Many taxpayers have recently received a Letter of Authority (LoA) from the Bureau of Internal Revenue (BIR), which may have caused anxiety. Normally, significant findings are initially identified and alleged in a BIR audit. Often, such findings come after the BIR compares the taxpayers’ books against tax returns. Out of this approach, millions or hundreds of millions, or even billions of alleged discrepancies are frequently left to the taxpayers to reconcile. No wonder taxpayers face elevated stress levels during BIR audits.
What are examples of the discrepancies cited during a BIR audit, and what may a taxpayer do about these?
One of the very common procedures during BIR audits is the comparison of the expenses recorded per book against the tax base reported in the withholding tax returns. The differences that arise are assessed for non-withholding of tax on expenses with the corresponding disallowance of the expenses as deductions for income tax purposes. That gives rise to an alleged withholding tax deficiency and an alleged income tax deficiency.
For the above-mentioned differences, it is worth checking whether there are expenses which are exempt from withholding taxes. For expanded withholding tax, some exempt transactions are payments to GPPs and payments to PEZA entities under ITH or 5% SCIT. For final withholding tax, transactions that are incurred outside the Philippines are some of the possible reconciliations. On the other hand, for withholding tax on compensation, the reconciliations could come from the employer’s share in government mandatory contributions, HMO premiums for group insurance, or de minimis benefits.
Another comparison being made by the BIR is the taxpayer’s income and expenses per book against those reported in the income tax returns (ITR) and value-added tax (VAT) returns. Any differences may be assessed for deficiency income tax or deficiency VAT.
In this type of finding, more often than not, discrepancies are due to the timing differences in the reporting of the income and expenses between the books and the tax returns. For instance, if you are engaged in the sale of real estate, the recognition of taxable income from such sales could be different based on the tax rules and the accounting rules. Unlike in the accounting rules, there is an installment method in the tax rules that may be applied for sale of real estate if the initial payment does not exceed 25% of the contract price.
In addition, another timing difference that may occur is the lease expense recognized by the taxpayer. Amortization of recognized right-of-use asset (ROUA) and interest expense on lease liability are the expenses recorded per books, while for income tax purposes, the lease expense deductible is the amount incurred during the period based on the lease contract.
There could be other reconciliations apart from the mentioned above; hence, taxpayers may want to be proactive and consider preparing ahead to deal with possible tax findings even before the LoA is served.
• Periodic reconciliation of books versus tax returns
It is prudent to have the books versus tax returns reconciled on a periodic basis, be it monthly or quarterly, so that the taxpayer is not surprised by the findings of a BIR audit. It will benefit the taxpayer to spot the discrepancies that need to be properly addressed ahead of the BIR audit.
• Supporting documents
To ease the burden of collating the documents that BIR may request during the BIR audit, it is best to prepare the proper documentation and to maintain an organized system of record-keeping. Invoices, receipts, contracts, or other pertinent documents related to the transactions should be kept and secured in a manner that is easy to retrieve. These documents will help taxpayers address the nature of the discrepancies that may be alleged by the BIR in an audit.
• Stay informed of recent tax updates and developments
Being informed of tax updates and the changes in the tax rules and procedures is crucial. With numerous tax rules and updates, it will be helpful for a taxpayer to attend tax seminars held by the BIR or by tax consultants. The knowledge of the tax rules will lead a taxpayer to identify the possible reasons why certain amounts in the books are different from the amounts per tax returns.
• Conduct a tax health check
Just as we give importance to our physical well-being by undergoing a regular medical check-up, it is also important that, as a taxpayer, a periodic tax health check conducted by the company’s tax team or by the company’s tax consultant is conducted periodically. This preemptive practice could immediately address the possible tax issues that may arise during a BIR audit.
Being proactive will surely reduce unnecessary stress and can help the taxpayers address issues that might be raised by the BIR in an audit process. By anticipating the potential discrepancies, taxpayers will face a less daunting BIR audit, thereby reducing anxiety.
Let’s Talk Tax is a weekly newspaper column of P&A Grant Thornton that aims to keep the public informed of various developments in taxation. This article is not intended to be a substitute for competent professional advice.
Marielle C. Baldemor is a senior in charge of the Tax Advisory & Compliance Practice Area of P&A Grant Thornton. P&A Grant Thornton is one of the leading audits, tax, advisory, and outsourcing firms in the Philippines, with 29 Partners and more than 1000 staff members.
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