REVENUE AUDIT MEMORANDUM ORDER NO.

1-00*

SUBJECT : Updated Handbook on Audit Procedures and Techniques Volume I

(Revision -Year 2000)

TO : All Internal Revenue Officers and Others Concerned

I. OBJECTIVE

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".

II. QUALITY AUDIT

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. 2-951, 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.

(SGD.) DAKILA B. FONACIER

Commissioner 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.

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

Revenue Tax Administration

Purpose
Contents of the Handbook

II. Accounting Methods

Cash Basis
Accrual Basis
Completion of Contract Basis
Percentage of Completion Basis
Installment Basis
Crop Year Basis

III. Bookkeeping Systems

Single Entry System

Double Entry System

IV. Accounting Records

Journal
Ledger
Subsidiary Book
Computerized Accounting System

V. 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
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

X. 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

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. 15-952

General Policies in the Investigation of Tax Fraud Cases

Revenue Memorandum Order No. 53-983

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

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 ant other taxes. This is
accomplished by:

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

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

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

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.

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.

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 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.

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. The costs incurred under the contract as of the end of the tax year are compared with the
estimated total contract costs; or

2. 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.

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 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.

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

1. Computation of Sales

Cash Sales (cash book) xx

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

2. Computation of Purchases

Cash purchases (cash book) xx

Add: Purchases on account:
Payments to creditors (cash book) xx
Less: Accounts payable (beginning balance) xx
Payments for purchases for the period xx
Add: Accounts payable (ending balance) xx xx
- -
TOTAL PURCHASES xx
==
3. Computation of Expenses

Cash payments for allowable expenses (cash book) xx

Add: Prepaid expenses (beginning balance) xx
Accrued expenses (ending balance) xx xx
- -
Total xx
Less: Prepaid expenses (ending balance) xx
Accrued expenses (beginning balance) xx xx
- -
TOTAL EXPENSES 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, 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 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.

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

2. 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.

3. 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 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. 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.

2. 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 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.

3. 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

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:

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.

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:

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;

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

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

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.

2. 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
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.

3. 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.

4. 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. 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
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.

2. 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.
3. 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. 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.

2. Professional skill and ingenuity must be exercised in the performance of the examination
and the preparation of the report.

3. Issues should be raised only when, in the Revenue Officer's opinion, they have real merit
and only when they will contribute in the proper determination of tax liability.

4. The confidential nature of all information pertaining to any assignment must be strictly
observed.

B. Standard of Preliminary Planning

1. 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.

2. Advance planning of work schedules with reasonable accuracy is essential for the
effective use of time.
3. 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 Identify other agencies or offices where the Revenue Officer can have access to their
records if the taxpayer cannot present the documents requested.

C. Standards of Field Work

1. 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.

2. The use of accounting skills, tax knowledge and ingenuity should be directed toward
recognizing and raising issues which relate to non-compliance areas.

3. 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.

4. The position taken with respect to each issue should be supported by adequate authority.

D. Standards of Reporting

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

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

3. 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.

E. Standards of Public Relations

1. Initial contact for audit arrangements should be made with the taxpayer and care should
be exercised in explaining the type of records required.
2. Revenue Officers must be fully cognizant of the proper sources for gathering information
and of the rights of the taxpayer and his representatives.

3. 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.

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

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;

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

12. Inconsistencies between items and also in the treatment with respect to bad debts,
inventory valuation methods, depreciation rates and methods, etc.;
13. 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;

14. The status of the retained earnings account as well as the basis of assets and depreciation
allowed or allowable; and

15. 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.

B. 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:

1. 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.

2. Claims for refund should be given the next priority in order to develop good BIR-
taxpayer relationship.

3. Cases assigned for reinvestigation should also be given priority attention.

4. 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

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

2. Serving of Letter of Authority

2.1 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.

2.2 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.

2.3 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
stamping the words "Revalidated on _____________" on the face of the copy of the Letter of
Authority issued.

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:

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)

4. 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:

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

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

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:

1. Minute Book

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.

2. Stock Transfer Book

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.

3. Partnership Agreement

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.

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

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.

6. Statements and Schedules Filed with Government Regulatory Agencies

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.
7. Appraisal Reports

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.

E. Initial Examination Techniques

1. Understanding the Taxpayer's Books and Records

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 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.

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.

2.5 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.

3. 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 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.

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 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.

4.2 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.

4.3 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.

4.4 When scanning adjusting journal entries, the following should also be looked into
closely:

4.4.1 Unusual and non-recurring entries;

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
4.5 Entries increasing liabilities as these could represent fictitious or contingent liabilities,
fictitious expenses, invalid loans to shareholders, or undeclared income credited to liability
accounts.

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:

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.

2. Elements of Internal Control

Internal control can be divided into three elements:

2.1 Control Environment

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.

2.2 Accounting System

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 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.

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

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.

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

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.

3.6 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.

3.8 Determine the books and records maintained and the frequency of recording transactions.

3.9 Determine if pre-numbered documents are being used.

3.10 Determine the extent of involvement of auditors and other third parties in the business.

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

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

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. Two Basic Types of Sampling

1.1 Statistical 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.

1.2 Judgmental Sampling

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 Internal Control

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

Large errors or high frequency of errors in the accounting system may require a large sample
size.

2.3 Materiality

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.

2.4 Analytical Review

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
e. Significant increases or decreases in taxable income from year to year
f. Significant adjustments on previous Revenue Officer's reports

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

3.2 The last month of the period under examination should be tested because of the
likelihood of errors and unallowable adjustments made before the end of the year.

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

3.4 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.

3.5 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.

3.6 Inspection of the corporate minutes and the articles of incorporation could lead to a
Revenue Officer's determination to sample a particular account.

3.7 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.

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

4. Examining the Sample Items

The sample items, as selected, should be verified as follows:

4.1. Analyze and determine the validity of the source documents.

4.2. Examine collaborating documents.

4.3. Check with third parties.

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

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

6. 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.

The following discussion offer guides and techniques in examining asset, liability and net worth
accounts. The Revenue Officer, however, is not precluded from applying other techniques which
are deemed necessary in a particular case.

A. Cash on Hand and in Bank

1. 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.

2. 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.

3. 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.

4. 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.

5. 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.

6. 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.
7. 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.

8. 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.

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

10. Note year-end bank overdrafts. This may indicate expenses which are fictitious or
unallowable since funds were not available for payment.

11. 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.

12. Determine whether voided checks have been properly adjusted in the books and credited
to the appropriate expense accounts, if applicable.

13. 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.

14. 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.

15. Test check disbursements from petty cash to determine if there are any unallowable items
included.

16. Scrutinize cash overages and shortages, being alert to occurrence of irregularities.

17. 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.

B. Notes and Accounts Receivable

1. 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.

2. 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.

3. Determine if subsidiary ledgers are in agreement with control accounts, and if not,
ascertain the reasons for any differences.
4. 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 there is little likelihood that they will ever be refunded. Whatever the cause, the
credits, if material, should be isolated for consideration.

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

6. Compare balances of accounts receivable and sales for the current year with that of the
preceding year. Investigate significant changes.

7. Investigate large and/or unusual balances classified as other accounts receivable.

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

9. Investigate the sources of notes receivable as there may be instances when the taxpayer
has other sources of income other than his regular business.

10. Determine whether accrued income on interest bearing notes or accounts has been
included in income.

11. 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.

C. Allowance for Bad Debts

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

2. Compare balances in the allowance account with that of the preceding year's. Investigate
significant changes.

3. Evaluate the reasonableness of the allowance by computing the ratio of the balance of
allowance for bad debts to the trade accounts receivable balance.

4. Compute the ratio of bad debts expense over sales. Analyze if such is reasonable.

5. Review the aging schedule of accounts receivable.

6. For accounts written off which were charged to expense, examine minute book for
authorization to write off accounts.
7. Ascertain that accounts written off are worthless by examining supporting documents
such as reports of collection agencies, correspondence with said customers and documents filed
in court, and court decisions on collection cases.

8. If possible, check the financial status of the customers for which allowance for bad debts
was provided.

9. 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.

D. Inventories

1. 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.

2. Verify the inventory valuation method being applied if such is acceptable for tax
purposes and consistently applied from year to year.

3. 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.

4. Check BIR authorization for changes in inventory valuation method and verify taxpayers
compliance with the requirements set forth under existing rules and regulations.

5. Check gross profit percentage variations. Conduct in-depth verification of items with
substantial variations.

6. Determine the significance of any notes or qualifying statements on financial reports

prepared by independent accounting firms.

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

8. 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.

10. 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.

11. Determine if there have been write-downs for "excess" inventory to below cost. Verify
authorization and supporting document/report for such write-downs.
12. 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.

E. 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. Verify authorization from Board of Directors for advances and loans to stockholders and
officers by checking duly approved minutes of meetings.

2. Identify company officers and stockholders who are granted advances regularly.

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

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

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. 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.

2. 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.

3. 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 relevant records.
4. Investigate sales to related parties and/or officers or stockholders below fair market
value.

5. Cross-check all investments during the year to the interest, dividend or rental income
accounts.

6. If investments or bonds were acquired at a premium or discount, determine whether the

premium/discount is amortized over the life of the bond.

G. 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. 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.

2. 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.

3. 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. 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.

3.2. Determine if acquisition and installation costs of fixed assets and leasehold
improvements have been capitalized.

3.3. 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.

3.4. 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
includes materials, labor and overhead including depreciation.

3.5. 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.
4. 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.

5. 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.

H. Allowances For Depreciation, Amortization And Other Valuation Reserves

1. Review the nature and source of all accounts and ascertain if they are being used to claim
unallowable deductions.

2. 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. 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.

2.2. 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
====

3. Ascertain the taxpayer's depreciation and amortization policies and consider the
following:

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

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

4. 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.

I. Intangible Assets

1. Investigate the nature of the intangible assets whether leases, patents, licenses,
trademarks, goodwill, copyright, franchise and others.

2. Costs of acquiring the intangible should be capitalized when useful lives can be
estimated. If not, no amortization is allowable for tax purposes.

3. 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.

4. Verify correctness of deductions claimed as amortization of intangible assets as follows:

4.1. Leasehold costs are subject to amortization over the term of the lease.

4.2. Goodwill cannot be amortized if it is for an indefinite period of time.

4.3. Research and development expenditures may either be capitalized or treated as outright
deductible expense.

4.4. Patents sold with the exclusive right to make, use and sell an article constitutes ordinary
income.

4.5. Organization expenses are subject to amortization and are not deductible in full on the
year incurred. Check the reasonableness of the taxpayer's amortization policy on organization
expense.

5. Determine if there have been transactions with related taxpayers. If so, verify if these are
made at arms-length.

6. Determine if income applicable to intangibles has been included as income, (e.g.

subleases, overriding royalties, franchise and other sources).

7. Analyze any transaction involving transfer of foreign rights to any foreign entity for an
equity interest or for nominal consideration.
8. Be alert to transactions which could have given rise to intangibles classifiable as asset
account which may have been recorded as expense.

J. Prepaid Expenses And Deferred Charges

1. Verify the nature and source of these assets and the manner in which they are charged off
to expense.

2. 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.

K. Other Assets

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

2. 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.

L. Exchange, Clearing or Suspense Account

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

2. 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.

M. 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. Reconcile subsidiary ledgers with the control accounts. Request the taxpayer for
explanation of any discrepancies noted.

2. Note existence of debit balances in the general ledger or subsidiary accounts. This may
indicate diversion of funds and other underdeclaration of income.

3. 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.

4. Review computation of year-end accruals with respect to their deductibility as expenses

or purchases.
5. 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.

6. 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.

7. 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.

N. Fixed Liabilities

1. 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.

2. Scrutinize any long-term outstanding liability to the owner, shareholders, officers or to a

related taxpayer as this may constitute accumulated unreported income.

3. 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.

4. 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.

5. 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.
O. Deferred Credits

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

2. 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.

3. 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.

4. 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.

5. When a taxpayer uses the installment method of reporting income, the 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. 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.

2. 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:

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.

3. 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.

4. Verify certain payments of loans against check vouchers and cancelled checks.

5. 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.

6. 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 documents supporting the entries.

Q. Capital Accounts

1. Capital or Owner's Equity-for sole proprietorship

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

1.2. 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.

1.3 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.

2. Partners' Capital - for partnerships

2.1. 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.

2.2. Reconcile amount appearing on the tax return, books and financial statements. Verify any
differences noted.

2.3. Examine pertinent provisions of partnership contract and check correctness of

distribution of partnership income and expenses.

2.4. Ascertain that the correct tax has been withheld on distribution of partnership profits.
2.5. If the taxpayer claims that it is a general professional partnership, examine partnership
contract and registration with the Securities and Exchange Commission.

3. 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, 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.

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:

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) 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 o f 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 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 Review the taxpayer's accounting method of revenue recognition if the same is acceptable
and consistent with prior years.

1.2 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 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.

1.3 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.

1.4 Account for all sales invoices issued. Match delivery receipts, gate passes, if any, against
sales invoices issued.

1.5 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.

1.6 Reconcile credits to sales with debits to accounts receivable and debits to cash receipts
book. Test check monthly entries.

1.7 Research unusual and unfamiliar issuances of goods or goods which are not normally
sold by the taxpayer.

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

1.9 Determine inventory method applied if acceptable and consistently followed.

1.10 Determine if merchandise is being withdrawn for personal use or for any other purpose
not in relation to normal sales process.

1.11 Scan credit memo issued to customers and test check entries to Sales Returns &
Allowances and Sales Discounts to insure proper recording of credits.

1.12 Verify cancelled sales invoices by test checking deposits made and withdrawal of goods
on the day of cancellation.
1.13 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
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.

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

1.15 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.

1.16 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.

1.17 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.

2. Rent Income

2.1 Obtain and review copies of lease contracts.

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

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

2.4 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.

2.5 Obtain information on rental of neighboring properties and compare with rent income
reported.
2.6 Examine official receipts issued. Compare total collections per official receipts with
entries in the cash receipts book and general ledger. Investigate discrepancies.

2.7 Ascertain acceptability and consistency of accounting methods used. For cash-basis
taxpayers, prepaid rent and rental deposits constitute income during the year of receipt.

2.8 Secure copies of lease contracts or agreements. Take note of lease contracts which are
actually conditional sales.

2.9 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.

3. Professional Fees

3.1 Determine the taxpayer's accounting method of recognizing income, whether cash or
accrual. Most professionals, however, adopt the cash basis of accounting.

3.2 Examine contracts with clients and other correspondence/documents in relation to

professional services rendered.

3.3 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.

3.4 Account for official receipts issued. Note any missing receipt or break in the series and
investigate the reasons therefor.

3.5 Analyze the reasonableness of expenses claimed in relation to income declared.

3.6 Conduct interviews and third party verification, if necessary.

3.7 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.

4. Income from Sale of Asset

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.

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

4.5 In case of disposal of capital assets, ascertain compliance with the provisions of the Tax
Code on capital gains and losses.

4.6 Verify sales of property reported on the installment basis and determine if all
requirements pertaining thereto have been complied with.

4.7 Determine if proper accounting for depreciation, book value and salvage value was
correctly taken up

4.8 Inquire from certain company personnel on possible sales of assets which may not have
been recorded in the books of accounts.

5. Other Income

5.1 Scrutinize the entries in the general ledger and general journal for any other income or
other receivables recorded thereto.

5.2 Test check entries in intercompany accounts to determine whether shifting of income or
management fees may have been made and charged to affiliates.

5.3 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:

1.1 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.

1.2 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.

1.3 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.
1.4 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.

1.5 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.

1.6 Verify entries in the general ledger account which originate from unusual sources such as
journal entries, debit and credit memoranda and other accounting records.

1.7 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.

1.8 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.

1.9 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.

2. Cost of Goods Sold

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

2.2 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.

2.3 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.

2.4 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.

2.5 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.
2.6 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.

2.7 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.

2.8 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.

2.9 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.

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

3.2 Review payroll sheets. All expenses claimed having the semblance of a compensation
payment should be verified together.

3.3 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.

3.4 Compare payroll costs with industry standards and other independent data. Require
explanations for significant deviations.
3.5 Observe the actual number of employees and relate this to the declared sales. Inquire if
independent contractors are hired in lieu of regular employees.

3.6 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.

3.7 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).

3.8 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.

3.9 Verify Social Security System Premium Remittance List to cross check the list of
employees to whom compensation was paid.

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 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

4.2 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.

4.3 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
e. Interest on loan at less than market rate to the extent of the difference between the market
rate and actual rate granted
f. Membership fees, dues and other expenses borne by the 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. Fringe benefits which are authorized and exempted from tax under the Tax Code or under
any special law

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

c. Benefits given to the rank and file, whether or not granted under a collective bargaining
agreement.

d. De Minimis benefits, such as:

d.1 Monetized unused vacation leave credits of employees not exceeding ten (10) days
during the year

d.2 Medical cash allowance to dependents of employees not exceeding P750 per semester or
P125 per month

d.3 Rice subsidy of P350 per month granted by an employer to his employees

d.4 Uniforms given to employees by the employer

d.5 Medical benefits given to the employees by the employer

d.6 Laundry allowance of P150 per month

d.7 Employee achievement awards (e.g. for the length of service or safety achievement)
which must be in the form of a tangible personal property other than cash or gift certificate, with
an annual monetary value not exceeding one-half (1/2) 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

d.8 Christmas and major anniversary celebrations for employees and their guests

d.9 Company picnics and sports tournament in the Philippines and are participated
exclusively by employees

d.10 Flowers, fruits, books or similar items given to employees under special circumstances
(e.g. on account of illness, marriage, birth of a baby, etc.).

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

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

4.5 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%

4.6 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))

b. An alien individual employed by:

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

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

4.7 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.

4.8 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.

4.9 Disallow claims for fringe benefits in excess of supported amounts or where the payees
are determined to be fictitious.

5. Rents

5.1 Verify pertinent provisions of the lease contract with the lessor.

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

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.

5.4 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.

5.5 Determine if there are any capital expenditures included in the accounts.

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

6. Royalties

6.1 Verify minute book and pertinent provisions of the contract with the lessor.

6.2 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.

6.3 Determine whether the proper amount of final withholding tax has been withheld and
remitted.
6.4 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 Verify sources of interest expenses such as actual notes, loans, mortgage or bond
instruments. Check whether the indebtedness is business related.

7.2 Determine the accounting method used by the taxpayer. If he uses accrual basis, only the
interest accruing during the taxable year is deductible.

7.3 Determine if interest paid or accrued applies to obligations due to related taxpayers.
Consider such items as:

a. Arm's length features

a.1 Bona fide obligations

a.2 Interest in excess of the prevailing rates in unrelated transactions.

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

7.4 Determine if deductions claimed relate to interest incurred in carrying tax 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.

7.7 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).

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

8. Taxes
8.1 Verify whether only the taxes properly paid or accrued during the year have been
claimed.

8.2 Determine that no protested taxes or reserves for deficiency taxes upon audit are claimed.

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

a. Income tax provided for under the Tax Code;

b. Income, war profits and excess profits taxes imposed by authority of any foreign country;

c. Estate and gift taxes; and

d. Taxes assessed against local benefits of a kind tending to increase the value of the
property assessed.

8.4 Determine if the taxpayer has title to the real and personal property being taxed.

8.5 Determine if there are any taxes on the purchase of capital assets that were already
capitalized but also charged to expense account.

9. Repairs

9.1 Determine depreciation policy of the taxpayer. A conservative depreciation policy often
contemplates a high degree of current repair expenditures.

9.2 Verify nature of expenditures. If the expenditure prolongs the life or enhances the value
of the existing assets, then it is not deductible but should be capitalized and depreciated over the
years of their estimated usefulness.

9.3 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

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

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

10.4 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.
10.5 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.

10.6 Determine if the method of deducting bad debts is acceptable and consistent with the
method applied in the preceding year.

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

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 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:

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. 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

b. 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. Refer to audited financial statements and audit reports to check if the net loss was
incurred during the first ten (10) years of operation;
b. Check if the period/taxable year when loss is claimed is within five (5) taxable years
following the loss; and

c. 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 Compare total depreciation as shown by the depreciation schedule with the 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.

12.3 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.

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

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

12.6 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.

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

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.
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.

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 Determine if the donee or recipient is the government or an accredited relief organization.

14.2 Determine if the contribution is to be utilized for the rehabilitation of calamity stricken
areas declared by the President.

14.3 Verify if the claim is actually paid within the taxable year.

15. Transportation and Travel, Representation and Entertainment

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

15.2 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

15.3 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.

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.

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

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

15.8 Determine from the analysis and verification of supporting documents the reliability of
the records.

15.9 Determine company-owned vehicles and the expenses incurred in connection with these
vehicles.

16. Stationery and Office Supplies

16.1 Determine if the expenses claimed are not capitalizable office furniture and equipment.

16.2 Verify if personal purchases by the taxpayer/owner are included in the account.

16.3 Determine the reasonableness of the expenditures.

16.4 Compare receipts with the amounts claimed and investigate significant discrepancies.

17. Professional Fees

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

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

17.3 Check legal expenses or representation expenses as it might at times be political

contributions, bribes or kickbacks, which should be disallowed.

17.4 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.

18. Insurance Expenses

18.1 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.
18.2 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. 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

b. Only the spouse claiming the additional exemption for dependents shall be entitled to this
deduction.

18.3 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.

18.4 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 Determine material amounts claimed as it may include capitalizable electrical equipment
or purchases of capital items from utility companies.

19.2 Examine the receipts issued by the utility companies. Compare the same with the
amounts claimed per return. Investigate material discrepancies.

19.3 Determine if there are personal expenses included in the expense account.

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

XI. Audit of Minimum Corporate Income Tax and Improperly Accumulated Earnings 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 Domestic corporations operating as proprietary educational institutions subject to ten

percent (10%) income tax rate;

1.2 Domestic corporations engaged in non-profit hospital operations subject to ten percent
(10%) income tax rate;

1.3 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;

1.4 Resident foreign corporations engaged in business as international carrier subject to

21/2% income tax on the "Gross Philippine Billings";

1.5 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) 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;

1.6 Resident foreign corporations engaged in business as regional operating headquarters

subject to ten percent (10%) tax on their taxable income; and

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

2. 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.

2.1.3 Ascertain legitimacy of deductions from gross sales such as sales returns, discounts and
allowances.

2.2 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. 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.

b. 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 warehouse.

c. 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. Determine the period when the taxpayer becomes subject to the minimum corporate
income tax.

3.2 Verify the year of taxpayer's registration with the BIR to ascertain whether or not it is
subject to MCIT:

a. Firms registered with BIR in 1994 and earlier years are covered by the MCIT beginning
January 1, 1998.

b. 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.

3.3 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.

4. 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.

5. 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.

B. Improperly Accumulated Earnings Tax

In accordance with Section 29 (A) of the Tax Code, an improperly accumulated 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. 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. 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.

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

a. Nature of the company's business;

b. Financial condition of the corporation at the close of the taxable year;
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;
f. Retention of cash, securities and other assets unrelated to the business operations;
g. Advances or loss to stockholders, whether or not interest shall be paid;
h. Dealings between the corporation and its stockholders, such as withdrawals by the
shareholders as personal loans or the expenditure of funds by the corporation for the personal
benefit of the shareholders;
i. The investment by the corporation of undistributed earnings in assets having no
reasonable connection with the business;
j. The need for business expansion;
k. The earnings and expansion history of the taxpayer;
l. Past savings effected by non-distribution of profits to stockholders;
m. Past tax avoidance history of the corporation;
n. Portion of shareholder's assets transferred to the corporation;
o. Sudden shift in corporate or dividend policy of the company;
p. The percentage of income distributed to shareholders during the taxable year; and
q. Retirement of stocks, this being a capital transaction and should result in reduction of
capital instead of reduction of earnings and profits.

2.2 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.

2.3 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. The profit is retained for working capital needed by the business;

b. The profit is invested in additions to plants, facilities and activities reasonably required
by the business provided that 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.

c. The accumulation of earnings is in accordance with contract obligations placed to the

credit of a sinking fund for the purpose of retiring bonds.

d. The profit is intended as reserves to meet competition, for anticipated losses or reverses
in business, and to meet business hazards and emergencies.

2.4 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.

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

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

3.2. 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.

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

3.4 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.

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

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.

B. Accounting Software Systems

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;
e. Reconcile the information reflected in the books, financial statements and the tax returns;
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
k. 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:

a. Find out what type of system software is being utilized.

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

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.

1. Unusual in Amount

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.

2. Unusual by Source
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.

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

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. Profit Margin

Net Income
----- = Profit Margin
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. The taxpayer maintains no books and records.

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 xxx
Less: Liabilities xxx
--
Net Worth xxx

Less: Prior Year's Net Worth xxx

--
Increase (Decrease) in Net Worth xxx
Add: Non-deductible items
Personal, lining and family
expenses xxx
Income tax payments xxx
Insurance Premiums xxx
Gifts xxx
Non-deductible contributions xxx
Net capital loss xxx
Amnesty tax payments xxx
Estate and donor's taxes xxx
Other non-deductible items xxx xxx
--
Net Income before further
adjustments xxx
Less: Non-taxable items
Gifts, donations and
Inheritance received xxx
Non-taxable stock
Dividends (if reflected
in Assets) xxx
Retirement pay from SSS xxx
Non-recognized gains
from exchange of
property under Sec. 40
of the Tax Code xxx
Social Security benefits
received from foreign
 gov't. and institutions
(PD220) xxx
Other non-taxable items xxx
--
Total non-taxable items xxx
--
Adjusted net income per investigation xxx
Less: Statutory Exemptions: xxx
1. Exemption of Working
Wife xxx
2. Personal and addt'l.
exemption xxx
3. Special additional
exemption xxx
--
Total Statutory exemption xxx
--
NET INCOME SUBJECT TO TAX xxx
===
2. Burden of Proof

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 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

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.

C. Bank Deposit Method

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.

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 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?

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

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

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

2. Computation of Gross Receipts Through Bank Deposit Method

Total Reconciled Bank Deposits xxx

Less: Non-taxable receipts
deposited (sch. 1) xxx
--
Net Deposits that resulted from
taxable receipts xxx
Add: a. Business expenses
paid in cash (sch. 2) xxx

b. Capital items paid

in cash xxx

c. Personal expenses
paid in cash (sch. 3) xxx

d. Cash accumulated
during the year from
receipts xxx

e. Increase in
Accounts Receivable xxx

f. Decrease in accounts
payable xxx xxx
-- --
Total xxx

Less: Non-taxable cash used in

 (a) thru (d) xxx
Decrease in accounts
receivable xxx
Increase in accounts
payable xxx xxx
-- --
Gross Receipts xxx
===

Schedule 1 Non-Taxable Receipts include:

- 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 xxx
Less: Total checks written xxx
Non-business expenses
paid by check xxx
Business expenses paid in check xxx
--
Business expenses paid in cash xxx
===
Schedule 3 Personal Expenses Paid in Cash
Total personal expenses xxx
Less: Business expenses paid in cash (xxx)
--
Personal expenses paid in cash xxx
===

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 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

 Variables for
Item Being Estimate of Item
Industry Tested Being Tested

Pizza Parlor Sales Pounds of flour

used multiply by
number of pizzas
per pound multiply
by average price
per pizza

Gas Station Gasoline Sales Number of liters

sold per supplier's
invoices multiply
by average price
per liter
Exercise Patronage Membership
statistics, club
individual
membership fees,
or monthly dues
Hotels Room Revenue Number of rooms
multiply by
occupancy rate
multiply by
average room rate
Laundry Washer and Cost per machine
Dryer load multiply by
number of times
machine was used
during business
hours and number
of machines
Professional Fees Billed Number of
employees
multiply by
utilization rate
multiply by hours
in a year multiply
by average billing
rate
Real Estate Rental Number of rental
Revenue units multiply
occupancy rate
multiply by
 average rent

F. 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 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 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).

1.2 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.
1.3 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.

1.4 Examine monthly withholding tax remittance returns (BIR Form 1601C) and compare
amounts remitted against the computed withholding tax on compensation per audit.

1.5 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.

2. 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).

2.2. 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.

2.3 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.

2.3 Verify the correctness of the payee classification and withholding tax rate applied.

2.5 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.

3. Final Withholding Taxes

3.1 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.

3.2 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.

3.3 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 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.

3.5 Verify correctness of remittance against monthly remittance returns (BIR Form 1601F)
and annual information return (BIR Form 1604CF).

4. Withholding Tax on Government Money Payments

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

4.2 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.

4.3 Determine the correctness of bases and rates of tax applied.

4.4 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.

B. 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

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

Certificate of Title (OCT)

1.3 Latest Tax Declaration

2. If the object of the sale or disposition is the principal residence of natural persons, verify
the following:
2.1. Whether the proceeds of the sale or disposition was fully utilized in acquiring or
constructing a new principal residence of the seller; and

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

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
Amount
---------------------- X 6%
Gross Selling Price

3. 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.

4. Ascertain correctness of the value of the property sold by conducting an ocular inspection
of the property.

5. 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.

6. 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. Total Selling Price/

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

b. Improvements introduced
from 1991 to present:
Construction cost per
building permit and/or
occupancy permit xxx
Improvements introduced
in 1986 to 1990:
Construction cost per
building permit and/or
occupancy permit xxx
Add 10% thereof per
year after year of
Construction xxx
--
Value of Improvements xxx
===

c. 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 xxx
Add: 100% of the FMV of the
improvements per latest tax
declaration, if classified as
residential or agricultural other
than fishpond/prawn farm xxx
or
150% of FMV of the
improvements per latest tax
declaration, if classified as
commercial, industrial and/or
agricultural devoted to
fishpond/prawn farm xxx
--
Value of improvements xxx
6.1.2 Determine tax base of land and improvements as follows:

Zonal value of land xxx

Add: Value of
Improvement under
a, b or c of 6.1.1, as
applicable xxx
--
Tax base of land and
improvements xxx
===

6.2 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 xxx
or
150% of FMV of
land per latest tax
declaration, if
classified as
commercial,
industrial and
agricultural devoted
to fishpond/prawn
farm xxx
--
Value of land
Add: Value of
improvements xxx
(from b or c of 6.1.1)
Value of Land and
Improvements xxx
--
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 xxx
===

7. 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.

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, 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 P100,000

Total Tax
Due at
6% thereof 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. Installment payment received P16,000

b. Total selling price P100,000
c. Total capital gains tax P6,000
d. Amount payable
annually (a) divided by
(b) multiplied by (c) 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.

The tax payments on installments received is computed as follows:

Computation of total capital gains tax:

Selling Price P100,000

Total Tax Due
at 6% thereof P6,000

Computation of taxes payable on installments:

Upon receipt of first payment

First payment received P10,000
Total contract price:
Selling Price P100,000
Less: Mortgage
assumed by buyer 40,000
----
Total contract
price 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 P12,500
---------
Total contract price P60,000
---------
Total capital gains tax P6,000
---------

Annual tax payable on installments:

[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 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 P100,000
Total Tax
Due at 6% thereof P6,000

Computation of tax payment in the year of sale:

First payment:
Cash P10,000
Excess of mortgage
assumed by buyer
over the
acquisition cost
(P50,000-P40,000) 10,000
---------
Total first payment 20,000
=======
Total Contract Price:
Selling Price P100,000
Less: Mortgage
Assumed 50,000
---------
 P50,000
Add: Excess of
mortgage
assumed
over basis of
property sold 10,000
----------
Total contract price P60,000
=======

Total basis of tax payable on first payment:

First payment P20,000

Contract Price P60,000
Total capital gains tax P60,000

Amount of tax payable on first payment:

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

Basis of tax payable on succeeding semi-annual payments:

Installment
received P10,000
Total contract
price P60,000
Total tax due P6,000
Amount of tax payable semi-annually:
[P10,000/P60,000] x 6,000 = P1,000
======

8. 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.

9. 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.

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".

2. If the settlement of the estate of the decedent is the object of judicial testamentary or
intestate proceedings, ascertain if:

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

2.2 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.

3. 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.

4. 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.

5. 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:
5.1 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;

5.2 Itemized deductions from gross estate allowed under Sec. 86 (A) of the Tax Code; and

5.3 The amount of tax due whether paid or still due and outstanding.

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

7. 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.

8. 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.

9. 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.

10. 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.

11. 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.

12. 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 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.

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 market value of the stocks to be valued.

12.2 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. The nature of the business and the financial history of the enterprise, from the date of the
incorporation;
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;
g. Sales of stocks and size of the block of stock to be valued;
h. Market price of stocks of corporations engaged in the same or similar line of business to
be valued;
i. Existence of corporate debts in favor of the family of the principal;
j. Restrictive agreements impairing the alienity of the stock;
k. Investments in business or property maintained at a deficit;
l. Dividend arrearages;
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.

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

13.1 Funeral Expenses

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.

13.2 Judicial Expenses

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 Claims Against The Estate

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. 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.

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 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.

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.

13.7.2 The loss must not have been compensated for by insurance, 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. 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;

b. 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

c. 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 P5,000,000

Family Home 2,000,000
-----
Gross Estate P7,000,000
(Less): Deductions
Other deductions P2,000,000
Family home 1, 000,000
Standard deduction 1,000,000 (4,000,000)
----- -----
Net Taxable Estate 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 P5,000,000

Family home 800,000

-----
Gross Estate P5,800,000

(Less): Deductions
Other deductions P2,000,000
Family home 800,000
 Standard deduction 1,000,000 (3,800,000)
----- -----
Net Taxable Estate 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 Total

Conjugal Properties:
Real properties P5,000,000 P5,000,000

Exclusive Properties:
Family home P2,000,000
Other exclusive properties 2,500,000 4,500,000
----- ----- -----

Gross Estate P4,500,000 P5,000,000 P9,500,000

(Less): Conjugal Deductions

Other deductions (2,000,000) (2,000,000)
----- ----- -----
Net Estate After Conjugal
Deductions P4,500,000 P3,000,000 P7,500,000

(Less):

Share of surviving spouse

(P3,000,000/2)
Family home
Standard deduction
Net Taxable Estate
(1,500,000)(1,500,000)
(1,000,000) (1,000,000
(1,000,000) (1,000,000)
------------ ---------- ------------
P3,500,000 P500,000 P4,000,000
========= ========= =========

b. Family home is a conjugal or community property

Exclusive Conjugal Total

Conjugal Properties:
Family home P2,000,000 P2,000,000
Other real properties 5,000,000 5,000.000
Exclusive Real Properties P2,000,000 P2,000,000
-------------- ------------- -------------

Gross Estate P2,000,000 P7,000.000 P9,000,000

(Less): Deductions:
Conjugal deductions (P2,000,000) (P2,000,000)
Share of surviving
spouse:
Conjugal property P7,000,000
Less: Conjugal 2,000,000
------------
deductions P5,000,000

Net conjugal estate

1/2 Share of surviving
spouse (2,500,000) (2,500,000)
Family home (1,000.000) (1,000.000)
Standard deduction (1,000,000) (1,000,000)
-------------- ------------- ------------
Net Taxable Estate P2,000,000 P500,000 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 Total

Conjugal Properties:
Family home P1,500,000 P1,500,000
Other real properties 5,000,000 5,000,000
Exclusive Real Properties P2,000,000 2,000,000
------------- ------------- ------------

Gross Estate P2,000,000 P6,500,000 P8,500,000

(Less): Deductions:
Conjugal deductions (2,000,000) (2,000,000)

Share of surviving
spouse:
Conjugal property P6,500,000
Less: Conjugal
deductions 2,000,000
------------
Net conjugal estate P4,500,000
 1/2 Share of surviving
spouse (2,250,000) (2,250,000)
Family Home (750,000) (750,000)
Standard deduction (1,000,000) (1,000,000)
--------------- ------------- -------------

Net Taxable Estate P2,000,000 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 1/2 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 Total

Conjugal Properties:
Other real properties P3,000,000 P3,000,000
Family home 1,000,000 1,000,000
Exclusive Real Properties
Other real properties P2,000,000
Family lot 400,000 2,400,000
--------------- -------------- ---------------
Gross Estate P2,400,000 P4,000,000 P6,400,000

(Less): Deductions:
Other deductions (1,000,000) (1,000,000)
Share of surviving
spouse
Conjugal properties P4,000,000
Less: Conjugal
Deductions 1,000,000
-------------
Net conjugal estate P3,000,000
1/2 Share of surviving (1,500,000) (1,500,000)
spouse
Family home and lot P400,000 (500,000) (900,000)
(P500,000 + P400,000)
Standard deduction (1,000,000) (1,000,000)
-------------- --------------- --------------
Net Taxable Estate P2,000,000 P- P2,000,000
========= ========= ========

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

Exclusive Conjugal Total

Conjugal Properties:
Real properties P6,000,000 P6,000,000
Personal properties 4,000,000 4,000,000
Family home 2,000,000 2,000,000
Exclusive Properties:
Real properties 4,000,000 4,000,000
Personal properties 1,000,000 1,000,000
-------- ---- ------------- ------------
Gross Estate 5,000,000 12,000,000 P17,000,000
(Less): Deductions:
Conjugal deductions 4,000,000 4,000,000
------------ ------------ -----------

Net Estate 5,000,000 8,000,000 P13,000,000

Less: Share of surviving spouse (4,000,000) (4,000,000)
Family home (1,000,000) (1,000,000)
Standard deduction (1,000,000) (1,000,000)
------------ ------------- ---------------
Net Taxable Estate 5,000,000 P2,000,000 P7,000,0000
========= ========= =========

b. Estate of WIFE:

Inherited Share from

Portion from Conjugal Total
Husband Estate

Conjugal real properties P750,000 * P3,000,000 P3,750,000

Conjugal personal properties 500,000 * 2,000,000 2.500,000
Family home 250,000 * 1,000,000 1,250,000
Exclusive properties 1,000,000 - 1,000,000
Paraphernal/exclusive personal
properties 250,000 - 250,000
------------ -------------- -------------
Gross Estate P2,750,000 P6,000,000 P8,750,000
(Less): Deductions:
Other deductions P500,000 (2,000,000) (1,000,000)
Family home (1,000,000) (2,500,000)
Standard deduction (1,000,000) (1,000,000)
Vanishing deduction **(1,964,286) (1,964,268)
-------------- ------------- -------------
Net taxable estate P285,714 P2,000,000 P2,285,714
 ======== ========= ========

* In addition to 1/2 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.

** Vanishing deduction:

Inherited properties P2,750,000

Less: 2,750,000 x P2,500,000 =
-------------------------
8,750,000 785,714
--------------

Amount subject to vanishing deduction P1,964,286

100% Vanishing Deduction P1,964,286

========

13.9 Standard Deduction

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. It must be substantiated by receipts.

b. 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 included in the gross estate of the decedent.

13. 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 (1/2), representing the share of the deceased, is
subject to VAT.

D. 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. 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.

2. 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.

3. Ascertain authenticity of the following documents:

3.1 Deed of Donation

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

Certificate of Title (OCT), for real properties

3.3 Latest Tax Declaration, for real properties

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.

6. 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.

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

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

9. 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 Ascertain the correct balance of the indebtedness as of the time of the donation.

9.2 Verify the genuineness of the deduction claimed and require the submission of pertinent
documents in support of the deduction.
9.3 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

1.1 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.

2. Special Investigation Division (SID)

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

3. 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.

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.

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 pertaining thereto.

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, 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.

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, through the ES, 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. 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.

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 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 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 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. 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.

4. The RDO shall then assign a RARO to assist and coordinate with the SID in the
investigation of the said case.

A. 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 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.

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 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)

This form, which shall be duly accomplished by the Revenue Officer, indicates the dates when
the docket was received and acted upon.

B. Table of Contents

The table of contents shall indicate the description and page number of each and every document
attached to the report.

C. Narrative 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 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.

2. 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;

2.4 the authorized representative of the taxpayer; and

2.5 the dates and results of conferences.

3. Results of investigation summarizing:

3.1 the audit findings;

3.2 discrepancies discovered, disallowances made and other relevant facts uncovered during
the examination;

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

4. A recommendation for:

4.1 the review/approval of the report of investigation and issuance of termination letter after
collection of the deficiency tax;

4.2 assessment of deficiency taxes indicating the prescription of the case;

4.3 issuance of tax credit/refund; or

4.4 such other recommendations as may be necessary under the circumstances.

D. 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 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.

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.

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

2. Working papers showing discrepancies, disallowances, adjustments and computation of

deficiency taxes

3. Reconciliation of net income per financial statements with the net income per income tax
return

4. Schedule of income producing property, if applicable

5. Schedule of taxes and licenses

6. Schedule of depreciation

7. Schedule of loans/notes/accounts payable and interest expenses/advances from

officers/stockholders

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

F. 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 All tax returns with all the required attachments for the year/period under audit;

1.2 Duplicate copy of Letter of Authority duly received by the taxpayer or his representative;

1.3 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);

1.10 Photocopy of Payment Form and Official Receipt as evidence of deficiency tax payment;

1.11 Comparative report of deficiency tax paid/assessed;

1.12 Post reporting notice/notice for an informal conference with the summary of findings (for
non-agreed assessment);

1.13 Logsheet/record of time spent by Revenue Officer(s);

1.14 Proof of exemption under Special Law, if applicable;

1.15 Delinquency verification report [for claims for refund/Tax Credit Certificate (TCC)]; and

1.16 Authority to issue refund/TCC (for claims for refund/TCC).

2. 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

ATTACHMENTS

June 9, 1995

REVENUE MEMORANDUM ORDER NO. 15-95

(amended by RMO 31-95)

SUBJECT : General Policies in the Investigation of Tax Fraud Cases.

TO : All Internal Revenue Officer and Other Concerned

A. 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 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 officer 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

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. SPECIAL INVESTIGATION DIVISION

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.
2.1.3 Tax fraud cases referred to it by the RDO.

3. 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.

This shall be considered sufficient compliance with RMO 44-93.

C. 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.

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. 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.

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 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

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.

E. ATTRIBUTION OF COLLECTION

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.

F. PENAL CLAUSE

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.

G. REPEALING CLAUSE
Any provision of any order and pertinent issuances inconsistent with his Order is hereby
revoked, modified or amended accordingly.

H. EFFECTIVITY

This Revenue Memorandum Order takes effect immediately.

(SGD.) LIWAYWAY VINZONS-CHATO

Commissioner

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 and proper tax by
fraudulent means. "The fraud contemplated by law is actual and not constructive. It must be
intentional fraud, consisting of deception willfully and 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.

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" - 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.

Effects of Fraud under the National Internal Revenue Code (NIRC)

1. Civil penalties rise to the imposition of the 50% surcharge; to be imposed by the BIR;

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;

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 False or fictions claims of deductions;

1.1.3.3 Misclassification of deductions -

Investments or major repairs or improvements claimed as nominal expenses;

1.1.3.4 Dividend declarations classified as expenses or salaries;

1.1.3.5 Withdrawals claimed as expenses or compensation;

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.Omission or understatement of taxable sales/income-

1.2.1.2 Keeping falsified books of accounts;

1.2.1.3 Non-issuance of sales invoices, or under- recording of sales to conceal the amount of
sales subject to business taxes on VAT;

1.2.1.4 Claiming fictions tax credits;

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 Deducting returned sales which were not actually returned.

1.2.2 Misclassification of sales or income -

1.2.2.1 Classifying sales as exempt when in fact they are 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 Claiming fictitious tax credits on non-existing invoices.

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;

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.

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. Increase in net worth, plus

b. Non-deductible item, less
c. Non-taxable income or receipts subjected to final tax or transfer
taxes, equals
d. Taxable net income, less
e. Personal and additional exemptions, equals
f. 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 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) The need for evidence of the source of income under this method:

"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 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) Use of false invoices or documents, and
(8) Willful destruction of accounting records.

2. 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, 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) xxx

(3) Payments of debts, payables, accruals,

and other liabilities - taken up in the ITR
and those not taken up, such as personal
and other liabilities. xxx

(4) 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 P xxx

B. Sources of Cash:

(1) Declared income per Income Tax Return xxx

Deduct: Accounts Receivables if taxpayer
is on cash basis method of accounting (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

(6) Cash at the beginning of the period xxx xxx

----- -----
Excess Cash as determined per Investigation 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.

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) Records of logs exported to the Forest management Bureau.

D. 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.

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;
22. Inadequate explanation for dealing in large sums of currency, or the 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;
32. Destruction of books and records, especially after the investigation was started;
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.

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) Review all available information;

(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) Understanding clearly the elements of the offense.

(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;

(b) Relative importance of the desired information;

(c) Best sources of information; and

(d) Best sequences for making the necessary inquiries.

(5) Gather background information:

(a) Obtain as much information as possible on the suspect;

(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.

G. PREPARATION AND ASSEMBLY OF REPORTS FOR FRAUD CASES

(1) Planning the 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.

(2) Assembly of a report:

A report should be assembled in the following manner:

(a) Table of Contents

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.

(b) Body of the Report

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;
b-7 Letter of Authority number, date issued, issuing of officer
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.
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 Explanation and defense of taxpayer
b-14 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

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")

(d) Appendices, Worksheets and Schedules

Appendices, worksheets and schedules should be arranged in 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 Dec. 31, 1993 Dec. 31, 1994

ASSETS (Net of Depreciation)

1. Cash on Hand ** Pxxxx Pxxxx

2. Cash in Banks xxxx xxxx
3. Accounts, Notes & Loans Receivable x x x x xxxx
4. Mortgage Receivable xxxx xxxx
5. Investments xxxx xxxx
6. Real Property - Land xxxx xxxx
7. Real Property - Improvements xxxx xxxx
8. Motor Vehicles xxxx xxxx
9. Inventory at the end xxxx xxxx
10. Furniture/Fixtures xxxx xxxx
11. Personal Properties xxxx xxxx
12. Other Assets xxxx xxxx
--------- --------
Total Assets Pxxxx Pxxxx

LIABILITIES
1. Accounts, Notes & Loans Payable Pxxxx Pxxxx
2. Mortgage, Payable xxxx xxxx
3. Other Liabilities xxxx xxxx
---------- ----------
Total Liabilities Pxxxx Pxxxx
----------- -----------
Net Worth at the End Pxxxx Pxxxx
====== =======
Less:

Net Worth at the Beginning xxxx

--------
Increase (Decrease) in Net Worth Pxxxx

** Supported by accompanying Cash Analysis Schedule

Add: Non-deductible Items

1. Personal, living and family expenses Pxxxx

2. Insurance premiums xxxx
3. Income tax payments xxxx
4. Gifts to others xxxx
5. Non-deductible expenses, taxes and
contributions not directly connected with
business of taxpayer xxxx
6. Net capital loss xxxx
7. Amnesty tax payments xxxx
8. Estate and Donor's taxes xxxx
9. Final tax payments xxxx
10. Other expenses which are non-deductible xxxx
--------
Total Non-deductible Items Pxxxx
---------

Net Income before further adjustments Pxxxx

---------

Less: Non-taxable items and income and

proceeds subjected to final tax:

1. Gifts, donations & Inheritance received Pxxxx

2. Non-taxable capital gains xxxx
3. Backpay/Pensions non-taxable xxxx
4. Proceeds of Life Insurance Policy xxxx
5. Non-taxable stock dividends (provided stocks
are reflected in Assets) xxxx
6. Pensions received under RA 4917 (private firms) xxxx
7. Retirement pay from GSIS and SSS xxxx
8. Non-recognized gains from exchanges of
property under Sec. 34(c)(2) of the Tax
code of 1988 xxxx
9. GSIS Cash Dividends xxxx
10. Social Security benefits received from
foreign government and institution (per PD 220) xxxx
11. 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.) xxxx
12. Other exempt income xxxx
13. Proceeds of sale of Real Estate subjected to
final tax under Sec. 21(e) of the Tax Code
of 1988 xxxx
--------
Total Non-taxable items Pxxxx
---------
Adjusted Net Income as per Investigation Pxxxx
----------
Less: Statutory exemptions:
Personal & additional exemption xxxx
----------
NET INCOME SUBJECT TO TAX xxxx

Income tax due thereon xxxx

Less: Amount previously paid xxxx
---------
Deficiency income tax still due Pxxxx
Add: 50% surcharges, if fraud can be proven xxxx
5% surcharges for late payment xxxx
------------
Total amount due, exclusive of interest Pxxxx
=======

CASH ANALYSIS
(Revised to conform with provisions of recent laws)
- 1994 -

Source of Funds -

Cash on hand and in bank at the beginning P xxxx

Add: 1. Cash received from business (sales) P xxxx
2. Collection of receivables xxxx
3. Proceeds of loans and mortgages xxxx
4. Proceeds of life insurance policies xxxx
5. Proceeds from sale of property, real or personal xxxx
6. Cash gifts, bequests and inheritance received xxxx
7. Non-fund deductions (depreciation
and provision for bad debts) xxxx
8. Backpay, pensions, benefits, gratuities received xxxx
9. Cash dividends & interest income xxxx
10. Wagering gains xxxx
11. Receipt of cash from any other source xxxx xxxx
------ ------
Total Available Funds for the Year P xxxx

Less: Application of Funds

*1. Cash purchases & business expenses xxxx
2. Cash paid for assets/property, real
or personal (full payment of installment) xxxx
3. Payments of loans, notes &
mortgage payable xxxx
4. Section 30(c)(1)(A to D)
(non-deductible items) xxxx
5. Section 31(a) cash disbursement:
a. Personal, living or family expenses xxxx
b. Capital expenditures xxxx
c. Premiums paid on life insurance xxxx
6. Cash disbursement of any kind xxxx
7. Cash on hand and in bank at the end xxxx xxxx
------- ------
CASH ON HAND AT THE END AS
RECONSTRUCTED 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

EXHIBIT REF.

W1 Atty. ROBY CAPULON 1 PP. 66-72 1990 ITR and

Bureau of Internal Attachments
Revenue District
Officer RDO No. XX, 2 PP. 73-80 1991 ITR and
Manila Attachments
Tel. No. 315-62-22

W2 Atty. CARLS MIRANDA JR. 1 PP. 81-83 Memorandum of

Bureau of Internal Revenue Interview
Intelligence Officer with Joel
Special Investigation Div. Cruz,
Revenue Region X, Manila accountant of
Tel. No. 61-24-08 SING and FURR
INC. dated
July 12, 1994
2 P. 84 APPENDIX A -
Computation
of unreported
Gross Receipt
- 1990, 1991
3 P. 85 APPENDIX B -
Computation
Adjusted
Taxable Income
1990, 1991
4 P. 86 APPENDIX C -
Computation
of Deficiency
Taxes - 1990,
1991
W3 ANJIE FARUMOG 1 P. 12 Affidavit dated
Manager FLORR, INC. August 4, 1994
125 ABC St. QC 2 P. 13 Confirmation letter
Tel. No. 40-15-24 dated June 6, 1994

W4 RUSSEL ROMULO 1 P. 14 Worksheet-Summary

Owner, DELL, INC of Payments made on
80 XYZ St. Cubao Services rendered by
Tel. No. 62-12-43 SING and FURR,
 INC.
2 PP. 15-20 Cancelled checks
Payable to SING and
FURR, INC.
3 P. 21 Memorandum of
Interview dated
September 10, 1994

W5 EMILLE FRENILLE 1 P. 22 Worksheet-Summary

Comptroller, of Gross Payments
CONTEMPLATE CORP. made to SING and
17 Sta. Cruz, San Pablo, FURR, INC.
Laguna, Tel. No. 143-62 2 P.23-30 Certified Copies of
Invoices of SING and
FURR, INC.
3 PP. 31-36 Cancelled Checks
Payable to SING and
FURR, INC.

W6 SANDREX DUTERTE 1 P. 38 Worksheet-Summary

Manager, MAGGS ENT. of Payments to
317 Davao St. Manila SING and FURR,
Tel. No. 60-45-01 INC.
2 P. 39-46 Certified Copies and
FURR, INC.
3 PP. 47-53 Certified Copies of
Official receipts of
SING and FURR,
INC.

ANNEX "A-3"

SAMPLE

APPENDIX A
COMPUTATION OF UNREPORTED GROSS RECEIPTS - 1990, 1991
SING and FURR, INC.

ITEM 1990 1991 WITNESS EX- REFE-

DESCRIP-
HIBIT RENCE TION OF
NO. EVIDENCE

FLORR INC. 160,000.00 190,000.00 ANJIE FARUMOR W3-1 P. 12

Affidavit
Manager, FLORR INC. W3-2 P. 13 Confirmation
 Letter

DELL INC. 9000,000 1200,0000 RUSSELL ROMULO W4-1 P.14

Worksheet
Owner, DELL INC. W4-2P P. 15-20
Cancelled
Checks
W4-3 P. 21 Memorandum

CONTEMPLATE
CORP. 1000,0000 1,600,0000 EMILLE FRENILLE W5-1 P. 22
Worksheet
Comptroller W5-2P P. 23-30 Invoices
CONTEMPLATE
CORP. W5-3 PP. 31-36 Cancelled
Checks

MAGGS ENTER-
PRISE 500,0000 75,000.00 SANDREX DUTERTE W6-1 P. 38
Worksheet
Manager, MAGGS
ENT. W6-2 PP. 39-46 Invoices

---- ---- W6-3P P. 47-53 Official

Receipts
GROSS RECEIPTS
PER INVESTI-
GATION 4000,000 545,000.000

REPORTED GROSS Atty. ROBY CAPU-

RECEIPT LON W1-1P P. 66-72 1990
ITR
(160,000.00)(1900,0000) Rev. District Off. W1-2P P. 73-80 1991
ITR
------------ --------------

UNREPORTED RDO No. XX, Manila

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 1991 WITNESS EXHIBIT REFE-

DESCRIP-
(Particulars) NO. RENCE TION EVI-
DENCE

REPORTED 960,0000 P117,800.00 Atty. ROBY W1-1,2 PP. 66-80

1990, 1991
TAXABLE CAPULON ITRs
INCOME Rev. District Off.
RDO No. XX, Mla.

ADD: UNRE-
PORTED
GROSS RE-
CEIPTS 240,000.00 355,000.00 Atty. CARLS APPENDIX P. 84
Computation of
MIRANDA, JR. A Unreported
--------------- ------------ - Intelligence Officer Gross
Receipts
SUB-TOTAL 336,000.00 472,800.00

LESS: ADDI-
TIONAL
EXPENSES
OR DEDUC-
TIONS - -
--------------- ---------------
ADJUSTED P336,000.00 P4728,00.00 TO APPENDIX C
TAXABLE
INCOME ======== ========

ANNEX "A-3"

SAMPLE

APPENDIX C
COMPUTATION OF DEFICIENCY TAXES - 1990, 1991
SING and FURR, INC.

ITEM EXHIBIT REFERENCE

(Particulars) 1990 1991 WITNESS NO.
ADJUSTED
TAXABLE
INCOME 336,000.00 472,000.00 Atty. CARLS APPENDIX P.85
MIRANDA, JR. B
--------------- --------------- Intelligence Officer

INCOME TAX
--------------------

INC. TAX Due

Thereon 117,600.00 165,480.00
Less: TAX Due/
Return 336,00.00 41,230.00 Atty. ROBY CAPULON W1-1,2 PP. 66-
80
-------------- ------------- Rev. District Off.

BASIC TAX 84,000.00 124,250.00 RDO No. XX, Mla.

ADD: 25% SUR-
CHARGE 21,000.00 31,062.50
50% SUR-
CHARGE 42,000.00 62,125.00
========== =========

June 1, 1998 June 1, 1998

REVENUE MEMORANDUM ORDER NO. 53-98

SUBJECT : 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

TO : All Internal Revenue Officers, Employees and Others Concerned

I. 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.

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. OBJECTIVE

This order is issued to:

a. Identify the documents to be required from a taxpayer during audit, according to
particular kind of tax; and

b. Identify the different audit reporting requirements to be prepared, submitted and attached
to a tax audit docket.

III. 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 accounting/business records, specifically,
records affecting the income, receipts, deductions, estate and other taxable transaction of a
taxpayer during the audit.

IV. REPEALING CLAUSE

All existing issuances or parts thereof which are inconsistent herewith are hereby repealed.

V. EFFECTIVITY

This order takes effect immediately.

(SGD.) LIWAYWAY VINZONS-CHATO

Commissioner of Internal Revenue

ANNEX A

INCOME TAX/WITHHOLDING TAX

A) Requirements from Taxpayer

1) Certified Financial Statements, including comparative Profit and Loss Statement with
Statement of Cost of Goods Manufactured and Sold, if applicable

2) Proof of claimed tax credit/s, if applicable

3) Proof of the claimed "Interest Expense", if applicable

4) Proof of claimed Bad Debts/worthlessness of credits, if applicable

5) Reconciliation of "Book Income" and "Taxable Income"

6) Certificate of Registration issued by the appropriate regulatory agency, together with the
conditions attached to such registration, if applicable

7) Proof of Exemption under special laws, if applicable

8) Certification of the appropriate regulatory agency as to taxpayer's entitlement to tax

incentives, if applicable

9) Xerox copy of used Tax Credit Certificate with annotation of issued TDM at the back, if
applicable

10) Proof of payment of deficiency tax, if any/applicable

a) current year/period
b) previous year/period

11) Reports submitted to applicable regulatory agency that reflects the financial condition
and result of operation of the taxpayer e.g., 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) Letter of Authority/Audit Notice

2) 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.).

3) Proof of payment of the tax, including Tax Debit Memo/TCC

4) Quarterly Income Tax Returns

5) Proof of payment of second installment - INCOME TAX, if applicable

6) Beginning and Ending Inventory List, if material/applicable

7) Notice of Loss; Proof of claimed Losses, if applicable

8) Duly validated Monthly Withholding Tax Returns

9) Duly validated Quarterly Withholding Tax Returns, if applicable

10) Duly validated Annual Withholding Tax Returns together with the required attachments
(Alpha List)

11) Duly received Information Returns

12) Form 1717 Series / Form 0500 Series (Audit Reports)

13) Narrative Memorandum Report

14) Revenue Officer's Activity Report / Log Sheet

15) Table of Contents

16) Working Papers of the monthly debit and credit balances of all accounts duly signed by
the Tax Auditors/Revenue Officers
17) Working Papers showing computation of income and/or withholding taxes due duly
signed by the Tax
Auditors/Revenue Officers

18) Schedule of Advances

19) Schedule of Interest Expense and Loans / Notes Payable (mention the creditor/s, date
contracted/granted, principal loan, interest rate and interest expense), if applicable

20) Schedule of Bad Debts, if applicable

21) Schedule of Loss, if applicable

22) Schedule of Advances from Officers and Stockholders, if applicable

23) Schedule of Advances to Officers and Stockholders, if applicable

24) Schedule of Miscellaneous Income, if material/applicable

25) Schedule of Miscellaneous Expense, if material/applicable

26) Schedule of Interest Income (give details as to source/s and amount), if

material/applicable

27) Schedule of Other Receivables/Miscellaneous Receivables, if material/applicable

28) Schedule of Other Payables, if material/applicable

29) 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

30) Computation of Realized Gross Profit and Unrealized Gross Profit, if the taxpayer is
engaged in the business of selling personal properties by installment

31) Computation of Gross Income from Contracts, if the taxpayer is engaged in

"Construction Business"

32) Detailed reconciliation of "Book Income" and "Taxable Income", if necessary

33) Reconciliation of the Financial Statements' figures with the Withholding Tax Returns'
and Information Returns' figures

34) Checklist of audit procedures undertaken

35) Agreement Form (for agreed assessment)

36) Notice for an Informal Conference/Post Reporting Notice with the summary of findings
(for non-agreed assessment)

37) Comparative Report of Deficiency Tax Paid/Assessed, if applicable

a) current year/period

b) previous year/period

38) Docket Locator Form

39) Delinquency Verification Report (for Claims for Refund / TCC )

40) Authority to Issue Refund / TCC ( for Claims for Refund / TCC )

41) Breakdown of Control Accounts, if applicable

42) Certification by the Revenue District Office, that he could not locate the BIR copy of the
tax return etc., if applicable

43) Result of Tax Mapping Program or Third Party Information Program for LAs/Audit
Notices issued thereunder

Note:

In case of non-availability of documents from RDO / RDC mentioned in B.2 - B.11, request
photocopies thereof from taxpayer

ANNEX B-1

VALUE - ADDED TAX

(For audit involving Claim for Refund / TCC)

A.) Requirements from Taxpayer

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 Amount Total

Name of Number InvoiceDate of OR Date of Input Invoice
Supplier of Supplier Number InvoiceNo. of OR Purchase Tax
Amount

3) 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)

4) Summary of importations made during the period with the following details:

Date of AWB/ Date of Total Date of O.R.

InvoiceSupplier Item BL No. Arrival Value Payment No. VAT

5) 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)

6) 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

7) Certification of taxpayer showing the amount of Zero-rated Sales, Taxable Sales and
Exempt Sales

8) 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

9) Articles of Incorporation - for first time filers

10) Sales Contract/Agreement

11) BOI Certificate of Registration

12) BIR Certificate of Registration

13) Certification from BOI, DOF, BOC, EPZA, etc., that subject taxpayer has not filed
similar claim for refund covering the same period

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

15) 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
16) Copy of the ITR and Certified Financial Statements, if applicable

17) Beginning and ending inventory of raw materials, work-in-process, finished goods,
supplies and materials

III. 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:

1) 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

2) export declaration/permit

c. accredited agent bank showing that the proceeds of 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. 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

b. 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

c. Bank credit memoranda and certificate from the BSP with information similar to 1-c
(export sales)

Additional Requirements for Manning Services:

a) Monthly BSP report on income of agency received

b). 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

3) 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

c) Evidence of actual receipt of goods and services

Additional Requirements for Mining Companies:

a) Reconciliation of billings against actual collection

b) Operating agreement with owner of mining claims, if applicable

4) 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) Photocopy of import entry documents and official receipts/confirmation receipts of

payment issued by the Bureau of Customs for value-added tax paid

B.) 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)

Note:

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) Proof of claimed tax credits

2) Proof of payment of the tax

3) Xerox copy of used Tax Credit Certificate (TCC) with annotation of issued Tax Debit
Memo (TDM) at the back

4) Proof of payment of deficiency tax

a) current year/period

b) previous year/period

5) Certification of the appropriate government agency as to taxpayer's entitlement to tax

incentives, if applicable

6) Certificate of Registration issued by the appropriate regulatory agency, together with the
conditions attached to such registration, if applicable

7) Certification of the appropriate regulatory agency as to the exempt sales of the taxpayer
under its regulatory supervision, if applicable

8) Proof of exemption under special law, if applicable

9) Sample invoice for "Exempt Sales", if applicable

B) Reporting Requirements to be prepared and/or submitted by the Revenue Officers

1) Letter of Authority / Audit Notice

2) Duly validated Percentage Tax Returns, including all the attachments thereto

3) Tax Debit Memo applied, if applicable

4) Form 1717 series / 0500 series (Audit Reports)

5) Narrative Memorandum Report

6) Revenue Officer's Activity Report/Log Sheet

7) Table of Contents
8) Working papers showing the computation of the taxable receipts/sales (tax base) and
percentage tax due duly signed by the Tax Auditors/Revenue Officers

9) Reconciliation of Financial Statements' figures and Percentage Tax Returns' figures

10) Schedule of Exempt Sales/Transactions, if applicable

11) Checklist of audit procedures undertaken

12) Agreement Form (for agreed assessment)

13) Post Reporting Notice/Notice for an Informal Conference with the SUMMARY OF
FINDINGS (for non-agreed assessment)

14) Comparative Report of Deficiency Tax Paid/Assessed, if applicable

a) current year/period

b) previous year/period

15) Docket Locator Form

16) Delinquency Verification Report (For Claims for Refund/TCC)

17) Authority to Issue Refund/TCC (For Claims for Refund/TCC)

Note:

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) Proof of payment of the tax

2) Xerox copy of used Tax Credit Certificate (TCC) with annotation of issued TDM at the
back, if applicable

3) Proof of Exemption under special laws, if applicable

4) Proof of payment of deficiency tax, if any

a) current year/period

b) previous year/period

B.) Reporting Requirements to be prepared and/or submitted by the Revenue Officers

1) Duly filed Documentary Stamp Tax Declaration

2) Duly filed Documentary Stamp Tax Return

3) Tax Debit Memo, if applicable

4) Duly received Information Returns for Documentary Stamp Tax

5) Letter of Authority / Audit Notice

6) Form 1717 Series / Form 0500 Series (Audit Reports)

7) Narrative Memo Report

8) Revenue Officer's Activity Report / Log Sheet

9) Table of Contents

10) Working Papers showing details and computation of tax base duly signed by Tax
Auditors/Revenue Officers

11) Working Papers showing computation of Documentary Stamps Tax Due duly signed by
Tax Auditors/Revenue Officers

12) Checklist of audit procedures undertaken

13) Agreement Form (for agreed assessment)

14) Notice for an Informal Conference / Post Reporting Notice with the Summary of
Findings (for non-agreed assessment)

15) Comparative Report of Deficiency Tax Paid / Assessed

a) current year/period

b) previous year/period

16) Docket Locator Form

Note:

In case of non-availability of documents from RDO / RDC mentioned in B.1 - B.4, request
photocopies thereof from taxpayer

ANNEX E

ESTATE TAX

A.) Requirements from Taxpayer

I. General

1) Certified true copy of the DEATH CERTIFICATE

2) 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

3) DEED OF EXTRA-JUDICIAL SETTLEMENT OF THE ESTATE, if the estate is settled

extrajudicially

4) SPECIAL POWER OF ATTORNEY, if applicable

5) COURT ORDER/DECISION, if the estate is settled judicially

6) A certified copy of the schedule of partition of the estate and the order of the court
approving the same, if applicable

7) Statement of the names of the executor, administrator and/or heirs, with their respective
addresses, who may be made liable for unpaid assessment

8) 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

9) Copy of the decedent's life insurance policy, if applicable

10) Proof that the transfer of property is from a fiduciary heir or legatee to the
fideicommissary, if applicable

11) 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

12) 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 institution for administration
purposes, if applicable

13) Proof of deficiency tax payment, if any

a) current year/period

b) previous year/period

14) Requirements in the investigation of other internal revenue taxes, if they are covered by
the tax audit

II. Real Property

1) Certified true copy/ies of the Transfer/Original/Condominium Certificate of Title/s of real

property/ies (front and back pages);

2) Certified true copy of the latest Tax Declaration at the time of death;

3) "Certificate of No Improvement" issued by the Assessor's Office where properties have

no declared improvement;

4) 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;

III. Personal Property 1

1) Certificate of Deposit/Investment/Indebtedness owned by the decedent and the surviving

spouse,

2) Certificate of registration of vehicles and other proofs showing the correct value of the
same,

3) 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

4) Xerox copy of certificate of stocks

5) Proof of valuation of other types of personal property

IV. Allowable Deductions 2

1) 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;

2) 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, 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

3) 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)

4) Proof of Claimed Tax Credit

5) Proof of Claimed Losses

6) Proof of Claimed Medical Expenses claimed

7) Proof of Claimed "Transfer for Public Purpose", if applicable

B.) Reporting Requirements to be prepared and/or submitted by Revenue Officers

1) Letter of Authority (LA)/Return Verification Order (RVO)/Audit Notice, whichever is
applicable

2) Duly validated Estate Tax Return

3) Proof of payment of the tax

4) 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

5) Form 0500 series/Form 1717 Series (Audit Reports)

6) Narrative Memorandum Report, for cases covered by LA/Audit Notice

7) Revenue Officer's Activity Report/Log Sheet

8) Table of Contents, for cases covered by LA/Audit Notice

9) Duly prepared Letter of Confirmation issued by the reviewing office

10) Docket Locator Form

11) Certified photocopy of the zonal value of properties located outside of the investigating
region

12) Working papers reflecting items of gross estate and deductions duly signed by Tax
Auditors/Revenue Officers

13) Working papers showing computation of estate tax due duly signed by Tax
Auditors/Revenue Officers

14) Report of Ocular Inspection, if applicable

15) Detailed Schedule of deductions, if applicable

16) Reporting requirements for all the other internal revenue taxes, if they are covered by the
tax audit

Note:

In case of non-availability of documents from RDO / RDC mentioned in B.2 - B.4, request
photocopies thereof from taxpayer

1. if applicable
 2. 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) Certification of the balance of mortgage assumed by the donee

2) Sworn statement of the relationship of the donor to the donee

3) 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)

4) Proof of exemption for exempt donations, if applicable

5) Proof of claimed tax credit, if applicable

6) Proof of claimed deductions, if applicable

7) Sworn statement that no other donations were made within the same calendar year, if
applicable;

8) Proof of payment of deficiency tax, if any

II. Real Property

1) Certified true copy/ies of the Original/Transfer/Condominium Certificate of Title ( front

and back pages )

2) Certified true copy/ies of the latest Tax Declaration (front and back pages)

3) "Certificate of No Improvement" issued by the Assessor's Office where the property/ies

have no declared improvements

III. Personal Property

1) 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

2) Certificate of Deposit/Investment/Indebtedness/Stocks for donated cash and securities

3) Certificate of Registration of vehicle

4) Proof of valuation of vehicle

5) Proof of valuation of other types of personal properties

IV. Claimed Deductions

1) Proof of claimed deductions

B.) Reporting Requirements to be prepared and/or submitted by the Revenue Officers

1) Letter of Authority/Audit Notice/Return Verification Order, whichever is applicable

2) Duly validated Tax Return

3) Proof of tax payment

4) Duly notarized Deed of Donation

5) Duly notarized Deed of Extra-judicial Settlement of the Estate with waiver of rights, if
the waiver is subject to donor's tax

6) 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, duly signed by Tax Auditors/Revenue Officers

7) Form 1717 Series / Form 0500 Series (Audit Report)

8) Table of Contents, for cases covered by LA/Audit Notice

9) Docket Locator Form

10) Agreement Form (for agreed assessment)

11) Post Reporting Notice/Notice for an Informal Conference with a Summary of Findings
(for non-agreed assessment)
12) Report of Ocular Inspection, if applicable

13) Narrative Memorandum Report, for cases covered by LA/Audit Notice

14) Revenue Officer's Activity Report

15) Duly prepared Letter of Confirmation issued by the reviewing office

16) Certified photocopy of the zonal value of property/ies

17) Checklist of audit procedures undertaken

18) Detailed schedule of claimed deductions, if applicable

Note:

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) Proof of payment of the tax

2) Deed of Absolute Sale/Document of Transfer

3) Certified true copy of the Certificate of Title of the real property (front and back pages )

4) Certified true copy of the latest Tax Declaration (front and back pages)

5) "Certificate of No-improvement" issued by the Assessor's Office, if the property has no

declared improvement
6) Special Power of Attorney, if applicable

7) Seller's latest Certificate of Registration with HLURB or HUDCC and the latest
LICENSE TO SELL, if applicable

8) Seller's latest Certificate of Accreditation issued by the appropriate Real Estate Builders
Association, if applicable

9) 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

10) Proof of Exempt Transfers, if applicable

11) Proof of deficiency tax paid, if any

12) Certificate of Non-productivity of ricefield and other agricultural lands issued by the
Barangay Captain, if applicable

13) Xerox copy of location plan, if applicable

B.) Reporting Requirements to be prepared and/or submitted by the Revenue Officers

1) Duly filed Tax Return/Tax Declaration

2) Return Verification Order (RVO)

3) Form 1717 Series/Form 0500 Series (Audit Report)

4) Report of Ocular Inspection, if applicable

5) Revenue Officer's Activity Report/Log Sheet

6) Working Papers showing computation of deficiency tax due duly signed by the Revenue
Officer

7) Docket Locator Form

Note:

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) Requirements from Taxpayer

1) Proof of payment of the tax

2) Deed of Absolute Sale/Document of Transfer

3) Proof of acquisition cost

4) Xerox copy of stock certificates

5) Proof of claimed selling expense

6) Xerox copy of the latest Financial Statements of the issuing corporation with computation
of the book value per share

7) Proof of payment of deficiency tax, if any

B) Reporting Requirements to be prepared and/or submitted by the Revenue Officers

1) Duly filed tax return/tax declaration

2) 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

3) Form 1717 series/Form 0500 series ( Audit Report)

4) Return Verification Order (RVO)

5) Docket Locator Form

6) Revenue Officer's Activity Report

Note:

In case of non-availability of document from RDO / RDC mentioned in B.1, request photocopy
thereof from taxpayer

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) Xerox copy of Certificate of Registration

2) Proof of valuation of the motor vehicles

3) Deed of Sale/Document of Transfer

4) Proof of payment of the tax

5) Proof of payment of deficiency tax, if any

B) Reporting Requirements to be prepared and/or submitted by the Revenue Officers

1. Duly validated Tax Returns

2. Return Verification Order (RVO)

3. Form 1717 series/Form 0500 series (Audit Report)

4. Working paper showing computation of the tax due duly signed by the Tax
Auditor/Revenue Officer

5. Docket Locator Form

6. Revenue Officer's Activity Report

Note:

In case of non-availability of document from RDO / RDC mentioned in B.1, request photocopy
thereof from taxpayer
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