Drawing the line on speculation-based assessments

Presumptions strike at the very core of the way we as individuals pass judgment. After all, it does make sense that the commonality of our human experiences yields to a consensus that a certain set of facts may produce a likely and foreseeable outcome.

In the realm of tax administration, presumptions also play a crucial role in simplifying the entire process of collecting taxes, taking into account the enormous administrative burden of an extensive tax audit, the desire to curb tax evasion committed through inaccurate taxpayer disclosures, and the urgency to generate money for nation-building.

This is because presumptions shift the focus of tax enforcement on other factual indicators of taxability in addition to the reporting made by taxpayers. For instance, failure to report a sudden growth in assets in the returns may indicate there is an undisclosed income yet to be taxed. In other cases, the enjoyment of tax incentives by local subsidiaries may be perceived as a means that may be used by their multinational parents to avoid taxes by eroding their collective tax base and shifting income away from the taxing jurisdiction where the same may be rightfully due.

It can also be said that to a certain extent, presumptions support the viability of the Third Party Information (TPI) matching programs of the Bureau of Internal Revenue (BIR). For example, in the course of a tax assessment, it is observable that a lower figure reflected in a taxpayer’s Summary List of Sales (SLS) as against his supplier’s Summary List of Purchases (SLP) usually gives rise to a presumption that a lower income is reported, which in turn, could result to a finding of deficiency income tax (IT) or deficiency value added tax (VAT).

Presumptive assessments are an important feature of tax audits especially in cases where taxpayers do not fully disclose their financial information or when they failed to file their returns. Considering the convenience offered by a sanctioned speculation of a taxpayer’s liability, it is not hard to imagine there is a significant reliance placed on it by the BIR because it shifts to the taxpayer the burden of sufficiently proving otherwise.

While ideally, a presumption cannot be a substitute for ultimate facts, it does offer recourse for when the facts-based rules on determining tax liability do not work because of the taxpayer’s own non-compliance.

However, in view of the large degree of discretion available to the tax office, it is prudent to set reasonable limits therefor. Otherwise, abuse of power and potential for arbitrariness may prevail in tax audits. Besides, due process dictates that presumptions should generally invite further inquiry, not a jump into conclusions.

Interestingly, the Court of Tax Appeals (CTA) had the opportunity to evaluate presumptive assessments from a legal standpoint. The CTA en banc in the case of Commissioner of Internal Revenue vs. Agrinurture Inc., CTA EB No. 1054 dated Jan. 13, tested the presumption that the existence of undeclared purchases equate to taxable income.

In this case, the taxpayer was assessed for alleged deficiency IT and VAT solely on account of the discrepancy found via a matching of the taxpayer’s purchase of merchandise extracted from the SLS of its suppliers and the taxpayer’s purchases per returns filed.

The BIR alleged that since the purchase of merchandise did not appear in the taxpayer’s return, nor was it reflected in its inventory or capital expenditures, the only conclusion is that the merchandise in question was eventually sold. Thus, the BIR issued a finding against the taxpayer for deficiency IT and VAT on the basis of speculated sales.

The CTA en banc did not agree with this proposition. They held “a finding of under-declaration of purchase does not by itself result in the imposition of IT and VAT”. The CTA’s justification for the foregoing principle was laid in straightforward terms. They reminded that the law itself clearly provided for the basis of imposing IT and VAT. For IT purposes, three elements must concur specifically: (1) there must be gain or profit; (2) the gain or profit is realized or received, actually or constructively; and (3) it is not exempted by law or treaty from income tax. On the other hand, VAT should be contingent upon the taxpayer’s receipt of an amount of money or its equivalent, from its sale, barter or exchange of goods or properties, or from sale or exchange of services.

Simply put, IT and VAT liability should be made to rest on the existence of facts namely: the fact there was a sale in the ordinary course of business and the fact there was a gain or profit realized out of the sale. Therefore, a presumption that undeclared purchase could mean there was a corresponding sale and accordingly, profit, if uncorroborated by any solid factual evidence to that effect, cannot be the basis for levying IT and VAT.

Additionally, the CTA en banc said for IT purposes, a taxpayer is free to deduct from its gross income a lesser amount, or not claim any deduction at all. What is prohibited by the law is to claim a deduction beyond the amount authorized therein. Thus, the only likely impact of an undeclared purchase is the taxpayer is unable to claim it as a deduction, which at any rate, he is legally allowed to do if he so pleases.

Conceded, there is merit in upholding the presumption of correctness of assessments made by the BIR, lest the very income stream of our government be prejudiced by protracted tax investigations. However, the Supreme Court in the case of Commissioner of Internal Revenue vs. Hantex Trading Co., Inc., G.R. No. 136975 dated March 3, 2005, cautioned the “prima facie correctness of a tax assessment does not apply upon proof that an assessment is utterly without factual basis, meaning it is arbitrary and capricious. Consequently, when the BIR has come out with a “naked assessment,” i.e., without any foundation character, the determination of the tax due is without rational basis”. Accordingly, this presumption of correctness of assessments cannot rely on another presumption no matter how reasonable or logical said presumption may be.

Presumptive assessments provide considerable value in tax collection efforts. To begin with, they have the potential to dampen tax evasion tendencies because they shift to the taxpayer the burden of proving against liability. Correlatively, these kinds of assessments allow the BIR to reallocate its limited resources, which would have otherwise been expended on the gathering of evidence to support its findings, to other equally important initiatives. Moreover, presumptive assessments promote transparency by encouraging taxpayers to maintain the accuracy and integrity of their books of accounts as well as to ensure their financial disclosures are forthcoming.

Nonetheless, it is critical to note that presumptive assessments are only means to arrive at the truth. They should not bar the BIR and the taxpayers’ mutual obligation to actively work together in guaranteeing taxes paid are indeed taxes due. Ever mindful that the power to tax may also be the power to destroy, it is sensible to be reminded of the succinct words of the Supreme Court on this point, to wit: “[the power of taxation] should be exercised with caution to minimize injury to the proprietary rights of a taxpayer. It must be exercised fairly, equally and uniformly, lest the tax collector kill the hen that lays the golden egg”.

Michael Angelo D. Adrid is a supervisor from the tax group of R.G. Manabat & Co. (RGM&Co.), the Philippine member firm of KPMG International.

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 the views and opinions of KPMG International or RGM&Co. For comments or inquiries, please email ph-inquiry@kpmg.com or rgmanabat@kpmg.com.

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