In tax audits conducted by the Bureau of Internal Revenue (BIR), the issuance of a valid assessment is a substantive prerequisite, thus making the Formal Letter of Demand (FLD)/Final Assessment Notice (FAN) crucial documents.
The FLD/FAN contain the official demand by the BIR for the taxpayer to pay deficiency taxes which the latter has been determined to be liable for during a tax audit. Further, the issuance of the FLD/FAN is also the point for determining whether the assessment has been issued within the required prescriptive period. Pursuant to Section 203 of the Tax Code, internal revenue taxes, as a general rule, should be assessed within three years after the last day prescribed by law for the filing or actual date of filing of the return, whichever is later.
For the FLD/FAN to be considered valid, certain prerequisites must be observed. First, Section 228 of the Tax Code requires that the taxpayer be informed in writing of the law and the facts on which the assessment is based; otherwise, the assessment shall be void. The use of the word “shall” means that the act of informing the taxpayer of both the legal and factual bases of the assessment is mandatory. The purpose of this requirement is for the taxpayer to be properly notified of the charge against him and to give the taxpayer a fair and reasonable opportunity to explain or defend himself. The rationale behind this requirement is the constitutional mandate under Article III of the Constitution (Bill of Rights), that no person shall be deprived of his or her property without due process of law.
In various decisions, the Supreme Court (SC) has pointed out the mandatory nature of the written notice requirement of the facts and law on which the assessment was based. In one decision, the SC ruled that merely notifying the taxpayer of his or her tax liabilities without details or particulars is not enough. Also, a FAN that only contained a table of taxes with no other details was considered insufficient.
Notwithstanding these decisions, the SC also clarified that the mandate of giving the taxpayer a notice of the facts and laws on which the assessments are based should not be mechanically applied. In a 2014 decision (G.R. No. 193100, Dec. 10, 2014), although the FAN and FLD issued to the taxpayer were not accompanied by a written explanation of the legal and factual bases of the deficiency taxes, the SC held that the requirement of Section 228 of the Tax Code was substantially complied with.
In that case, the records showed that the taxpayer was sufficiently apprised of the nature, factual and legal bases, as well as how the deficiency taxes being assessed were computed. The taxpayer was provided a summary report which contained an explanation of the Findings of Investigation stating the legal and factual bases for the deficiency assessment. Further, the Preliminary Assessment Notice (PAN) contained a computation of the deficiency taxes with a detailed explanation of the particular provision of law and revenue regulation violated which enabled the taxpayer to protest the PAN.
According to the SC, considering the exchange of correspondence and documents between the BIR and the taxpayer, the BIR had fully informed the taxpayer in writing of the factual and legal bases of the deficiency tax assessment, which enabled the latter to file an “effective” protest. As such, the written notice requirement in Section 228 of the Tax Code was substantially complied with.
Another essential requirement for the FLD/FAN to be valid is that it should contain a definite tax liability with a definite due date for payment. In the landmark case of CIR vs. Fitness by Design, Inc. (G.R. No. 215957, Nov. 9, 2016), the SC invalidated the FAN issued against the taxpayer since the assessment amount remained indefinite and there was no demand for payment.
In that case, as the FAN was undated, the SC ruled that the total amount of the tax liability of the taxpayer would depend on when the latter decides to pay, thus making the amount of assessment indefinite. Further, as the FAN did not contain a due date, there was no actual demand for the taxpayer to pay the deficiency taxes.
The Fitness by Design case should be differentiated from that of the 2022 Court of Tax Appeals (CTA) case of BASF Philippines, Inc. vs. CIR, CTA Case No. 10221 dated Nov. 3, 2022. In the latter case, while the FAN provides that: “the interest and the total amount due will have to be adjusted if paid beyond the date specified therein.”, the CTA ruled that the FAN contained a definite amount of tax liability with a definite due date since the FAN, in this case, indicated a due date, unlike in the Fitness by Design case.
The CTA pointed out that in determining the validity of the assessment, what is crucial is the definiteness of the amount indicated in the FAN with respect to the deadline or due date provided. The CTA further held that the amount of deficiency VAT plus interest is definite and certain on the due date indicated in the FAN which is Jan. 21, 2019. This remains to be the fact despite a warning from the BIR that additional interest (consequently affecting the total amount due) shall continue to accrue if payment is made beyond the due date.
Knowing the substantive requirements for the FLD/FAN to be valid is very important and works to the benefit of both the taxpayer and the BIR. On the part of the taxpayer, this affords an opportunity to explain or defend itself before it is required to pay deficiency taxes. On the part of the BIR, instances of assessments being voided for failure to comply with the due process requirement will be avoided. After all, taxes are the lifeblood of the nation which we are required to pay to enjoy a civilized society.
The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The content is for general information purposes only and should not be used as a substitute for specific advice.
Rachel Sison is a senior manager at the Tax Services department of Isla Lipana & Co., the Philippine member firm of the PwC network.
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