Procedures and Techniques in the Audit of Value-added Tax and Prescription of the Minimum Reporting Requirements

July 11, 1990 REVENUE AUDIT MEMORANDUM ORDER NO. 1-90 SUBJECT : Procedures and Techniques in the Audit of Value-added Tax and Prescription of the Minimum Reporting Requirements This Order outlines the procedures and techniques in the audit of value-added tax and prescribes the minimum reporting requirements . PRELIMINARY APPROACH TO VERIFICATION Essential to an effective audit of value-added tax is the familiarization with the business organization of the taxpayer, and whether it has business establishments other than its main or head office; the economic activity, whether concerned in the sale of goods and, or sale of services, etc. the accounting methods and policies, and the degree of internal control, etc. It may also be necessary to refer to the report of the audit of the value-added tax liabilities of the taxpayer for the immediately preceding period in order to be aware of the deficiencies that were reported, but may have remained uncorrected in the current period under audit. I. AUDIT OF SALES AND OUTPUT TAX A. Gross Taxable Sale of Goods and Services 1. Reconcile the amount of each category of sales per VAT return with the recorded amount of sales per subsidiary sales journal, including the control subsidiary sales ledger and/or the general ledger of the head office, and any subsidiary sales journal for each branch. 2. Review the composition of the sales account in the journals and ledgers and ascertain that: 2.1 Only those transactions which are specifically exempted under Section 103 officially exempted under Section 103 of NIRC are treated as exempt sales. 2.2 " Deemed " sales of goods are recorded as taxable transactions (Sec. 4, RR 5-87). 2.2.1 Transfer, use or consumption not in the course of business of goods originally intended for sale or for use in the course of business. Transfer of goods not in the course of business can take place when the VAT-registered person withdraws goods from his business for his personal use; 2.2.2 Distribution or transfer to shareholders or investors as share in the profits of the business; 2.2.3 Transfer to creditors in payment of debt or obligation; 2.2.4 Consignment of goods if actual sale is not made within 60 days following the date such goods were consigned. Consigned goods returned by the consignee within the 60-day period is not deemed sold; and 2.2.5 Retirement from or cessation of business or death of an individual with respect to inventories of all goods on hand, whether capital goods, stock-in-trade, supplies or materials as of date of such retirement or cessation, whether or not the business is continued by the new owner or successor, estate or heir. The following circumstances shall, among others, give rise to transactions "deemed sale": i Change of ownership of business or incorporation of the business in the case of a single proprietorship; ii Dissolution of a partnership and creation of a new partnership which takes over the business; and iii Death of an individual who is a VAT-registered person, even if the estate or heirs of the decedent shall continue to operate the business. 2.3 Sales declared as zero-rated actually emanate from export sales, foreign currency denominated sales, and other transactions that may qualify as zero-rated sales or effectively zero-rated sales (Sec. 100 (a) (1) (2), 102 (a) (1) (2) (3), NIRC and Sec. 8, RR 5-87). 2.3.1 For "direct export sales", review export documents such as commercial invoice/receipts, bills of lading or airway bill, export declaration/permit, packing list, etc; and ascertain that the proceeds of the sale had been actually inwardly remitted. This will require a liquidation statement from the Central Bank or any of its accredited agent banks certifying as to the amount of the export proceeds or consideration, the date of inward remittance, conversion rate and the total peso value thereof (RMO 23-88). 2.3.2 For "foreign currency denominated sales" review the transactions and ascertain the following: i The buyer is a non-resident. ii The goods are assembled or manufactured in the Philippines for household or personal use. iii The goods are paid for in convertible foreign currency inwardly remitted through the banking system. This requirement may be evidenced by a statement from the Central Bank or its accredited bank. iv The sales do not exceed an aggregate value of US $1,000 or its equivalent. 2.3.3 For zero-rated sale of services, review copy of the contract to ascertain the person for whom the services were rendered, amount of consideration and description of the services rendered. The compliance for the requirement for inward remittance should be evidenced by statement of liquidation from the Central Bank or its accredited agent bank. 2.3.4 For effectively zero-rated transaction, secure copy of the approved application for zero-rating. Take note of the effectivity and revocation date of zero-rated transaction. Transaction effected before the effectivity date as indicated in the approved application are subject to VAT (RMO No. 2-88). 3. Analyze all the accounts affecting total sales, particularly cash account; accounts and/or notes receivable; collections from receivables; sales discounts and sales returns; bad debts written-off; etc. In the case of sale of service, include in the analysis other accounts such as advances, retention receivables, mobilization fees, etc. 3.1 Apply the following pro-forma computation to arrive at the total sale of goods Cash Sales P__ Add: Collections on accounts receivable P__ Collection on notes receivable __ (if it pertains to sale of goods) Sales discounts granted __ Sales returns and allowances from sales on account __ Bad debts written off __ Accounts receivable, ending __ Notes receivable, ending __ __ Total receivables during the period P__ Less: Accounts Receivable, beginning P__ Notes Receivable, beginning __ Sales on account __ Total Sales during the period P__ 3.2 Account for the quantity of goods actually sold in appropriate cases, as a tool to further audit Finished goods, beginning __ Add: Production or purchases __ Total available for sale __ Less: Finished goods inventory, end __ __ Number of Units issued __ Less: Samples or destroyed or lost items __ __ Number of units sold during the period __ Multiply by average selling price per unit __ __ Total sales per audit P__ 3.3 Determine the taxable sale by computing Total sales during the period (from 3.1) P__ Add: Deemed sales per audit from 2.2) __ __ Total Sales per audit __ Less:Zero-rated sales (from 2.3) __ Exempt Sales (from 2.1) __ __ Gross Taxable Sales P__ Less: Sales returns and allowances __ __ Taxable Sales P__ 3.4 Apply the following pro-forma computation to arrive at the gross receipts during the period Income or billings during the period P__ Add: Accounts receivable, beginning P__ Retention receivable beginning __ __ Total Available for Collection __ Less: Accounts receivable, ending __ Retention receivable, ending __ __ __ __ Collection from receivable __ Add: Deposits or Advances and Mobilization fee __ Gross receipts during the period __ Less: Gross receipts from exempt service __ Gross receipts from zero-rated service __ __ __ __ Taxable Gross Receipts P__ NOTE: ALL ACCOUNTS SHOULD BE NET OF VAT . B. Audit checks to detect irregularities in invoicing and accounting for transactions 1. Scrutinize the entries appearing in the subsidiary sales journal and compare the same with the information shown in the sales invoices. 2. Determine compliance with invoicing requirements and procedures. 2.1 Ascertain that invoices bear all necessary information including the VAT registration number (Sec. 108(a) and 238, NIRC). 2.2 For the verification of the VAT liabilities for the 1st quarter/semester of 1988, account for the unused sales invoices as of December 31, 1987, as prescribed under RMC No. 51-87, and verify authority to print subsequent receipts/invoices. Any discovery of discrepancy or the use of unauthorized receipts or invoice the printing of which are not authorized may suggest fraudulent practices. 2.3 Check authority to use cash register machines and verify whether each register machine in use is duly authorized. 2.4 Ensure that the sales invoices issued for sales transactions are all accounted for. Account for any break in the sequence of serial numbers of sales invoices and official receipts issued and invoices assigned to branches. In case of cancelled sales invoice the original copy should be on file. 2.5 Be alert to the use of double set of invoices bearing identical serial numbers. 2.6 Verify if the transactions covered by "Statement of Account", "Delivery Receipt", "Debit Notes", and other similar documents are properly recorded as sales. The mere issuance of these documents without the corresponding sales invoice is a violation of the bookkeeping regulations and an indication of unrecorded sales except in the case of bona fide consignment sales. When confronted with a delivery receipt, ascertain whether it covers a consummated sale or consignment sale. Consignment sale shall be considered as taxable sale after sixty (60) days following the date of consignment (Sec. 4(D), RR 5-87). 2.7 If the taxpayer is engaged in both taxable and exempt transactions, ascertain that only VAT invoices are issued for VAT taxable transactions and separate invoices are issued for exempt transactions (Sec. 21 RR 5-87). Exempt transactions for which VAT invoices are issued shall be considered subject to VAT. 2.8 In the case of zero-rated transactions to BOI-export-oriented enterprises or other entities whose purchases are effectively zero-rated or exempted under special laws or international agreement, check if the words "ZERO-RATED" or "EXEMPT" had been prominently stamped or in printed on the sales invoice. If not, the transactions should be considered taxable (Sec. 2(a)(3), RR 2-88). 3. Determine the manner of billing the value-added tax. If the VAT is not separately billed or is erroneously billed in the invoice, multiply the gross amount of sales (including the amount intended by the seller to cover the tax or the tax billed erroneously) by 1/11 or such other factor applicable to persons partially exempt under special laws to determine the correct output tax (Sec. 6(a) and (b), RR 5-87). 4. If the taxpayer enjoys full or partial exemption from payment of the value-added tax pursuant to special laws, verify the extent of exemption and compliance with the condition of such exemptions. Determine the amount of output tax by applying the corresponding factor applicable to the level of exemption: Percent of Exemption Factor 0% 1/11 10% 1/12.11 20% 1/13.5 50% 1/21 75% 1/41 5. Verify whether other charges such as excise taxes, packaging, insurance, freight and delivery expense, etc., are treated as part of the gross taxable sales. 6. In the case of gross taxable sales of services (GTSS), advance payment or downpayment or deposits, as well as the cost of materials supplied with the services shall form part of the GTSS. If it is claimed that the material component of the contract price is for the account of the customer or contractee, verify the terms of the contract to ascertain who actually made the purchase and in whose name the transaction was invoiced. 7. Identify instances of gross selling prices of goods and services being unreasonably lower than the actual market price, and make the necessary adjustments (Sec. 6(a), RR 5-87). 8. Account for deductions from sales such as sales returns, allowances and discounts. Sales returns and allowances may be deducted from the gross taxable sale if they have been previously recorded and are properly supported by debit memos. Discounts, on the other hand, can only be taken into account if indicated on the face of the invoice at the time of sale and without condition as to subsequent happening of an event or fulfillment of certain conditions such as prompt payment or attainment of sales goals (Sec. 100(d) (3)). 9. For VAT taxpayer claiming the privilege of paying the 4% contractor's tax after December 31, 1987, verify his compliance with the following conditions: 9.1 Filing of information return showing the contractor's name, the outstanding contract price as of December 31, 1987, and a declaration to pay the contractor's tax due. 9.2 Copy of the contractor's billing issued prior to January 1, 1988 must be attached to the information return. 9.3 Ascertain the recording of the outstanding contract price receivable (on contracts completed and billed as of December 31, 1987) on the taxpayers books of accounts. 9.4 Filing of the contractor's tax return on or before January 30, 1988 or the 20th day of the month following the end of each calendar quarter. Non-compliance with any of the above condition subjects the amount received to 10% VAT (Sec. 6(g) of RR 5-87). 10. Be resourceful in discovering underdeclaration of sales. Abnormal levels of: inventories, sales, purchases, accounts receivables, including manipulation on interbranch transactions, among others, etc., may suggest instances of underdeclaration. Cross-check transactions reflected in the books of accounts against the records of selected customers and suppliers. II. AUDIT OF PURCHASES AND INPUT TAX 1. Reconcile the amount of each category of purchases per VAT return with the amount of purchases per subsidiary purchases journal (Sec. 22(b), RR 5-87). Check if all the information required are maintained in the purchase journal. 2. Review the composition of the purchase accounts in the journals and ledgers and ascertain that: 2.1 Purchases from non-VAT and/or exempt persons do not result in any input tax credit. 2.2 Effectively zero-rated purchases do not result in any input tax credit. 2.3 Purchases from VAT persons, which are personal in nature, shall not give rise to input tax credit. 2.4 Deemed-paid input tax credits (for purchases from BOI-registered pioneer enterprises) have been determined correctly in accordance with Sec. 13(4) of RR 5-87. 3. Scrutinize the entries appearing in the subsidiary purchase journal and compare with information shown on the purchase invoice. 4. Determine substantiation of claims for input tax credits. 4.1 The purchase invoice is issued in the name of the VAT-registered taxpayer claiming the input credits; bears the VAT number of the seller; the goods/services purchased are adequately described; and the printer's authority to print is indicated thereon. 4.2 For domestic purchases of goods (including capital assets) and services in the course of business, these must be supported by VAT invoices or receipts showing the information required in Sec. 108(a) and 238 of the NIRC. A cash register machine tape, although it indicates the VAT registration number of the seller, does not constitute valid proof of input tax credit (Sec. 15(a) RR 4-87). The same condition will apply for delivery receipts or statements of accounts issued by the seller. 4.3 Credit for input tax on importation shall be supported with import entries or equivalent documents showing actual payment of VAT on imported goods (Sec. 15(b) RR 5-87). Therefore, withdrawals of raw materials or other goods for customs bonded warehouses without the payment of VAT are not entitled to input tax credit. 4.4 VAT invoices issued for exempt and zero-rated transactions will not generate input credits to the purchaser. 5. Determine the manner of billing on purchase invoice or receipt to ascertain correctness of input tax credits (Sec. 13, RR 5-87). 6. Ascertain that purchase returns and allowances granted to the taxpayer results in a corresponding reduction in the input tax credit balance (Sec. 6(c) of RR 5-87). 7. If the taxpayer enjoys exemption on its sale of goods or services under special laws, he is only entitled to input tax credits equivalent to his level of exemption in the year of sale. For example: X, a BOI-registered pioneer enterprise, enjoys a 10% tax exemption for the taxable year under investigation. During the same year, his sales amounted to P1,000,000 and the input tax on his purchases amounted to P50,000. The creditable input tax shall be computed as follows: Input tax: Input tax x Level of exemption = Unallowable input tax Input tax - Unallowable input tax = Creditable input tax Thus: Input tax P50,000 Less: Level of exemption (P50,000 x 10%) 5,000 __ Creditable input tax P45,000 ====== 8. Applications for the issuance of tax credit certificates and refund affecting the input tax credit accounts must reduce the input tax credit available at the time of application. These include not only applications for the TCC filed with the BIR, but also with other government agencies such as the BOI and the Bureau of Customs (Sec. 11, RR 5-87). 9. If a VAT-registered person is also engaged in exempt activities, the input taxes paid for purchase of goods (including capital goods) and services which cannot be attributed to either operation shall be allocated between the VAT taxable operation and the non-VAT operation using the computation prescribed in Sec. 12 of RR 5-87. The amount allocated to the exempt transaction should reduce the input tax credit balance. For instance: Sales: From VAT operation P300,000 From non-VAT or exempt activity 200,000 Purchases which cannot be directly attributed to taxable and exempt activity 60,000 Input tax 6,000 Input tax to VAT taxable operation Sales on VAT Taxable Operations Total Input Tax ----------------------------- x Input = Creditable to Total Sales (VAT Taxable + non-VAT Tax VAT operation or exempt activity) P300,000 x P6,000 = P3,600 500,000 Thus: Input tax P6,000 Less: Unallowable input tax credit attributable to exempt activity 2,400 ______ Allowable input tax credit P3,600 ===== 10. Reconcile the amounts of input tax claimed in the VAT return for the portion carried over from previous quarters and the balance carried to succeeding quarters with the amounts recorded in the books of accounts. 11. Ascertain that the recorded amount of the purchase of goods, services and capital goods are net of VAT. III. AUDIT OF TRANSITORY INPUT TAX 1. Verify the taxpayers VAT registration date to determine the basis of allowable transitional input tax credits. 1.1 Persons registered under VAT as of January 1, 1988 are entitled to presumptive input tax credit equivalent to the sales tax element present in the inventory as of December 31, 1987 either as a debit balance in the deferred sales tax credit account or 8% of the value of inventory of materials and supplies (Sec. 26, RR 5-87). 1.2 Persons becoming liable to value-added tax after the effectivity of the VAT law are entitled to transitory input tax credit equivalent to 8% of the value of inventory of goods, materials and supplies, the purchase of which was subjected to VAT or the actual value-added tax paid on such goods, materials and supplies, whichever is higher (Sec. 17, RR 5-87). 2. If the taxpayer is a VAT-registered person as of January 1, 1988, determine his entitlement to presumptive input tax, as follows: 2.1 Manufacturers, producers and importers: i) Deferred sales tax credit balance as of December 31, 1987. ii) Input tax credit equivalent to 8% of the inventory of supplies as of December 31, 1987. iii) In the case of importers, input tax of 8% on the inventory of goods imported in 1985 and prior years, provided that the same had been segregated and recorded as such. 2.2 Persons, other than manufacturers, producers or importers such as construction contractors, service contractors, etc., are entitled to input tax credits equivalent to 8% of the value of the inventory of materials and supplies, other than capital goods, on hand as of December 31, 1987 which were purchased to be used or to be supplied with the sale of services, such as inventory of bags of cement, bond papers, etc. It does not cover goods which were purchased for resale independently of sale of services. 2.3 Wholesalers and retailers: i) Input tax of 8% of the value of inventory of goods purchased for resale in the same state it was purchased on hand as of December 31, 1987. ii) Input tax of 8% of the value of goods, other than capital goods purchased not for sale but for use in the business on hand as of December 31, 1987. 3. Secure copy of the inventory list as of December 31, 1987 filed with the revenue district office where it is registered. Claims for transitional input taxes by taxpayers who failed to comply with the provisions of RMC No. 35-87 should be disallowed. 4. Secure copy of audited or interim financial statement, as the case may be, as of December 31, 1987. Reconcile the balances of inventory accounts shown in the balance sheet with the amount appearing in the inventory list and the value of inventory used as basis of the 8% presumptive input tax. 5. In the case of manufacturers, producers or importers, reconcile the balance of the deferred sales tax credit account as reflected in the balance sheet as of December 31, 1987 with the declared amount of excess sales tax credit reported in the percentage tax return for the quarter/period ending December 31, 1987, and if available, the deferred sales tax credit per report of investigation of business tax for the semester ending December 31, 1987. 6. In ascertaining the correct basis of presumptive input tax, exclude the following: 6.1 Items in the inventory which are exempt from sales tax. 6.2 Items in the inventory which are exempt from value-added tax. 6.3 Capital goods including "supplies and spare parts" whose estimated lives are greater than one year and are treated as depreciable assets. 6.4 Items in the inventory as of December 31, 1987 where the taxpayer has no legal title such as goods still in transit, goods under consignment, etc. 7. In order to preclude undue claim for presumptive input tax arising from inflated value of inventory as of December 31, 1987, verify the inventories of two or three prior years and compare the value of inventory for such years in relation to the amount of sale. If the amount of inventory suggests that it may have been inflated, verify the accuracy of the list by test-checking sales and purchases of sample items. IV. REPORTING REQUIREMENTS The audit report should be brief and concise but complete in all details necessary to its understanding. It must be accompanied by 1. Copy of the letter of authority 2. VAT returns for the audited period, together with proofs of payment of VAT 3. Worksheets showing the following schedules: 3.1 Analysis of sales and output tax 3.2 Analysis of purchases and input tax 3.3 Analysis of relevant accounts such as cash, receivables, payables, advances, etc. 3.4 Adjustments to sales and output tax 3.5 Adjustments to purchases and input tax 3.6 Computation of deficiency value-added tax 4. Revenue officer's memorandum report and duly accomplished VAT audit report form 5. Agreement form, in proper cases 6. Photo copy of the revenue official receipt or confirmation receipt evidencing payment of deficiency tax, if applicable 7. Other documents, if applicable 7.1 Inventories of materials and supplies submitted to the BIR pursuant to RMC 35-87 7.2 Approved application for zero-rate, if applicable 7.3 Notice of revocation of approved application for zero-rate, if applicable 7.4 Photocopies of certificate of registration with other government agencies evidencing exemption from value-added tax 7.5 Copy of audited financial statements and the percentage tax returns as of December 31, 1987 (only for letters of authorities issued covering the first quarter of 1988 to verify the correctness of the presumptive input tax) 7.6 Proof of actual inward remittances of proceeds of export sales 8. Checklist of duly accomplished procedures prescribed herein Strict compliance herewith is enjoined. (SGD.) JOSE U. ONG Commissioner of Internal Revenue