Understanding tax investigations

(First of two parts)

As it was told, Joseph and Mary journeyed back to their hometown, Bethlehem, because the Roman Emperor wanted his soldiers to count the number of people in the tribes of Israel. The town became full of people to comply with this order, and so Joseph and Mary ended up in a stable to stay for the night.

This scene has always been associated as the prelude to the first Nativity.  But I have always viewed it to be Caesars’ way of establishing his tax base, his version of tax mapping.  Why, even Caesar thought it was crucial to establish a healthy tax base to ensure the continued fiscal survival of his empire!  And that remains true to this day, the tax authority is continuously finding ways to widen the tax base and taxpayers have been finding ways to elude it. It is a never ending play of the proverbial game of hide and seek. The tax authority seeks to catch taxpayers in the tax net while the taxpayer avoids it.

It would be less painful if we ponder upon the point Benjamin Franklin tried to hammer succinctly when he said, “Certainty? In this world, nothing is certain but death and taxes”.

So whether we agree with Franklin or not, as life plays itself out, from birth to death, tax is intricately intertwined in all our affairs.  And reality bites harder when one is faced with a tax investigation.

Letter of authority, anyone?

A tax investigation is an audit process conducted by the Bureau of Internal Revenue (BIR) which generally starts with the issuance of a letter of authority (LOA) by the proper office in the BIR to a taxpayer who has been selected for audit. It is an official document that empowers a Revenue Officer to examine and scrutinize books of accounts and other accounting records, in order to determine the correct internal revenue tax liabilities of the subject taxpayer.

If unfamiliar with an LOA when served, we watch out for the following:

1. An LOA is BIR Form No.1965 and denominated as “Letter of Authority”;

2. It bears a document number and the BIR Logo;

3. It specifies the BIR Office which is accountable for it (i.e. Revenue Region No.8, Makati City, and Revenue District Office No.49, North Makati);

4. It is dated and bears the name and address of the subject taxpayer;

5. It states the name of the Revenue Officer (RO) assigned to perform the tax audit;

6. It states the kinds of taxes and period under tax investigation;

7. It bears the signature of the authorized officer and his title/position;

8. It provides for the name, address and contact number usually of the Revenue District Officer (RDO) for all official communications relating to the tax audit;

9. It bears an important reminder that says that LOA becomes void if it contains an erasure, or if not served to the taxpayer within 30 days for the date thereof, or if dry seal of BIR office is not present; and

10. It provides for a space upon which the subject taxpayer may acknowledge receipt of the LOA by affixing his signature over printed name and the date of receipt.

From the time the LOA is served, the Revenue Officer (RO) has 120 days from the date of receipt by the taxpayer to conduct the tax investigation and submit the required report of investigation.

The assessment notice

After the tax investigation is conducted, the following shall be issued by the BIR:

1. Notice of informal conference

2. Preliminary assessment notice; and

3. Formal letter of demand and assessment notice

A Notice for Informal Conference is issued by the BIR after the tax investigation is conducted. It is a written notice informing the subject taxpayer that the findings of the audit conducted on the books of accounts and accounting records indicate that additional taxes or deficiency assessments have to be paid. It is in this informal conference that the findings of the audit are communicated to the taxpayer more so if the recommendation of the RO is the imposition of deficiency assessment. For his part, the taxpayer shall have 15 days from the date of receipt of the Notice for Informal Conference to explain his side.

If after the informal conference, there remains a discrepancy, a Preliminary Assessment Notice (PAN) is issued. A PAN is a communication issued by the Regional Assessment Division, or any other concerned BIR Office, informing a taxpayer who has been audited and informed of the findings of the Revenue Officer, following a review of these findings. If the taxpayer disagrees with the findings, he shall then have 15 days from receipt of the PAN to file a written reply contesting the proposed assessment.

On the other hand, a Notice of Assessment is a declaration of deficiency taxes issued to a taxpayer who fails to respond to a PAN within the prescribed period of time, or whose reply to the PAN was found to be without merit. The Notice of Assessment shall inform the taxpayer of this fact, and thus, gives due course to the report of investigation prepared by the RO who conducted the audit.

Together with the Notice of Assessment, a Formal Letter of Demand is also issued calling for payment of the taxpayer’s deficiency tax or taxes. To be valid, both the Notice of Assessment and the Formal Letter of Demand shall state the facts, the law, rules and regulations, or jurisprudence upon which the assessment is based.

At this juncture, it must be stressed that generally the BIR has the right to investigate and make an assessment within three years from the last day prescribed by law for the filing of the tax return for the tax that is being assessed or from the day the return was filed, if filed out of time.  By way of an exception, in cases involving tax fraud, the BIR has 10 years from the date of discovery of such fraud within which to make the assessment. (To be concluded)

(Alma L. Barcelo is a director for Tax and Corporate Services of Manabat Sanagustin & Co., CPAs, a member firm of KPMG network of independent member firm affiliated with KPMG International, a Swiss Cooperative. This article is for general information only and is not intended to be, nor it is a substitute for, informed professional advice. While due care was exercised to ensure the quality of the information contained in this article, readers should carefully evaluate its accuracy, completeness and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances. For comments or inquiries, please e-mail [email protected] or [email protected]).