Electronic documents: A valid evidence to substantiate business expenses?

Incurring expenses is a normal part of business operations. For Income Tax purposes, expenses may be claimed as a deduction provided that these expenses are allowable deductions under the Tax Code, and they comply with the requirements of deductibility.

The Tax Code and several court cases have discussed that for an expense to be deductible, a taxpayer must prove that the expense was paid or incurred within the taxable year, and, is an ordinary and necessary expense in the conduct of the taxpayer’s business or profession. There is a 1981 Supreme Court (SC) case that laid down some guiding principles in determining whether an expense is ordinary and necessary. In the said case, the SC noted that an expense will be considered “necessary” where the expenditure is appropriate and helpful in the development of the taxpayer's business. On the other hand, it is “ordinary” when it connotes a payment that is normal in relation to the business of the taxpayer and the surrounding circumstances. The term ordinary does not require that the payments be habitual or normal in the sense that the same taxpayer will have to make them often; the payment may be unique or non-recurring to the particular taxpayer affected.

The expense should also be subjected to withholding tax, if applicable.  In addition, the expense must be substantiated with sufficient evidence, such as official receipts and other adequate accounting records. The latter requirement may be an area of difficulty for some taxpayers, especially for those who have moved or are planning to move to a paperless system. The question, therefore, is if a digitized document satisfies the substantiation requirement for the deductibility of an expense.

A similar question was posed to the Bureau of Internal Revenue (BIR) by a taxpayer who explained that it has adopted a system of storing staff reimbursements that the taxpayer claimed as deductible expenses in electric format only (i.e., scanned copies of the original documents).  According to the BIR in this 2023 Ruling, the scanned copies of the receipts/bills evidencing business expenses did not satisfy the record-keeping requirements under Sections 34(A)(1)(b) and 237 of the Tax Code, respectively.

In ruling against the taxpayer, the BIR took into consideration Revenue Regulations (RR) No. 17-2013, RR No. 09-2009 and Republic Act No. 8792, otherwise known as the Electronic Commerce Act of the Philippines (e-Commerce Act).

Under RR No. 17-2013, taxpayers must retain copies of the books of accounts, including subsidiary books and other accounting records for ten (10) years, wherein taxpayers are required to retain the hard copies for the first five years. Thereafter, the taxpayer has the option for the remaining five years to retain the documents as electronic copies in an electronic storage system (compliant with the requirements under Section 2-A of RR No. 17-2013) or as hard copies. The term “other accounting records” includes the corresponding invoices, receipts, vouchers and returns, and other source documents supporting the entries in the book of accounts.

Simply put, while the keeping of electronic copies of supporting documents and other accounting records is not prohibited for the first five years, the original hard copies must likewise be preserved during this period. For the next five years (i.e., 6th to 10th year), the accounting records may be kept in electronic form only and the taxpayer may dispense with the hard copies.

The BIR also cited an administrative issuance (RR No. 09-2009) which outlined the requirements, obligations and responsibilities imposed on taxpayers for electronic record keeping and maintenance of electronic books of accounts and electronic records.  Under Section 8.2 of the RR, a taxpayer intending to store its records in microfilm, microfiche and other storage-only imaging systems must secure a permit from the BIR prior to adopting this system.

The BIR also emphasized in the said Ruling that the term electronic records mentioned in RR 9-2009 must be read in relation to the e-Commerce Act and that the scanned document alone cannot prove the integrity of the document if the original document from which the scanned document was based on does not exist anymore. As such, it cannot be considered an electronic document nor an original document under the e-Commerce Act. Further, the BIR noted in the Ruling that the paperless environment contemplated in the e-Commerce Act (i.e., all original documents are generated electronically without any actual hard copies) does not apply to a scanned document since it came from an original printed copy.

Taxpayers who intend to shift from a paper-based system to a digital one should be mindful of the requirements for expense deductibility, as the risk of disallowance in the event of a tax audit is there. After all, the burden rests on the taxpayer to prove that he is entitled to the claimed deductions and is compliant with tax regulations. On the flip side, this may be the opportune time for our authorities to revisit existing tax regulations to catch up with the changes in business practices brought about by evolving technologies.