Audit Procedures to Minimize Reinvestigation of Tax Cases

October 1, 1981 REVENUE AUDIT MEMORANDUM ORDER NO. 1-81 SUBJECT : Audit Procedures to Minimize Reinvestigation of Tax Cases TO : All Regional Directors and Other Internal Revenue Officers Concerned A. BACKGROUND . 1. It has been observed that reports of investigation of cases are referred back to the examiner for reinvestigation upon request of a taxpayer who disagrees with the deficiency assessment. A contested assessment arises from a disagreement on facts as reported by the examiner or differences in the application of a particular provision of law or regulation. cd i 2. In order to minimize reinvestigation of internal revenue tax cases already reported by the examiners, the facts as found by the examiners should be definitely established in the report . To attain this objective, it is necessary to crystallize the arguments of both the taxpayer and the examiner on factual and legal issues involved in the discrepancies which are used as basis for a deficiency tax determination. This will also facilitate final administrative decision on any issue involved in a contested deficiency tax assessment recommended by the investigating examiner . B. PRE-AUDIT PROCEDURES . 1. In order to enhance the adequacy of the scope of audit to be undertaken by an examiner in investigating a tax return or case assigned to him, the chief of section or group supervisor, as the case may be, shall formulate a checklist of audit procedures. Although a checklist of audit procedures may be standardized for application to similar cases, the section chief/group supervisor, jointly with the division chief/revenue district officer, should endeavor to devise a checklist of special audit procedures which shall be undertaken in auditing or investigating each tax case. 2. A copy of the checklist should be attached to the examiner's report as one of the bases for audit-reviewing the report of investigation. Although it is impractical to make rigid rules covering the arrangement and content of all working papers, the same should be standardized as to size and type of paper, indexing, cross referencing, binding and general arrangement of data. 3. In addition to the foregoing, the section chief/group supervisor must thoroughly evaluate each income tax return before assigning it to an examiner. Each section chief/group supervisor shall prepare a list of items to be verified by examiners. The list shall be known as Pre-Examination List and shall be attached to the return. The examiner shall comment on all items listed in the pre-examination list in his audit report. 4. Investigation procedures should not, of course, be confined to the items listed for verification. The examiner should exercise his judgment, skill and discretion in extending the scope of his audit, not only to any item appearing in the return and statements attached thereto, but also to areas which can potentially lead to an assessment and/or collection of deficiency tax. C. ADDITIONAL REPORTING REQUIREMENTS . 1. In cases where the taxpayer does not agree with the findings and recommendations of the examiner, whether the issues involved are questions of fact or questions of law, the examiner must request the taxpayer to submit a memorandum, specifying his objections to the examiner's findings. 2. The examiner should thoroughly evaluate the taxpayer's arguments or objections and may require additional proof to substantiate the taxpayer's arguments. If it is necessary to defer a partially completed audit to allow the taxpayer time to secure additional information, a memo should be prepared in duplicate outlining the work to be done by the taxpayer and the approximate date of the resumption of the audit. Whenever completion of an examination is deferred to accommodate a taxpayer, the examiner should secure a "Waiver of Prescription" 3. If the examiner does not agree with the taxpayer's contention, he should discuss in detail his reasons for reiterating his findings and must refute every argument presented by the taxpayer in a separate memorandum which will form part of his audit report. 4. Where the taxpayer agrees to the findings of the examiner, the latter shall require the taxpayer to sign the agreement form. The agreement form shall indicate the deficiency tax due from the taxpayer as well as the increments thereto arising from the deficiency assessment. aisa dc D. AUDIT REVIEW-LEVEL . 1. In all cases where the taxpayer does not agree with the findings and recommendations of the examiner, the taxpayer should be given further opportunity to present his side of the case. A preliminary ten-day letter should be prepared, informing the taxpayer of the proposed assessment. The preliminary ten-day letter, if feasible, should contain the reasons for the discrepancies as discussed by the examiner in his memorandum. If it is not practicable to incorporate the examiner's arguments in the preliminary ten-day letter, a copy of the examiner's memorandum should be enclosed with the preliminary ten-day letter to the taxpayer. The taxpayer should not be allowed to examine the working papers which contain the examiner's comments having no direct bearing on the audit computations. This is especially true of comments which express the auditor's opinion drawn from the facts as he understands them. Examiners should never under any circumstances allow a taxpayer to read comments of a confidential nature. cdt 2. The taxpayer should be requested to submit his reply within the ten-day period from receipt thereof. If no reply is received within the ten-day period, formal assessment should be prepared. 3. If the taxpayer answers within the ten-day period, a thorough evaluation of his arguments should be made to determine whether or not the examiner has taken into account all the facts and circumstances of each contested item of discrepancy and to determine whether the examiner exercised good judgment in making his recommendations. 4. If, upon audit review, the examiner's findings are found justified, a formal assessment notice containing the recommended deficiency assessment should be prepared. 5. If, in the light of the taxpayer's reply to the preliminary ten-day letter, the evidence to support the examiner's findings and recommendations appears inadequate, the report of investigation should be returned to the examiner for further reinvestigation. The examiner should prepare a memorandum embodying his comments and recommendations. If there are changes in his recommended assessments, he should prepare new Examiner's Report Form No. 17.17 C and 17.17 D and explain fully the causes for the change. cdt If the issue involves a difficult and doubtful question of law, the report should be forwarded to the Legal Office for advice and opinion. 6. In cases where the report of examination is accompanied by the Agreement Form duly accomplished and signed by the taxpayer, the Audit Review Division concerned or Assessment Branch, as the case may be, shall issue the assessment notice without the preliminary ten-day letter if it finds no additional discrepancy in its review of the cases. This usually closes the case. The case will not be reopened to make an adjustment unfavorable to the taxpayer, unless there is evidence of fraud, malfeasance, collusion, concealment or material misrepresentation and/or there was substantial error based on an established Internal Revenue Regulations existing at the time of the previous examination. 7. In cases where records are incomplete or non-existent, it will be necessary to estimate the tax liability based upon the most reliable information the examiner can obtain. In these instances, the comments should be complete and should indicate clearly the method used in estimating the tax liability, the particular method used in preference to some other, and any additional factors tending to confirm the correctness of the examiner's estimate of the tax liability . cdt E. PERFORMANCE EVALUATION FACTOR . Compliance or noncompliance with the additional reporting requirement shall be taken into account in evaluating the examiner's performance under RMO No. 14-81. F. EFFECTIVITY . This Audit Memorandum Order shall take effect beginning with reports of investigation submitted on or after September 1, 1981. cdt ROMULO M. VILLA Acting Commissioner