The truth in the case of false returns

For too long a time, there existed two opposing views in the interpretation of Section 222(a) of the Tax Code. The said provision lists the exceptions to the three-year period of limitation of assessment of taxes, including the filing of a false return or fraudulent return with intent to evade tax or of failure to file a return, which merits the application of the extraordinary 10-year prescriptive period for assessment.

Under the first view, the filing of a false return is a deviation from the truth, whether intentional or not, and it will merit the application of the 10-year prescriptive period. On the other hand, under the second view, the 10-year prescriptive period would only apply if the filing of false returns was done deliberately and with the intent to evade or reduce tax liability.

To finally settle this matter, the Supreme Court (SC), in an August 2023 decision involving a petitioner foreign fast-food chain corporation licensed to do business in the Philippines, expressly abandoned the first view when it agreed with the petitioner that for a return to be considered false and for the extraordinary period of assessment to apply, it must contain errors or misstatements which are deliberate or willful.

In the said case, the SC discussed the two due process requirements that must be satisfied in applying the extraordinary period of prescription. The first requirement is that the tax authorities must clearly state in the assessment notice that the extraordinary prescriptive period is being applied. The Commissioner of Internal Revenue (CIR) must also provide the basis of allegations of falsity or fraud. However, when there is a presumption of falsity or fraud as when there is a substantial misdeclaration in the return exceeding 30 percent, the burden of proof will shift to the taxpayer. Nevertheless, the CIR must still indicate in the notice or assessment the computation by which it ascertained such misdeclaration.

As applied in the same case, the SC found that the first due process requirement was not met because the CIR failed to show by clear and convincing evidence that the petitioner was notified that it was being assessed using the extraordinary period of assessment and no basis was provided to the taxpayer.

Contrary to the CIR’s position, the presumption of falsity could not be invoked to shift the burden of proof to the petitioner because the 30 percent threshold was not met, and the CIR did not disclose the computation used in determining how the 30 percent threshold was exceeded. Furthermore, assuming that there was underdeclaration, it was not deliberate because even though the petitioner overlooked its gross receipts from interest income for VAT purposes, it declared its interest income for Income Tax purposes.

The second requirement is that the tax authorities must not have acted in a manner that is inconsistent with the invocation of the extraordinary prescriptive period, or that they have not misled the taxpayer into believing that the ordinary period of prescription will apply. In the said case, the CIR initially agreed with the taxpayer to execute two waivers to extend the assessment period.

However, the CIR served the Final Assessment Notice a day prior to the expiration of the extended deadline, wherein the CIR alleged that the petitioner filed a false return to invoke the 10-year prescriptive period. The SC found that the CIR had no intention to extend the assessment period, and the invocation of 10-year prescriptive period was only an afterthought to prevent the lapse of assessment period. As such, the CIR also failed to meet the second due process requirement in this case as well.

As observed by Justice Caguioa in his concurring opinion, the second view underscores the Court’s duty to give effect not only to the letter of the law, but more importantly, to the spirit and the policy that animate it. In interpreting Section 222(a) of the Tax Code, it should be remembered that the prescriptive period for assessment and collection exists to strike a balance between allowing the government to effectively assess and collect taxes and ensuring fairness and protection for taxpayers.

The second view is also consistent with the logic that an under or overstatement in the return does not necessarily amount to a falsehood. Otherwise, all inaccuracies – including clerical or arithmetic miscalculation, no matter how trivial – shall render the return false which, in turn, may be a ground to invoke the extraordinary prescriptive period. In other words, this may provide the CIR an opportunity to find errors indiscriminately in all tax audit investigations and effectively grant unbridled authority to prolong the period to assess the prejudice of taxpayers.

While this ruling gives hope to taxpayers, what is more significant is how it serves as a check to the assessment power of the CIR, which is not absolute. This also serves as a reminder to the tax authority that they bear the burden of establishing, with clear and convincing proof, the existence of grounds warranting the application of the extraordinary period of assessment.

Camille Anne Duterte is a Tax Supervisor 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 Supervisor Camille Anne Duterte or Tax Partner Kathleen L. Saga through [email protected], 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.