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Presumptions in tax assessments

SUITS THE C-SUITE By Erickson Errol R. Sabile

Business World (05/25/2015 – p.S1/4)
In tax examinations, the Bureau of Internal Revenue (BIR) usually applies a set of standard
procedures, with two being the most common. First, it compares the purchases reported on the
Summary List of Sales (SLS) submitted by suppliers, on the one hand, with the purchases reported
on the value-added tax (VAT) returns/Summary List of Purchases (SLP) by the taxpayer, also
known as the Reconc iliation Listing for Enforcement System (RELIEF) audit.

Second, it compares the expense items reported in the Financial Statements (FS)/Income Tax
Return (ITR) with the items reported on the Alphabetical List of Payees From Whom Taxes Were
Withheld (Alphalist).

Where the amounts per SLS submitted by suppliers are higher than the amounts on the taxpayer’s
VAT returns/SLP, or where the expense amounts per taxpayer’s Alphalist are greater than those
reflected in the FS/ITR, the BIR examiners will assess defici ency income tax and VAT on the basis
that the unreported purchases and expenses result in undeclared income. This approach and
conclusion traces its roots from the “Net Worth Method” first used in 1956 in the case of Eugenio
Perez vs. J. Antonio Araneta to prove unreported income.


In the Net Worth Method, there are five ways by which taxpayers may be assessed for deficiency
income tax:

· The taxpayer’s own books and records, if made available by lawful means. When truthful, the
taxpayer’s own books and records usually establish the nature and source of the unreported
income; if false, these at least afford a starting point from which income items may be verified
from other sources.

· Books and records and corroborative statements of th ird persons who have dealt with the
taxpayer, often establishing payment of monies which would constitute taxable income to the

· Bank deposits and bank records.

· Increase in net worth; including investments, purchases of property and other busi ness
transactions by the taxpayer.

· Analysis of expenditures, to show that expenditures were in excess of declared or available

income or expenditures for claimed items of deductions were fictitious or overstated.

The purpose of each of these is to establ ish taxable but unreported income and any combination of
the methods may be resorted to by the government to support its case.

More recently, however, the Court of Tax Appeals (CTA) has promulgated decisions which
effectively restrict an unfettered use of the Net Worth Method.


Three elements are required for the imposition of income tax, namely: (a) there must be gain or
profit, (b) the gain or profit is realized or received, actual ly or constructively, and (c) it is not
exempted by law or treaty. Income tax is assessed on income received from any property, activity
or service and it must be clearly established that the taxpayer received such income.
In a January 2015 case, the CTA r uled that a finding of underdeclaration of purchases does not, by
itself, result in the imposition of income tax and VAT. The CTA ruled that deficiency income tax
and VAT may be assessed when there was an income realized by the taxpayer and such income
was not reported. No deficiency assessment can be made on account of undeclared purchases. The
CTA said that a taxpayer is free to deduct from its gross income a lesser amount, or not claim any
deduction at all. What is prohibited by the income tax law is to claim a deduction beyond the
authorized amount, not an underdeclaration of purchase or unaccounted expense.

The same is true for VAT, which is based either on the gross selling price or gross value in money
of the goods or properties sold, bartered or exch anged, or gross receipts derived from the sale or
exchange of services. Section 108 (A) of the Tax Code defines “gross receipts” as the total amount
of money or its equivalent representing the contract price, compensation, service fee, rental or
royalty, including the amount charged for materials supplied with the services and deposits and
advance payments actually or constructively received during the taxable period for the services
performed or to be performed for another person, excluding VAT.

In assessing VAT, it must be shown that the taxpayer received an amount of money or its
equivalent from its sale, barter or exchange of goods or properties, or from the sale or exchange
of services performed. VAT, like income tax, also cannot be assessed based on un derdeclared


Similarly, in a January 2014 case, the CTA rejected the BIR’s allegation that the taxpayer had
undeclared income on the basis that there was an unaccounted source of cash and therefore
undeclared income since the income payments per Alphalist were greater than the expenses per
FS/ITR. The CTA said that such comparison failed to show that the income payments to the
taxpayer’s payees per se could be equated to taxable income. Th e purported unaccounted cash
could well be presented in the balance sheet for accounting purposes and not in the Income
Statement; hence, it is not proper to form the conclusion that the supposed unaccounted cash is
part of the reportable income in the Inc ome Statement.

Thus, even if the expenses per Alphalist were to be considered as income, the same shall be offset
by treating the equivalent payments as purchases for which input tax credits may be claimed.
Thus, no taxable income will result from the said transactions.

In these and other similar CTA decisions, the message is clear. While tax assessments are
presumed to be correct, the assessment itself should not be based on presumptions regardless of
how logical the presumption might be. The assessment mu st be based on actual facts in order to
stand the test of judicial scrutiny — a reiteration of a 2005 decision by the CTA that in a naked or
a baseless assessment, the determination of the tax due is without rational basis, and that the
determination must rest on all the evidence introduced and its ultimate determination must find
support on credible evidence.

In a February 2015 decision, the CTA also ruled that while the BIR can resort to the Best Evidence
Obtainable Rule and estimate the tax liability of taxpayers who failed to submit their accounting
records lost due to calamities, the BIR is still, however, required to provide sufficient basis for its

Given the seriousness of a BIR tax assessment, it is important that taxpayers have a clear
understanding of the due process and other legal considerations involved in the tax assessment.
They must be equipped with the latest jurisprudence not only for better compliance but also to
defend themselves against tax assessments.