Tax Articles

Presumed Income from Unrecorded Expenses

By Atty. Fulvio D. Dawilan

The due process requirements in the issuance of deficiency tax assessment oblige a call for payment of deficiency tax to state the facts, the law, rules and regulations or jurisprudence on which the assessment is based. The right to be properly informed is a basic right of every taxpayer which cannot not be ignored, and noncompliance of which will result in an invalid assessment.

The are common items present in almost every assessment issued by our tax authority after the conduct of examination by its revenue officers. One of these is the tendency of the examiners to include an item of assessment described as “unaccounted source of cash”, “unaccounted expenses” or “unrecorded income due to unrecorded expenses/purchases”. These and similar other descriptions are used by the examiners interchangeably but the usual inference is the same - since there is unrecorded expense/cost/purchase, there is correspondingly an unrecorded income. And for that unrecorded income, deficiency income tax and VAT are accordingly imposed. These usually result from discrepancies arising from the comparison by the examiners of the information provided by the taxpayers in its various reports/submissions with the other reports of the same taxpayer or with that of third parties.

The merits of these tax impositions had already been dealt with in a number of cases. And the verdict is clear – no income tax and VAT assessment should be imposed on any finding for unrecorded expenses.

Court decisions had uniformly declared that there are three (3) elements necessary in the imposition of income tax. These are: (a) there must be gain or profit; (b) the gain or profit is realized or received, actually or constructively; and (c) it is not exempted by law or treaty from income tax. Income tax is assessed on income received from any property, activity or service. As such, in the imposition of or assessment of income tax, it must be clear that there was an income, and such income was received by the taxpayer, not when there is an under-declaration of purchases or expenses. A finding of “unaccounted source of cash” without further proof, does not by itself result in the imposition of income tax. Tax authorities cannot assess a taxpayer with “undeclared income” solely on the basis of a finding that it has unaccounted or undeclared expenses.

To emphasize, this message from the decided cases involving this issue is clear – an unrecorded expense cannot give rise to deficiency income tax. Similarly it cannot give rise to a deficiency value-added tax.

In fact, the Courts had also repeatedly emphasized that for income tax 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 income tax law is to claim a deduction beyond the amount authorized therein. Hence, even granting that there is an undeclared disbursement, the same is not prohibited by law. Simply relying on the fact that there is an undeclared disbursement, an imposition or assessment of the subject does not hold water.

I agree that it is the taxpayer that would even be prejudiced with any reduction to its deductible expense because this would necessarily mean an increase in tax base, and as the tax base increases, the amount of tax payable to the government would likewise increase. To add an undeclared expense to the income of the taxpayer would result in double burden to the taxpayer – first, when he fails to claim the same as deduction which results in the increase of his tax liability and second is when it is added to the income which also has the effect of further increasing tax liability.

I would like to add that the term “purchases”, “expenses” or “costs” are not similar to “income”. There is therefore no rhythm in concluding that, with an under-declaration of purchases, expenses or costs, there would be a corresponding under-declaration of income. This goes without saying that even if there is indeed undeclared expense, it is not necessary that there is a corresponding income. This fact alone does not translate to under-declaration of an income.

With these cases declaring the inappropriateness of an assessment from alleged undeclared expenses/purchases, I believe this approach in determining the liabilities of taxpayers should be discontinued. This frees the resources of the parties and the Courts in resolving issues that had already been laid to rest by a number of decided cases.

I fully subscribe to the ratiocination of the Courts that in the imposition or assessment of income tax and VAT, there has to be an income, not when there is an undeclared disbursement. The purpose of an examination is to recompute the taxes due from the taxpayer. Hence, instead of adding the noted discrepancy to the taxable income, the proper approach is to deduct the unclaimed expenses/purchases from the taxable income as additional deductible expenses/costs, not the opposite.