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As featured on BusinessMirror:  The source of it all

Which came first: chicken or egg? This is a classic mind-boggling question that shows us that there should be a source for everything. Applying this principle in tax audits, one of the common assessments of the Bureau of Internal Revenue (BIR) for income tax is unaccounted source of cash. This usually results whenever the aggregate amount of expenses declared in the income tax return is lower than the aggregate amount of expenses declared in other tax returns such as expanded withholding tax.

At first glance, one may wonder how under-declaration of expenses in income tax return would lead to an income tax deficiency. A Supreme Court case further explains this scenario. It is founded on the theory that money and properties in excess of liabilities that are not reported/accounted for in the taxpayer’s income tax return lead to the inference that there is undeclaration of income. There is the assumption that most assets are derived from a taxable source. Hence, in the said Supreme Court case, the taxpayer’s unexplained acquisition of properties was assessed with deficiency income tax. As the taxpayer was not able to explain the source and so refute the presumption, the income tax deficiency was sustained.

However, in a recent Court of Tax Appeals (CTA) decision, it was held that undeclared purchases/expenses should not lead to income tax deficiency. To give a brief background, the CTA case decided on a petition for review against a Warrant of Distraint and/or Levy issued by the BIR to collect assessed tax liabilities. Proceeding on to discuss the tax assessments subject of the warrant, the Court ruled that undeclared expenses/purchases should not be automatically treated as income even if said purchases are truly undeclared. It further explains that the determining factor for the imposition of income tax is on gains or profits derived from a transaction. In contrast to this, an expense/purchase transaction is an outflow of money and there is apparently no gain or profit derived from this. The Court adds that a taxpayer is free to deduct a lower amount of expenses in its income tax returns because what is prohibited is to claim deductions more than what is authorized by the law. Likewise, value-added tax (VAT) should also not be imposed on these undeclared purchases.

While taxpayers may refer to this recent CTA decision in arguing against BIR assessments of the unaccounted source of cash, it is worthy to note that CTA decisions only carry a persuasive effect and are not yet jurisprudential. There is also the challenge of how this CTA decision could be reconciled with the SC case.

At the end of it all, what is important is for taxpayers to properly maintain an accounting of all their transactions so that during an audit, it can explain any noted discrepancies. Tax authorities, on the other hand, could also consider the discussions made in the recent CTA case.

Ria Danielle T. Ching
Senior Manager
KPMG in the Philippines

Ria Danielle T. Ching is a Tax Senior Manager from the Tax Group of KPMG in the Philippines (R.G. Manabat & Co.), a Philippine partnership and a member firm of the KPMG global organization of independent member firms affiliated with KPMG International Limited, a private English company limited by guarantee. The firm has been recognized as a Tier 1 in Transfer Pricing Practice and in General Corporate Tax Practice by the International Tax Review. For more information, you may reach out to tax senior manager Ria Danielle T. Ching or partner Leandro Ben M. Robediso through ph-kpmgmla@kpmg.com, social media or visit www.home.kpmg/ph.

This article is for general information purposes only and should not be considered as professional advice to a specific issue or entity. The views and opinions expressed herein are those of the author and do not necessarily represent KPMG International or KPMG in the Philippines.