. The narrative report shall contain the following: 1.

A preliminary statement stating: 1.1

the basis of the authority to investigate, specially the Letter of Authority Number, Tax Verification Notice Number, or Referral Number, date issued/served and details of referrals or revalidations, if any;

1.2

type of investigation/verification undertaken; and

1.3

2.

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profile of the taxpayer, particularly the type of business organization, nature of business, product line, other sources of income, information of its registration with the SEC, BOI, EPZA, etc., identification of major owners/stockholders and subsidiaries/affiliates, if relevant, brief description of accounting system/method used, description of any extraordinary business activity and kinds and amounts of incentives availed of, if any.

A brief description of the approach in investigation stating: 2.1

the books of accounts, records and documents verified;

2.2

the audit procedures adopted;

2.3

access to records undertaken;

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3.

2.4

the authorized representative of the taxpayer; and

2.5

the dates and results of conferences.

Results of investigation summarizing: 3.1

the audit findings;

3.3

basis of computation of recommended deficiency taxes/tax credit or refund. if any; and

3.2

4.

A recommendation for: 4.1 4.2 4.3 4.4

D.

discrepancies discovered, disallowances made and other relevant facts uncovered during the examination;

the review/approval of the report of investigation and issuance of termination letter after collection of the deficiency tax;

assessment of deficiency taxes indicating the prescription of the case; issuance of tax credit/refund; or

such other recommendations as may be necessary under the circumstances.

Duly Accomplished Revenue Officer's Audit Report

These forms are required to be accomplished properly and accurately by the Revenue Officer in reporting the results of investigation/verification. BIR Forms 1717 are used for non-computerized district offices while BIR Forms 0500 are prescribed for computerized districts under the BIR's Integrated Tax System (ITS). BIR Form 1717A/0500 — This form shall be accomplished by all Revenue Officers in reporting results of investigation/verification of income tax liabilities of taxpayers. BIR Form 1717C/0501 — This form is to be used in reporting results of investigation on Capital Gains Tax on real property transactions.

BIR Form 1717C-1/0502 — This form is to be used in reporting results of investigation/verification on Capital Gains Tax on stocks transactions not traded thru a Local Stock Exchange. BIR Form 1717-D/0503 — This form is to be used in reporting results of

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investigation/verification on Donor's Tax.

BIR Form 1717-E /0504 — This form is to be used in reporting results of investigation/verification on Estate Tax. BIR Form 1717-P/0505 — This form is to be used in reporting results of investigation/verification on Percentage Tax. BIR Form 1717-S/0506 — This form is to be used in reporting results of investigation/verification on Documentary Stamp Taxes.

BIR Form 1717-V/0507 — This form is to be used in reporting results of investigation/verification on Value Added Tax (VAT). BIR Form 1717-W — This form is to be used in reporting results of investigation/verification on Withholding Taxes. BIR Form 0508 — This form is to be used in reporting results of investigation/verification on Withholding Tax on Compensation. BIR Form 0509 — This form is to be used in reporting results of investigation on Expanded Withholding Tax. THSaEC

BIR Form 0510 — This form is to be used in reporting results of investigation/verification on Final Withholding Tax. BIR Form 1717-X — This form is to be used in reporting results of investigation on Excise Taxes.

BIR Form 0511 — This form is to be used in reporting results of investigation on Specific Excise Tax. BIR Form 0512 — This form is to be used in reporting results of investigation on Ad Valorem Excise Tax.

BIR Form 0513 — This form is to be used in reporting results of investigation/verification on Claims for Value Added Tax Credit/Refund. BIR Form 0514 — This form is to be used in reporting results of investigation/verification on Excise Tax Credit/Refund. E.

Working Papers

Working papers form the most important portion of a report as they provide all the information on the investigation conducted. They are the best evidence of the scope of the investigation and the diligence with which it was completed. They further constitute the basis for the Revenue Officer's determination of tax liability.

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The working papers should include all notes made before, during, and after a tax investigation, which relates to his findings on a particular tax return and shall include items raised during the analysis of the return as possible issues. It should also include explanations on the various observations and analyses of pertinent schedules and information.

Working papers prepared by the Revenue Officer are used as sources of a more detailed information, which he may use later on as a witness in court in case of litigation. The properly concluded examination should therefore be reflected by adequate working papers. Memory should not be relied upon in recounting the facts determined in the investigation. There is no better way to present the fact that an item or issue has been extensively explored on except by significant notes in the working papers. Each of the working papers should be labeled clearly showing the name of the taxpayer, year of examination, date prepared and the signature of the Revenue Officer should appear on each page. The pages should be numbered and prepared in the Revenue Officer's own handwriting.

The minimum reportorial requirements regarding the documents, forms, specific schedules and working papers to be attached to the docket are prescribed in RMO No. 53-98, as shown in the Appendix of this Manual. They would vary in every case depending upon the type of return, nature of the business, sources of income, and other similar circumstances. The requirement is that the working papers should document whatever transpired during the examination. This would include summaries or transcripts of accounts analyzed, schedule of specific items checked, reconciliation of accounts, analysis of reserves and all other pertinent notes of the work performed. The basic working papers consist of, but are not limited to the following: 1.

Working papers showing real and nominal accounts

3.

Reconciliation of net income per financial statements with the net income per income tax return

2.

4.

Schedule of income producing property, if applicable

5.

Schedule of taxes and licenses

6.

Schedule of depreciation

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Working papers showing discrepancies, disallowances, adjustments and computation of deficiency taxes

Schedule of loans/notes/accounts payable and interest expenses/advances

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from officers/stockholders

F.

8.

Schedule of miscellaneous income, if material

9.

Schedule of bad debts

10.

Schedule of Accounts Receivable and advances to accounts

11.

Schedule of miscellaneous expenses, if material

Attachments to the Docket of the Case

Attachments consist of documents that are necessary to the proper understanding and substantiation of results of the investigation. The documents to be attached to the dockets are composed of but not limited to: 1.

General Requirements 1.1 1.2 1.3

Duplicate copy of Letter of Authority duly received by the taxpayer or his representative; Audited financial statements with supporting schedules and reconciliation statements for the period under investigation;

1.4

Narrative memorandum report;

1.5

Table of contents;

1.6

Checklist of audit procedures undertaken (Schedule RM-1);

1.7

Working paper showing computation of deficiency tax payment;

1.8

Duly signed Agreement Form, if applicable;

1.9

BIR Form 1717/0500 Series (Revenue Officer's Audit Report);

1.11

Comparative report of deficiency tax paid/assessed;

1.10

1.12

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All tax returns with all the required attachments for the year/period under audit;

IDASHa

Photocopy of Payment Form and Official Receipt as evidence of deficiency tax payment; Post reporting notice/notice for an informal conference with the summary of findings (for non-agreed assessment);

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1.13

Logsheet/record of time spent by Revenue Officer(s);

1.14

Proof of exemption under Special Law, if applicable;

1.16

Authority to issue refund/TCC (for claims for refund/TCC).

1.15

2.

Delinquency verification report [for claims for refund/Tax Credit Certificate (TCC)]; and

Specific Requirements by Tax Type

The required documents to be attached to the docket containing a report of investigation/verification per type of tax are enumerated and prescribed in RMO No. 53-98. APPENDIX Revenue Memorandum Order No. 15-95 General Policies in the Investigation of Tax Fraud Cases Revenue Memorandum Order No. 53-98

Checklist of Documents to be Submitted by a Taxpayer upon Audit of his Tax Liabilities as well as of the Mandatory Reporting Requirements to be Prepared by a Revenue Officers all of which comprise a Complete Tax Docket cdll

June 9, 1995

ATTACHMENTS

REVENUE MEMORANDUM ORDER NO. 15-95 (amended by RMO 31-95)

A.

SUBJECT

:

General Policies in the Investigation of Tax Fraud Cases.

TO

:

All Internal Revenue Officer and Other Concerned

OBJECTIVE

To provide the policies and rules in the manner of investigating tax fraud cases by the Tax Fraud Division (TFD), Special Investigation Division (SIDs) and the Revenue

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District Offices (RDOs) for criminal prosecution, and to avoid the multiple issuances of Letter of Authority and/or simultaneous investigation of the same taxpayer covering the same taxable year.

All revenue officers concerned shall be guided by the updated "Guidelines and Investigative Procedures in the Development of Tax Fraud Cases for Internal Revenue Officers", hereto attached as Annex "A". B.

JURISDICTION 1.

TAX FRAUD DIVISION

2.

SPECIAL INVESTIGATION DIVISION

1.1. The Tax Fraud Division shall have the jurisdiction to conduct or undertake the investigation and/or reinvestigation of cases referred to or developed by the Division, and those assigned, referred or approved by the Commissioner of Internal Revenue. 2.1. The SID shall have jurisdiction over the following cases:

2.1.1. Tax fraud cases referred to it by the Intelligence and Investigation Service (IIS) 2.1.2 Tax fraud cases initiated and developed by the SID.

3.

2.1.3 Tax fraud cases referred to it by the RDO.

REVENUE DISTRICT OFFICERS

3.1. If in the course of the regular examination of returns, indication of fraud were discovered, the RDO must transmit the records of the case immediately to the SID and provide assistance in the formal investigation thereof. C.

This shall be considered sufficient compliance with RMO 44-93.

PROCEDURE

A Preliminary Investigation must first be conducted to establish the prima facie existence of fraud. This shall include the verification of the allegations on the confidential information and/or complaints filed, and the determination of the schemes and extent of fraud perpetrated by the denounced taxpayers.

The Formal Fraud Investigation, which includes the examination of the taxpayers books of accounts through the issuance of Letters of Authority, shall be conducted only after the prima facie existence of fraud has been established. Copyright 2015

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1.

TAX FRAUD DIVISION

1.1. Where indications of fraud have been established in a preliminary investigation, the TFD thru the Assistant Commissioner, Intelligence and Investigation Service (IIS), shall request/recommend the issuances of the corresponding Letter of Authority by the Commissioner which will automatically supersede all previously issued Letter of Authority with respect thereto. 1.2 Thereafter, a copy thereof shall be immediately furnished the RDO and/or the SID of the Revenue Region having jurisdiction over the taxpayer, who upon receipt thereof, must immediately transmit to the TFD all the documents in their possession relative thereto; and must withdraw and cancel any issued Letter of Authority therefor.

No Letter of Authority shall be issued for any taxpayer already covered by a Letter of Authority issued by the Commissioner. 1.3. Reports on cases recommended for criminal prosecution shall be forwarded to the Assistant Commissioner, Legal Service, Attn: Litigation and Prosecution Division, thru the IIS. However, if after evaluation the Litigation and Prosecution Division resolves that the evidence is not sufficient to warrant the filing of a criminal action against subject taxpayer, the case shall be referred back to the TFD thru the IIS, for further documentation and/or appropriate action.. 1.4. No Assessment Notice shall be served upon any taxpayer recommended for criminal prosecution for tax evasion, following the Supreme Court's ruling in the case of Ungab vs. Cusi, 97 SCRA 877. 1.5. All other reports on cases not recommended for criminal prosecution shall be forwarded to the Commissioner, thru the IIS, for approval. 2.

SPECIAL INVESTIGATION DIVISION

2.1. The Chief of the SID shall issue the corresponding Letter of Authority if the prima facie existence of fraud has been established, and the same has been confirmed by the Regional Tax Fraud Committee (RTFC), composed of the following: a. b. c. d. e.

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Regional Director — Chairman Chief, SID — Member RDO having jurisdiction over the taxpayer — Member Chief, Assessment Division — Member Chief, Legal Division — Member

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The RDO shall then desist from issuing any Letter of Authority to the taxpayer concerned, and shall transmit to the SID all the documents in its possession relative thereto.

However, the RDO may assign one Revenue Officer, whose name shall be included in the Letter of Authority as the "RDO" Assisting Revenue Officer" (RARO), to assist and coordinate with the SID in the formal investigation.

2.2. Where the SID has established the prima facie existence of fraud against a taxpayer who has been the subject of an on-going or terminated investigation by the RDO, the SID shall nevertheless forward the record of the records of the case for evaluation to the RTFC. If after evaluation the RTFC confirms to the SID the prima facie existence of fraud, the following procedures shall be followed:

2.2.1. Where the investigation is on-going - the RDO concerned shall withdraw its Letter of Authority and immediately cease and desist from further investigation. The records of the case shall then be forwarded to the SID concerned which, thereafter, shall issue a Letter of Authority and proceed with the formal fraud investigation. 2.2.2. Where investigation is already terminated — the office who has the possession of the records shall, upon written request, immediately forward the records to the SID concerned.

If a re-investigation is necessary, the SID shall forward the same to the IIS with a recommendation for the issuance of the corresponding Letter of Authority by the Commissioner of Internal Revenue.

2.3. Where the business activities and/or establishments are situated in more than one revenue region, the tax fraud case must be referred to the TFD thru the IIS.

2.4 If after conducting the preliminary investigation the prima facie existence of fraud cannot be established, but a potential deficiency tax assessment exists, the case shall be referred to the RDO concerned for appropriate action. 2.5. Reports on cases recommendation for criminal prosecution shall be forwarded to the Legal Division of the Revenue Region. If after evaluation the Legal Division resolves that the evidence is not sufficient to warrant the filing of a criminal action against subject taxpayer, the case shall be referred back to the SID, for further documentation and/or appropriate Copyright 2015

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action.

2.6 Reports on cases not recommended for criminal prosecution shall be forwarded to the Assessment Division of the Region. 3.

REVENUE DISTRICT OFFICES

3.1 Upon discovery of the indication(s) of fraud during the regular examination of the returns, the Revenue Officer should make a detailed report thereof to the Revenue District Officer who shall immediately transmit the records of the case to the SID. 3.2 The RDO shall then assign a RARO to assist and coordinate with the SID in the investigation of the said case.

D.

CIVIL FRAUD

E.

ATTRIBUTION OF COLLECTION

F.

PENAL CLAUSE

G.

REPEALING CLAUSE

H.

EFFECTIVITY

In case the quantum of evidence gathered does not warrant a criminal prosecution because it is not sufficient to prove the guilt of the taxpayer beyond reasonable doubt there exists a clear and convincing evidence that fraud has been committed, a corresponding 50% surcharge shall nevertheless be imposed. All collections arising out of the investigations by the TFD and SID, the latter either by itself or through coordination with the RDO, shall be attributed to the RDO having jurisdiction over the taxpayer. Strict compliance with this RMO is hereby enjoined. Any willful violation hereof shall be treated as gave misconduct and the corresponding penalty of dismissal as provided under Civil Service Rules and Regulations shall be imposed. Any provision of any order and pertinent issuances inconsistent with his Order is hereby revoked, modified or amended accordingly. This Revenue Memorandum Order takes effect immediately. (SGD.) LIWAYWAY VINZONS-CHATO Commissioner

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ANNEX "A"

GUIDELINES AND INVESTIGATIVE PROCEDURES IN THE DEVELOPMENT OF TAX FRAUD CASES FOR INTERNAL REVENUE OFFICERS A.

OBJECTIVES:

The substantial revenue collections of the government derived from the series of tax amnesties signify to a large that the BIR has not effectively tapped a great number of potential sources of revenue. The tremendous shortfall in revenue collections for the preceding year should spur the BIR on the need for a more systematic and vigorous tax campaign by instilling more awareness and tax consciousness among our taxpayers, more especially those who have continuously flaunted our revenue laws with impunity. To provide a strong detergent to the commission of fraud against the revenues for the purpose of increasing and enhancing our revenue collections, the imposition of criminal sanctions, in addition to the civil liabilities, on erring taxpayers should be implemented to the fullest extent of the law in line with the pronouncement of the President of the Philippines. These guidelines are, therefore, presented to guide and to refresh all internal revenue officers with the necessary know-how in the investigation, evaluation, and submission of reports of fraud cases envisioned to withstand judicial scrutiny.

B.

NATURE AND TYPES OF FRAUD:

Definition-fraud or evasion —

Tax fraud or evasion means the elimination or reduction of one's correct proper tax by fraudulent means. "The fraud contemplated by law is actual and constructive. It must be intentional fraud, consisting of deception willfully deliberately done or resorted to in order to induce another to give some legal right "Aznar vs. CTA and Collector, G.R. No. L-20569, Aug. 25, 1974.

and not and ...

Factors in Fraud or Evasion —

All the following elements must be proven by competent evidences to establish the existence of fraud: 1. The end to be achieved - the payment of less tax than that known by the taxpayer to be legally due:

2. The accompanying state of mind which is variously described as being "evil", "in bad faith", "deliberate and not accident", or "willful" — Copyright 2015

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the exact term used is not too important.

3. The overt act done or scheme used by the taxpayer to achieve the non-payment of taxes known to be due. The act or scheme must be tinged with some elements of deceit, misrepresentation, trick, device, concealment or dishonesty." Fraud under Tax, Balter.

Burden of Proof in Establishing Fraud:

A tax fraud or evasion case is basically criminal case.

In the establishment of fraud, the burden of proof is on the Bureau of Internal Revenue. The presumption that an officer of the government has performed his duty regularly (Sections 5, Rule 131 of the New Rules of Court), as in the case of the correctness of deficiency assessments, is not applicable in fraud cases. "In criminal cases, the burden of proof as to the offense charged lies on the prosecution." (Section 2, Rules 131, New Rules of Court). Mere suspicious and mere doubts on the intention of the taxpayer are not sufficient proof of fraud. Fraud is never presumed, it must be proved. Types of Tax Fraud Cases Criminal Fraud —

A criminal tax fraud case results when all the elements of fraud can be proven beyond reasonable doubt. Proof beyond reasonable doubt not mean such a degree of proof as, excluding possibility of error, absolute certainty; only required, or that degree of proof which produces conviction in an unprejudiced mind. Here, the taxpayer upon conviction shall be liable from the deficiency taxes, to both criminal and civil penalties.

Civil Fraud —

A civil tax fraud case results when all the elements of fraud cannot be proven beyond reasonable doubt, but rather by clear an convincing evidence amounting to more than a mere preponderance, and cannot be justified by mere speculation. "Preponderance of evidence" means that the testimony adduced by one side is more credible and conclusive than that of the other.

"Clear and convincing" need not rise to proof beyond reasonable doubt as in a criminal case but yet must be stronger than mere preponderance of evidence. Here, the taxpayer shall be liable aside from the deficiency taxes only to the civil penalties. Copyright 2015

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Effects of Fraud under the National Internal Revenue Code (NIRC)

1. the BIR;

Civil penalties rise to the imposition of the 50% surcharge; to be imposed by

2. Criminal penalties involving the imposition of penal sanctions — imprisonment and/or fine to be imposed by the Regional Trial Court (RTC) upon conviction; 3. Power of the Commissioner to asses and collect the tax is extended to 10 year from date of discovery, however, Sec. 280 provides the five year prescription on the filing of criminal action;

4. Cases involving fraud cannot be the subject compromise as mandated by Section 204, NIRC; 5. Suspension and temporary closure of the business operations of a taxpayer under Sections 111 of Tax Code for violation of the VAT provisions.

C. METHODS OF PROVING FRAUD IN CRIMINAL AND CIVIL TAX FRAUD CASES:

1. The Direct Approach Method or by Direct Evidence, also called Specific Item Cases — Proof of fraudulent acts are adduced by specific items of fraudulent transactions. It is that one, if the allegations are believed, the existence of the principal or ultimate fact is proven without any inference or presumption. Specific Item Cases determined by the direct approach method —

1.1 Income Tax

1.1.1 Omission or understatement of taxable income — 1.1.1.1

Failure to file income tax return.

1.1.1.2 Items of income and expenses, or assets or liabilities have been omitted, or falsely claimed in the accounting records or return in order to minimize or reduce taxes; 1.1.1.3 Misclassification of accounts — Income taken upon and classified as liabilities; erroneous classification of income from taxable to exempt; ordinary gains classified as capital gains; non-deductible expenses disguised as deductible items; and capital expenditures classified as deductible items.

1.1.1.4 Sales/Income of domestic branches purportedly shown as income of the foreign head office; Copyright 2015

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1.1.1.5 Keeping two sets of invoice or receipts — one set registered with the BIR and sales or income recorded thereon are the ones posted in the accounting records, whereas the other set is not reported for tax purposes; 1.1.1.6 Keeping two sets of books of accounts records — one set registered with the BIR and the other set reflects the correct transactions and not registered and reported to the BIR; 1.1.1.7

Non-issuance of receipts to customers; and

1.1.1.8 Sales invoices or receipts issued to customers reflects the correct transactions, but invoices or receipts recorded for tax purposes reflects much smaller amounts. 1.1.2

Utilization of other persons or entities —

1.1.2.1 Establishment of several entities — corporations, partnerships, or proprietorships, by a person by making it appear that sale are made by the different entities created when in fact such sales are only made by one person; 1.1.2.2 Allocating income and expenses to other persons in order to reduce or minimize taxes by a controlling person; and

1.1.2.3 Establishment of a registered partnership or corporation, using dummy partners or stockholders. 1.1.3 Improper claims of costs of sales and deductible expense.

1.1.3.1 Fictions purchaser, or padding of purchaser, or that proceeds are diverted to the personal benefit of the taxpayer or his assign; 1.1.3.2 1.1.3.3

False or fictions claims of deductions; Misclassification of deductions —

Investments or major repairs or improvements claimed as nominal expenses;

1.1.3.4 salaries;

1.1.3.5 compensation; Copyright 2015

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1.1.3.6 Claim of depreciation of non-existing assets or already fully depreciated, or on assets which were appraised higher for credit purposes; 1.1.3.7 Claim of purchases from no-VAT sources as VAT purchases and claiming tax credits thereon; and

1.1.3.8 Improper claims of tax credits without having paid the input taxes passed on by the seller. 1.1.4 Claims of false personal exemptions —

Claiming exemptions as married by an unmarried individual or head of the family by single persons who do not actually support their parents; and

Claiming false additional exemptions of alleged children, or children who are already of age or who are not physically incapacitated.

1.2 Business Taxes - VAT and Percentage Taxes 1.2.1.

Business Taxes - VAT and Percentage

1.2.1.1. sales/income-

Omission

or

understatement

of

1.2.1.2

Keeping falsified books of accounts;

1.2.1.4

Claiming fictions tax credits;

taxable

1.2.1.3 Non-issuance of sales invoices, or underrecording of sales to conceal the amount of sales subject to business taxes on VAT; 1.2.1.5 Crediting sales against items or income discounts of costs of sales to conceal the amount of sales subject to business taxes on VAT. 1.2.1.6 Deducting against sales or income discounts which were granted subsequently and not in the sales invoice. 1.2.1.7 actually returned.

Deducting returned sales which were not

1.2.2 Misclassification of sales or income — 1.2.2.1

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taxable,

1.2.2.2 Misclassification of sales of goods subject to VAT as only subject to percentage taxes;

1.2.2.3 Claiming domestic sales as export sales when in fact the goods were sold in the domestic market; and 1.2.2.4 Sales in the local market which are made to appear as sales by the foreign head office. 1.2.3 Claim of fictions tax credits —

1.2.3.1 Claiming tax credits on purchases of goods from Non-VAT registered enterprises; and 1.2.3.2 invoices.

Claiming fictitious tax credits on non-existing

1.2.4 Non-payment of VAT on materials imported for re-export —

Materials were applied against originally imported for re-export, but which were used instead on goods sold in the local market.

1.3 Estate Tax

1.3.1 Failure of file estate tax return;

1.3.2. Filing of estate tax returns in different jurisdictions to avoid payment of the higher graduated tax, as in the case where the deceased-owned properties in various places;

1.3.3 Willful under-valuation of the market values of the properties of the estate; 1.3.4 Willful omission of some properties especially those located in places other than the residence of the deceased; and 1.3.5 Claim of fictions items - funeral expenses, claims against the estate, judicial and testamentary expenses. 1.4 Donor's Tax

1.4.1 Failure to file donor's tax return;

1.4.2 Filing of returns within the same year in various jurisdictions to evade the payment of the higher graduated tax; Copyright 2015

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1.4.3 Willful omission of prior donations made during the same taxable year;

1.4.4 Willful undervaluation of the market value of the property donated, and 1.4.5 Insufficient consideration on sales of property, the difference between the market value from the consideration agreed upon, considered as subject to the donor's tax. 1.5 Excise Taxes

1.5.1 Misclassification of articles subject to excise tax by making it appear that a particular manufactured articles falls within a lower tax classification; 1.5.2 Illegal manufacture of articles subject to excise tax;

1.5.3 Unlawful possession or removal of articles subject to excise tax, and for which no tax has been paid; 1.5.4 Unlawful use of denatured alcohol;

1.5.5 Unlawful possession of cigarette papers in bobbins, etc; and

1.5.6 Shipment or removal of liquor or tobacco products under false names or brands or as an imitation of any existing or otherwise known product name or brand. 1.6 Documentary Stamps

Non-affixture of the correct documentary stamps on pertinent document or papers. 1.7 Withholding Taxes

Failure to withhold the correct taxes as withholding agent under the pertinent provisions of the Tax Code.

2. Indirect Approach or by Indirect Method — This relies upon circumstances evidence of determining the correct income or transaction of a taxpayer. Circumstantial evidence is that which tends to prove the existence of the disputed fact by proof of other facts which have a legitimate tendency to lead the mind to a conclusion that the fact exists which is sought to be established. However, where circumstances evidence is relied upon to prove a fact, the circumstances must be proved by direct evidence and cannot themselves by inferred. Copyright 2015

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The legal bases for an indirect approach in the determination of the correct income or transactions of a anchored on Sections 16 and 37 of NIRC of 1988. Principle Types of Indirect Approach or Indirect Methods Used — 1.

Net Worth or Inventory Method or Net Worth & Expenditure Method

This is a method of reconstructing income based on the theory that if the taxpayer's net worth has increased in a given year in an amount larger than his reported income, he had understand his income for that year. Formula:

The mathematical formula for this method may be laid down as follows: a. b. c. d. e. f.

Increase in net worth, plus Non-deductible item, less Non-taxable income or receipts subjected to final tax or transfer taxes, equals Taxable net income, less Personal and additional exemptions, equals Net income subject to tax

The Commissioner's determination of taxpayer's unreported income through the net worth expenditure method usually involves the following steps: (1) The net worth on a fixed starting date is established (excess of assets over liabilities). This starting date is usually the beginning of the first tax year under examination. The amount of such net worth is considered of vital importance in order to foreclose the possibility than an increase in net worth during the tax year, or an excess of expenditure over reported income, did not originate from prior accumulated funds (i.e. hoarded cash or undisclosed assets which would not represent income during the tax year.) (2) The net worth at the close of each tax year under examination is established;

(3) Comparison is made of the net worth at the beginning and end of each year, to determine the increase, if any;

(4) The increase in net worth for each year is adjusted to eliminate items accounting for such increases which arise from non-tax sources (i.e., gifts, bequests, other receipts exempt from tax, etc.) and adjustment is made where property is sold at a profit but the entire profit is not taxable because of long-term capital gain provision. The increase in net worth for the year, after these eliminations and adjustments, is presumed to be income realized Copyright 2015

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in that year;

(5) The amount of non-deductible expenditures is determined or estimated. These items usually consists of personal, family and living expenses; and (6) The reconstructed income under the net worth expenditure method is the sum of items (4) and (5) and this amount is then compared with the income reported, if any, by the taxpayer. (Id. par. 6059, see also Perez vs. Araneta, L-10507, May 30, 1958, Reyes vs. Col. of Internal Rev., L-11534 and L-11558, Nov. 25, Jamir vs. Col of Int. Rev. L-16552, Mar. 30, 1962; Avelino vs. Col. of Int. Rev. L-17715, July 31, 1963). Circumstance and conditions necessary to warrant the use of the indirect method in establishing a prima facie case of fraud:

(1) That the taxpayer's accounting records are inadequate and do not clearly reflects his income; of that the taxpayer maintains no books and records; or that taxpayer's accounting records are available, but he refuses to produce them; (2) That there is a fixed starting point or opening net worth, i.e., a date beginning of a taxable year or prior year to it, at which time the taxpayer's financial conditions can be affirmatively established with some definitives; (Statements of net worth of taxpayers who availed of the tax amnesty under the provisions of Executive Order No. 41, may be used as the starting point as at December 31, pursuant to the authority given to the BIR under section 7 of said Executive Order)

(3) That the circumstances are such that the method does reflect the taxpayer's income with reasonable accuracy and certainly, and proper and just addition of personal expenses and other non-deductible expenditures were made and correct; fair and equitable credit adjustments were given by way of eliminating non-taxable items or receipts or taxable income which have been subjected to final tax. (4) method:

The need for evidence of the source of income under this

"In all the leading cases on this matter, courts are unanimous in holding that when the tax case is civil in nature, direct proof of sources of income is not essential. . . . However, when a taxpayer is criminally prosecuted for tax evasion, the need for evidence of a likely source of income becomes a pre-requisite for a successful prosecution . . ." RMC No. 43-74. This proof of a likely source of income may be shown by any of the

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following:

(1) Demonstrating that there were specific omissions of income items by the taxpayer in his income tax return. (2) A showing that the nature of the taxpayer's business is such that it has capacity of generating a substantial income.

(3) Proofs of underdeclaration of income by the existence of unregistered sales invoices, which were not recorded in the books; (4)

Findings of unrecorded purchases;

(5) Existence of business permits, license from government agencies as to the types of businesses the taxpayer is engaged in;

(6) Keeping separate sets of books — one registered and the other reflecting the correct transactions of a business. (7)

2.

(8)

Use of false invoices or documents, and

Willful destruction of accounting records.

Expenditures Method or Excess Cash Expenditures Method

The expenditures method proceeds on the theory that where the amount of money which a taxpayer spends during a given year exceeds his reported income, and the source of such money is otherwise unexplained, it may be inferred that such expenditures represent unreported income. The discussion on when and how the net worth method should be used are equally applicable to the expenditures method. In a case where the taxpayer has several assets (and liabilities) whose cost bases remain the same throughout the period under investigation, the expenditure method may be preferred over the net worth method because a more laconic presentation can be made of the computation of taxable income. This is because assets and liabilities which do not change during the period under investigation may be omitted from the expenditures statement. The expenditures method is used often on a taxpayer who spends his income on lavish living and has little, if any, net worth. Formula:

The expenditure method of determining income should be applied by deducting the aggregate yearly expenditures from the declared yearly income (Col. of Int. Rev. vs. Jamir, 4 SCRA 7;8 March 30, 1962). Under this formula enunciated by the court in the above-cited case,

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the particular in the use of this method are shown below: A.

Expenditure for a given taxable year: (1)

All expenses and deductions claimed per return filed with the BIR (Exclude non-cash items, such as aromatization of goodwill, depreciation of assets, application of deferred expenses from prior period, etc.) P xxx

(2)

Expenses, personal and non-deductive or deductible for tax purposes, as determined per investigation (Exclude non-cash terms) Payments of debts, payables, accruals, and other liabilities — taken up in the ITR and those not taken up, such as personal and other liabilities.

(3)

(4)

xxx

xxx

Payment of taxes

xxx

(5) Acquisition of assets — per ITR and personal acquisitions such as cars, appliances, even real estate.

xxx ——

Total Expenditures per Investigation B.

(1)

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Sources of Cash:

Declared income per Income Tax Return Deduct: Accounts Receivables if taxpayer is on cash basis method of accounting

P xxx xxx (xxx)

Add : Collection from receivables

xxx

(2)

Non-taxable receipts, prizes, royalties, etc.

xxx

(3)

Non-Taxable receipt, such as dividends donations from abroad

xxx

(4)

Receipts subjected to transfer such as donations, inheritance

xxx

(5)

Cash loans, if any

xxx

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(6)

Cash at the beginning of the period

Excess Cash as determined per Investigation

xxx ——

xxx —— P xxx ——

As in the case of the Net Worth Method, when a tax case is civil in nature, direct proof of sources of income is not essential. However, when a criminal case is filed against the taxpayer, the need for evidence of a likely source of income becomes a prerequisite. 3.

Percentage Method

Although the use of this method is of little value in criminal cases, it is useful in test-checking or corroborating the results obtained by some other means of proof such as specific items, net worth, and expenditures methods, and for evaluating allegations from information regarding unreported profits or income.

The percentage method is a computation whereby determinations are made by the use of percentages or ratios considered typical of the business under investigation. By reference to similar businesses or situations, percentage computations are secured to determine sales, gross profit, or even net profit. Likewise; by the use of some known base and the typical percentage applicable, individual items of income or expenses may be determined. These percentage may be externally derived or they may in some instances be internally derived from the taxpayers accounts for other periods or from an analysis of subsidiary records. Gross profit percentages may be other similar data. Also other years not covered by the investigation or portion of year under investigation may indicate typical percentage applicable to the entire year or year under investigation.

It must, however, be emphasized that in comparing transactions of similarly situated business, the name of the particular taxpayer used as the model must not be divulged to the taxpayer under investigation nor in the report as this would constitute as a violation by an internal revenue officer of the provision of Section 269, NIRC of 1988, on unlawful divulgence of trade secrets. 4.

Unit and Value Method

This is not a prime method of proof. The determination or verification of gross receipts may be computed by applying price and profit figures to the known ascertainable quality of business done by the taxpayer. This method is feasible when the investigation can ascertain the number of units handled by the taxpayer and also when he knows the price or profit charged per unit.

There may be regulatory body to which the taxpayer units of production or service. Copyright 2015

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Examples are: (a)

Records of sugar milled by a sugar central;

(b) Records of fish production to the Bureau of Fishery and Aquatic Resources;

(c) Records of production by pioneer industries to the Board of Investments; and D.

(d)

Records of logs exported to the Forest management Bureau.

SOURCES OF FRAUD CASES: 1.

From routine examination of returns:

a. Keeping no records or inadequate records despite substantial transactions reflected in the returns;

b. Standard of living of the taxpayer, such as the possession of expensive cars and jewelries; or staying in a luxurious mansion, and, ownership of properties whose values far exceed his probable sources of income as declared per return; c.

Records verified, were not property declared for tax purposes.

d. False vouches and receipts which were verified in the course of the routine examination. 2.

From Information furnished by:

a. An informant who has knowledge of the transactions of the taxpayer which were not properly declared for tax purposes;

b. Referrals from other government offices or from other investigating units of the BIR. 3.

Thru initiative of the investigating officers: a.

From newspaper reports;

b. Thru research of available government records such as from offices of the Register of Deeds, Bureau of Highways, and other government offices; and

c. In relation to an investigation of another taxpayer, where suspects that certain transactions were not declared for tax purposes. Copyright 2015

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E.

INDICATIONS OF FRAUD 1.

Maintaining two sets of books and records;

2.

Concealment of Assets;

3.

Destruction of books and records;

4.

Large or frequent currency transactions;

5.

Payments to fictions companies or persons;

6.

False or altered entries and documents;

7.

Overdeclaration of purchases or under declaration of sales;

8.

Use of false names or nominees;

9.

Large company loans to employees or other persons;

10. Payee names on checks left blank and inserted at a later date; 11. Excessive billing accounts; 12. Excessive spoilage or defects; 13. Double payment on billing; 14. An individual negotiating checks made payable to corporation; 15. Second or third party endorsement on corporate checks; 16. Excessive use of exchange checks or clearing accounts; 17. Personal expenses paid with corporate fund;

18. An understatement of income attributable to specific transactions and denial by the taxpayer of the receipt of the income or inability to provide a satisfactory explanation for its omission; 19. Substantial unexplained increases in network over a period of years;

20. Failure to file a return, especially for a period of several years although substantial amounts of income were received; 21. Concealment of bank accounts, brokerage accounts, and other property;

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unexplained expenditure of currency, (especially when in a business not calling for large amounts of cash); 23. Failure to deposit receipt to business account contrary to normal practices; 24. Claiming fictions or improper deductions; 25. Substantial amount of personal expenditure deducted as business expenses;

26. False entries or alternation made on the books and records, backdated or postdated documents, false entries or invoices or statement, or other false documents; 27. Failure to keep records, especially if put on notices by the BIR as a result of prior examination, concealment of records or refusal to make certain records available. 28. Distribution of profits to fictions partners;

29. False statements, especially if made under oath about a material fact involved in the investigation;

30. Attempt to hinder the investigation. Failure to answer pertinent questions or repeated cancellations of appointments. Avoiding the investigator; 31. The taxpayers knowledge of taxes and business practices where numerous questionable items appear on the returns; started;

32. Destruction of books and records, especially after the investigation was 33. Transfer of assets for purposes of concealment; 34. Involvement in illegal activity (illegal income); 35. Failure to disclose all relevant facts; 36. Unsubstantiated or unexplained wealth;

37. Mental handling of ones affair to avoid keeping records usual in transactions of the sale kind;

38. Keeping no records or inadequate despite substantial transactions in the return; and 39. Any conduct, the likely effect would be mislead or to conceal material facts.

The items listed are the indications of fraud most commonly committed but are not all inclusive. Copyright 2015

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F.

PROCESSING OF A TAX FRAUD CASE 1.

Preliminary Investigation

The purpose of preliminary investigation is to establish the existence of a prima facie indications of fraud. To gather evidence therefor the courses of action that may be conducted pursuant to the pertinent Tax Code provision, are but not limited to the following: a.

Sec. 7

—

Access to records to private persons or entities, and government offices and agencies; and

b.

Sec. 15

—

Arrest persons and seize documents and instruments, if the violations of the Tax Code are done within the view of a revenue officer.

c.

Sec. 16 C —

Conduct inventory taking or surveillance.

d.

Sec. 171

Conduct a search for excise taxable articles.

—

2. Preparation of a preliminary investigation report with a recommendation of the issuance of a Letter of Authority: The examiner or revenue official who discovers a potential tax fraud case must submit a memorandum report to his immediate superior stating the facts and circumstances which constitute the indication of fraud, and the evidence at hand to be verified and confirmed. The issuances and approvals of Letters of Authority for fraud cases shall be in accordance with existing rules and regulations on such issuances. The issuance of Letters of Authority, in the case of the Tax Fraud Division, may be dispensed with when so warranted by the circumstance of the case, provided that the taxpayer shall be noticed by the Commissioner of Internal Revenue that his internal revenue tax liabilities are under investigation or that the report thereon has been submitted. 3.

Formal Fraud Investigation:

(a) Whenever there appears to be a need for a formal tax fraud investigation of a particular taxpayer, a work plan must be prepared in accordance with the following guidelines: (1)

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(2)

Determine the objectives of the investigation; (a)

Development of criminal tax case;

(b) Deciding the particular provision of the NIRC allegedly violated and asking by whom, when, where, and by what means. Were Revenue Regulations, Revenue Memorandum Circulars or BIR Rulings and Issuances also violated or involved; (c) offense.

Understanding clearly the elements of the

(3) If it is an investigation referred by an informant, recontact and obtain detailed information about the origin of the case, who has been talked to, what was said, available records, etc. Re-interview the person who initially provided the information or made a the allegation. (4)

Determine the following: (a)

Information that is needed;

(c)

Best sources of information; and

(b) (d) inquiries. (5)

Relative importance of the desired information; Best sequences for making the necessary

Gather background information:

(a) suspect;

Obtain as much information as possible on the

(b) Obtain tax return Revenue District Offices concerned;

(c) Obtain pertinent records such as General Information Sheet Articles of Incorporations, Constitution and By-Laws, Financial other information from Bureau of Domestic Trade, Department of Trade and industry and other government agencies.

(6) In conclusion, decide if an examination of the taxpayer's books of accounts is warranted and the best method of proof. Copyright 2015

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G.

PREPARATION AND ASSEMBLY OF REPORTS FOR FRAUD CASES (1)

Planning the report:

(2)

Assembly of a report:

Before starting to write a report, the should have in mind a definite outline of the arrangement in which the facts and evidence may be presented in the most effective manner. A good general plan is to state the problem, present the results of the investigation, and set forth the conclusion and recommendations. A report should be assembled in the following manner: (a)

Table of Contents

(b)

Body of the Report

The table of contents should indicate the subject matter, and page number in the docket, to provide quick reference to important features of the case. The format of the report must more or less contain the following information and presentation whenever it is necessary: b-1 Name and Address of Taxpayer

b-2 Tax periods involved in the investigation b-3 Returns filed and statute of limitations

b-4 Type of violation - indicate the pertinent provisions of the Tax Code violated. b-5 Origin of the case

b-6 Name and Titles of cooperating BIR officers; officer

b-7 Letter of Authority number, date issued, issuing of b-8 Date of taxpayer was first contracted by the examiners b-9 Representatives of the taxpayer

b-10 Brief description of the method used in the evasion or other violation. Copyright 2015

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b-11 Related cases

b-12 Summary of facts determined during the investigation

— Explanations on the evidence in support of the tax deficiency — Explanations on the evidence in support of the criminal aspect b-13 b-14

Explanation and defense of taxpayer Conclusion and recommendations

The body of the report should contain a reference to the appendices or worksheets and schedules, the appendices should contain a reference to exhibits which consist of supporting documents. For example: "Appendix A is a summary of the unreported receipts from sales, and Exhibits 8 to 25 are copies of documents in support thereof" Important matters in the exhibits generally should be explained in the report. However, if a document is of the nature that it is adequately described in an appendix no further explanation is necessary. When mentioning or referring to a document that is submitted as an exhibit, including the written statement of a witness, insert the exhibit number in parenthesis immediately following the reference. The examiner, before beginning his report, should arrange the proposed appendices and exhibits in the order of his planned presentation of facts and evidence, and then he prepares his report discussing the appendices and exhibits in that order. When the report is completed, the exhibits should be assembled in the order in which they are originally mentioned in the report, and they should be numbered for easy reference. (c)

List of Witnesses and Exhibits

(d)

Appendices, Worksheets and Schedules

The list of witnesses is an essential part of a report in a criminal case. The witness may be listed in alphabetical order, or in the order in which they are mentioned in the report, or in the probable order of their appearance in the trial. Give each witness a number. Give each piece of evidence and the witness proposed testimony a separate exhibit number. (For example, please see Annex "A-2")

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the order of presentation facts and evidence of the case. And they should be numbered for easy reference. (For sample, please see Annex "A-3")

ANNEX "A-1"

PRO-FORMA STATEMENT OF ASSETS, LIABILITIES AND NETWORTH (Revised to conform to recent laws) PARTICULARS ASSETS (Net of Depreciation)

Dec. 31, 1993

Dec. 31, 1994

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12.

Cash on Hand ** Pxxxx Cash in Banks xxxx Accounts, Notes & Loans Receivable xxxx Mortgage Receivable xxxx Investments xxxx Real Property — Land xxxx Real Property — Improvements xxxx Motor Vehicles xxxx Inventory at the end xxxx Furniture/Fixtures xxxx Personal Properties xxxx Other Assets xxxx ——— Total Assets Pxxxx LIABILITIES 1. Accounts, Notes & Loans Payable Pxxxx 2. Mortgage, Payable xxxx 3. Other Liabilities xxxx ——— Total Liabilities Pxxxx ——— Net Worth at the End Pxxxx ====== Less: Net Worth at the Beginning

Pxxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx ——— Pxxxx Pxxxx xxxx xxxx ——— Pxxxx ——— Pxxxx ======= xxxx ——— Pxxxx

Increase (Deceased) in Net Worth ** Supported by accompanying Cash Analysis Schedule Add: Non-deductible Items 1. 2. 3. Copyright 2015

Personal, living and family expenses Insurance premiums Income tax payments

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4. 5. 6. 7. 8. 9. 10.

Gifts to others Non-deductible expenses, taxes and contributions not directly connected with business of taxpayer Net capital loss Amnesty tax payments Estate and Donor's taxes Final tax payments Other expenses which are non-deductible

Total Non-deductible Items Net Income before further adjustments

xxxx xxxx xxxx xxxx xxxx xxxx xxxx ——— Pxxxx ———— Pxxxx ————

Less: Non-taxable items and income and proceeds subjected to final tax: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11.

12. 13.

Gifts, donations & Inheritance received Non-taxable capital gains Backpay/Pensions non-taxable Proceeds of Life Insurance Policy Non-taxable stock dividends (provided stocks are reflected in Assets) Pensions received under RA 4917 (private firms) Retirement pay from GSIS and SSS Non-recognized gains from exchanges of property under Sec. 34(c)(2) of the Tax code of 1988 GSIS Cash Dividends Social Security benefits received from foreign government and institution (per PD 220) Other non-taxable items (such as those excluded under Sec. 28(b) of NIRC of 1988, those subjected to final tax such as foreign earnings by a non-resident Filipino, royalties, prizes, yields on deposits, dividends, share in profits of taxable partnership, etc., per Sec. 21(b), Sec. 21(c), Sec. 22(2) of NIRC of 1988.) Other exempt income Proceeds of sale of Real Estate subjected to final tax under Sec. 21(e) of the Tax Code of 1988 Total Non-taxable items

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Pxxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx

xxxx xxxx xxxx ———— Pxxxx ———— 151

Adjusted Net Income as per Investigation

Pxxxx ————

Less: Statutory exemptions: Personal & additional exemption

xxxx ———— xxxx

NET INCOME SUBJECT TO TAX Income tax due thereon Less: Amount previously paid

xxxx xxxx ———— Pxxxx xxxx xxxx ———— Pxxxx =======

Deficiency income tax still due Add: 50% surcharges, if fraud can be proven 5% surcharges for late payment Total amount due, exclusive of interest

CASH ANALYSIS (Revised to conform with provisions of recent laws) - 1994 Source of Funds — Cash on hand and in bank at the beginning Add: 1. Cash received from business (sales) 2.Collection of receivables 3.Proceeds of loans and mortgages 4.Proceeds of life insurance policies 5.Proceeds from sale of property, real or personal 6.Cash gifts, bequests and inheritance received 7.Non-fund deductions (depreciation and provision for bad debts) 8.Backpay, pensions, benefits, gratuities received 9.Cash dividends & interest income 10.Wagering gains 11.Receipt of cash from any other source

P xxxx

Total Available Funds for the Year Less: Application of Funds *1.Cash purchases & business expenses 2.Cash paid for assets/property, real or personal (full payment of installment) 3.Payments of loans, notes & mortgage payable 4.Section 30(c)(1)(A to D) (non-deductible items) Copyright 2015

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xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx ——

P xxxx xxxx

xxxx —— P xxxx

xxxx xxxx xxxx xxxx 152

5.Section 31(a) cash disbursement: a. Personal, living or family expenses b. Capital expenditures c. Premiums paid on life insurance 6.Cash disbursement of any kind 7.Cash on hand and in bank at the end CASH ON HAND AT THE END AS RECONSTRUCTED

xxxx xxxx xxxx xxxx xxxx ———

xxxx ——— P xxxx ======

*7 Source: This item should be included as a contra account to Item No. 1 of Application of Funds if it includes non-cash deductions such as depreciation, bad debts, applications of deferred items.

Thus, if item 1 of Application of Founds does not reflect non-cash deductions, there is no necessity to include Item 7 to Sources of Funds. ANNEX "A-2"

SAMPLE LIST OF WITNESSES and EXHIBIT SING and FURR, INC. No. 24 Changi Street, Manila W1

W2

EXHIBIT Atty. ROBY CAPULON Bureau of Internal Revenue District Officer RDO No. XX, Manila Tel. No. 315-62-22

1

Atty. CARLS MIRANDA JR. Bureau of Internal Revenue Intelligence Officer Special Investigation Revenue Region X, Manila Tel. No. 61-24-08

2

PP. 73-80 1991 ITR and Attachments

1

PP. 81-83 Memorandum of Interview with Joel Div. Cruz, accountant of SING and FURR INC. dated July 12, 1994 P. 84 APPENDIX A — Computation of unreported Gross Receipt

2

Copyright 2015

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REF. PP. 66-72 1990 ITR and Attachments

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W3

ANJIE FARUMOG Manager FLORR, INC. 125 ABC St. QC Tel. No. 40-15-24

W4 RUSSEL ROMULO Owner, DELL, INC

3

P. 85

4

P. 86

1

P. 12

2

P. 13

1

P. 14

80 XYZ St. Cubao Tel. No. 62-12-43 2 3

W5

EMILLE FRENILLE Comptroller, CONTEMPLATE CORP. 17 Sta. Cruz, San Pablo, Laguna, Tel. No. 143-62

1

2 3

W6

Copyright 2015

SANDREX DUTERTE Manager, MAGGS ENT. 317 Davao St. Manila Tel. No. 60-45-01

CD Technologies Asia, Inc. and Accesslaw, Inc.

— 1990, 1991 APPENDIX B — Computation Adjusted Taxable Income 1990, 1991 APPENDIX C — Computation of Deficiency Taxes — 1990, 1991 Affidavit dated August 4, 1994 Confirmation letter dated June 6, 1994 Worksheet-Summary

of Payments made on Services rendered by SING and FURR, INC. PP. 15-20 Cancelled checks Payable to SING and FURR, INC. P. 21 Memorandum of Interview dated September 10, 1994 P. 22

Worksheet-Summary of Gross Payments made to SING and FURR, INC. P.23-30 Certified Copies of Invoices of SING and FURR, INC. PP. 31-36 Cancelled Checks Payable to SING and FURR, INC.

1

P. 38

2

P. 39-46

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Worksheet-Summary of Payments to SING and FURR, INC. Certified Copies and 154

3

SAMPLE

ITEM

FURR, INC. PP. 47-53 Certified Copies of Official receipts of SING and FURR, INC. ANNEX "A-3"

APPENDIX A COMPUTATION OF UNREPORTED GROSS RECEIPTS — 1990, 1991 SING and FURR, INC. 1990

FLORR INC.

160,000.00

DELL INC.

9000,000

CONTEMPLATE CORP.

1000,0000

1991

190,000.00

1200,0000

1600,0000

WITNESS

ANJIE FARUMOR

Manager, FLORR INC.

RUSSELL ROMULO Owner, DELL INC.

PRISE

500,0000

————

75,000.00

NO.

W3-1 W3-2

W4-1

W4-2P

REFERENCE DESCRIPTION OF

EVIDENCE P. 12 P. 13

P.14

P. 15-20

GATION

4000,0000

UNREPORTED Copyright 2015

(160,000.00) ————

Letter

Worksheet Cancelled Checks

W5-1

P. 22

Worksheet

CORP.

W5-3

PP. 31-36

Cancelled

SANDREX DUTERTE

W6-1

P. 38

Worksheet

ENT.

W6-2

PP. 39-46

Invoices

W6-3P

P. 47-53

Official

W1-1P

P. 66-72

1990 ITR

EMILLE FRENILLE Comptroller

Manager, MAGGS

————

W5-2P

P. 23-30

Memorandum

Invoices

Checks

Receipts

545,000.000

REPORTED GROSS RECEIPT

Confirmation

P. 21

GROSS RECEIPTS

PER INVESTI-

Affidavit

W4-3

CONTEMPLATE

MAGGS ENTER-

EXHIBIT

Atty. ROBY CAPU(1900,0000) ————

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LON

Rev. District Off.

W1-2P

P. 73-80 1991 ITR

RDO No. XX, Manila Philippine Taxation Encyclopedia 2014

155

GROSS

RECEIPTS 240,000.00

35,5000.00

TO APPENDIX B

ANNEX "A-3" SAMPLE APPENDIX B COMPUTATION OF ADJUSTED TAXABLE INCOME 1990 & 1991 SING and FURR, INC. ITEM

1990

(Particulars)

REPORTED

TAXABLE

960,0000

1991

P117,800.00

INCOME

WITNESS

EXHIBIT

Atty. ROBY

W1-1,2

NO.

CAPULON

REFERENCE

PP. 66-80

Rev. District Off.

DESCRIPTION EVIDENCE

1990, 1991 ITRs

RDO No. XX, Mla.

ADD: UNREPORTED

GROSS RECEIPTS

SUB-TOTAL

240,000.00

355,000.00

Atty. CARLS

—————

—————

Intelligence Officer

336,000.00

LESS: ADDITIONAL

OR DEDUCTIONS

—

—————

472,800.00

Computation of

A

Unreported

Gross Receipts

—

—————

ADJUSTED

P336,000.00

P4728,00.00

INCOME

========

========

TAXABLE

MIRANDA, JR.

APPENDIX P. 84

TO APPENDIX C

ANNEX "A-3" SAMPLE APPENDIX C COMPUTATION OF DEFICIENCY TAXES — 1990, 1991 SING and FURR, INC. ITEM (Particulars)

1990

1991

WITNESS

EXHIBIT NO.

REFERENCE

ADJUSTED Copyright 2015

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TAXABLE INCOME

336,000.00

472,000.00

Thereon

117,600.00

165,480.00

Return —————

336,00.00 41,230.00 —————Rev. District Off.

—————

Intelligence Officer —————

Atty. CARLS MIRANDA, JR.

APPENDIX

P.85

Atty. ROBY CAPULON

W1-1,2

PP. 66-80

B

INCOME TAX

———————— INC. TAX Due

Less: TAX Due/

BASIC TAX

84,000.00

124,250.00

CHARGE

21,000.00

31,062.50

CHARGE

42,000.00

62,125.00

ADD: 25% SUR50% SUR-

==========

June 1, 1998

RDO No. XX, Mla.

=========

June 1, 1998

REVENUE MEMORANDUM ORDER NO. 53-98

I.

SUBJECT

:

TO

:

Checklist of Documents to be Submitted by a Taxpayer upon Audit of his Tax Liabilities as well as of the Mandatory Reporting Requirements to be Prepared by a Revenue Officer, all of which Comprise a Complete Tax Docket All Internal Revenue Officers, Employees and Others Concerned

BACKGROUND

It has been observed that for the same kind of tax audit case, Revenue Officers differ in their request for requirements from taxpayers as well as in the attachments to the dockets resulting to tremendous complaints from taxpayers and confusion among tax auditors and reviewers. cdphil

For equity and uniformity, this Bureau comes up with a prescribed list of requirements from taxpayers, per kind of tax, as well as of the internally prepared reporting requirements, all of which comprise a complete tax docket. II. Copyright 2015

OBJECTIVE CD Technologies Asia, Inc. and Accesslaw, Inc.

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This order is issued to: a.

b. III.

Identify the documents to be required from a taxpayer during audit, according to particular kind of tax; and

Identify the different audit reporting requirements to be prepared, submitted and attached to a tax audit docket.

LIST OF REQUIREMENTS PER TAX TYPE Income Tax/ Withholding Tax – Annex A (3 pages) Value Added Tax – Annex B (2 pages) – Annex B-1 (5 pages) Percentage Tax – Annex C (2 pages) Documentary Stamp Tax – Annex D (1 page) Estate Tax –

Annex E (4 pages)

Donor's Tax – Annex F (2 pages)

Withholding Tax Remittance Return/Capital Gains Tax Return/Documentary Stamp Tax (For transactions involving onerous transfer of real property) – Annex G (2 pages) Capital Gain's Tax Return/Documentary Stamp Tax (For transactions involving onerous transfer of shares of stock not traded through a local stock exchange) – Annex H (1 page) Withholding Tax Remittance Return/Capital Gains Tax Return (For transactions involving onerous transfer of motor vehicles) – Annex I (1 page)

It is to be emphasized that before a docket be released by an investigating office, each and every page thereof be consecutively numbered. It is worth mentioning, likewise, that an investigating Revenue Officer/Tax Auditor must always request for the presentation of books of accounts, and

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accounting/business records, specifically, records affecting the income, receipts, deductions, estate and other taxable transaction of a taxpayer during the audit. LibLex

IV.

REPEALING CLAUSE

All existing issuances or parts thereof which are inconsistent herewith are hereby repealed.

V.

EFFECTIVITY

This order takes effect immediately.

cda

(SGD.) LIWAYWAY VINZONS-CHATO Commissioner of Internal Revenue ANNEX A INCOME TAX/WITHHOLDING TAX A)

Requirements from Taxpayer 1) 2) 3) 4) 5) 6) 7) 8) 9) 10) 11)

Copyright 2015

Certified Financial Statements, including comparative Profit and Loss Statement with Statement of Cost of Goods Manufactured and Sold, if applicable Proof of claimed tax credit/s, if applicable Proof of the claimed "Interest Expense", if applicable Proof of claimed Bad Debts/worthlessness of credits, if applicable Reconciliation of "Book Income" and "Taxable Income" Certificate of Registration issued by the appropriate regulatory agency, together with the conditions attached to such registration, if applicable Proof of Exemption under special laws, if applicable Certification of the appropriate regulatory agency as to taxpayer's entitlement to tax incentives, if applicable Xerox copy of used Tax Credit Certificate with annotation of issued TDM at the back, if applicable Proof of payment of deficiency tax, if any/applicable a) current year/period b) previous year/period Reports submitted to applicable regulatory agency that reflects the financial condition and result of operation of the taxpayer e.g.,

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Annual Statement prepared by insurance companies submitted to the Insurance Commission etc., if applicable B.)

Reporting Requirements to be prepared and/or submitted by the Revenue Officers 1) 2)

3) 4) 5) 6) 7) 8) 9) 10) 11) 12) 13) 14) 15) 16) 17) 18) 19) 20) 21) 22) 23) 24) 25) 26) 27) 28) Copyright 2015

Letter of Authority/Audit Notice Duly filed Income Tax Return with all the required attachments (Account Information Form, Schedule of Taxes and Licenses, Schedule of Income Producing Properties, Schedule of Depreciation, Breakdown of Selling and Administrative Expenses, etc.). Proof of payment of the tax, including Tax Debit Memo/TCC Quarterly Income Tax Returns Proof of payment of second installment — INCOME TAX, if applicable Beginning and Ending Inventory List, if material/applicable Notice of Loss; Proof of claimed Losses, if applicable Duly validated Monthly Withholding Tax Returns Duly validated Quarterly Withholding Tax Returns, if applicable Duly validated Annual Withholding Tax Returns together with the required attachments (Alpha List) Duly received Information Returns Form 1717 Series / Form 0500 Series (Audit Reports) Narrative Memorandum Report Revenue Officer's Activity Report / Log Sheet Table of Contents Working Papers of the monthly debit and credit balances of all accounts duly signed by the Tax Auditors/Revenue Officers Working Papers showing computation of income and/or withholding taxes due duly signed by the Tax Auditors/Revenue Officers Schedule of Advances Schedule of Interest Expense and Loans / Notes Payable (mention the creditor/s, date contracted/granted, principal loan, interest rate and interest expense), if applicable Schedule of Bad Debts, if applicable Schedule of Loss, if applicable Schedule of Advances from Officers and Stockholders, if applicable Schedule of Advances to Officers and Stockholders, if applicable Schedule of Miscellaneous Income, if material/applicable Schedule of Miscellaneous Expense, if material/applicable Schedule of Interest Income (give details as to source/s and amount), if material/applicable Schedule of Other Receivables/Miscellaneous Receivables, if material/applicable Schedule of Other Payables, if material/applicable

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29) 30) 31) 32) 33) 34) 35) 36) 37) 38) 39) 40) 41) 42) 43)

Note:

Computation of Realized Gross Profit and Unrealized Gross Profit, if the taxpayer is engaged in the business of selling real estate, whether by installment or lump sum Computation of Realized Gross Profit and Unrealized Gross Profit, if the taxpayer is engaged in the business of selling personal properties by installment Computation of Gross Income from Contracts, if the taxpayer is engaged in "Construction Business" Detailed reconciliation of "Book Income" and "Taxable Income", if necessary Reconciliation of the Financial Statements' figures with the Withholding Tax Returns' and Information Returns' figures Checklist of audit procedures undertaken Agreement Form (for agreed assessment) Notice for an Informal Conference/Post Reporting Notice with the summary of findings (for non-agreed assessment) Comparative Report of Deficiency Tax Paid/Assessed, if applicable a) current year/period b) previous year/period Docket Locator Form Delinquency Verification Report (for Claims for Refund / TCC ) Authority to Issue Refund / TCC ( for Claims for Refund / TCC ) Breakdown of Control Accounts, if applicable Certification by the Revenue District Office, that he could not locate the BIR copy of the tax return etc., if applicable Result of Tax Mapping Program or Third Party Information Program for LAs/Audit Notices issued thereunder

In case of non-availability of documents from RDO / RDC mentioned in B.2 B.11, request photocopies thereof from taxpayer LLjur

ANNEX B-1 VALUE-ADDED TAX (For audit involving Claim for Refund / TCC) A.) Copyright 2015

Requirements from Taxpayer CD Technologies Asia, Inc. and Accesslaw, Inc.

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I.

Requirements mentioned in Annex B

II.

Additional General Requirements 1)

3 copies of "Application for VAT Credit / Refund"

2)

Summary List of Local Purchases specifying the following:

Registered VAT Name of Number Supplier of Supplier

3)

4) Date of Invoice

Supplier

5)

6)

7) 8)

9) Copyright 2015

Invoice Number

Date of Invoice

OR No.

Date of OR

Amount of Purchase

Total Input Invoice Tax Amount

Photocopies of VAT purchase invoices for purchase of goods and official receipts for purchase of services. (The invoices/official receipts must be arranged according to the summary list)

Summary of importations made during the period with the following details: Item

AWB/ BL No.

Date of Arrival

Total Value

Date of Payment

O.R. No.

VAT

Photocopies of invoices, import entry documents, official receipts or confirmation receipts evidencing payment of VAT. (Segregate documents paid by cash from those paid by tax debit memo) VAT Returns filed for the quarter showing that the amount applied for refund/TCC has been reflected as a deduction from the total available input tax, as well as VAT Return for the succeeding quarter

Certification of taxpayer showing the amount of Zero-rated Sales, Taxable Sales and Exempt Sales

A statement showing the amount and description of the sale of goods and services, name of persons or entities (except in case of exports) to whom the goods or services were sold and date of the transaction, where the applicant 's zero-rated transactions are regulated by certain government agency Articles of Incorporation — for first time filers

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10)

Sales Contract/Agreement

11)

BOI Certificate of Registration

12)

BIR Certificate of Registration

14)

Sworn statement that ending inventory as of the close of the period covered by the Claim has been used directly or indirectly in the products subsequently exported as supported by export documents, if the applicant is 100% exporter

13)

15)

16) 17) III.

Certification from BOI, DOF, BOC, EPZA, etc., that subject taxpayer has not filed similar claim for refund covering the same period

Documents of liquidation evidencing the actual utilization of the raw materials in the manufacture of goods at least 70% of which has been actually exported, if the applicant is an indirect exporter Copy of the ITR and Certified Financial Statements, if applicable Beginning and ending inventory of raw materials, work-in-process, finished goods, supplies and materials

Additional Specific Requirements 1)

For Export Sales (Semi-conductor companies, garments, food etc.)

a.

sales invoice number, name of buyer, airway bill / bill of lading number, lading date, amount of sales in foreign currency, peso value of sales, conversion rate, date of remittance, bank credit memo number and amounted remitted in pesos

b.

Photocopies of export documents:

2)

export declaration/permit

1)

c. Copyright 2015

Invoices/ receipts evidencing sale of goods, as well as the name of the person to whom the goods were delivered with respect to foreign currency denominated sales accredited agent bank showing that the proceeds of

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the sale in acceptable foreign currency had been inwardly remitted and accounted for in accordance with BSP rules and regulations. The statement should also show the amount in foreign currency of the export proceeds or consideration, date of export, date of inward remittance, conversion rate into Philippine currency and the total peso value thereof. 2.

For Zero-Rated Sale of Services (contractors, mining, etc.)

a.

b.

c.

Authenticated copy/ies of the contract/s showing the person/s for whom the services were rendered, amount of consideration, description of the services and documents evidencing actual payments

Photocopies of official receipts and billings together with a summary of the date of billing, name of principal, official receipt number, date of receipt, amount in foreign currency and the corresponding value thereof, date of remittance, name of bank, bank credit memo number and amount remitted in pesos Bank credit memoranda and certificate from the BSP with information similar to 1-c (export sales)

Additional Requirements for Manning Services: a)

b)

Monthly BSP report on income of agency received

Breakdown of gross foreign receipts specifying the nature of foreign currency received (e.g. Commission, allotment manning fee, agency fee, advances, etc.) showing the total foreign currency value with its peso equivalent, bank credit memo number, name of bank and date of remittance pred

3)

Copyright 2015

Effectively zero-rated sale of goods (mining, etc.)/services (contractors, etc.)

a)

Summary of Sales invoices/receipts showing the name of the person entity to whom the sale of goods or services were delivered, order of delivery, amount of consideration and description of goods or services delivered (RR 6-89 and RMC 2-90)

b)

Reconciliation of billings against payment

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c)

Evidence of actual receipt of goods and services

Additional Requirements for Mining Companies: a)

b) 4)

Note:

Operating agreement with owner of mining claims, if applicable

Purchase of Capital Goods

a)

Original copies of invoices/receipts showing the date of purchase, purchase price, amount of value-added tax paid and description of the capital equipment locally purchased

b)

On imported capital goods

1) B.)

Reconciliation of billings against actual collection

Photocopy of import entry documents and official receipts/confirmation receipts of payment issued by the Bureau of Customs for value-added tax paid

Reporting Requirements to be prepared and/or submitted by the Revenue Officers I.

Requirements mentioned in Annex B

II.

Additional Requirements (All the requirements mentioned above)

In case of non-availability of documents from RDO / RDC mentioned in B.2 B.6, request photocopies thereof from taxpayer ANNEX C OTHER PERCENTAGE TAXES

A)

Requirements from Taxpayer 1) 2)

Copyright 2015

Proof of claimed tax credits Proof of payment of the tax

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3) 4) 5) 6) 7) 8) 9) B)

Xerox copy of used Tax Credit Certificate (TCC) with annotation of issued Tax Debit Memo (TDM) at the back Proof of payment of deficiency tax a) current year/period b) previous year/period Certification of the appropriate government agency as to taxpayer's entitlement to tax incentives, if applicable Certificate of Registration issued by the appropriate regulatory agency, together with the conditions attached to such registration, if applicable Certification of the appropriate regulatory agency as to the exempt sales of the taxpayer under its regulatory supervision, if applicable Proof of exemption under special law, if applicable Sample invoice for "Exempt Sales", if applicable

Reporting Requirements to be prepared and/or submitted by the Revenue Officers 1) 2) 3) 4) 5) 6) 7) 8) 9) 10) 11) 12) 13) 14) 15) 16) 17)

Letter of Authority / Audit Notice Duly validated Percentage Tax Returns, including all the attachments thereto Tax Debit Memo applied, if applicable Form 1717 series / 0500 series (Audit Reports) Narrative Memorandum Report Revenue Officer's Activity Report/Log Sheet Table of Contents Working papers showing the computation of the taxable receipts/sales (tax base) and percentage tax due duly signed by the Tax Auditors/Revenue Officers Reconciliation of Financial Statements' figures and Percentage Tax Returns' figures Schedule of Exempt Sales/Transactions, if applicable Checklist of audit procedures undertaken Agreement Form (for agreed assessment) Post Reporting Notice/Notice for an Informal Conference with the SUMMARY OF FINDINGS (for non-agreed assessment) Comparative Report of Deficiency Tax Paid/Assessed, if applicable a) current year/period b) previous year/period Docket Locator Form Delinquency Verification Report (For Claims for Refund/TCC) Authority to Issue Refund/TCC (For Claims for Refund/TCC) cda

Note: Copyright 2015

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In case of non-availability of documents from RDO / RDC mentioned in B.2 B.3, request photocopies thereof from taxpayer ANNEX D DOCUMENTARY STAMP TAX A.)

Requirements from Taxpayer 1) 2) 3) 4)

B.)

Reporting Requirements to be prepared and/or submitted by the Revenue Officers 1) 2) 3) 4) 5) 6) 7) 8) 9) 10) 11) 12) 13) 14) 15) 16)

Copyright 2015

Proof of payment of the tax Xerox copy of used Tax Credit Certificate (TCC) with annotation of issued TDM at the back, if applicable Proof of Exemption under special laws, if applicable Proof of payment of deficiency tax, if any a) current year/period b) previous year/period Duly filed Documentary Stamp Tax Declaration Duly filed Documentary Stamp Tax Return Tax Debit Memo, if applicable Duly received Information Returns for Documentary Stamp Tax Letter of Authority / Audit Notice Form 1717 Series / Form 0500 Series (Audit Reports) Narrative Memo Report Revenue Officer's Activity Report / Log Sheet Table of Contents Working Papers showing details and computation of tax base duly signed by Tax Auditors/Revenue Officers Working Papers showing computation of Documentary Stamps Tax Due duly signed by Tax Auditors/Revenue Officers Checklist of audit procedures undertaken Agreement Form (for agreed assessment) Notice for an Informal Conference / Post Reporting Notice with the Summary of Findings (for non-agreed assessment) Comparative Report of Deficiency Tax Paid / Assessed a) current year/period b) previous year/period Docket Locator Form

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Note:

In case of non-availability of documents from RDO / RDC mentioned in B.1 B.4, request photocopies thereof from taxpayer cdasia

ANNEX E ESTATE TAX A.)

Requirements from Taxpayer I.

General 1) 2)

3) 4) 5) 6) 7) 8) 9) 10) 11) 12)

Copyright 2015

Certified true copy of the DEATH CERTIFICATE NOTICE OF DEATH duly received by the BIR, if the gross taxable estate exceeds P20,000 for deaths occurring on or after Jan. 1, 1998; or if the gross taxable estate exceeds P3,000 for deaths occurring prior to Jan. 1, 1998 DEED OF EXTRA-JUDICIAL SETTLEMENT OF THE ESTATE, if the estate is settled extrajudicially SPECIAL POWER OF ATTORNEY, if applicable COURT ORDER/DECISION, if the estate is settled judicially A certified copy of the schedule of partition of the estate and the order of the court approving the same, if applicable Statement of the names of the executor, administrator and/or heirs, with their respective addresses, who may be made liable for unpaid assessment Income Tax Returns with all the needed attachments, and duly certified Financial Statements covering transactions in the year of death and one (1) year prior to the date of death Copy of the decedent's life insurance policy, if applicable Proof that the transfer of property is from a fiduciary heir or legatee to the fideicommissary, if applicable Proof that the transfer of property is from a first heir, legatee or donee to a beneficiary designated by the first heir's predecessor, if applicable Proof that the transfer of property is to a social welfare, cultural and charitable institutions, no part of the net income of which inures to the benefit of any individual and that not more than 30% of the transferred property is used by such

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13) 14) II.

Real Property 1) 2) 3) 4)

III.

1)

3)

4) 5)

Certificate of Deposit/Investment/Indebtedness owned by the decedent and the surviving spouse, Certificate of registration of vehicles and other proofs showing the correct value of the same, Proof of valuation of shares of stocks at the time of death For listed stocks — newspapers clippings/certification from the STOCK EXCHANGE For unlisted stocks — latest Financial Statements of issuing corporation with computation of book value per share Xerox copy of certificate of stocks Proof of valuation of other types of personal property

Allowable Deductions 2(2) 1) 2)

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Certified true copy/ies of the Transfer/Original/Condominium Certificate of Title/s of real property/ies (front and back pages); Certified true copy of the latest Tax Declaration at the time of death; "Certificate of No Improvement" issued by the Assessor's Office where properties have no declared improvement; Certification from the Municipal/City/Provincial Assessor's Office as to the declared real properties in the name of the decedent and/or his/her surviving spouse at the time of death;

Personal Property 1(1) 2)

IV.

institution for administration purposes, if applicable Proof of deficiency tax payment, if any a) current year/period b) previous year/period Requirements in the investigation of other internal revenue taxes, if they are covered by the tax audit

Certification of the Barangay Chairman as to the domicile of the decedent at the time of his death, if FAMILY HOME is claimed as a deduction; Proof of CLAIMS AGAINST THE ESTATE, if applicable a) Certified true copy of the duly notarized promissory note or contract of loan signed by the decedent and the surviving spouse; b) In case of advances made by individuals or corporation to the decedent, copies of vouchers,

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3)

4) 5) 6) 7) B.)

Reporting Requirements to be prepared and/or submitted by Revenue Officers 1) 2) 3) 4)

5) 6) Copyright 2015

cancelled checks, contract of loan or other documents evidencing the advances c) Collection or demand letter of the creditor d) Authenticated copy of the latest Balance Sheet of the Corp. e) Certification Under Oath as to the balance of the decedent's account, signed by the President, Vice-President or other responsible official of the corporation, or the individual creditor f) Certified true copy of a mortgage contract g) Where settlement is made thru the Court, pertinent documents filed with the court evidencing "claims against the estate", or the court order approving the said claims, if already issued; h) Statement/accounting of disposition of the proceeds of the loan, for loans incurred within 3 years prior to the death of the decedent Proof of Other Claimed Deductions a) On property previously taxed or vanishing deductions — a copy of the duly bank validated estate/donor's tax return and proof of payment of the tax on previous transmission/transfer b) On claims against insolvent person — a copy of insolvency proceedings / SEC Certification on dissolved corporation (where the value of the decedent's interest is included as part of the gross estate) Proof of Claimed Tax Credit Proof of Claimed Losses Proof of Claimed Medical Expenses claimed Proof of Claimed "Transfer for Public Purpose", if applicable

Letter of Authority (LA)/Return Verification Order (RVO)/Audit Notice, whichever is applicable Duly validated Estate Tax Return Proof of payment of the tax STATEMENTS OF ASSETS AND DEDUCTION duly certified by an independent CPA, if the gross taxable estate exceeds P2,000,000 for deaths occurring on or after Jan. 1, 1998; or if the gross taxable estate exceeds P50,000 for deaths that occurred prior to Jan. 1, 1998 Form 0500 series/Form 1717 Series (Audit Reports) Narrative Memorandum Report, for cases covered by LA/Audit Notice

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7) 8) 9) 10) 11) 12) 13) 14) 15) 16)

Revenue Officer's Activity Report/Log Sheet Table of Contents, for cases covered by LA/Audit Notice Duly prepared Letter of Confirmation issued by the reviewing office Docket Locator Form Certified photocopy of the zonal value of properties located outside of the investigating region Working papers reflecting items of gross estate and deductions duly signed by Tax Auditors/Revenue Officers Working papers showing computation of estate tax due duly signed by Tax Auditors/Revenue Officers Report of Ocular Inspection, if applicable Detailed Schedule of deductions, if applicable Reporting requirements for all the other internal revenue taxes, if they are covered by the tax audit cdtai

Note:

1. 2.

In case of non-availability of documents from RDO / RDC mentioned in B.2 B.4, request photocopies thereof from taxpayer if applicable Proofs of all the claimed deductions must be presented to the Revenue Officer during the original investigation and that only photocopies must be attached to the docket. ANNEX F DONOR'S TAX

A.)

Requirements from Taxpayer I.

General 1) 2) 3) 4)

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Certification of the balance of mortgage assumed by the donee Sworn statement of the relationship of the donor to the donee Proof that the donee is a qualified relative of the donor, if the donation is being taxed using the schedular rates. (e.g. BIRTH CERTIFICATE) Proof of exemption for exempt donations, if applicable

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5) 6) 7) 8) II.

Real Property 1) 2) 3)

III.

2) 3) 4) 5)

Proof of claimed deductions

Reporting Requirements to be prepared and/or submitted by the Revenue Officers 1) 2) 3) 4) 5) 6)

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Proof of valuation of shares of stock at the time of donation a) For listed stocks — newspaper clippings/certification issued by the Stock Exchange as to the value per share b) For unlisted stocks — latest audited Financial Statements of the issuing corporation with computation of the book value per share Certificate of Deposit/Investment/Indebtedness/Stocks for donated cash and securities Certificate of Registration of vehicle Proof of valuation of vehicle Proof of valuation of other types of personal properties

Claimed Deductions 1)

B.)

Certified true copy/ies of the Original/Transfer/Condominium Certificate of Title ( front and back pages ) Certified true copy/ies of the latest Tax Declaration (front and back pages) "Certificate of No Improvement" issued by the Assessor's Office where the property/ies have no declared improvements

Personal Property 1)

IV.

Proof of claimed tax credit, if applicable Proof of claimed deductions, if applicable Sworn statement that no other donations were made within the same calendar year, if applicable; Proof of payment of deficiency tax, if any

Letter of Authority/Audit Notice/Return Verification Order, whichever is applicable Duly validated Tax Return Proof of tax payment Duly notarized Deed of Donation Duly notarized Deed of Extra-judicial Settlement of the Estate with waiver of rights, if the waiver is subject to donor's tax Working papers showing the computation of gross donation and deductions claimed, details of previous donations made within the same calendar year and computation of deficiency tax due, if any,

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7) 8) 9) 10) 11) 12) 13) 14) 15) 16) 17) 18) Note:

duly signed by Tax Auditors/Revenue Officers Form 1717 Series / Form 0500 Series (Audit Report) Table of Contents, for cases covered by LA/Audit Notice Docket Locator Form Agreement Form (for agreed assessment) Post Reporting Notice/Notice for an Informal Conference with a Summary of Findings (for non-agreed assessment) Report of Ocular Inspection, if applicable Narrative Memorandum Report, for cases covered by LA/Audit Notice Revenue Officer's Activity Report Duly prepared Letter of Confirmation issued by the reviewing office Certified photocopy of the zonal value of property/ies Checklist of audit procedures undertaken Detailed schedule of claimed deductions, if applicable

In case of non-availability of documents from RDO / RDC mentioned in B.2 B.5, request photocopies thereof from taxpayer ANNEX G WITHHOLDING TAX REMITTANCE RETURN (For transactions involving onerous transfer of Real Property classified as ordinary asset, whether Taxable or Exempt) CAPITAL GAIN'S TAX RETURN (For transactions involving onerous transfer of Real Property classified as capital asset, whether Taxable or Exempt) DOCUMENTARY STAMP TAX

A.)

Requirements from Taxpayer 1) 2) 3) 4)

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Proof of payment of the tax Deed of Absolute Sale/Document of Transfer Certified true copy of the Certificate of Title of the real property (front and back pages ) Certified true copy of the latest Tax Declaration (front and back

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5) 6) 7) 8) 9) 10) 11) 12) 13) B.)

Reporting Requirements to be prepared and/or submitted by the Revenue Officers 1) 2) 3) 4) 5) 6) 7)

Note:

pages) "Certificate of No-improvement" issued by the Assessor's Office, if the property has no declared improvement Special Power of Attorney, if applicable Seller's latest Certificate of Registration with HLURB or HUDCC and the latest LICENSE TO SELL, if applicable Seller's latest Certificate of Accreditation issued by the appropriate Real Estate Builders Association, if applicable Certificate of Exemption from Withholding Tax/Capital Gains Tax/Documentary Stamp Tax issued by the Commissioner of Internal Revenue or his representative to the taxpayer, if applicable Proof of Exempt Transfers, if applicable Proof of deficiency tax paid, if any Certificate of Non-productivity of ricefield and other agricultural lands issued by the Barangay Captain, if applicable Xerox copy of location plan, if applicable Duly filed Tax Return/Tax Declaration Return Verification Order (RVO) Form 1717 Series/Form 0500 Series (Audit Report) Report of Ocular Inspection, if applicable Revenue Officer's Activity Report/Log Sheet Working Papers showing computation of deficiency tax due duly signed by the Revenue Officer Docket Locator Form

In case of non-availability of document from RDO / RDC mentioned in B.1, request photocopy thereof from taxpayer ANNEX H

CAPITAL GAINS TAX RETURN/DOCUMENTARY STAMP TAX (For transactions involving onerous transfer of shares of stock not traded through the LOCAL STOCK EXCHANGE) A) Copyright 2015

Requirements from Taxpayer CD Technologies Asia, Inc. and Accesslaw, Inc.

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1) 2) 3) 4) 5) 6) 7) B)

Reporting Requirements to be prepared and/or submitted by the Revenue Officers 1) 2)

3) 4) 5) 6) Note:

Proof of payment of the tax Deed of Absolute Sale/Document of Transfer Proof of acquisition cost Xerox copy of stock certificates Proof of claimed selling expense Xerox copy of the latest Financial Statements of the issuing corporation with computation of the book value per share Proof of payment of deficiency tax, if any Duly filed tax return/tax declaration Working papers showing the composition of gross sales, acquisition cost/book value of shares, selling expenses, realized gain and computation of deficiency tax due, if any, duly signed by the Tax Auditor/Revenue Officer Form 1717 series/Form 0500 series ( Audit Report) Return Verification Order (RVO) Docket Locator Form Revenue Officer's Activity Report

In case of non-availability of document from RDO / RDC mentioned in B.1, request photocopy thereof from taxpayer cda

ANNEX I WITHHOLDING TAX REMITTANCE RETURN (For transactions involving onerous transfer of motor vehicle classified as ordinary asset) CAPITAL GAINS TAX RETURN (For transactions involving onerous transfer of motor vehicles classified as capital asset) A)

Requirements from Taxpayer 1) 2)

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Xerox copy of Certificate of Registration Proof of valuation of the motor vehicles

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3) 4) 5) B)

Reporting Requirements to be prepared and/or submitted by the Revenue Officers 1. 2. 3. 4. 5. 6.

Note:

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Deed of Sale/Document of Transfer Proof of payment of the tax Proof of payment of deficiency tax, if any Duly validated Tax Returns Return Verification Order (RVO) Form 1717 series/Form 0500 series (Audit Report) Working paper showing computation of the tax due duly signed by the Tax Auditor/Revenue Officer Docket Locator Form Revenue Officer's Activity Report

In case of non-availability of document from RDO / RDC mentioned in B.1, request photocopy thereof from taxpayer

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1.

2.

1 (Popup - Popup)

Endnotes

if applicable

2 (Popup - Popup)

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Proofs of all the claimed deductions must be presented to the Revenue Officer during the original investigation and that only photocopies must be attached to the docket.

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